Everything you need to know about investing in Sovereign Metals. The company is superb value at circa 22p per share — here’s why.
Sovereign Metals (LON: SVML, ASX: SVM) is perhaps not a household name on the FTSE AIM market. The rutile-graphite explorer is, however, well-known to ASX investors — having been listed down under for many years prior to its December 2021 UK listing.
The company launched on the London market on 14 December, issued its positive flagship scoping study a couple of days later — and then announced it had raised £1 million from UK investors for further exploration on the 22 December.
Of course, December 2021 was also when the Bank of England started increasing the base rate from a piddling 0.1% to the current 5.25%. This rapid tightening of monetary policy has hit most growth shares, and the stock fell from well above 30p to 23p by late February 2022. March then saw Sovereign soar to 45.5p by the end of the month, after some ‘spectacular’ exploratory results and signing an offtake Memorandum of Understanding with Hascor.
You could argue that getting this IPO away — even if just a dual listing — was a win for the company. The IPO market was pretty awful in 2022, and even worse in 2023. December 2021 was perhaps the last chance saloon prior to the hoped-for 2024 recovery, and the dual listing has perhaps been key to SVML’s share price stability in a market where others have fallen far more sharply.
For context, you could argue that despite Greatland Gold’s significant recovery since my edit in mid-October, the London-listed stock would have held up better if it had got its ASX listing away.
But while Sovereign has made significant further progress since the IPO, its shares are nevertheless changing hands for just 22p today. There are various reasons for this slide — including the broader risk-averse market and wider investor awareness of the Lassonde Curve — but there is now excellent value to be found.
However, before we get to the meat of the investment case, it’s important to cover the usual caveats:
- This is not financial advice. Do your own research and make your own decisions.
- All investing carries risk.
- There are some important first steps to consider before investing in AIM shares, or in mining shares. Generically, these centre around developing financial resilience and diversification.
Also — here’s the required reading before you continue:
- Risks of investing in mining stocks
- Valuing junior resource assets
For balance, Sovereign — with a circa AU$250 million market capitalisation — is not a minnow and its flagship will in all likelihood be developed. But it’s also not BHP, an ASX 200 index tracking ETF, Microsoft, or gold. The investment thesis rests on hopes of significant growth and therefore there is, to an extent, a corresponding level of risk.
The other qualification is that this research is not FCA-registered. I either author or edit a significant number of regulated broker notes where the language and tone are limited in nature — here, I am free to cover some subjective elements which a NOMAD or compliance team would not allow.
I focus on generating high returns using money set aside for small cap investing. I enjoy the rollercoaster ride that sometimes accompanies this strategy — and understand that not every investment will succeed. But for context, the S&P 500 has delivered average annual returns of circa 11% since 1957 – anything above this is considered higher risk by the markets.
And I’m targeting much more than 11% with Sovereign Metals.
With all that being said:
Let’s dive in.
Considering Graphite and Titanium
The two critical minerals that Sovereign plans to extract are graphite and titanium. That’s good news. Both will be in significantly higher demand over the next decade.
Let’s start with graphite.
Graphite is often overlooked when compared to lithium, copper, and nickel. However, it’s just as essential to the green energy and EV revolution as its more popular cousins. And as it’s less covered, it’s probably worth giving a quick chemistry lesson.
Graphite is a form of carbon found either as crystal flakes or as a mass, and constitutes the third naturally occurring form of carbon, the others being coal and diamond. Graphite’s structure is unique as it works as an excellent electrical conductor, maintains strength at high temperatures, and is resistant to corrosion.
The non-metal is a core material in both the renewable energy and battery metal markets. For context, every EV requires circa 40-60kg of graphite, roughly 40 times more than the required lithium. Tesla CEO Elon Musk is on record arguing that lithium-ion batteries ‘should be called nickel-graphite’ for their relative weights.
Standard graphite must be made into spherical graphite if it is to be used in the anodes within lithium-ion batteries which act as the power source of EVS. This is done by refining flake graphite into ultra-high purity microscopic spheres.
Further, removing impurities within pre-processed graphite typically requires the use of hydrofluoric acid. The acid is effective, but very toxic and must be neutralised after use and disposed of safely. It’s worth noting that grinding the flakes into balls is electricity-intensive and therefore expensive.
This poses an ESG difficulty, though also an investing opportunity in the handful of companies are looking to streamline the process.
Like lithium, graphite is not traded on commodity exchanges, but is instead valued by averaging offtake agreements. This is because like lithium, graphite is typically non-fungible, and purity, size, crystallinity, and total processing costs all affect the final sale price. Spherical graphite commands a high price premium, costing more than three times as much as standard graphite. And graphite from rutile sources is the ultra-premium product, as I will discuss below.
Currently, the lithium-ion battery market accounts for circa 35% of global graphite supplies, but to meet the needs of current car manufacturer plans, the global supply needs to double in just five years. This is unlikely to be possible, especially as investors shy away from opening up new operations through the recession.
Benchmark Minerals data shows that the proportional cost of graphite within a li-ion battery stands at circa 15%; this means graphite company investors could stand to benefit from 15% of the growing EV market even if graphite prices remain static.
An important side note is the future potential of graphene. Graphene is a material developed from breaking graphite down into one-atom thick sheets of carbon and many predict it could become a world-changing material.
It’s the globe’s first 2D material, ten times lighter and 100x stronger than steel, is elastic, transparent, and can carry heat and conduct electricity better than copper. Its ductile properties are so exceptional that it comes close to superconductor levels, without needing to be either heated or cooled. As technological advances come, graphite/graphene supply could become ever more critical.
Like lithium, China controls much of the global graphite supply, by some accounts as much as 70%. Western countries are now attempting to develop their own mines and processing facilities but remain even further behind than with lithium.
And of course, as part of a tit-for-tat exchange whereby the US is banning the export of advanced semiconductors to China, while China bans critical minerals exports to the US to stop the country from making semiconductors (all part of the wider AI race), China has banned the export of most forms of graphite to the US.
This will light a fire under ex-China near-term graphite producers, including Sovereign but also other smaller picks such as Blencowe and GreenRoc, the former of which has already benefitted from US government funding. For context, the US gets roughly 33% of its graphite from China and has no domestic production.
But right now, graphite prices have artificially slumped. This is primarily due to Chinese EV subsidies — the country has played an excellent game — removing EV subsidies resulting in large corporate stockpiles of critical minerals, driving prices down and allowing the country’s businesses to gain even more of a stranglehold as western investors baulk at investing in the dip of the commodity supercycle.
Graphite prices have also slumped due to excess processing capacity; high graphitization costs and limited capacity saw Chinese processors add massively more capacity — from 1 million tonnes in March 2022 to 2.3 million tonnes in December 2022. This caused a fall in processing costs and therefore a rise in the production of synthetic graphite — which even if it is more expensive to create — also became cheaper as needle coke prices had also fallen dramatically.
This has created a situation where the price differential between synthetic active anode material (AAM) and natural-based AAM has narrowed to only a few percentage points. But the key point is that the surplus graphite is artificial — current stockpiles will dwindle, and prices will rise again.
Of course, this will take time. The synthetic sector is now large enough and the price differential low enough that whenever demand increases, Chinese synthetic producers will now always come into pick up the slack faster than mining operations can get ramp up production. And regardless, China has significant natural graphite deposits of its own.
The investment case, therefore, rests on the graphite export ban. China has banned export of the material to the US — and in any event, any electric battery made in the US that includes components or critical minerals extracted or processed from China will not be eligible for a US$7,500 credit from the Inflation Reduction Act, starting in 2024.
The US — and allies — were previously reliant on Chinese graphite. And they will now need to secure supplies from ex-China sources; in other words, there is now an artificial supply problem that will result in higher prices for western acquirers.
Then there’s titanium. Ten points to guess which country controls global supply?
China — the largest producer in the world as it has circa 30% of global reserves in the form of ilmenite ore. Here the US is in even more of a bind; I am certain China will impose an export ban to the country because the US does not keep the metal in its ever-dwindling national defence stockpile and is reliant for 92% of its titanium from Japan. You can probably spot the problem.
Incidentally, you might want to consider similar implications for uranium supply — and also that tungsten will likely face a similar export ban soon. Good news for Golden Metal Resources perhaps, less so for US supply chains.
China has been winning the critical minerals trade war for years, and titanium is one mineral the US needs. It’s used in everything from spacecraft to missiles, ships, car parts and robotics and is absolutely essential in both military and civilian applications. It’s twice as strong as aluminium, almost 50% lighter than steel but as strong.
Of course, the US has been lazy. Domestic titanium sponge production had been falling for years when the country ceased production altogether in 2020. Russia and China together now control more than 70% of the global titanium market, and China’s titanium sponge capacity has risen by over 1,000% over the past few years.
Now even if the US can continue to rely on Japan for titanium supply, there are two problems with this strategy. First, the geopolitical risk (Tokyo and Beijing are not exactly on great terms, and Taiwan continues to simmer in the background). Second, Japan is operating at capacity, so the US cannot get more titanium from the country as its needs scale.
In other words, the US has handed control of yet another critical mineral to two of its greatest opponents. The US Commerce Department covers 16 ‘critical infrastructure’ sectors which are economic priorities — and titanium is needed in 15 on them.
Manufacturing is a different story — the US retains relatively strong titanium sponge processing capabilities, as interestingly, does Ukraine.
I am certain that China will soon impose an export ban on titanium, tungsten, and uranium to the US (as it has with graphite and certain rare earth elements) and the continued US reliance on Japan for this critical mineral is a supply chain weakness that must be urgently addressed.
Which brings us nicely to:
Sovereign Metals: the Kasiya flagship
Before getting into ownership details, Malawi governance, financing et al, it’s important to start with the deposit. This is true both when designing a flow sheet or considering an investment; and fortunately in this case the deposit is exceptional.
Kasiya Rutile-Graphite Project
The plan is clear — to develop a long life, large scale and profitable operation (to be fair, this is the usual plan). But the company released its Pre-Feasibility Study in September 2023, and the share price has barely moved since.
Counterintuitively, this may be good news. Once you get to a certain level of certainty, study releases should not come as a surprise to anybody — and while the asset is now further de-risked, the main issue seems to be getting the wider market to understand the importance of this particular asset.
Initial rutile was found in 2018 during ongoing graphite test work (the company was not looking for titanium at the time), drilling in 2019 confirmed high-grade and widespread rutile, and its footprint was tripled in 2020. The maiden JORC resource in 2021 confirmed that Kasiya was one of the largest rutile discoveries ever — and by 2022, upgraded the asset to the largest rutile deposit AND the second-largest graphite deposit in the world.
Once again, if you haven’t read this article and your mining knowledge is sketchy, do so now.
Regardless, with all financial figures in US dollars, key PFS results include:
- Current MRE: 17.9Mt rutile @ 1.01% and 24.4 MT graphite @ 1.32%
- $1,605 million after tax Net Present Value
- 28% after tax Internal Rate of Return
- $415 million average annual EBITDA, 64% EBITDA margin
- 222ktpa rutile, 244ktpa graphite average annual production
- $597 million capex to first production
- $404/tonne opex
- 25 years life of mine, though this would only mine 30% of the current known mineralisation
This looks world class. And it is.
The only factor I would double check in the later DFS, is production expectations for the first year. These are often lower before a ramp up and can impact on initial profitability. PFS figures in this regard are often based on too many assumptions.
But on a larger scale, the plan is to produce both rutile and graphite through two stages of development: stage 1 at 12Mtpa throughput for the first five years and Stage 2 at 24Mtpa thereafter — by the development of 4 pits being mined simultaneously.
The basic investment case is simple: the potential returns are enormous, the titanium and graphite in the ground could see the asset become the world’s largest (perhaps second-largest dependent on measurement) producer of both critical minerals, and producing costs are also extremely cheap compared to competitors and generic industry standards.
For context, rutile sources of titanium command a price premium nearly ten times that of ilmenite — for the lithium investors, it’s somewhat akin to comparing a spodumene deposit with a lepidolite deposit, or perhaps a brine or clay-based asset.
Kasiya’s 18Mt resource is more than double that of Sierra Rutile’s Sierra Leone deposit which is the only rutile resource that can hold a candle to Kasiya. The rutile zones occur across a 200 square kilometre area — which is all the more extraordinary when you consider that no large rutile dominant deposits have been discovered in over 50 years.
Kasiya is by a long, long way the largest rutile deposit in the world. New deposits are not being found, and existing assets are depleting alongside declining ore grades. Best of all, natural rutile supply is forecast to fall sharply from 2024 — by 52% by 2033.
All yours for circa £120 million in market cap, apparently.
Then there’s the graphite — even without the graphite, the rutile would be enough. Here, Kasiya is the second-largest flake graphite deposit worldwide — however second by a significant margin, to Syrah Resources’ Balama deposit in Mozambique.
But unlike Balama, one of the key factors to understand is that the graphite processing costs will be very low because the graphite is a co-product of the rutile production and therefore a significant portion of the opex can be ‘shared’ with the rutile. In fact, Kasiya should be the lowest cost producer of graphite anywhere in the world when the mine comes online (with the standard caveats around theory and practice).
In chemical terms, the company can produce 96% TGC, very coarse flakes, with over 60% in the large to super-jumbo fractions (above 180 microns), and with overall recovery of 62%. It’s also high purity and highly crystalline which are key for uses in lithium battery anodes — because this means the graphite is both conductive and easy to upgrade to the minimum requirement of 99.95% TGC.
Regarding of contaminants (which are usually brushed over), they’re fairly low. The rutile product grade stands at 96% TiO2 at a +98% recovery, while uranium, thorium, chromium, and zirconium levels are all at a minimum.
Accordingly, Sovereign has engaged in three non-binding Memorandums of Understandings with Mitsui, Chemours and Hascor. These are the big boys in the space, but the non-binding aspect is actually a positive as it makes any potential buyout that bit easier.
Environmental Credentials
As a general rule, cheap processing equals green processing, and Kasiya is no exception.
Natural rutile requires no upgrading for use in titanium pigment feedstock (unlike the labour/energy/carbon intensive process required to upgrade ilmenite). Indeed, the plan is to use hydro mining followed by wet concentration plant processes — which is far less carbon intensive than the drilling, blasting, crushing, and grinding required at hard rock deposits.
This will leave Kasiya with the lowest carbon footprint of major producers — Syrah generates 0.4CO2eq/tonne, China 1.2CO2eq/tonne, and Kasiya will generate just 0.2eq/tonne.
In addition to its natural characteristics, renewable energy solutions are at hand: the 60MW Salima solar power plant recently commissioned by JCM, in addition to the nearby Nkhoma substation which is already equipped to hook up Kasiya to hydro-sourced grid power. For context, the entire project is anticipated to require a maximum of 56MW at full production so will not only be environmentally friendly (by mining standards), but also have access to reliable power, a top concern in African nations.
Logistics
Kasiya is also extremely well connected for ports and shipments.
It has access to the Nacala Logistics Corridor, a refurbished railway running nearly 1,000km to transport coal from mines in Mozambique to the port of Nacala — which by necessity had to run through Malawi. Happily, this provides Sovereign with direct access to the sea, and in further good news, the railway is controlled by Vale and Mitsui.
It’ll be staying open for decades to transport billions of dollars of coal, and luckily for Sovereign (yes, this particular chance was definitely luck), a branch line passes close to Kasiya. Good for capex, good for opex.
Nacala itself is the deepest port in Southern Africa — and is designed to export 18 million tons of coal alongside passengers and generic cargo.
Malawi: jurisdictional judgement
Malawi may be adjacent to Zambia, but the comparatively smaller African nation is not a mining powerhouse by any means. The mining sector in its entirety is worth circa 1% of its annual GDP — and the only other asset from the country I have covered in any depth is Mkango Resources’ Songwe Hill Rare Earth asset — which itself is coming to a critical value junction.
But while I’ve covered other African countries in depth before, Malawi’s relative lack of mining projects means I need to mention a few key concerns. For context, one of my pet peeves is when investors treat the entire continent of Africa as one location from a risk perspective — when in reality, each country is different with diverse advantages and drawbacks.
The good news is that the state has enjoyed sustained peace since gaining independence in 1964 and has held relatively fair elections every five years since one-party rule ended in 1993.
And while the mining industry may be nascent, the potential is very much there. Consider Zambia’s recent moves to encourage copper investment as a blueprint; Malawi has the resources, and the government is keen to exploit them.
Despite the peace, the country is not wealthy. World Bank data puts it at the fourth poorest in the world, with 80% of the population living on less than $2.15 per day using 2019 figures. Mining could change this.
His Excellency President Lazarus Chakwera is on record — in 2022 — enthusing that ‘Malawi is poised to benefit from a package committed by the US towards development projects and programs on the African continent.’ And in front of the US General Assembly, he specifically made the case that ‘the recent discovery in Malawi of the largest deposit of rutile in the world means that Malawi’s economic rise is imminent.’
The country’s economic development focuses are on agriculture (not surprising given Zimbabwe’s blueberry boom), tourism, and mining. The Inter-ministerial Project Development Committee is firmly committed to working with Sovereign — with the Ministry of Mining recently formally noting that ‘we applaud the timely investment by Rio Tinto (Sovereign shareholder) as it will mark a milestone towards realizing the country’s aspirations of a prosperous Malawi. Government’s commitment is to ensuring growth of the mining sector…establishing a conducive investment environment.’
In other words, there should be no unpleasant regulatory surprises. Sovereign has been operating in the country for nearly a decade as a reliable employer and has developed strong relationships with all the relevant officials.
And the PFS does demonstrate Kasiya’s potential to provide substantial socio-economic benefits for Malawi including monetary returns, job creation, skills transfer and sustainable community development initiatives. My one caveat despite the company’s protestations is that training up staff to operate the mine will not be easy — the skilled workforce available in Zambia or Zimbabwe, for example, does not exist on the same level yet.
Of course, Sovereign will change that.
Rio Tinto involvement
Rio is heavily involved in Sovereign in a number of ways. And this is good news on a number of levels, not least because $119 billion titan is already the world’s largest titanium feedstock producer (among heavy involvement in many, many other assets).
It produced 1,200ktpa of titanium dioxide in 2022, is engaged multiple titanium projects in Africa, and has invested heavily in battery metals analysis including most recently its Battery Lab last month.
I’ve touched on the company many times before in analysis for blue chip clients — it’s often a chart topper for best dividend stocks — but recent pieces on Investing Strategy include its partnership with AIM great Greatland Gold to explore tenure in Australia, and also its first entry into Rwanda to explore for lithium with minnow Aterian.
Let’s look at the strategic investment:
- AU$40.4 million for 15% of Sovereign Metal’s total shares (July 2023)
- Option to acquire an additional 4.99% by the end of July 2024
- Proceeds to be used to advance Kasiya (critically, to complete the DFS)
- Collaboration to qualify Kasiya’s graphite, focus on supplying the li-ion battery anode market
- Understanding to negotiate a mine construction funding package
- Option for Rio to become operator up to 180 days post DFS
- If operator option taken, exclusive rights to market 40% of annual production
- Right to appoint a director
- Rights to first refusal (boilerplate terms)
It’s worth noting that Sprott retains 8% of the shares in Sovereign, with a further 8% held by other institutional investors. Directors and Management hold 11% (skin in the game always a good sign), and Australian High Net Worth investors, 20%. This means much of the share base is in strong hands — which is good for certainty but can generate increased volatility.
In early November, Rio and Sovereign announced a bulk sampling program to extract >100 tonnes of ore for qualification — the key component to graphite sales agreements. Graphite produced from this test will be shared with prospective buyers.
Where next for Sovereign Metals?
Rio’s reasons for involvement are obvious — the world’s largest titanium feedstock producer, facing falling grades and few discoveries, is obviously going to be jump at a pairing with owner of the largest rutile deposit on Earth.
Rio and Sovereign together now maintain a joint technical committee composed of three members from each company. And the obvious endgame is that Rio will buy the remaining shares of Sovereign, or acquire the Kasiya asset, shortly after the DFS is released.
Indeed page 69 of Argonaut’s November 2023 ‘Metals and Mining Research — Best Undeveloped Projects’ report makes the case that:
‘The greatest hurdle to development will be funding of initial capital requirements. In our view Rio Tinto’s endgame is to become 100% owner of Kasiya. Rio will be in no rush to make a bid for SVM, so we may not see any corporate activity until after the completion of the Kasiya DFS. Alternatively, if SVM’s PFS numbers meet threshold expectations, RIO may wish to take executive control of the project, catalysing a takeover offer of SVM in the short to medium term.’
A Rio Tinto offer is essentially inevitable. Maybe not today, maybe not tomorrow, but the world’s largest titanium feedstock producer is simply not going to allow another major to wrest control of this project. In supply terms, Kasiya is simply too valuable — and as Sovereign mitigates risk over the next six to 12 months, an offer could come at any stage.
In essence, Sovereign is using Rio’s intel and know-how on world-class, multi-generational projects in project configuration prior to the DFS kicking off at some point during mid-2024. Thereafter, my anticipation is that construction will begin in 2026 and first production may occur from perhaps 2027, though ramping up will likely take to 2028. As a caveat, these dates are my best guess, and initial construction could well come sooner or later than this.
But the market capitalization is circa £120 million. Regardless of when the offer is made, the offer price will be significantly higher than this, and likely several multiples.
Rio will not want to invest the $597 million capex cost without taking control of the deposit — and for context, the total expected revenue for the modelled 25 years LOM is a whopping $16 billion. And being realistic, 25 years is conservative for the deposit; the DFS will likely see sizeable production/mine life increases.
The stock has been trundling along within a strict range since July 2022, so unlike many explorers there’s unlikely to be a substantial dip anytime soon — though the technical analysts are free to consult their horoscopes.
The risk is low (relatively), the rewards are obvious. The market has ignored the importance of the deposit and the significance of Rio’s involvement.
Shrewd investors will soon start paying attention.
This article has been prepared for information purposes only by Charles Archer. It does not constitute advice, and no party accepts any liability for either accuracy or for investing decisions made using the information provided.
Further, it is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.