A weak commodity market and a negatively-received production delay in October have pushed shares in Rainbow Rare Earths (LSE:RBW) down to 4.8p, well below their 2018 high of nearly 24p, achieved in April. Despite this, the firm has taken major steps forward, steadily increasing production at its Gakara project in Africa and completing wide exploration work to support the release of a maiden JORC resource by year-end. With rare earths looking set to benefit from the inbound electric vehicle boom driving battery metals like nickel and cobalt, CEO Martin Eales explains why Rainbow’s current share price weakness could provide a good buying opportunity.
Rainbow Rare Earths listed in January last year to target production in the rare earths sector. The rare earths comprise seventeen chemical elements that often occur in similar deposits and share properties.
Thanks to their diversity, the elements have many uses including catalysts, alloys, glasses, and electronics. However, the one that Rainbow is most interested in is their use in the production of strong magnets. Rare earth magnets are used in several growing areas including electric generators and wind turbines. However, they are perhaps most notable for their use in electric vehicle (EV) motors. Indeed, with global EV sales growing 63pc last year alone, magnet rare earths now account for c.70pc of the total RE value chain.
With estimates putting 530m EVs on the road by 2040, Eales believes the current growth dynamic will continue for some time. As rare earths represent a much smaller market than established battery metals like nickel and cobalt, he says they provide investors with an attractive, alternative way of getting exposure to the upside potential on offer:
‘Every EV motor has a strong magnet in it, and we believe these will become more prevalent as the world continues to shift away from traditional vehicles. So, the demand drivers surrounding lithium, cobalt, and nickel in the EV batteries also apply to rare earths. Unlike these metals, there is not a lot of near-term supply for rare earths as projects take a lot of money to get going. Even if supply can be incentivised by financing, many projects are still three or four years away from supplying the market, providing an ongoing tailwind for prices.’
Rainbow is taking advantage of this dynamic at its Gakara project, located in the African nation of Burundi. The historic mine holds more than 1,000 RE discoveries with a basket heavily weighted (c.20pc) towards magnet rare earths. However, the real string to the site’s bow is its high grades, which sit at between 47-67pc total rare earth oxide (TREO), compared to an average project grades of 1-4pc TREO.
The site entered production from its Gasagwe mining area in December last year, followed shortly by the commissioning and construction of a processing plant. This development made Rainbow one of few rare earth producers outside China and the only African producer. Eales says Gakara’s high grades allowed production to begin at a ‘fraction of the cost and less time’ than similar RE projects:
‘Typically, rare earth operators have to mine thousands more tonnes at their projects than we do because the grades are lower. We are also supported by our veins, which are easily identifiable and extractable . We process far fewer tonnes and can use a smaller plant because we don't have to upscale or beneficiate our ore. This was quick and cheap, allowing us to enter production at a capex cost of just $2.23m.’
Output from Gasagwe has continued ever since, accompanied by ongoing drilling work to better understand the area and help to boost production. Work has also been completed to bring a second area called Murambi into production, supported by a £1.6m placing at 12p a share in August.
An aerial view of the Gakara rare earths project
Until recently, Rainbow was aiming to ramp up production to 5,000tpa, or 400t a month, by the end of 2018. However, this target was announced as delayed in October until 2019. It put this down to a challenging geological environment and uncertainty around average yields at Murambi, which has now entered production. Compounding this, the business has also suffered lower production rates from Gasagwe over recent months due to unpredictable vein structures.
The firm said the precise date at which it hits its target production rate will depend on progress at Murambi and one or two additional mining areas that it plans to bring online over the next nine months. It plans to release upgraded production guidance for the 12 months to June 2019 early next year. With shares falling from 9.6p to 4.5p over a matter of days following the announcement of the delay, Eales argues that the market over-reacted to the news:
‘We had set ourselves an ambitious production target for the end of this year. We haven’t quite got there, so we have pushed it back to next year. We know what we need to do to get there and the market I think punished us quite hard and did not realise that our strategy remains unchanged. We know what a great project we have got here so we will get our heads down and crack on with it and the share price will take care of itself over the long term. If Murambi ends up performing as we expect it to, then hopefully we will see production numbers double because both areas will be producing at a similar rate. It is difficult to forecast production as we do not have reserves and resources at present, but what we do know is that, given our inventory, we have multiple years of operation here and we will be going for a good while yet.’
As well as ramping-up production, the last year has seen Rainbow increase its efforts to explore Gakara’s upside potential. This work began in November 2017 when an airborne magnetic survey found significant exploration upside at the project, identifying four large, prospective anomalies for a carbonatite source for Gakara's rare earth veins.
In particular, one anomaly complemented a ground-based gravity survey at Gakara’s Kiyenzi prospect, which was selected for investigation after it was found to contain large boulders at surface with very high RE grades. Following this, the firm carried out a phase one exploration drilling campaign on the Kiyenzi anomaly and the wider prospect area. This work identified new high-grade rare earth mineralisation up to 5m thick, consistent with that found previously in the boulders.
After failing to find mineralisation at the other anomalies, Rainbow began phase two drilling at Kiyenzi in July. The results will form the basis of its maiden JORC resource, which Eales says will be released this month. Following this, the firm hopes to identify a large deposit to enable production to ramp up to 10,000tpa or more.
Gakara mining licence perimeter, mining areas, and rare earth discoveries
Over a longer-term horizon, Rainbow is also looking at ways to process its own rare earth concentrate. As it stands, the business produces a mixed mineral product and sells it to someone in the market that will then separate the concentrate into processed rare earths and sell it on at a much higher price.
The business took its first significant step towards this goal in August when it partnered with a firm called TechMet. The company will fund a DFS for downstream rare earth separation at Gakara on a reimbursable carry basis up to $3m. According to Eales, Rainbow’s RE concentrate currently sells at a c.70pc discount to the finished metal product. As a result, he said he is very excited by the potential presented by any future JV with Techmet:
‘We have always said that if we can calculate the economics to allow us to process our own material then would be determined to do so. We are the feedstock, so if we can process our own material to make a higher value product, then the margins are very attractive. Our work with Techmet has begun, but we haven't given any estimated time for completion. I would imagine we would be seeing some news on that towards the end of next year. We are very excited about the possibilities because if we can narrow the gap between our sale price and our customers’ sale price, then it could have some serious benefits.’
Financially, Eales tells us that Rainbow’s revenues and cash balance are funding its existing work programme. The firm’s last publicly stated cash position came in its annual results in September, when it revealed that it had $354,000 as of 30 June 2018. However, it bolstered this considerably in August when, as mentioned, it raised £1.6m ($2m) to- in its own words- ‘cater for the sometimes irregular sales cycle for its concentrate and ensure sufficient working capital reflecting the company's complexity and nature of its operations’.
In October, the business then said it remained focused on using its existing cash and financing to reach concentrate sales of 250-300ts per month, the point at which it expects to be generating positive EBITDA. Once Rainbow has reached this point, Eales plans to use its relatively fixed cost base to reduce its operating cost per tonne by bringing additional areas into production:
‘Over the next year, we want to accelerate the third and fourth mining areas into production. We are currently using some of our recent placing proceeds to explore and develop an area called Gomvyi, which could be our third mining area. Our cost base is pretty fixed, so as we get more tonnes through the plant, costs come down significantly, and we achieve greater profitability.’
Despite this optimism, Rainbow’s shares have been on a downward trend since April, when they sat at highs of close to 24p. Alongside October’s negatively-received delay this can at least be pinned partly on this year’s broader commodities sell-off stemming from concerns over a US/China trade war, something that has hit junior miners across the board in H2 2018. It is worth noting, however, that Rainbow continues to enjoy strong backing from institutional investors Miton AM (4.6pc) and L&G (4.7pc). Likewise, management have taken advantage of this year’s downturn to increase their stakes. In particular, non-exec chairman Adonis Pouroulis, who founded Petra Diamonds and Chariot, maintained his 25pc stake in the company by participating in the August placing.
Eales tells us he believes that market sentiment towards Rainbow will begin to align with management once the firm provides proof of concept by achieving some of its near-term goals. He expects this to occur shortly:
‘Over the near term, I think the market will be looking at our maiden JORC resource and will be looking for us to demonstrate that we are cashflow positive on a monthly basis. These catalysts will provide some more understanding around the speed of ramp-up of production. One thing for sure is that the feedback from customers is very positive and we are sure there is a lot of demand for everything we produce.’
Alternative EV play
While the delay to Gakara’s profitable production is disappointing, it is worth noting that Eales insists nothing has changed in Rainbow’s business plan. Objectively, this point carries a lot of weight. Not a lot of junior miners can boast production revenues and imminent profitability in a niche metal sector that has substantial exposure to the popular EV investment play.
If this all sounds interesting to you and you are confident in Rainbow’s cash position, then the stock’s recent weakness could provide a decent entry point ahead of significant expected newsflow. Indeed, over the coming months, it will be worth keeping an eye on how the market responds Rainbow’s maiden JORC resource for Gakara alongside ongoing production and profitability updates.
Author: Daniel Flynn
Disclosure: The author does not own shares in the company mentioned above