Full steam ahead for ZincOx as it formalises Korea off-take agreement

ZincOx Resources (LON:ZOX) this morning revealed it has formally completed an off-take agreement with Korea Zinc, which will take all of the group’s production from the first phase of its recycling plant in the country.

Pricing of the zinc under the 10-year agreement will be based on the international formula for valuing concentrates, though ZincOx will also receive a fee for removing fluorides and chlorides from the finished product.

The revolutionary recycling plant is due for completion in the first quarter of next year, and will cost US$110 million to build.

ZincOx is meeting $60 million of that figure from its own cash resources, while Korea Zinc is stumping up the remainder in two tranches. The first is a $15 million development facility being charged at a rate of 15 per cent a year, and the second is a $35 million off-take loan at five percentage points over the London interbank rate.

Chairman Andrew Woollett said: "We are delighted to have such strong support from one of the world's largest zinc producers and their commitment reinforces the strength of the technology. 

"Excellent progress is being made at site and the development remains on schedule and within budget"

ZincOx has found a way of processing the zinc rich dust from arc furnaces that is using a piece of equipment called a rotary hearth furnace.

This is a piece of equipment that has been around for 10 years and is traditionally used to treat waste from giant steel mills.

Obviously the company has modified it to extract zinc from the dust, but in doing so has come up with a remarkably efficient and effective recycling process.

And unlike the other technology on the market such as the Waelz Kiln it can process this potentially hazardous by-product without the need of a subsidy.

This is crucial because it means the ZincOx business model is self-sustaining.

The recovery of zinc is high – upwards of 97 per cent – and the fine, white zinc oxide powder created is of much better quality than that produced from the conventional recycling process. 

And there is zero waste as there is also a passable iron ore product that can be fed back into arc furnaces.

The decision to set up its first full-scale production facility in Korea is down exclusively to a tie-up with Korea Zinc, which is providing loans that will help finance the Pohang plant.

However there has also been strong support from government. “(Our site) has foreign investment zone status, which gives us five years tax-free and a further two years at 50pc of the nominal rate,” Woollett said in a recent interview with Proactive Investors. 

“The government has bought the land on our behalf and rents it to us. They have this scheme because land in Korea is expensive. We have a 50-year lease over a fully permitted site that cost about US$20 million to purchase last summer.”

ZincOx has a deal with all Korea’s scrap recycling companies to process 400,000 tonnes of dust, which should result in annual output of around 92,000 tonnes of zinc in concentrate. 

The first plant should be up and running early next year, with the second part of the project in production in 2013.

This second phase is currently expected to cost US$142 million as it will incorporate a washing plant, although Woollett is hopeful of further savings.

However both plants generate impressive returns based on some very conservative assumptions on the price of zinc and pig iron.  ZincOx took a price of US$2,250 a tonne as the benchmark for the former and US$450 a tonne for the latter when it came up with a US$97 million net present value of for each phase based on a discount rate of 10 per cent. Each plant would generate an impressive US$29 million in EBITDA a year, the company calculates.

The economics are such that the operation breaks even down to a price of US$950 a tonne of zinc, and there is a natural hedge in the model.

The model works because there is zero cost for the steel mills associated with ZincOx’s recycling – the company even arranges for the dust to be collected and transported. This actually offers a net saving to the steel industry of around US$25 million a year, who would have paid to have the dust buried in landfill sites.  

But those transportation costs will be borne by the steel companies if the price of zinc falls. 

However all the expert forecasts suggest the cost of the metal is headed higher thanks to the increased demand from the likes of India and China, both of which are actually galvanising more of its steel products than has occurred traditionally.

The “bear view” is that zinc prices will bump along at around $2,250 a tonne for the foreseeable future, while the bulls predict the price will be closing in on $3,750 a tonne by the early months of 2014, at which price EBITDA would more than double.

The groundwork on phase one of the Korea project is already underway. The company has already purchased a second-hand rotary hearth furnace together with other equipment from Severstal for US$4 million.

Currently being modified by the fabricators, the furnace would have cost US$60 million new, and Woollett reckons ZincOx has acquired US$20-25 million of “useful equipment”.

The shares, meanwhile, value the company at less than the cash ZincOx is carrying on its balance sheet. 

This suggests there is still a huge amount of skepticism about the company’s ability to achieve the goal of having a functioning zinc recycling plant up and running in less than a year.

Actually the current share ascribes zero chance of success in Korea or elsewhere.

Yet the technology works and has been tested, albeit in a pilot scale study. The finance is in place, a blue-chip partner has been found and sufficient supplies of the feedstock have been sourced and secured.

So the risks are on the execution side, which means potential delays commissioning the plant, or indeed that the furnace doesn’t work in the way it has been designed.  

Investors should, however, draw comfort from the thorough due diligence exercise carried out by Korea Zinc, the world’s second largest producer of zinc metal, which is lending US$50 million to the project.

However if the shares aren’t re-rated to reflect progress made thus far then it is obvious what will happen – the company will be taken out. Worse still it will be acquired at the wrong price. 

It will be intriguing to see how Korea Zinc reacts to the emergence of a potential predator as it is the obvious buyer of the business. Perhaps we should keep an eye on the shareholder register.

The company’s broker Ambrian reckons ZincOx is worth 100 pence a share (current price 51 pence), and this barely recognises the potential of phase II in Korea, let alone the prospects of a roll-out elsewhere in the world.  

“To put the investment opportunity into perspective - ZincOx is a fully-fledged, pre-production play on the zinc market, and also represents a recycling story — something that is almost unique in the equity market,” says Ambrian analyst Nick Mellor.

“Its extremely low market valuation puts a fully financed development story at a lower value than most low-grade gold exploration projects on AIM. The investment opportunity is highly compelling in our view.”

Simon Miller, analyst at Broker Northland, said it was a "significant boost to the company's plans to reclaim zinc from blast furnace waste and steel scrap.

"The plant will be the only domestic source of zinc in Korea. Zinc remains a strategic metal for the steel industry and the proportion of galvanising in steel has a long way to catch up in Asia and especially China compared to the West."