Xanadu Mines (ASX:XAM)

A Diversified Explorer in Mongolia
We initiate our coverage of Xanadu Mines with a speculative buy recommendation, and a target price of 0.93 aud.

Junior mining company with several promising projects in Mongolia at strategically useful locations. Xanadu’s management selects its projects based on its proximity to infrastructure in addition to the quality of the potential resource. It holds several thermal coal, coking coal, copper and gold projects, of which the thermal coal projects are at advanced exploration stages.

Market price undervalued compared to its peers. Our analysis shows that XAM is trading at an EV/Resource ratio much lower than its peers. The price is also lower than the prices paid at recent acquisitions in Mongolia—Hunnu Coal and QGX’s Baruun Naran.
 
A portfolio of high-quality assets that gives the stock significant upside potential. These include promising coking coal, porphyry copper, and epithermal gold projects which we have not attributed value, such as the Nuurstei coking coal project for which a JORC exploration target is expected to be published by the end of 2012, a porphyry copper project next to the famous Erdenet copper mine, and other projects at earlier stages with good assay and survey results.
 
Strategic alliance with the raw materials supply chain giant Noble Group. The Xanadu–Noble joint venture vehicle Ekhgoviin Chuluu holds several promising early stage projects that could eventually lead to an acquisition of Xanadu by Noble Group. This gives an upside potential to Xanadu shares.
 
Structured to easily spin off separate projects. Xanadu’s projects are organized to make the buyout of one or more of its projects by a senior mining company easy, as different subsidiary LLC’s hold different projects. The company’s assets are well prepared for acquisitions, hence reinforcing the upside potential.
 
Two senior mining companies, Sakari Resources and Noble Energy, have significant equity hares in Xanadu. The presence of these potential buyers in Xanadu’s structure means that a strategic acquisition is possible.

Sakari Resources (formerly Straits Asia Resources) is a coal producer listed on the Singapore Stock Exchange (Ticker: AJ1), which operates two thermal coal mines in Indonesia. Sakari has a market cap of about 1.8 billion USD, and is currently exclusively focused on mining and exporting high-quality thermal coal. 45.4% of Sakari Resources is owned by The Petroleum Authority of Thailand (PTT), which is a mostly-state-owned energy company with a goal of ensuring the energy security of Thailand.

In addition to Sakari, Noble Energy Group also has a stake in Xanadu. Noble is headquartered in Hong Kong, and is listed on the Singapore Stock Exchange (Ticker: N21). The company manages a global supply chain of agricultural and energy products, metals and minerals (they source, market, process, finance and transport these products). It sources essential raw materials from low-cost producers such as Brazil, Argentina, Australia and Indonesia to supply growing economies such as China.

Projects

Xanadu has numerous project sites in Mongolia, but is actively working on four coal and three metals projects in Mongolia. The company has moved forward relatively quickly to assess its resources,  and two projects already have JORC compliant resource estimates.

Xanadu has formed a joint-venture company named Ekhgoviin Chuluu (EC) with Noble Group, in which each partner owns 50% of the assets. The following table shows the organization of Xanadu’s projects and the subsidiaries formed to help facilitate any buy-out.
Experienced management team. Xanadu’s management team includes individuals with background in mining, geology, as well as mining-specific finance. We believe the extensive combined experience of the management team is a reason to be confident in Xanadu’s potentials.

Coal

Khar Tarvaga

One of Xanadu’s flagship thermal coal projects, Khar Tarvaga, was  discovered in 2007 with the inadvertent help from a marmot, whose fur was coated in coal (hence its name—Black Marmot). Xanadu received a 30-year mining license for this project site in October of 2011, which is 100% owned by the company. Khar Tarvaga’s has 327 million tonnes of JORC compliant resources; this was estimated by the consulting firm SRK.

The Khar Tarvaga project is located 45km east of the Trans-Mongolian railway in the Tuv province. Xanadu has considered two different uses for its coal: mine-mouth power generation and conversion to other forms of fuel.

Although the project site is about 150km south from Ulaanbaatar, the company management indicates that there are opportunities to supply power to the Chinese grid in addition to the Mongolian grid.

Coal to Liquids technology, although expensive, has been one of the major discussion topics in the Mongolian energy sector. As Mongolia has no large oil fields, the country imports almost all of its diesel and gasoline fuels for consumption.

Xanadu Mines hired the consulting firm Nexant Inc., to assess the suitability of the coal at Khar Tarvaga for coal gasification and liquefaction. Nexant concluded that the thermal coal at Khar Tarvaga is suited to both types of processing, which means the synthetic natural gas (SNG) or petroleum substitute based on the Coal to Liquids (CTL) technology can be produced.

Galshar

This thermal coal project is located in Dornogovi province in southeastern Mongolia, 120km from China’s border. It’s also 65km from an existing railroad spur for the Bor Undor fluorite mine.

Galshar is 100% owned by Xanadu, and it consists of six exploration licenses totalling over 340km2. Over 170mt of inferred and indicated JORC compliant resource has been identified here in November, 2011. Xanadu drilled 74 holes in 2011, and extracted 8,707 meters of cores to define the resource.

Xanadu is preparing to apply for a mining license here, but expects further drilling at Galshar to increase the resource estimate to over 200mt.

Similar to the other thermal coal properties that Xanadu owns, the management is interested in both mine-mouth power generation and CTL technologies at Galshar. In addition, the management is considering exporting its high quality thermal coal after upgrading through moisture extraction processes.

Nuurstei

Nuurstei is Xanadu’s flagship coking coal project, for which the company will look to have a JORC exploration target before the end of the year. The size of the property is about 40km2.

It is located in Khuvsgul province, which is over 300km west from the nearest rail-road in Erdenet. Nuurstei is close to the provincial capital Mörön, and Xanadu is one of several companies and local groups that created the North Mongolian Railroad Association, whose purpose is to promote the building of a railroad from Erdenet to Moron.

By the end of 2011, Xanadu had drilled over 3,500 meters in a 10- hole program. The coal seams discovered were 6-12 meters thick and moderately dipping. A preliminary washability test confirmed that the finished product would have less than 12% ash, low sulphur and crucible swell numbers (CSN) of 8 to 9.

The Xanadu-Noble joint venture vehicle Ekhgoviin Chuluu owns 60% of Nuurstei, with the right to acquire another 20%. The rest is owned by Blackrock, a Mongolian company.

Please subscribe to our journal to read more.