Mining Stocks: Understanding Feasibility

By Andrew Beattie AAA

The mining stock business is unique in that it is based on using up its assets. Naturally, the most important thing for an investor valuing these companies is to know how much of what the company has. This is where the feasibility study comes in. In this article, we'll look at the feasibility study and what it is actually telling investors.

The Mining Cycle
The mining cycle looks fairly simple on paper. A mining company stakes a claim, does a feasibility study of the deposit, digs it all up and sells it on the market. However, the actual process is much more complicated and is at its most vulnerable between the feasibility study and the beginning of the actual mining. Because of this, most of the action in a mining company's stock occurs between the feasibility studies and the start of operations – at least it does when the deposit in question is significant to the company's overall operations. The stock of a mining major with a mixture of producing mines and deposits undergoing feasibility will move less on the results of a study than a smaller miner betting a large amount of its operations on the deposit.

Breaking Down the Feasibility Study
At the end of the day, every mining project must pay back the money that is put into developing it, plus a profit. The feasibility study simply tells the mining company and its investors whether or not a certain deposit is going to be worth mining based on a range of factors. For this reason, the feasibility study can be thought of as the end of the exploration phase. If a deposit is feasible, the mining company can begin development, or sell the claim to a bigger player or take some other course of action to realize the value of the deposit.

Capital Costs
Just like any other company, mining companies need to pay for machinery, labor and taxes, etc. The capital costs in a feasibility study will usually include mine design (equipment and infrastructure needed to get the rock above ground), processing needed to extract the minerals from the rock, disposal of tailings, power and water supply, support facilities, consultants, reclamation costs and so on. The capital costs sum up many of the other areas of the feasibility study by putting a total price on extracting the mineral deposit from beginning to end.

Geological Challenges
Mining is a 50% geology and 50% market story. The geological analysis within a feasibility study addresses the complexity of the ore body within the deposit – its orientation, shape, width, any twists, etc. Complexities add costs to the extraction process, thereby making a deposit more sensitive to market prices than a similar deposit with less geological challenges.

A general rule is that the closer an ore body is to a vertical orientation, the more likely the rate of extraction will be slower. A nice wide horizontal deposit can be taken out at much lower costs and much faster than a narrow, vertical one. Moreover, some vertical mines are rejected because significant structural support is needed to make them safe. This is not an issue in most horizontal deposits.

Mining Rate
Due to geological challenges, the deposit may not be conducive to quick mining. This directly affects the mining rate and how many years it will take – assuming full operation – to pull all the material out of the ground. When a deposit is relatively easy to get to, a company can ramp up or slow down operations in response to market signals. When the mining rate is limited by the geology, the company has much less flexibility to take advantage of rises in the market price.

Dilution
Dilution refers to the rock that must be mined, taken away and processed in order to get to the minerals that the company wants; more rocks to go through means more costs per ton. For many deposits, the rock that comes out of the ore body is crushed down into fine sand to extract minerals and precious metals. Mining companies obviously want as much material in each rock as possible, but market prices will decide what level of dilution is acceptable.

Market Prices
All mines are affected by the market value of the minerals they contain. However, market price affects untapped deposits much more than mines already operating. A rise of a couple of dollars an ounce for a commodity can turn a costly and difficult deposit into a profitable project. For this reason, the feasibility study also looks at the market price of the materials that will be mined and what they are likely to be at the time of production. Even in the best market circumstances, the cash flow on a mine usually looks like a check mark, with the first years running negative as the infrastructure is built, and the latter years showing increasing cash flow as the mining gets easier and extracted minerals are sold on the market.

The Feasibility Study and Mining Investors
A feasibility study is a snapshot of the economics of the time. As the price of metals and minerals fluctuates over time, so too does the feasibility of a deposit. If a feasibility study is good, the company takes the mine to the next phase, whether that is the start of operations, a partnership with another company or a sale. Each of these actions will have a different impact on the stock, but most will be positive.

In contrast, a negative feasibility will almost always hurt a stock, although the negative impact will be in proportion to how important that deposit is to the company overall. If it is one of 50 or 100 claims and operating mines, then it may not even be noticed. If it is one of three or even the only one, then expect the market reaction to be severe.

The Bottom Line
As a mining investor, it is important to remember that a feasibility study is not bulletproof. There are many cases of a company underestimating capital costs, overestimating the ore grade and botching the entire process. A feasibility study is an important piece of information in evaluating a mining stock, but there are others that are equally important, including the company's mining record and balance sheet.

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