How much further to run for Zincox Resources?

ZincOx listed on Aim in 2001 at 100p, but by the end of that year few people gave it a ghost of a chance of survival. Stubbornly low base metal prices had forced the Irish zinc producer Navan to close its mines and file for bankruptcy amidst a blaze of publicity. The backdraught of ill sentiment knocked ZincOx?s price most of the way downstairs to 36p.

How times change. Since those days the price has added a zero, making ZincOx one the best performers on AIM. Make no mistake though ? it long ago ceased to be a recovery story, but over the last two years alone the share price has climbed inexorably from £1.20 to 355p at the time of writing.

Quite a ride, then. But the investing questions are, is it worth upwards of £173m, and after a brilliant run, how close might it be to a natural summit? To answer that, let?s put the business model and assets through the scanner.

Background
ZincOx is a fascinating and complex company that started life with a solvent extraction technology originally developed within Reunion Mining to deal with the Namibian Skorpion zinc oxide deposit. Oxide deposits are unloved compared to zinc sulphide ores as they tend to be very difficult to concentrate into a material suitable for use by a conventional ?smelter?. Reunion Mining?s CEO Andrew Woollett and the inventor Noel Masson reckoned their new approach was applicable to other oxide deposits, recruited half of the Reunion Mining board and birthed ZincOx. Anglo American swallowed Reunion a couple of years later.

A decade on, operations are spread across three continents. In addition to its technology, the company owns a controlling stake in a high-grade zinc deposits, owns its own smelter and is developing a very promising and potentially lucrative zinc recycling strategy. To use the buzz words, the company is ?vertically integrated?, and as long as one is not bearish about zinc, it is hard not to be impressed by ZincOx?s strategy.

Recycling
ZincOx has changed focus in recent times to recycling, to such an extent that the company?s logo is to be modified to include a version of the international recycling symbol.

The business model is beautifully simple. Just over a third of the world?s steel is recycled from scrap and all 300-plus plants worldwide generate a waste product called electric arc furnace dust, or EAFD. Over 5 million tonnes of the stuff are produced annually. Of that, roughly half is recycled in inefficient Waelz kilns and the rest is shipped to landfill.

And there?s the rub. EAFD typically contains a tasty 21-30% iron, 15-25% zinc and 2-4% lead, but it also contains cadmium and arsenic. Along with the lead they make EAFD a hazardous waste which incurs a stiff disposal penalty.

ZincOx?s technology can deal with this very efficiently. The zinc alone is 3 to 5 times richer than the ore of the average zinc mine and offers pig iron as a by-product. The toxic metals become confined within a lead concentrate which is itself saleable. The resultant zinc concentrate will be shipped to ZincOx?s own smelter to produce high quality zinc metal.

The first rotary hearth furnaces are planned for Ohio, USA and Aliaga, Turkey. Supplies of EAFD are already agreed. In Ohio, ZincOx will actually be paid to take it, whereas in Turkey it merely comes free of charge! The zinc concentrate from both operations will be shipped to the Big River Zinc smelter located just outside St Louis, which the company bought for a nominal £8.1m after the supply of concentrate dried up. ZincOx has no such problem and plans to turn this facility around by adapting it to suit their solvent extraction process. Redevelopment is underway and is expected to cost about £45m as opposed to over £150m to build from scratch.

The company reckons the business model of two regional scale rotary hearth furnaces feeding continental scale zinc production facilities is a blue print it can roll out elsewhere in the world. EAFD supply option agreements have already been signed in Thailand and Woollett anticipates deals in the rest of the Far East. Ultimately its ambition is to mop up 30% of the world market.

Mining
ZincOx also owns 52% of the undeveloped Jabali deposit in Yemen. Jabali contains 9MT at 9.2% zinc, and is open pittable with a remarkably low 2:1 strip ratio. Despite the doubling of capex (capital expenditure) since the 2005 feasibility study, this should be a decisively economic project. The key event at Jabali will be the grant of an Exploitation Contract from the Yemeni Government, and the fact that ZincOx?s well-regarded Yemeni partners own almost half will do them no harm. The Yemenis are not renowned for being lightning quick but if granted tomorrow, production could theoretically commence in Q4 2008, mining equipment allowing.

Yemen is not the most stable of countries and conventional funders have upped drawbridge, leaving the company to turn to specialist emerging market hedge funds. A US$120m bond with fixed interest and a zinc price related coupon is at the final documentation stage

In 2005 ZincOx sold its interest in Kazakhstan?s Shaimerden zinc deposit for £3.3m plus additional payments linked to the zinc price. The deal called for five additional annual payments, the first of which netted ZincOx £4.4m. Payments are linked to the zinc price but if the latter remains near today?s levels, the January 2008 payment could be almost £20m, with more to come. Not bad for an investment of just £1m.

Funding
ZincOx has just reached an expensive moment in its story. Refurbishment at Big River Zinc, construction of rotary hearth furnaces in Ohio and Aliaga and funding of the Jabali mine will need slabs of capital approaching £240m.

This will be offset by £20m in the bank. A further £6.5m should arrive from Teck Cominco?s likely exercise of its warrants (which are safely in the money). The company also hopes to monetise the value of the Shaimerden royalty to the tune of £35-45m up front, and the Jabali bond will take care of another £60m.

This is where life gets interesting. Teck Cominco is not merely on board as an alternative hedge fund and might well establish a joint venture relationship on one or more projects, whereby they pick up some of the residual tab. ZincOx would benefit from their mine-building expertise, marketing and other know-how. The last financial results intimated that ZincOx?s equity requirement could total about £80m, of which conventional debt could comprise the balance of the requirement. The company does not foresee a major issue of shares.

Profits from the recycling operations should commence in mid-2008. The excellent March 2007 research note on the company website estimates 2009 profits after tax from Aliaga, Ohio and Big River at £9m, £11m and £13m respectively, using a conservative zinc price of $1800/t (zinc is currently worth double that). Allowing for some dilution, 2009 earnings per share work out at 33p discounted at 10% pa. Applying a P/E 15 gives a share value of 559p. This completely discounts value from further developments in the Far East but does ignore country risk.

All told, this intriguing story looks like it could be nearer its beginning than its end. 2007 is going to be a pivotal year.