Description

Applied Minerals (ticker AMNL) is not your typical value investor’s pitch, due to its somewhat speculative nature, but the dramatic upside potential makes the stock worthy of discussion. AMNL is a mining and mineral technology company, and a leading global producer of halloysite clay, trading at 24% of a highly-risked NAV and <1x 2015/16 EPS. The key questions which must be answered to justify AMNL’s upside are: 1) will halloysite clay achieve commercial success?; 2) can AMNL fund the development of its Dragon Mine, which is the only significant large-scale halloysite clay mine in the western hemisphere?; and 3) are the other potential revenue streams worth anything? If we can answer each of these with at least “partly”, then there is a significant margin of safety. I will attempt to do so below.

What is halloysite clay?

Halloysite is a non-toxic clay exhibiting a rare and naturally-occurring tubular structure. While chemically identical to commonly-used kaolin clay, the extremely rare tubular structure, which takes millions of years to develop, provides a range of functionality that other materials cannot. The key intrinsic properties include a high aspect ratio, a high surface area, hollowness, and the ability to bind water.

AMNL markets a number of halloysite products, including Dragonite (for applications such as a controlled release carrier for active ingredients, used in environmental remediation, agriculture, paints/coatings, and catalysts); Dragonite-XR (flame retardant and polymer reinforcement); Dragonite-HP (polymer reinforcement); and Dragonite-PureWhite (cosmetic industry applications). AMNL also holds a broad portfolio of intellectual property surrounding the technology related to its material.

I would encourage you to take a look at the AMNL site for further background as well as 3^rd-party research:

http://appliedminerals.com/site/our-products

http://appliedminerals.com/applications/flame-retardancy-application-page

http://appliedminerals.com/site/research

AMNL Background

AMNL is a mine to market producer of halloysite clay, owning the Dragon Mine in the Tintic District of Utah. This mine is the only known measured resource of halloysite in the Western Hemishpere (Imerys, based in France, owns a lower-quality halloysite mine in NZ). Per a 2012 analyst report: From the late 1800s through 1930, mining at the property focused on iron ore with gold and silver as trace byproducts of production. From 1949 through 1977, Filtrol Corporation mined over one million tons of halloysite for use as a petroleum cracking catalyst. Production was shut down in 1977 due to a variety of factors including a mine fire, a cracking catalyst substitute for halloysite, and falling oil prices. Since May 2008, a detailed investigation has been conducted to determine the quantity of the halloysite and remaining iron ore resources. This includes significant drilling and exploration activities as well as an updated resource statement issued in April 2011.

In terms of management, the current CEO Andre Zeitoun (former SAC and RBC portfolio manager) – and significant inside owner – took over in January 2009, installing his team and ousting the former management group, who had been accused of securities fraud. After placing a new Board of Directors, Zeitoun continued work on a 3-year study to better understand the Dragon Mine’s resources, and as indicated above, this was completed in 2011 (note that this only pertains to a portion of AMNL’s property, 11 of 230 acres):

In addition, a JV agreement was formed in 2010 with KibbeChem, a polymer compounder specializing in foaming agents.  In early 2011, the first commercial order for Dragonite-HP was awarded by Signature Fencing, a modular flooring systems manufacturer. The company is also selling nucleated polymers to Ames TrueTemper for hose reels and other products. 

Finally, in early 2011 AMNL announced the hiring of Dr. Chris DeArmitt as CTO, previous head of specialty polymer product development at Electrolux and BASF, where he was also responsible for the scouting of new technologies on behalf of BASF Venture Capital. At the time of his hiring, DeArmitt said: “The commercial potential of Applied Minerals’ Halloysite-based products as a high tech material is very exciting. I have seen very few materials during my career that match its potential. As a functional additive or filler in plastics, coatings, adhesives or cosmetics, Halloysite gives remarkable property enhancements spanning the gamut from boosted mechanical properties to the controlled release of active agents. Furthermore, while most high performance materials are synthetic, expensive and of questionable toxicity, Halloysite - as a naturally occurring clay – is both affordable and environmentally friendly.”

Note that because the area in Utah where the Dragon Mine is located is a historical mining district, there is well-developed surrounding infrastructure. Furthermore, the company has invested in a new state-of-the-art processing facility which will be able to produce up to 45k tons of halloysite to meet customer specifications – this is due online in Q1’13. The existing processing plant will be devoted to iron oxide (10kt of capacity – can be expanded to 40kt for <$2mm).

Insiders own ~30% of the company.

Commercial Opportunity

As detailed in a November analyst day (http://appliedminerals.tempwebpage.com/images/uploads/events-presentations/Applied_Minerals_2012__Shareholder_Presentation.pdf), AMNL has made significant progress on a number of commercial developments. The company gave specific updates on: flame retardancy applications; lightweighting of polymer composites; and, iron oxide pigment products.

Flame Retardancy:

• The market is currently 1.96mm mt ($5.4bn) growing at 6.0%/a
• Mineral-based retardants represent 65% of market volume
• Dragonite competes by having:
  • Lower required loadings (preventing brittleness caused by peer products)
  • Superior reinforcement ability
  • Usability in transparent and engineering polymers, where there is a great need
  • In April 2012, AMNL announced a supply agreement with Samsung Cheil Industries; product validated by 5+ end-users
  • At 2% market share, 1.96mm mt, AMNL sells 39,200 mt = $166mm revenue opportunity

Nucleating and Lightweighting of Polyethylene:

• Through nucleation of polyethylene, Dragonite drives a reduced cost, improved quality, and reduction in weight for the injection molding industry
• 50% of polypropylene, the 2^nd-largest plastic in the world, is pre-nucleated, versus 0% for polyethylene (the most common plastic)
• Prevalent demand for lightweighting in automotive and aerospace – Dragonite reduces weight by 10-15% with 30%+ production speed improvements (the clay essentially speeds up the cooling period of the plastic by accelerating crystallization)
• Multiple molding companies in manufacturing scale-up trials (already selling to Ames)
• At 5% market share, 500,000 t, AMNL sells 25,000 t = $100mm revenue opportunity

Iron Oxide Pigment:

• IOPs are mined by only three companies in three states in the US; including synthetics, 57% are used in concrete and other construction materials, 29% in coatings and paints, 6% in foundry uses, and the rest in other applications
• The US is a net importer of over 50% of its needs (natural IOP: Cyprus, Spain, France, etc; synthetic: China, Germany, etc)
• With a 200k t US market, at a price per tonne of $1470, and AMNL’s current processing capability of 10k t = $15mm revenue opportunity; for less than $2mm, AMNL would be able to expand its capacity to 40k t

In addition, the company is sitting on 4.5mm t of waste piles containing a mixture of clay and iron oxide which may be beneficial for the environmental remediation market. For analysis’ sake, assume a conservative ASP of ~$50-150/t, sold over a number of years – at a range of $225mm-675mm, the value of the waste alone shows how cheap AMNL is today (EV of $149mm today). Certain applications, such as oil spill clean-up or uranium absorption, may in fact garner prices on the order of $500/t, with the worst-case scenario being $15-20/t as aggregate or clay for brickmaking (~$68-90mm of value; my estimation of the downside case in AMNL). Note, the company announced in June 2011 a Cooperative Research and Development Agreement with the EPA to pursue the development of Dragonite sorbent technology for the remediation of oil from contaminated salt marsh and wetland environments.

Valuation

While an NAV approach to methodology is arguably the best way to value a mining company (or in this case, a minerals technology company), like any DCF there are dramatic changes based on long-term price, cost, and discount rate assumptions. To that end, it seems sensible to sanity-check AMNL’s valuation using earnings multiples, and on both counts it is apparent that AMNL has significant upside.

NAV (assumes discount rate of 15%, ends at 2022, assumes unit cost 5x management expectation, and limits revenue to identified areas discussed above; ignores NOL, ignores waste pile, ignores future commercial opportunities):

Multiples:

As seen in the tables below, based on simple assumptions, AMNL is trading at an extremely low earnings multiple, on the basis of easily-derived “potential” EPS. I have used only the commercial opportunities already discussed, and provide a second table haircutting the illustrative volumes by 80%. Obviously, there is an element of the unknown as it relates to timing, but I (and management) would view the EPS in the top table as possible within 3-4 years; and, I would note that there is value in the company even if we are off by a material amount of volume (or price, or cost). Other products are also in the pipeline – note the 11/29 release discussing a new JV to develop and market an all-natural line of skincare products based on Dragonite. Furthermore, the first leg of halloysite development does not require further capex as the processing plant is already in place.

Per management, the cost to mine and process their halloysite is $100/t. I have provided sensitivities of $500/t and $1000/t, though I am doubtful that management is off by a factor of 10.

In addition to the iron ore, AMNL may possibly be sitting upon other non-halloysite resources, namely a copper/gold porphyry (FCX is exploring at a property 15 miles north of Dragon; Rio Tinto is also close by);  they are currently drilling to assess the resource.

Conclusion and Catalysts

Since the new management team has taken over, much progress has been made and AMNL is poised to benefit in the near-term as their core product reaches commercial scale. Given the depth of resources and the value-added industrial and consumer applications evident, the company should see a dramatic earnings ramp, for which one is paying little for today. Downside is also protected to the extent the company were to liquidate its assets. With the first material commercial transactions likely to occur in 1H’13 and further disclosures around product development, AMNL shares should rerate.

Catalyst