2023-05-31 04:23:01 ET
Summary
- The Maracas Menchen mine has an NPV of $2 billion according to a 2021 life plan but Largo has been in the red for three consecutive quarters.
- Heavy rains in December and early 2023 led to a delay in the infill drilling campaign and Largo revised its production, sales, and cost guidance.
- The next few quarters are likely to be challenging as falling global steel output puts pressure on vanadium prices.
Introduction
I've written seven articles on SA about vanadium mining company Largo (LGO) (LGO:CA) so far, the latest of which was in March 2023 when I said that the year appeared to be starting strong thanks to high vanadium pentoxide (V2O5) prices and that the company could be back in the black soon.
Well, I think that the Q1 2023 financial results were underwhelming, and I find it disappointing that the company revised its production, sales, and cost guidance for the full year due to heavy rains. In addition, global vanadium prices have been sliding since early March and I think that there could be further decreases in the coming months due to slowing global steel output. In view of this, I'm cutting my rating on the stock to hold. Let's review.
Overview of the recent developments
In case you're not familiar with Largo or my earlier coverage, here's a short description of the business. The company owns the Maracas Menchen vanadium mine in Brazil which accounts for about 7% of global vanadium supply with a nameplate capacity of 13,200 tonnes. The mine employs 379 people and it has a reserve life of 20 years. Largo is also constructing an ilmenite concentration plant there with a production capacity of 150,000 tonnes that is expected to be commissioned in Q2 2023. Commercial production is forecast to be reached in the second half of the year and the company is evaluating the potential to produce titanium dioxide pigment as a possible follow-on product. In 2021, Largo released an updated life of mine plan for Maracas Menchen that showed an after-tax net present value ((NPV)) of $2 billion at around $8 per pound for the majority of the mine life. However, low vanadium prices could put the company in a tough spot as the total CAPEX (including a titanium dioxide pigment plant) was forecast at over $350 million by 2027.
Besides Maracas Menchen, Largo has a physical vanadium holding arm named Largo Physical Vanadium Corp (VANAF) (VAND:CA) which is listed on the TSX Venture Exchange that has a market capitalization of C$32.1 million ($23.6 million) as of the time of writing. Largo's 65.7% stake in the company is thus valued at C$21.1 million ($15.5 million). In addition, Largo has a clean energy subsidiary called Largo Clean Energy which is focused on vanadium redox flow battery (VRFB) solutions. The latter has a battery manufacturing facility in Wilmington, Massachusetts, and is building a 6.1 MW vanadium battery for a customer in Spain which is expected to be delivered in Q3 2023.
Largo
Turning our attention to the Q1 2023 production and financial results, V2O5 output declined by 13.6% year on year due to reduced massive ore inventory following heavy rainfall in December 2022 and early 2023. As you can see from the table below, the effective grade of ore milled during the period was 14.2% lower compared to a year earlier. Yet, the production was in the upper range of the production guidance of 1,900-2,200 tonnes for the quarter.
Largo
The lower grades and a shutdown of the processing plant in January for the completion of planned maintenance and refractory refurbishment in the kiln pushed up cash operating costs excluding royalties to $5.15 per pound. It seems that Q2 is starting on a weak note as April production was just 676 tonnes (see page 7 here ).
Largo
However, sales of V2O5 equivalent rose by 27.6% to 2,849 tonnes as logistical challenges eased and Largo expects to see further improvement in the coming months. In April, the company sold a total of 1,101 tonnes of V2O5 equivalent.
However, the heavy rains in December and early 2023 have led to a delay in the infill drilling campaign for the year and Largo has revised its production, sales, and cost guidance. The production guidance was cut to 9,000 - 11,000 tonnes from 11,000 - 12,000 tonnes of V2O5 equivalent, the sales guidance was downgraded to 8,700 - 10,700 tonnes from 10,300 - 11,300 tonnes; and the guidance for cash operating cost excluding royalties per pound sold was revised to $4.85 - 5.65 from $4.85 - 5.25. It seems that Q2 will be particularly weak.
Largo
Looking at the financial results for Q1 2023, Largo remained in the red as strong sales couldn't offset the much higher direct mine and production costs attributable to low ore availability. In addition, other general and administrative expenses soared due to higher depreciation in the corporate segment due to software products while the finance costs rose due to a higher debt load and initial financing fees on new debt facilities.
Largo
Turning our attention to the balance sheet, Largo had a net debt of $3.4 million as of March 2023 which represents a significant increase compared to December as the company turned to loans to finance $23.4 million of CAPEX in Q1 2023.
Largo
Looking at what to expect in the future, I'm concerned that the net loss and net debt could soar over the next several months as global vanadium prices are likely to continue falling. You see, vanadium prices have been declining since March just like with many other commodities due to global economic growth concerns.
Investing.com
In April, global steel production began declining too and the steel industry accounts for just over 90% of global vanadium demand. According to data from the World Steel Association , crude steel production in its 63 member countries fell by 2.4% year on year to 161.4 million tonnes in April. The decrease was driven by China where steel rebar prices in hit their lowest in three years as a result of low economic growth, particularly in the property sector.
With no signs that China's economic growth and construction activity are likely to improve in the near future, I think that it's likely that global steel output will continue declining over the next several months which is likely to put further downward pressure on vanadium prices. In my view, V2O5 pentoxide prices in Europe could fall below $6 per pound by the end of 2023 which would put serious pressure on the financial results of Largo over the next few quarters.
Investor takeaway
The Maracas Menchen mine has an NPV of $2 billion according to the 2021 life of mine plan which is over 7 times higher than Largo's market capitalization as of the time of writing. However, the company has been in the red for three consecutive quarters and it looks that the next few quarters are likely to be challenging as falling global steel output puts pressure on vanadium prices. In my view, this is the wrong time to open a position and I'm changing my stance on the company to neutral.
For further details see:
Largo: The Remainder Of 2023 Could Be Challenging As Vanadium Prices Slide