GMP and Macquarie Equity Research on Polaris Minerals

Now that they are a client of Wellington Financial Fund III, we care deeply about the research being published on TSX-listed Polaris Minerals (PLS:TSX). They are in the aggregates business, which is a first for us since our firm was founded in 2000. Here are two Research snaphots from GMP Securities and Macquarie Capital Makets Canada:

GMP Research:

“Completes purchase of land in the Port of Long Beach, California and bridge financing

Polaris will own 66% of Pier B, CEMEX (their strategic partner) will own 34%. The price of the
acquisition is $15.8mm for Polaris’ interest and it will be financed with a $20mm loan.

We are maintaining our BUY recommendation and our target of $7.50/share (unchanged) based on a 1.0x multiple (unchanged) to our NAV of $7.34/share (down from $7.38/share).

Late last night, Polaris announced the closing of their Pier B acquisition, which was originally discussed in our August 5th 2008 Mid-day comment. Recall that Polaris announced their intent to purchase a parcel of land at Pier B, in the Port of Long Beach, California, for US$15.18 million.
Based on this transaction Polaris will own 66% of Pier B and Cemex, their strategic partner, will own 34%. The price of the acquisition is $15.8 mm for the PLS interest, putting the total acquisition price in line with our expectation of around $24mm.

The Polaris portion of the transaction will be financed by a $20mm one-year term loan with GMP
Investment Management LP [and syndicate].

This is a similar financing approach that Polaris used for the Orca Quarry when they completed a $60mm debt financing with Ingalls and Snyder LLC prior to building the mine. At the end of Q2/08, Polaris had $8.3 mm in cash. We assume that the remainder of the bridge loan will likely be for completion of the Eagle Rock feasibility study.

The reason CEMEX has only a 34% interest at this point is that the Eagle Rock feasibility study has yet to be completed and the Polaris/CEMEX agreement does not include Eagle Rock; it only includes aggregate distribution from the Orca Quarry. Once the feasibility is complete CEMEX could decide to invest in Eagle Rock or sign a distribution agreement for Eagle Rock’s crushed rock. Should this occur, CEMEX would then likely bring their interest in Pier B to 50% acquiring a further 16% interest.

The Pier B acquisition is a key strategic move by Polaris. With the San Francisco market already ring fenced by Polaris/CEMEX, this transaction essentially allows them to focus on the Los Angles market. Pier B is deep water port site and provides Polaris with the opportunity to construct an aggregates terminal, a crushed rock terminal and ultimately a cement facility with CEMEX; all close to very good infrastructure.

Pier B has the size to accommodate a 3 mm tonnes per year terminal even though it has the same footprint as the Richmond terminal in San Francisco. We expect that the emission bubble at Pier B will be in line with the contemplated plant size. The capital and operating cost will be shared between Polaris and CEMEX with CEMEX having exclusive distribution rights for the aggregates.

Pier B offers Polaris the opportunity to access an aggregate market where quarries have been closing. The Los Angeles market is the largest market for construction aggregates in North America and is one that is a top priority for the future CEO at Polaris, Herb Wilson.

It is expected that permitting for Pier B will take about 18 months and require that Polaris and CEMEX put a concrete cap in place over the whole Pier B site thereby removing any need for site remediation. First shipments from Pier B would likely be in 2011. We expect the capital cost of constructing a terminal at Pier B to be around $27 mm, although this amount is likely to increase given capex inflation pressures.

We have previously attributed values of $4.2mm in cash and $15.8mm to pier B in our NAV calculation, offset by the $20mm one year loan. Adjusting our model to include the warrant issue, our NAV is now $7.34/share from $7.38.share. Our NAV does not include a value for Eagle Rock at this point. We are lowering our 2008 EPS to reflect the higher interest expense; we had previously forecasted an 8% interest rate. We have also lowered our 2009 EPS to reflect interest payments at a rate of 15%, which is almost double our 8% estimate. Our new 2008 EPS is now a loss of ($0.05)/share from a loss of ($0.03)/share. Our 2009 EPS is now $0.07/share from $0.11/share.

Although we have decreased our earnings, we still believe in the long term thesis for Polaris. The 2009 shipment targets in our model conservative and achievable. Polaris is still in a growth phase and in our view will not be able to benefit from economies of scale until early next year.”

Macquarie Research:

“Building for the long term
(All figures in USD unless otherwise noted)

Event

Polaris Minerals reported 2Q08 EPS of ($0.05) and CFPS of $0.01, in line with our expectations and comparable 1Q08 EPS of ($0.06) and CFPS of $0.01.

Aggregate sales were down from 521,000 tons in 1Q08 to 500,000 tons in 2Q08. Production dropped from 793,000 tons to 581,000 tons QoQ.

Impact

Gross margin per ton rose to $0.79 in 2Q08 from $0.42 in 1Q08. The rise in gross margin is attributed to increased sales prices and improved throughput at the Richmond Terminal. Although margins were strong, average costs also increased due to the impact of higher fuel prices for shipping.

Earnings revision

We have adjusted our estimates to reflect the quarterly results and higher operating costs. Our 2008 and 2009 CFPS dropped from $0.10 to $0.01 and from $0.32 to $0.20, respectively.

Price catalyst

We are reducing our price target to $9.00 to reflect our lower cash flow estimates. Our target represents a discount of 23% to our NAV.

Polaris expects improved sales in the third quarter, which typically has the highest sales volumes of the year. The company is maintaining its revised production guidance of 2.1–2.5m tons for the year.

An updated technical report from the Orca Quarry is expected this fall, and the feasibility study for Eagle Rock is expected by the end of 2008.

Action and recommendation

We maintain our Outperform rating, but stress that a long-term investment outlook is required. The recently acquired Pier B at Long Beach will provide a strong base for expansion of terminal capacity for production from Orca and Eagle Rock into the L.A. market. In the near term, we remain cautious due to the weak construction market in California; in the long term, ongoing supply concerns and high barriers to entry in the state bode well for the company and
for the stock.”

MRM
(disclosure – our Fund III owns warrants in PLS)