ANALYSIS: Two local lithium players will be hoping their early move into the sector justifies the hefty interest rates on their loans.
Interest rates on corporate debt can tell you a lot about a company, its industry and the wider economy.
Generally speaking, any business prepared to pay 15 per cent on a portion of its debt is either super-keen to get the cash, or is seen by lenders as being at the top end of risk.
Interestingly, that’s the rate one of Western Australia’s emerging lithium stars is prepared to pay on a $US110 million loan.
Altura Mining, perhaps even more interestingly, is not alone in paying around double the going rate for debt finance at a time when most people imagine the cost of debt is close to an all-time low.
The lithium twins are developing adjacent projects in the Pilbara region, with both bearing the name of Pilgangoora.
In theory, Altura and Pilbara are riding a wave of investor enthusiasm for lithium, one of the leading commodities in the sector dubbed ‘battery metals’ because of their role in the production of long-life, rechargeable batteries, such as those used in electric cars and for a growing variety of industrial and household applications.
Because lithium is currently commanding a high price, and there has been a surge of interest in electric vehicles, most investors probably imagine that banks and other traditional providers of debt finance are rushing to support the industry.
That might not be the case, however, judging by the interest rates just agreed to by Altura and Pilbara –a rate of between 12 and 15 per cent tells a different story, given the cost of debt to the average company listed on the ASX is between 3 per cent and 4 per cent, and a private business can probably expect to pay around 7.5 per cent for a bank loan.
For example, BHP secured a rate of 2.05 per cent in its latest debt issue.
In defence of Altura and Pilbara, debt for small miners has always been hard to get and usually comes at a higher-than-average rate because of the natural risks associated with the commodities industry, including sudden price movements, construction risk associated with new projects and operational risk.
So, not many people noticed the rate or terms of the deal when Pilbara reported in June that it had secured its $US100 million debt package at a rate of 12 per cent from a syndicate of local and international fund managers.
But there was a collective intake of breath from investors when Altura reported its $US110 million debt package late last month, because it is not stretching the point to say that an interest rate roughly double what most businesses could secure could be described as onerous.
Pilbara’s deal, the cheaper of the two, involves five-year bonds that mature in June 2022 and are secured by all of its Pilgangoora lithium assets.
Other terms include a proviso that Pilbara’s bonds will be interest only for the first three years, while the company has the right to buy back the bonds at any time, which should enable refinancing at a cheaper cost once cash starts to flow from lithium sales.
Altura’s senior secured loan notes have been placed with three international investor groups arranged by New York-based Jett Capital Advisers and are for a term of three years at a rate of 14 per cent for the first 18 months after the date of utilisation, and 15 per cent for the rest of the term.
Both mining companies are clear in their aim of being among the early entrants in the Australian lithium boom, which has led to a stampede for exploration tenements and a rush to shift discoveries into the evaluation and development phase.
Being an early mover in the lithium business is important for a number of reasons, including the need to secure sales deals with lithium processors, the mainly Asia-based companies that convert material such as spodumene concentrate into chemically usable forms such as lithium hydroxide and lithium carbonate.
The fact that both Pilbara and Altura have agreed to such high interest rates to ensure they can raise the debt component of their financing arrangements is a guide to the urgency they recognise in getting into production as quickly as possible – almost certainly to ensure that rivals do not beat them to the market.
In business, such an urgent approach is dubbed first-mover advantage.
Will it work? Will Pilbara and Altura be able to succeed as businesses by agreeing to pay high rates of interest on their debt, or will the annual servicing obligation hamstring their financial performance?
The answer to those questions is a function of time, demand for lithium, rival entrants in the market, and the price of lithium not falling because of oversupply and slower-than-expected growth in demand.
Deutsche Bank believes lithium (in its many forms) will slip in price over the next few years as supply more than matches demand, before surging higher after the year 2023.
Canada-based bank Canaccord Genuity described Altura’s debt package as ‘a major milestone’, which ensured limited equity dilution (meaning the company didn’t have to issue many new shares).
However, the cost of the package is described as expensive, with its high interest rate and the requirement to issue equity warrants that can be converted into shares.
“With traditional bank debt typically not available to hard-rock lithium projects, this should be seen as a reasonable outcome against the potential dilution from full equity funding (issuing more shares), or deferring the project until cheaper financing becomes available,” Canaccord said.
The challenge now for the emerging lithium producers is to deliver on the promise of being early movers in a new industry with profits being applied to a rapid pay down of debt.
While that will be a heavy lift, there is a significant WA precedent of an emerging miner successfully managing high-cost debt in its early years.
Fortescue Metals Group struggled in its early days to fund its iron ore mines, but has emerged as one of Australia’s top 20 companies – and only had to pay between 4.75 per cent and 5.125 per cent on its latest issued of unsecured notes.