Danakali (DNK) – The premier potash company

Danakali (DNK) – The premier potash company

Danakali is an LSE and ASX listed company with a 50% owned stake in the Colluli potash project in Eritrea. The other 50% of the project is owned by the Eritrean National Mining Corporation, a state-owned company.  The project’s Front End Engineering Design showed a post-tax NPV (using a 10% discount rate) of $902 million, IRR of 29.9% and an expected life of mine of 200 years (DNK latest share price 46.5p, market cap £121 million).

The project will be developed in two stages, Module I and Module II – the two stage approach decreases capital requirements and allows the company to train up the in-country workforce that it requires.

Potash is used as a fertiliser for crops and improves yields. There are two primary types of potash – Sulphate of Potash (SOP) and Muriate of Potash (MOP). MOP is the most common fertiliser, however it can only be used for certain crops as the high levels of chloride are toxic to many plants. SOP is a premium product that can be used on all crops including high value crops such as fruits, nuts and coffee.

Danakali’s SOP product has excellent characteristics:

Source: danakali.com.au.

The Colluli project is finance ready and financing discussions are strengthened by a take-or-pay offtake agreement with EuroChem (a billion dollar fertilizer company based in Switzerland). Eurochem will take, pay, market and distribute a minimum 87% of SOP production for a 10 year term.

Risks

Country Risk – Eretria is a relatively unknown country and was at war with Ethiopia from 1998 until this year. The country is subject to a UN arms embargo; fortunately, this does not stop investment into mining and given the thawing of relations with Ethiopia, the embargo may be lifted. Given that the government owns 50% of the project, the project should receive support. All material permits are already in place.

Project Financing – The project has strong economics, permits and an off-take agreement which increases the likelihood that the project will attract funding although this is not guaranteed.

Take-or-pay agreement – The EuroChem agreement may be cancelled if project financing has not been executed by the beginning of September 2019 or commercial production has not been achieved by 1st July 2022.

Cash burn – Danakali is not currently revenue producing, interim results showed cash and cash equivalents of over $14 million and liabilities of less than $1 million.

SOP prices – may fluctuate however SOP has seen table demand over the past few years and given global population increases demand should remain robust over the coming decades.

Rewards

Free cash flow – Average undiscounted cash flows net to Danakali start at $43 million under Module I and increase to $85 million once Module II is completed.

Fast payback – compared to advanced peers such as Sirius Minerals (SXX), the payback period is significantly higher. Before Sirius announced an additional 13 – 20% of funding requirements this week the after-tax debt free IRR was 26%. Given that the IRR doesn’t include debt costs and the increased capex the IRR is likely to be below 20% for Sirius’s project.

Product premium – due to the high Potash grade of Danakali’s product farmers are able to use less of the product and it therefore commands a significant price premium to lower quality products or MOP fertilisers.  The peer group comparison on page 24 of the company’s recent Investor Forum presentation shows that Danakali’s product can command a near 100% premium to its nearest peer.

Note: Emmerson (EML) has recently completed a scoping study and a later article will compare the two projects directly.

Danakali trades at a 30% discount to its share of Module 1 NPV of $242 million and a 61% discount to Module II’s $439 million. Given the quality of the project, economics and product, there is a good chance the project will be financed, and a financing package could cause the shares to move higher. However, there is a limit to how far the share price can move whilst maintaining a suitable discount to NPV, given the project location. Were the shares to experience any weakness then the investment proposition could become more compelling.

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