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Our view: Initiating coverage on Ares Strategic Mining with an Outperform and Speculative risk rating. Our thesis is driven by the changing market dynamics involving China becoming a net importer of fluorspar, the U.S. breaking away from foreign imports of the mineral, and high grade and resource prospects of the Lost Sheep property.
Company Overview
Ares Strategic Mining is a mineral exploration and development company based in Vancouver, Canada. Ares is currently focused on developing its 100%-owned Lost Sheep fluorspar project in Juab County, Utah, which consists of 67 claims spanning 1,447 acres. The Lost Sheep mine is currently one of the few, if not the only, permitted and past producing fluorspar mine in the United States.
Uncontested Market Space
Ares is currently one of the few, if not the only, permitted and past producing fluorspar mine in the United States. The United States currently imports 100% of its fluorspar consumption from abroad, given virtually no domestic producers owing to foreign competition that has left the industry dormant for more than two decades. With a major MOU signed that involves the sale of 60,000 tons per year and limited competition, Ares is well-positioned to scale and become an eminent supplier in the United States.
Tightening Supply as China Decreases Exports
As the Chinese economy grew and China became a global manufacturing hub, the country has been consuming more and more of its local fluorspar production. This coupled with the fact that the Chinese government has been closing down domestic mines that do not meet environmental standards due to anti-pollution measures have not only caused global fluorspar supply to tighten significantly but also made China a net importer of metspar in 2018. This has sparked the need for buyers to source their supplies from elsewhere and should work in favor of emerging miners like Ares.
The Need to Diversify Supply Chain
As Covid-19 continues to disrupt global trade, we believe that many American companies that tended to rely on a single or a small group of suppliers in Mexico or China are feeling an acute need to diversify their supply chains and/or source their supply locally. With the Trump administration expressing an unequivocal desire to break away from foreign imports of critical minerals and support for local producers, we believe Ares should stand out in the marketplace and benefit from this changing landscape.
Valuation & Recommendation
We are valuing Ares based on 2021 EV/EBITDA of 4.5x. At our estimated 2021 EBITDA of ~$8 million, this implies a price target of US$0.39. We are assigning the stock with a Speculative Risk rating given the undetermined resource estimate, nascent stage of the project, and limited operating history.
Fluorspar Primer
What is Fluorspar?
Fluorspar, the commercial name for fluorite, is a hardrock mineral composed of 51.1% calcium and 48.9% fluorine (CaF2). Pure fluorspar is colorless but they can be found with colorful hues if tinted with other elemental impurities. Fluorspar is the principal source of the world’s fluorine supply.
Fluorspar found its first application as a flux in metallurgy. A German mineralogist Georgius Agricola first referred to the mineral as ‘fluores’, from the Latin fleure, meaning “to flow” in his book, “De re metallica,” which was the first written detailed description of how to prepare metals from ores. Published in 1530, the book described fluorite as “stones which become liquid in fire.”
Today, fluorspar is still widely used as a flux in manufacturing steel and aluminium. However, it has also found applications in a number of other industries ranging from consumer additives to pharmaceutical to electronics. Because fluorspar is not renewable and key to a number of industries, it is considered a “critical mineral” by many governments including the United States, the European Union, and China.
Uses of Fluorspar
Uses of fluorspar depend on its grade of purity, which the industry classifies into 3 categories:
- Acid-grade fluorspar (“acidspar”) is the highest grade with greater than 97% CaF2. Acidspar is primarily used in the manufacturing of hydrofluoric acid (HF) (hence acid-spar), which is used as a starting point for a myriad of industrial and consumer products including refrigerants, solvents, high-performance plastics, glassware, and a variety of fluoropolymers (e.g., Teflon). Another primary use of acidspar is in the production of aluminum fluoride (AIF3), which is used as a flux in the production of aluminium.
- Ceramic fluorspar is the next grade down with 85%-96% CaF2. Ceramic fluorspar is used in the manufacturing of specialty glass, ceramics, and enamelware.
- Metallurgical fluorspar (“metspar”) is the lowest grade with 60%-85% CaF2. Metspar is used just like Agricola described it – to lower the melting point of steel, making it less costly to manufacture.
Ceramic and metallurgical fluorspar are often placed in the same category and simply called “metspar” for convenience. We will follow this convention throughout the report.
Where is it Found?
Fluorspar is not an uncommon mineral and its occurrence can be found in all continents of the world primarily in the form of vein and replacement deposits. However, it is rare to find high-grade (>20% CaF2) deposits in large and concentrated enough quantities that justify a commercial operation. As such, there are only a few primary fluorspar mines in operation today.
The United States Geological Survey (USGS) identified Mexico as having the largest fluorspar reserve in the world with 68 million tons followed by China with 42 million tons and South Africa with 41 million tons. Mexico is currently the key supplier of the U.S. supplying 66% of the country’s 440,000-ton-per-year consumption.
Extracting Fluorspar
Fluorspar is mined by both open-pit and underground methods depending on the orientation of the orebody. Once the ores are extracted, they are generally crushed, washed, and screened before being fed to the beneficiation plant (beneficiation refers to the process of upgrading the ore to commercially acceptable grades). The beneficiation process can be skipped for naturally high-grade fluorspar, as they can be sold directly as metspar after being visually screened and manually sorted, thereby reducing cost.
Most beneficiation plants today employ a combination of gravity and froth flotation processes to upgrade fluorspar. The first step in beneficiation generally involves the gravity method, which uses liquids to separate out gangue minerals (waste products such as calcite and quartz) from the ore based on the differences in the density of the minerals. Coarse metallurgical grade fluorspar is obtained from this method.
To produce acidspar, however, the froth flotation process is required. The flotation method involves feeding finely grounded fluorspar into tanks containing agitated non-toxic reagents. Air bubbles are introduced into the tank, whose function is to pick up fluorspar grains and float to the top while gangue minerals sink to the bottom. The froth are collected and further processed into powder or pellets depending on their end uses.
Industry Landscape
Stable Demand Underpinned by Core Industries
Given the diverse applications of fluorspar and the critical role it plays in the supply chains of various core industries, world fluorspar production has been relatively stable growing at 2.5% CAGR with production volume ranging from 5-7 million tons per year during the past 10 years. We view this as a significant positive for fluorspar producers as having a stable and diversified demand base helps prevent wild swings in price that could pose challenges for the industry.
Going forward, we believe the growth in fluorspar demand will continue to be driven by the steel and aluminium industries, which have been posting strong growth at 4.1% and 5.4% during the past 10 years, respectively. Much of this demand will come from China and India. China now produces 51.3% of the world’s crude steel, up 13.2% from 38.1% in 2008. Similarly, India has increased its share by 1.6% from 4.3% to 5.9% during the same period.
Tightening Supply as China Decreases Exports
China has been among the world’s top exporter of fluorspar supplying 56% of the United States’ consumption between 1991 and 1994. However, as the Chinese economy grew and the country gained eminence as the world’s manufacturing hub, China has been consuming more and more of its locally produced fluorspar and, in 2001 after joining the WTO, began to tighten quotas on fluorspar export. From 2001 to 2009, the annual export quota had fallen by almost two-thirds, from 1.5 million tons to 550 thousand tons. Correspondingly, exports declined from 1.1 million tons to less than 270 thousand tons during the same period. This prompted the United States, Mexico, and the European Union to request a WTO consultation with China regarding its export restrictions on many minerals including fluorspar. The WTO Panel Report, issued in July 2011, found many of China’s export restrictions violated China’s WTO obligations. China lifted its export quota in 2010 while the dispute was still pending and although its exports have increased since the 2009 level, it is only 30%-40% of what the country used to export two decades ago.
The United States Breaking Away from Foreign Imports of Critical Minerals
The United States has been a 100% net importer of fluorspar since 1997. Recognizing that a disruption to the supply chain of critical minerals could put its economy and military at risk, the Trump administration has been unequivocal in its efforts to break away from this foreign dependency. As such, we believe that local producers who are able to supply fluorspar to the domestic market at competitive rates will not only receive preference over foreign producers but also stand to gain exponentially from having very limited local competition.
The United States was the world’s leading producer of fluorspar from 1910 to the mid-1950s with production of as much as 400,000 short tons (362,873 metric tons) in 1943. However, the industry began to see a steady decline from thereon driven by foreign competition. By 1982, there was only one producer left and by 1997, the entire industry was wiped out. The U.S. became a 100% net importer of fluorspar.
The situation is still the same more than two decades later despite the U.S. being the 4th largest producer of crude steel and home to the world’s largest manufacturer of hydrofluoric acid (Honeywell). Mexico, Vietnam, South Africa, and China currently supply 93% of the U.S.’ 440,000-ton-per-year fluorspar needs.
Recognizing that the supply of critical minerals has long been dependent on other nations, President Trump signed an executive order (Executive Order 13817 – A Federal Strategy to Ensure Secure and Reliable Supplies of Critical Minerals) on December 26, 2017 to break away from this trend and directed the Secretary of the Interior to identify a list of minerals that are vital to the prosperity of the American economy and military. The United States Geological Survey (USGS) was tasked to produce this list and in May 2018, the Department of the Interior finalized it with names of 35 minerals that the USGS had identified. Fluorspar was included in this list.
Producers of minerals deemed “critical” can expect to receive government support in the form of expedited permitting, federal investment in resource extraction and downstream processing, tax incentives for investment in technologies, and provisioning of advanced topographic data.
Ares Strategic Mining
Company Overview
Ares Strategic Mining is a mineral exploration and development company based in Vancouver, Canada. The company is currently focused on developing its 100%-owned Lost Sheep fluorspar mine and its surrounding claims in Juab County, Utah. The project consists of 67 claims spanning 1,447-acre area and is located on the Spor Mountain range, 70 km northwest of the nearest town, Delta, or approximately 214 km south-west of Salt Lake City.
Ares also holds interests in other mining projects including 100% interest in Jackpot Lake property that comprises 140 mineral claims covering an area of 2,800 acres in Clark County; and the Wilcox Playa property covering an area of 1,434 acres located in the Wilcox Playa Basin, Arizona.
Ares was formerly known as Lithium Energy Products Inc. The company changed its name to Ares Strategic Mining Inc. in February 2020.
Recent Developments
April 16, 2020 – Ares announces it has commenced the drill program at the Lost Sheep mine. The company has engaged More Core Diamond Drilling Services from Stewart, BC to complete a Phase 1 drill program consisting of 14 Reverse Circulation drill holes.
March 17, 2020 – Ares announces that it has entered into a strategic partnership with the Mujim Group, a large multinational fluorspar mining and distribution company. The Mujim Group has agreed to invest its time and expertise in assisting Ares in achieving greater production levels and efficiency at the Lost Sheep mine.
March 3, 2020 – Ares recommences trading on the TSX Venture Exchange under the ticker ARS.
February 19, 2020 – Ares announces the closing of its $1.8 million financing.
The Lost Sheep Mine
A Brief History
The Lost Sheep mine and its surrounding claims on Spor Mountain has a history that dates back to 1941 when the Spor family, local ranchers and residents of Delta, Utah, first staked a claim there and sold some 8,750 tons of fluorspar to the Geneva Steel Plant from 1944 to 1948.
In 1948, the Lost Sheep property was recognized for having fluorite deposits after Albert and Earl Wilden came across purple rock chips in badger diggings while searching for stray sheep. The Wildens were the first to stake a claim at the Lost Sheep mine and since 1948 until 2014 and under various different owners, the mine produced some 169,000 short tons of metallurgical grade fluorspar, making it the largest fluorspar producer in Utah.
A March 1981 mineral survey study titled “Geology of the Fluorite Occurrences, Spor Mountain” conducted by the Utah Department of Natural Resources reported that the Lost Sheep mine is also the largest fluorspar deposit in Utah.
It is important to note that since the Lost Sheep claim was first staked, no systematic exploration and mining have taken place until Ares took ownership and recently commenced the drilling program.
The ownership by Ares will make it the first time that the Lost Sheep property and its surrounding claims are professionally managed with exploration, development, and marketing resources.
High Grade Fluorspar
Fluorspar from the Lost Sheep mine has been known for its naturally high grade that can be sold as metspar directly with no beneficiation needed. The high grade and small grain size found there are reportedly favored by steel mills as they induce faster reactivity times. As such, products coming out of the Lost Sheep mine have been sold at a premium to nearby buyers in the past.
The earliest mention of the high grade fluorite found at the Lost Sheep property can be traced back to a 1954 geological survey bulletin named “Fluorspar Deposits of Utah” written by M. H. Staatz, et al, and published by the United States Department of the Interior, where the author discusses the characteristics of Lost Sheep’s fluorspar as reported by Geneva Steel, a steel mill located in Vineyard, Utah:
“About 100 railroad cars of ore were shipped from the Lost Sheep property; it assayed more than 90 percent CaF2 and less than 1 percent SiO2. One carload was reported to have the following analysis: 94.90 percent CaF2, 0.44 percent SiO2, 1.12 percent CaO, 0.32 percent MgO, 0.012 percent S, and 4.5 percent H2O.”
Samples that were assayed in 2015 from the Lost Sheep property confirmed similar results with purity ranging from 48.5%-89.4% as shown below. For reference, most fluorite mines have grades of 5%-30% purity.
Resource Estimate
According to technical reports performed on the Lost Sheep property and its surrounding claims, a precise resource estimate cannot yet be determined due to limited topographic information associated with the nature of the deposit. However, our conversation with management suggests that the first two pipes that the company is working on delineating are expected to contain at least 150,000 tons of fluorspar.
The Lost Sheep Property Today
With a paved highway leading to the property, the Lost Sheep mine is accessible by car making haulage convenient. The mine is currently equipped with extraction equipment that is adequate for continuing a small-scale operation that has been in place prior to Ares’ ownership. However, additional equipment and upgrades would be required as the company scales its operations.
Ares also owns an 8.84 acre property upon which a three-port warehouse is located in northern Delta, Utah. The warehouse has been used as a bagging facility in which 50 pound sacks of beneficiated fluorite are prepared for shipping. The Union Pacific railroad is located right next to the warehouse making it convenient for the company to send shipments via rail should it need to do so.
Investment Thesis
Uncontested Market Space
As Ares resumes drilling and producing at the Lost Sheep property, it will be one of the few, if not the only one, domestic suppliers in the United States. With the U.S.’ desire to break away from being 100% dependent on fluorspar imports, we believe Ares stands to benefit tremendously from having this favorable market position.
As of November 18, 2019, Ares has entered into a Memorandum of Understanding (MOU) with Possehl Erzkontor North America Inc., a supplier of raw materials to the steel, metallurgical, and chemical industries based in Cincinnati, Ohio, in which Possehl will become Ares’ exclusive agent for the sale and worldwide distribution of fluorspar produced at the Lost Sheep mine. Possehl will be responsible, under a take or pay sales agreement, for selling all of the Company’s expected 60,000 tons per year production of metspar for the next 5 years. This MOU also involves Possehl advancing US$2,000,000 under a forward sale agreement to enable Ares to meet its working capital and investment needs.
In addition to Possehl, the company has also garnered interest from ThyssenKrupp and two other multinationals for the purchase of its fluorspar. Securing interest from buyers at this stage and at these terms suggests the extent to which the domestic market is starved of suppliers. Furthermore, Possehl’s willingness to extend working capital help highlights the extent to which buyers are willing to work with suppliers to procure their goods.
The Need to Diversify Supply Chain
As the coronavirus continues to wreak havoc on financial markets and disrupt global supply chains, many companies are, perhaps for the first time, waking up to the reality that they cannot depend on a single group of suppliers or country for their raw materials.
This notion is exemplified earlier this month when the potential closure of Orbia’s Las Cuevas mine, the largest fluorspar producer in the world, had companies like India’s Cipla and Britain’s GlaxoSmithKline, two of the largest producers of asthma inhalers, sufficiently concerned to be sending letters to Orbia requesting the company to keep its mine in operation, given that 80% of the world’s inhalers use fluorite that is mined there. The closure of the Las Cuevas mine would not only put the operations of both companies at risk but also threaten the production of 30 million inhalers at a time when those with respiratory conditions are the most vulnerable to Covid 19.
In addition to GlaxoSmithKline and Cipla, American companies like DuPont, Honeywell, Alcoa, and 3M are similarly at immediate risk should the mine shutter. Honeywell’s biggest import partner is Mexichem Fluor S.A. de C.V., a subsidiary of Orbia and the operator of the Las Cuevas mine. In the past 5 years, the company has imported some 612 million kilograms (612,000 tons) of fluorine-related products from its Mexican partner, according to Panjiva.
Needless to say, the need to secure a local source of fluorspar is an urgent one. This combined with the U.S. government’s support for local miners should bode well for Ares and all other domestic fluorspar producers.
Tightening Supply as China Becomes a Net Importer
A gradual yet major shift that has been occurring in the global fluorspar trade has been China’s emergence as a growing importer of the mineral. As shown below, China’s fluorspar import value as a percentage of export has been growing at an accelerating pace since 2005, suggesting that China may be on a path toward becoming a permanent net importer.
The year 2018 further exemplifies this notion, as it marked the first time since 1997 that the import value of metspar exceeded the export value by almost US$10 million. It also marked the first time that total fluorspar import value as a percentage of export reached a record-high of 68.7%.
The driving forces behind this trend appear to be China’s increasing consumption of locally produced fluorspar as its economy grows and the closure of unqualified mines as part of anti-pollution measures imposed by the government. Since 2011, the Chinese government has been enforcing strict environmental restrictions on fluorspar mines as part of its increasing focus on ‘ecological civilization.’ This has caused many smaller mines, particularly in southeastern provinces, to close down. A comment provided by a Chinese fluorspar trader in July 2019 reflects this notion:
“Some producers in Zhejiang stopped production due to the recent heavy rain, and environmental inspections remain strict in most regions of China. [This] limits production of fluorspar to some degree, with some unqualified enterprises facing potential shutdown.” (Fastmarkets, Industrial Mineral)
As a consequence of mine closures, a research published by Roskill reported that some 600,000 tons were withdrawn from global output in 2017. This has sent the price of acidspar coming out of China soaring from $240 per ton in 2016 to $398 in 2018.
We believe that the unpredictability of fluorspar prices coming out of China and the uncertainty associated with availability of supply due to mine closures should propel new buyers to think twice before engaging with Chinese suppliers. For buyers who currently trade with China, we believe this should propel them to consider locating new sources of supply. China’s changing market landscape should also make producers elsewhere appear more competitive, particularly those with a low-cost structure and high-grade deposits that could be expected of Ares.
Key Risks
We are assigning Ares with a Speculative Risk rating to reflect the risks outlined below.
Limited Operating History
Ares as a company and its Lost Sheep project have a limited operating history. The nascent stage of the project and the fact that Ares has yet to generate revenue make it difficult to project its financial performance, evaluate market acceptance, assess management effectiveness, and reflect on the value of the stock.
Undetermined Resource Estimate
While the Lost Sheep property and its surrounding claims have had a history of significant fluorspar production and sales that can be traced back to the 1940s, the question of how much fluorspar is available is yet to be determined. As such, any financial projections and earnings estimates are speculative in nature and must be read with caution.
Customer Concentration and Counterparty
Ares has yet to establish a diversified customer base and as such is subject to customer concentration and counterparty risk. There is a risk that Ares’ customers could default on their purchase contracts and/or Ares could lose its key customers. This would jeopardize Ares’ financial and operational wellbeing should it find itself unable to attract new buyers.
Liquidity
Ares’ shares are thinly traded with a 10-day average volume of 1,410 shares. The lack of an active market for the shares can pose challenges for sellers or buyers who are looking to buy/sell a significant volume.
Commodity Price
The price of fluorspar is subject to many macroeconomic factors. Should the price of fluorspar fall to levels that would render operations unprofitable, Ares could experience significant losses.
Valuation
We are valuing Ares at 2021 EV/EBITDA of 4.5x, a ~52% discount to the Diversified Metals and Mining sector EV/EBITDA average of 9.5x. The discount applied primarily reflects the risks associated with Ares’s limited operating history and nascent stage of the project. This equates to a price per share of US$0.39.
The implied return to our price target supports our Outperform rating.
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Ratings
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