Duluth Complex: A World-Class Value Play


The Gold Report recently interviewed John Tumazos, principal and founder of John Tumazos Very Independent Research LLC. Mr. Tumazos, a top analyst according to Institutional Investor, discusses the Duluth Complex, a polymetallic mining district in Minnesota, and the five companies that comprise the Complex.

The Gold Report recently interviewed John Tumazos, principal and founder of John Tumazos Very Independent Research LLC. Mr. Tumazos discussed the Duluth Complex, a polymetallic mining district in Minnesota, and the five companies that comprise the Complex. Mr. Tumazos has been recognized as a top analyst 42 times in the annual Institutional Investor survey for metals, which is regarded by many to be the most comprehensive survey for Wall Street analysts.

TGR: Letís begin with the Duluth Complex, the world class, polymetallic mining district in Minnesota. How many companies are involved with the Complex?

JT: There are four publicly traded companies: Franconia Minerals Corp. (TSX: FRA), Duluth Metals Ltd. (TSX:DM; TSX:DM.U), PolyMet Mining Corp. (AMEX: PLM; TSX: POM), a diversified company called Teck Cominco Ltd. (NYSE:TCK; TSX:TCK.A; TSX:TCK.B), and a privately held company called Encampment Minerals Inc. All of these companies have assets located within the Duluth Complex.

TGR: What percentage of the Complex does Duluth Metals own?

JT: It owns about 30%. The company recently announced new resources there. There are now`15.2 million ounces in precious metals; 3.15 billion pounds of nickel; 10.2 billion pounds of copper; and 167 million pounds of cobalt. Duluth Metals doesnít measure silver, rhodium or ruthenium.

TGR: Are you currently recommending Duluth Metals?

JT: I have an overweight or a buy on Duluth Metals, PolyMet Mining and Teck Cominco. I donít currently have a recommendation on Franconia Minerals, but Iíve written on the company, and I did host Franconia at my conference on March 27, and invited the company back for next year.

TGR: What prices are you using when you estimate the value of these companiesí resources?

JT: I use $9 nickel; $3.25 copper; $12 cobalt; $1500 platinum; $350 palladium; $850 gold. These are obviously lower than the current market prices, but theyíre within 10%, with a few exceptions. For palladium, itís maybe 15%; for cobalt, itís less than one-third the market, and for platinum, itís about 80% of the market. Gold is at $883 right now, so I am at a $33 discount for gold.

TGR: Why such a big discount on cobalt?

JT: Because there are a number of nickel and copper mines that will produce a lot of cobalt.

TGR: All right. Turning now to PolyMet Mining, this company has completed a feasibility study and is seeking an environmental and operational permit to start commercial production in the second half of 2008. Whatís the status of those permits?

JT: I understand that in June, the state agency is going to publish the draft of the Environmental Impact Statement, which will be followed by a comment period and revisions. So it seems to be moving along.

TGR: If PolyMet gets the permit, what does that mean for some of the other companies, particularly Duluth Metals?

JT: PolyMet and Teck Cominco are adjacent to one other, west to east, so the assets of those two are like a pair. . . so that operationally, Teck Cominco and PolyMet are a natural pair, and Duluth and Franconia are a natural pair.

TGR: A natural pair, in the sense that it would be logical to combine their operations for greater efficiency?

JT: Yes, plus it would mean a lower environmental footprint. Whatís best for the economics happens to also be best for the environment in this case. I think that Duluth is the easiest project of the four.

TGR: Do you mean with regard to the fundamentals?

JT: Duluth Minerals is the only one of the five companies that has no open pit. It also has a single block of high-grade, underground ore. So, you donít have stripping and you can put most of the waste back into the mine as backfill. Duluth also has two to three times higher grades than PolyMet. I think what Duluth has is better ore or better rock than PolyMet or Franconia, whose disclosures are current. Teck Cominco has not made a detailed disclosure. The most recent information we have for the company comes from prior owners of the property, and that information is 30 to 40 years old.

TGR: So how do the three companies whose disclosures are current compare with each other?

JT: Franconia has three underground pods each containing 100 million tons of ores. Duluth has one pod with 733 million tons, and counting. So, itís much bigger and itís also all one pod, whereas Franconia ended up with three shafts, or three sets of workings, because the pods are three or four miles apart.

TGR: What about PolyMet?

JT: PolyMet is all open pit with relatively lean ore contentó.08 nickel, .027 copper, and a third of a gram of precious metals. Overall, PolyMetís material is one-third to one-half as rich as Duluthís. PolyMet has fewer tons and a lesser grade.

TGR: In a recent seminar, you talked about these companies combining their efforts. Could you elaborate on that?

JT: I think several of the companies should combine to reduce what they spend on environmental consultants and on metallurgical testing and engineers. For example, each of them is going to have a very similar hydrometallurgical (Platsol) recovery plant. It should be one design with three carbon copies, or just one big plant.

All of these companies are using the same recovery process. So there is a great deal of duplication of permitting, engineering, design, and then thereís construction capital and operating capital. And every time you have a duplicate building, it is a duplicate environmental footprint. In the case of Franconia and Duluth, they should at least share a shaft Ė an interlocking infrastructure would be much safer.

TGR: So why hasnít there been more collaboration?

JT: It isnít clear that Teck Cominco is of the same mind as the others. The other three public companies are each using the same metallurgical process from a company in Toronto. Teck has its own autoclave system it calls "Seesaw." The other three companies claim their process recovers platinum group metals while Teckís doesnít. And Teck claims that all of the other properties have poor metallurgical recoveries. I get the feeling that Teck may have fewer resources because the company uses its own process, and doesnít look outside. However, there have been lab tests that have verified the recoveries of all three of these companies on the ores. So Iím inclined to believe the three independent companies, and that Teck Cominco is suffering from a ďnot-invented hereĒ syndrome.

TGR: Do you think Teck will eventually be swayed?

JT: I expect the company will not move forward. I donít know if it will just hold onto its claims, or drop them. But Teck has many other projects throughout the world. Itís a large, complicated company. Its oil sands are very exciting and the biggest consumer of funds in the company.

TGR: Would it make sense for the other three to come together?

JT: It would be easiest for Franconia and Duluth to come together because their properties adjoin each other. PolyMet is 15-20 miles south.

TGR: But PolyMet has a mill.

JT: The mill has no value to the other two. It would be useful to Teck, because its property is adjacent to PolyMetís. But I think if youíre dealing in tens of thousands of tons a day, 15 to 20 miles is too far to travel.

TGR: Do you think Duluth Minerals and PolyMet will build their own mill?

JT: Thatís what I would expect. Teck would be in a better position to share PolyMetís infrastructure if it wanted to.

TGR: When you initiated coverage on Duluth Minerals, you came up with a $15 stock price. Could you summarize how you arrived at that price?

JT: I estimate that Duluth can spend a $1.5 billion to build 40,000 tons a day, and institute a dividend in 2018 when it goes from $20 to $40 and pays off 10% debt in 2019 and half a billion in cash in 2020 year end. And I estimate that from 2018 on, itís trading at little more than $2 a share, which I think would be worth $30. So, I am saying $15.

TGR: And last but not least, what milestones will have to be met to take us to this $15 level?

JT: Duluth will probably double its resources over the next several years. That may not be a milestone, because the company already has plenty of ore. The first milestone would be if the company were to delineate high-grade pockets that could get a quick payback. On June 4, Duluth defined 17-20 million metric ton zone that was 25% richer than the average ore.

And on April 2, the company announced it had intersected a new footwall zone of higher grade mineralization in the Giants Range Batholith below the lower contact of the Duluth Complex where the main Nokomis copper-nickel-PGE mineralization is situated, beneath the zones it called the ďFootwall.Ē That looked like it could have been 50% richer. So, the first milestone would be in my opinion defining some high-grade areas that could give the company a quick payback or quicker than 2019. Maybe itís possible to shave one or two years off of that.

The second milestone would be to complete environmental permits, which isnít possible until 2010 at the earliest because the company needs two years for baseline data collection, and then it has to have a final mine design. It also has to have a year or so to draft FDIS and comments and finalize it.

TGR: And the third milestone?

JT: The third would be financing, principally a $900 hundred million dollar series 10% or so bonds. The fourth would be completing construction. The fifth would be producing one year at the first phase of design.

TGR: That puts us at 2015 by the time Duluth is in production, right?

JT: I figure the company is in production in 2013.

TGR: Yes, exactly, and the price isnít going to be $15 then, either.

JT: I can hope.

TGR: One could only hope, but, of course, these markets make us wonder sometimes.

JT: I think thereís an extraordinary divergence between BHP Billiton Ltd. (NYSE: BHP), Rio Tinto PLC (NYSE: RTP), Anglo American PLC (NASDAQ: AAUK) or Freeport-McMoRan Copper & Gold Inc. (NYSE: FCX) or other similar companies that have huge resources and no revenue. I believe the companies that havenít yet produced are a better value.

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