Uk Equity Research

UK equity research 14 September 2009

Mining, FTSE AIM

Buy

Titanium Resources Group*

from Neutral

A capital idea

Current price Target price

7.62p

The year 2008 was tough for many mining companies, but few more so than Titanium

20p

Resources Group (TRG). The company closed ranks to stabilise the operation and cut costs to recover from the capsizing of Dredge 2. As the group prepares to increase production, the stock is trading at a very attractive 40-80% discount to the market on a

Market cap: Shares in issue: Gearing (FY1): Interest cover (FY1):

range of valuation metrics. In our view, TRG is one of the best recovery plays in the

£17.9m 234.8m 12.9% 1.1x

sector and we again upgrade to a Buy recommendation, setting a 20p target price.

Year to Dec

Full valuation data on back page Performance 1 month: 3 month: 12 month: High/low: 12 months: Last results: Next results: Next event:

Stock All-Share 79.4% 6.1% 64.9% 13.2% -49.2% -6.1% 15.0p / 3.3p

•

TXR.L / TXR LN

•

• Analyst:

Tim Dudley 020 7012 2097 [email protected]

John McGloin 020 7012 2090 [email protected]

Priced at close, 11 September 2009

*Arbuthnot acts as broker and/or advisor to this company and has agreed to publish research on it at least annually.

PBT $m

EPS c

EPS growth %

DPS c

Yield %

P/E x

EV/EBITDA x

VORR x

2008A

49.4

-32.7

-48.6

701.3

0.0

0.0

na

-3.0

-0.3

2009E

43.9

-10.2

-3.6

-92.5

0.0

0.0

na

16.5

-1.0

2010E

54.9

2.6

0.6

-117.7

0.0

0.0

19.3

4.4

1.2

2011E

76.0

14.0

3.1

382.0

0.0

0.0

4.0

0.6

0.1

Source: Arbuthnot estimates, company data

Interims, 14 Sep 09 Prelims, 6 Mar 10 Prelims, 6 Mar 10

Reuters/BBG:

Sales $m

•

Heavily discounted by the market. On a 2010E basis, the market is currently applying a 40-70% discount to peers on several valuation multiples including EV/sales, EV/EBITDA and P/E. The market value represents 30% of net assets, which is an 80% discount to peers. On a DCFbased valuation, TRG is trading at 20% of our generated NPV, which is a 70% discount to peers. TRG’s in-situ reserve value also trades at a c.80% discount, although its basket value of products per tonne of ore is c.50% higher than closest peer, Kenmare Resources. We think this heavy discounting is unwarranted given the high quality and world-class nature of TRG’s rutile deposit. Positive progress on costs in H1, with production to increase in H2. TRG cut costs by 42% in H1 as the company scaled down the operation following last year’s D2 incident. Cost reductions were greatly assisted by a $9.9m cut in fuel costs as the operations benefited from the newly-commissioned HFO power plant. H1 sales were $19.8m, narrowing the operating loss over H1 2008 by c.90% to -$0.9m, and generating positive cash flow from operations of $2.3m. The company expects to improve the performance in H2, as production will increase as Dredge 1 enters a higher-grade zone. With full-year production of 75kt expected, generating sales of c.$40-45m, we think the scale of the operation has been missed by the market. Strategy to increase capacity selected. After assessing the options to increase the mine’s production capacity to improve economies of scale, TRG’s preferred strategy is to complete the construction of Dredge 3 (D3). With a 12-month lead time and a cost of c.$25m, we expect D3 could deliver additional production capacity of 30ktpa, providing a c.30% capacity increase. However, as we stated in a bulletin on 25 June following a site visit, TRG would require an injection of capital to pursue this option. Valuation and recommendation. Given the 40-80% trading discount in TRG’s current share price relative to its closest peers on a number of physical and financial metrics, we see significant upside in the stock. We generate our target price using an NPV valuation of £110m, setting a target price (assuming likely dilution) of 20p, which could be achieved if the company can recapitalise to increase production. We therefore upgrade our recommendation from Neutral to Buy.

Arbuthnot is authorised and regulated by The Financial Services Authority and is a member of The London Stock Exchange. Registered Office: Arbuthnot House, 20 Ropemaker Street, London EC2Y 9AR. Registered in England Number: 762818

Titanium Resources Group*

14 September 2009

Overview

Company activities

Titanium Resources Group (TRG) operates the rutile-rich Sierra Rutile Mine in Sierra Leone, which the company restarted in 2006. The mine produces rutile and ilmenite, primarily for the titanium dioxide pigment market for use in paints, paper and plastics. TRG is operating one dredge to produce rutile at a rate of c.75-100ktpa, generating sales of between c.$40-50m pa, since the second dredge capsized in July 2008. With one dredge operating, TRG is evaluating development and funding options to expand production to realise some economies of scale to overcome the high fixed cost base of operating a large mine in Sierra Leone. Key issues on which investors must take a view

Although TRG’s operations are large scale and contain significant net assets relative to the market value, for the company to move into robust profitability it will require capital to expand production. The operation needs more than one dredge working to adequately cover fixed overheads and be profitable. Likely expansion scenarios require between c.$20-40m to be invested, with the company preferring the option to complete construction of D3, at a cost of $25m. Therefore, investors must be comfortable that the company can first access the capital and second, execute the expansion plans. Likely direction of consensus revisions

While not widely followed, consensus is likely to be most sensitive to the success of any recapitalisation of the company. The markets for the company’s rutile product have remained fairly robust during the recent downturn. Therefore, with improving global market conditions, we would expect that a number of industry players might be interested in the quality and scale of the deposit, particularly once profitability can be demonstrated. Consequently, a clear development plan, improved market communication and effective delivery are likely to attract a higher market rating for the company. Valuation and reason behind target price

Given TRG’s 40-80% trading discount relative to its closest peers on a number of physical and financial metrics, the potential upside in the stock is apparent. We generate our target price using our NPV valuation (post securing finance) of £110m. Assuming that there is a likely dilution in the shares in the future, we establish a price range (dependent on the amount of dilution) of 20-28p per share. We have settled on 20p for our target price, which could be achieved if the company can re-capitalise to increase production. We therefore place a Buy recommendation on the stock and expect that the company will continue to be rediscovered by the market. Risks to our view

The key risks are 1) securing necessary funding, which we think has a good chance of being overcome. 2) The execution risk of operation and expansion plans, combined with increased cost control. Recent management changes improve the outlook in this regard. 3) Commodity markets - while the price has increased for TRG over the past 12 months, a prolonged US recession could affect consumption and demand for the company's products. Finally, 4) Sovereign risk is an important consideration, although this is reduced by the positive relationship the company has with the Sierra Leone government and the relative stability currently achieved in the country.

2

Arbuthnot Securities

Titanium Resources Group*

14 September 2009

Investment case We view Titanium Resources Group as one of the best recovery plays in the junior mining sector. The company is heavily discounted vs. its peers and asset backing, resulting from a disastrous 2008 in which a dredge capsized and a major shareholder liquidated its fund. A recapitalisation of the currently break-even operation would allow the company to increase production and benefit from improved economies of scale. Mine is in production, with

•

sales of c.$40-45m

Trading at a 40-80% discount to

•

peers on a range of physical and financial metrics

Significant inherent value: Our site visit in June this year refocused our attention on the inherent value in the group. •

2009 production is c.75kt of rutile per annum, generating c.$40-45m turnover, which means the current operations are cash flow breakeven. Net assets represent c.30% of the current share price, which is a c.80% discount to peers, and include power plants, port & barging facilities as well as other saleable plant and equipment.

•

TRG’s deposit is the world’s largest natural rutile deposit. This is an advantage as most deposits in production are ilmenite rich, whereas TRG’s resource contains over 65% rutile. Rutile contains twice the titanium concentration of ilmenite and requires less processing, which means rutile can command a six-fold price premium.

Heavily discounted by the market: A review of TRG’s closest peers, many of whom have also had their problems, demonstrates that TRG has been heavily penalised for its troubles. •

The basket value of minerals per tonne of ore is 55% higher than TRG’s closest peer, Kenmare Resources. Furthermore, based on the in-situ value of the reserves of c.$2bn, relative to the group’s EV, TRG trades at a c.80% discount to its peers.

•

Compared to its peers, TRG trades on a 40-80% discount on several metrics including EV/sales, EV/EBITDA, P/E and P/Net Assets. On a DCF-based valuation, it is trading at 20% of our NPV, which represents a c.70% average discount to its peers.

Figure 1: Trading discounts on valuation metrics 100%

Discount to Peers

80%

60%

40%

20%

0% EV/Reserves

P/NPV

P/Net Assets

2010E EV/sales

2010E 2010E P/E EV/EBITDA

Source: Arbuthnot estimates

TRG has opted to complete construction of D3, rather than resurrect D2, requiring $25m

We generate a valuation of 20p, on a post-financing basis

•

Capital is required to increase production capacity: To improve economies of scale, funds are necessary to increase production. TRG intends to complete the construction of D3, which will increase the mine’s production capacity by c.30%. We estimate that to complete construction of D3 and undertake other smaller projects to improve processing efficiencies will cost c.$25m. The lead time is likely to be 12 months and is dependent on TRG raising the necessary funding.

Our target price is based on our NPV valuation of £110m. Assuming that there is dilution in the shares in the future, we establish a price range (dependent on the amount of dilution) of 20-28p per share. We have settled on the low end of the range ie, 20p, for our target price, which could be achieved if the company can re-capitalise to increase production.

Arbuthnot Securities

3

Titanium Resources Group*

14 September 2009

Sierra Rutile mine Sierra Rutile mines titaniumbearing mineral sands from the world’s largest natural rutile deposit

Sierra Rutile mines titanium-bearing mineral sands and holds the tenements covering an area considered to be the world’s largest natural rutile deposit. The operation currently produces the titanium minerals Rutile (TiO2) and Ilmenite (FeTiO3) concentrates for export. Figure 3: Location of operations in Sierra Leone

Africa

Sierra Leone

Freetown Nitti Port

Sierra Rutile mining area

Sherbro Island

Source: Company data

The operation is located in Sierra Leone, 135km south-east of Freetown and 30km inland from the coast

At the end of 2008, Sierra Rutile was 97.5% held by Titanium Resources Group, with the government earning-in a 30% interest over a c.15-year period by relinquishing PAYE tax. The operation is located 135km south-east of Freetown and 30km inland from the coast. The leases were granted by an act of parliament, with 33-year terms from 2002, making them among the most secure in Sierra Leone. Mining is currently performed using one bucket line dredge, which was re-commissioned in 2006. The mineral sands are dredged from constructed ponds before being concentrated and processed. The product concentrates are then transported to Sierra Rutile’s port on the Sherbro River for export. Figure 2: products and equipment

Rutile

Dredge 1

Source: Company data, Australian Mineral Atlas

than ilmenite

Sierra Rutile holds mining leases over a land area of 580km2, containing proven and probable reserves of 259Mt at 1.48% recoverable rutile, which gives 3.8Mt of rutile and an expected mine life of c.20+ years. The mine is unique due to its high concentration of rutile. Rutile is a premiumquality titanium mineral as it contains a higher concentration of titanium than ilmenite. The deposit consists of 65-70% rutile, 15-20% ilmenite and 3-5% zircon. Mineral sand deposits with high concentrations of rutile are rare, as it is more usual to find high concentrations of the lower-

4

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Rutile is a premium-quality titanium mineral as it contains a higher concentration of titanium

Titanium Resources Group*

14 September 2009

quality and lower-value ilmenite, which require additional processing to remove the iron content required to meet the specifications for titanium product feedstocks.

Recent site visit We visited the Sierra Rutile operation in Sierra Leone on 1819 June 2009

We visited the Sierra Rutile operation in Sierra Leone on 18-19 June 2009. D1 was operating in the Lanti pond, mining a zone of c.1.5% grade material and heading toward a higher-grade section (over 2% rutile). The company expects D1 to reach this higher-grade section in Q4 and we estimate that this will boost production from c.6ktpm to c.9ktpm towards the end of the year. We anticipate that these higher grades will continue out to 2012, resulting in a 20% YoY increase in production in 2010 (adding c.$8m in revenue). Development options

Management is considering options to increase production

Completing the construction of Dredge 3 appears to be the most attractive option

At the time of our visit, management was in the process of evaluating the options for increasing the mine’s output. In the interims (14 September 2009), the company announced that its preferred strategy to increase production is to complete the construction of Dredge 3. Previously, D2 was intended to provide scale by doubling production to 200kt; however, the company is now investigating non-D2 opportunities such as starting D3 and utilising a dry mining fleet to increase production. If the company were to proceed with this option, we believe the mine would be capable of providing a sustainable and profitable c.130ktpa production rate (c.$70m sales), offset by reduced capex needs and deferred (unproductive) pond relocations. D3’s pontoon has been completed and all the parts for the dredge’s construction are on site, although work was halted following the D2 incident. To finish the job, the company only needs to acquire the processing components for the dredge and auxiliary equipment (tenders, loaders). Including capital to also undertake projects to improve processing efficiencies (which may add a further c.5ktpa in capacity), these works are expected by the company to cost $25m and take 12 months to complete construction and commission. Power plant reducing fuel costs

The new power plant is almost cutting power costs in half

We saw the new HFO power plant in operation. It is already providing significant cost benefits (reducing power costs by over 50% from 34c/kWh to 13-14c/kWh) as fuel represents c.25% of the operating costs. However, without D2, the reduced demand is diluting the benefits as when the load is lower, the plant switches to run on diesel. While diesel is 20% more efficient than the old plant, the periods of low load have lasted up to four hours per day. The company is investigating lowering the tolerance limits imposed by the OEM, which requires the switch from diesel to HFO. Even with these issues, the new plant helped reduce fuel costs by $9.9m in H1. Operation now stabilised

Production is currently breakeven, but TRG needs to increase production to realise economies of scale

Currently, we estimate the mine (with lower grade) is barely washing its face on a cash basis. Given the first half production, we anticipate production of 75kt rutile in 2009, providing c.$40-45m in sales, totally offset by mine cash costs (c.$3.2m per month), capex, WC and SGA costs. Overall, we had our reservations given the company’s history, but the site visit reminded us of the mine's potential as the main asset - a world class rutile resource - is still there. Production needs to increase to realise economies of scale, with the key inputs being time and capital.

Arbuthnot Securities

5

Titanium Resources Group*

14 September 2009

Figure 2: Operational gearing 50%

Operating Margin

30% 10% -10% -30% -50% -70% 60

80

100

120

140

160

180

200

220

240

260

Rutile Production, kt Source: Company data, Arbuthnot estimates

Dredge D2 insurance claims One insurance claim on the dredge 2 incident has been settled, with the potential for further cash to be paid

In April, TRG reached a Settlement Agreement with one insurer in relation to the company's insurance claims, following the capsizing of Dredge D2. The settlement was with the second largest of the reinsurers of TRG’s insurance policy for property damage and business interruption. The amount paid out so-far was $3.5m. With outstanding claims with the remaining insurers, there is the potential, though it might take some time, to realise further cash. The company is at this stage pursuing its claims through the courts against the balance of the reinsures, and will incur legal costs in the process.

6

Arbuthnot Securities

Titanium Resources Group*

14 September 2009

Comparative valuation Closest peers are Kenmare Resources and Iluka Resources

We selected two of the company’s closest peers for a market comparison: ASX-listed Iluka Resources and AIM-listed Kenmare Resources, with both companies having had their share of troubles over the last 12 months. The major diversified miners such as Rio Tinto and Anglo American’s BEE spin out, Exxaro, are key players in the industry, but we chose to focus on the two other companies that are primarily mineral sand producers.

Value of reserves TRG’s basket value per ore tonne is better than Kenmare, while the relative value of the reserves is discounted 80% by

Given that the mineral sand peers have different quantities of each mineral sand, instead of comparing the grade of the contained minerals, we calculated an in-situ value per tonne of ore based on the current market prices for rutile, ilmenite and zircon.

the market

Figure 3: Comparative reserves valuations

Iluka Resources

Iluka Resources

Kenmare Resources

Kenmare Resources

Titanium Resources Group

Titanium Resources Group

0

5 10 15 20 In-Situ Value per Reserve Ore tonne ($/t)

25

0% 5% 10% 15% 20% 25% Enterprise Value (EV) / In-Situ Value of Reserves

Source: Company data, Bloomberg, Arbuthnot estimates (excludes bauxite reserves)

This provides a relative measure of the value of the reserve base and the potential margin available for each producer. The higher the in-situ values per tonne are, the higher the potential margins if extraction costs are similar. We also calculated the enterprise value (EV) as a proportion of the in-situ value for the companies, as shown in the right hand graph in Figure 2 above. The two peers traded at 22% of the value of the in-situ reserves. Given the value per tonne of TRG’s reserves, particularly when compared to Kenmare, it is surprising to again see TRG trade at a discount of over 80% discount to the peers.

Arbuthnot Securities

7

Titanium Resources Group*

14 September 2009

Financial metrics We also reviewed the financial metrics of the mineral sands producers. As each company (for a variety of reasons) is expected by the market to be loss making in 2009, we first compared EV/sales over the three-year window and then compared the companies’ EV/sales, EV/EBITDA and P/E multiples for 2010E. We also provide our standard P/NPV measure based on our DCF models for the companies. EV/sales

While on a tonnage basis, consensus estimates for 2010 suggest Kenmare will produce eight times more product tonnes (c.800kt) than TRG (c.90kt), the actual value is much more comparable. TRG has forecasted sales in 2010 of c.$50m, which is only c.40% less than Kenmare’s forecasted sales of c.$90m (being mostly ilmenite). In 2009, the difference in sales between the two companies is only c.15%, as Kenmare is ramping up commercial production. Therefore, we have reviewed the relative values of the three companies on an EV/sales basis, which demonstrates that TRG is trading at a 40-90% discount to Iluka and Kenmare in 2009 and 2010. TRG is discounted by 45-90% on

Figure 4: Comparison of EV/sales

its 2009/10 EV/sales forecast

14

EV/SALES

12 10 8 6 4 2 0 2008A

2009E

Iluka Resources

Kenmare Resources

2010E Titanium Resources Group

Source: Company data, Bloomberg, Arbuthnot estimates

EV/EBITDA & P/E

metrics

Looking at our and consensus estimates for 2010 including EV/EBITDA and P/E, we continue to see a discount for TRG of between 40-70%. Note that TRG’s 2010 estimates are not dependent on the company increasing capacity (which benefits 2011), only on increasing production from higher grades at D1.

8

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TRG is trading at a 40-70% discount on 2010 financial

Titanium Resources Group*

14 September 2009

Figure 5: Comparison of 2010E financial metrics

EV/SALES

EV/EBITDA

P/E

0

5

10

15

20

2010 Multiples Iluka Resources

Kenmare Resources

Titanium Resources Group

Source: Company data, Bloomberg, Arbuthnot estimates

On our 2010 estimates, TRG trades on multiples of 1x sales, 5x EBITDA and 12x P/E, potentially dropping to 4x P/E in 2011 if the D3 expansion goes ahead (including our assumed share dilution). Net asset backing

We believe the market valuation for TRG’s net assets is far too low given the substantial amount of plant and equipment the company owns, including the recently-constructed c.$30m power plant. Compared to the peers, who trade above their net asset value, TRG is trading at a discount of c.80%. TRG has debt of c.£30m, owed to the government of Sierra Leone, which has been and should continue to be very cooperative in its rates and repayments. Our recent site visit highlighted

Figure 6: Price/net assets on balance sheet

the assets held by the group,

1.8

which are heavily discounted by the market

1.6

P/Net Assets

1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 Iluka Resources

Kenmare Resources

Titanium Resources Group

Source: Company data, Bloomberg, Arbuthnot estimates

Price per NPV

We have also compared the current trading discount to the NPV of the company’s operations and projects. This shows that the peer group on average trades at c.50% of the NPV, while TRG is trading at 20% of the NPV, which equates to a discount to the peers of c.70%.

Arbuthnot Securities

9

Titanium Resources Group*

Based on our NPV valuation,

14 September 2009

Figure 7: P/NPV comparison

TRG trades at 20% of NPV - a

1.0

70% discount relative to peers

0.9 0.8

P/NPV

0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 Iluka Resources Source: Company data, Bloomberg, Arbuthnot estimates

10

Arbuthnot Securities

Kenmare Resources

Titanium Resources Group

Titanium Resources Group*

14 September 2009

DCF valuation & target price We value TRG on a DCF basis over a 20-year mine life

We use our DCF model for TRG’s operations to generate our valuation and target price. We have run the model over the 20-year mine life, and assumed that D3 is constructed and no further expansions are performed. Our numbers also assume that a full equity re-capitalisation takes place, and therefore include the potential share dilution. Table 1: Valuation As at 11 September 2009

(£m)

Sierra Rutile Mine – DCF based NPV at a 10% discount rate

120

Cash/(debt) (End H1 2009)

-25

Total

95

-

Current value per share Current shares (m) Current NPV per share (p)

246 (rounded)

40

Value per share post possible fundraising Sierra Rutile Mine – DCF based NPV at a 10% discount rate

120

Cash/(debt) – post fundraise (£m)

-10

Total valuation post fundraise (£m) Possible range in the number of new shares issued (m) Possible valuation per share post fundraise (p) Target price (p)

110 150 - 300 20 - 28 20

Source: Arbuthnot estimates

We generate a post financing valuation of c.£110m, setting a TP of 20p

Based on the above assumptions, we calculate a valuation for the mine of £120m. Given our assumption that TRG will go to the market to raise funds, we include a possible share dilution range, which generates a post fundraising valuation of £110m and a value per share ranging from 20p to 28p. We have taken 20p as our revised target price, which represents c.2.6x upside to the current share price. On this basis we upgrade to a Buy recommendation.

Arbuthnot Securities

11

Titanium Resources Group*

14 September 2009

Titanium market Rutile has a higher titanium and titanium pigment content vs. ilmenite, providing the rutilerich TRG with a unique market advantage

TRG’s main business, Sierra Rutile, sells titanium-bearing heavy mineral sands into the titanium feedstock for processing into titanium dioxide pigment (for paints, paper and plastics) and titanium metal. In this market, TRG has a key advantage as its mineral sand resource is rutile rich, which attracts premium prices due to its significantly higher titanium and titanium pigment content compared to ilmenite. The higher grade makes rutile significantly easier and cheaper to process into the titanium mineral products, making it a desirable, high-quality blend feedstock. Figure 8: Titanium and titanium dioxide content of rutile vs. ilmenite

Rutile

% Titanium (Ti)

Ilmenite

Rutile

% Titanium Dioxide (TiO2)

Ilmenite

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Source: Arbuthnot estimates (in pure state)

Rutile commands a 6x price premium to ilmenite

TRG holds a competitive advantage due to the high grade and scarce nature of natural rutile as most mineral sand deposits around the world are ilmenite rich. In monetary terms, TRG can command a price premium of up to 6x vs. the ilmenite sands producers.

Titanium demand Demand for titanium minerals is driven by global demand for titanium dioxide (TiO2) pigment. The titanium dioxide pigment industry consumes 93% of the feedstock, which is used to make a highquality, white opaque pigment used in paint, paper and plastics. It is usually sold under term contracts. Figure 9: Titanium mineral feedstock consumption Titanium metals, 7%

Titanium Dioxide Pigment (TiO2), 93% Source: US Geological Survey

Titanium dioxide pigment demand

The titanium dioxide pigment market is $10bn in size and demand has increased at an average rate of 3% pa over the last 30 years, in line with the long-term growth in the world economy.

12

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Titanium Resources Group*

14 September 2009

Titanium dioxide pigment is predominately used in paints and coatings, as it is the highestquality, opaque and bright white pigment. Figure 10: Titanium dioxide demand by end use Paints & coatings, 60%

Plastics, 24%

Other, 7% Paper, 9% Source: Tronox Inc,

Figure 11: Titanium dioxide pigment demand growth 8.0

world TiO2 pigment demand, million tonnes

3% pa growth forecast 6.0

4.0 +3% pa actual growth 2.0

0.0 1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

2016

Source: TZMI, IBMA, Lyondell

China is now the main driver of titanium dioxide pigment demand

Historically, consumption of titanium dioxide pigment was concentrated in North America and Western Europe; combined these regions accounted for more than half the world’s demand. However, as Chinese production and demand increases, the country’s consumption is expected to grow at least at a rate of 7% pa over the next ten years, representing a 43% total increase in demand. This increase should offset lower growth in traditional markets. Figure 12: Forecast 10-year titanium dioxide pigment demand growth by region

Asia Pacific, 16%

Nth America, 18%

Middle East & Africa, 7%

Western Europe, 6%

Central Europe, 6%

China, 43%

Central & Sth America, 4%

Source: TZMI, IBMA

Arbuthnot Securities

13

Titanium Resources Group*

14 September 2009

Titanium metal demand

While pigment demand takes the largest share of the market, the titanium metal industry is also expanding driven by the growing use of titanium. Titanium’s use has risen due to its low density relative to its strength and corrosion resistance. Demand for the metal has come from industrial applications and the aerospace industry, where titanium can account for up to 10% of the weight of a commercial aircraft. Figure 13: Titanium metal demand by end use

Figure 14: Titanium metal production inputs

industrial, 49%

Alloys & Scrap, 25%

consumer / other applications, 13%

aerospace, 38%

Titanium Sponge, 75%

Source: Roskill - Economics of Titanium Metal Report, Arbuthnot estimates

Producers are installing new titanium sponge melting and milling capacity to meet growing demand for high-quality material from the aerospace industry. With the number of passenger aircraft expected to more than double by 2025 and each aeroplane using increasing quantities of titanium, demand is rapidly rising. Titanium sponge makes up 75% of the input for titanium metal products and is produced from processing natural or synthetic rutile. We also expect this increase in demand to flow down through to high-grade rutile ores.

Supply Currently, c.6Mt of titanium-bearing mineral sands are produced each year, of which 9.5% are rutile. This production comes from an estimated worldwide resource base of 1.3bn tonnes of deposits, of which 8% is rutile. Recent increases in the share of rutile production have been driven largely by the re-start of operations at the Sierra Rutile mine in 2006.

7000

12%

6000

10%

5000

8%

4000 6% 3000 4%

2000

2%

1000 0 1996

0% 1997

1998

1999

2000

Ilmenite Source: US Geological Survey

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Arbuthnot Securities

2001

2002 Rutile

2003

2004

2005

2006

Rutile % of production

2007

2008

Rutile % of production

Mine Production, tonnes

Figure 15: World production of rutile and ilmenite

Titanium Resources Group*

14 September 2009

Figure 16: World resources of rutile vs. ilmenite Rutile 8%

Ilmenite 92%

Source: US Geological Survey

Prices The price history and comparative prices for titanium-bearing minerals and titanium consumables are displayed Figure 17 below. Figure 17: Titanium feedstock prices 800 700

Titanium Ore Price ($/t)

600 500 400 300 200 100 0 Mar Sep Mar Sep Mar Sep Mar Sep Mar Sep Mar Sep Mar Sep Mar Sep Mar Sep Mar Sep Mar Sep Mar Sep Mar Sep 97 97 98 98 99 99 00 00 01 01 02 02 03 03 04 04 05 05 06 06 07 07 08 08 09 09 Titanium Ore Rutile Conc min 95% TiO2 Bagged US$/t FOB/Aus Titanium Ore Rutile bulk conc min 95% TiO2 Europe $/tonne fob/Aus Titanium Ore Ilmenite bulk conc min 54% TiO2 Europe $/tonne fob

Source: Bloomberg, Metal Bulletin

Rutile attracts a 6-8x premium to ilmenite…

Rutile prices can attract a premium of between 6x (for bulk rutile concentrate) and 10x (for bagged rutile concentrate) the price of ilmenite concentrate, because of its superior titanium concentration, quality and lower processing requirements. With the increasing demand for titanium-based products, premium quality producers are well-placed to obtain high prices and should continue to attract robust demand for its products from customers looking to up-blend lower-quality and plentiful ilmenite. This will become all the more pertinent as rising power costs make the economics of processing lower-quality ilmenite increasingly unattractive.

Arbuthnot Securities

15

Titanium Resources Group*

14 September 2009

Titanium Resources Group - Summary TXR LN / 7.62p / £18m / Buy 20 p*

Profit & Loss (pre-x) Revenues Expenses Depreciation Gross profit SG&A Operating profit non-operating gains share of JVs EBITDA PBIT Net interest PBT Tax PAT Minority interest Dividend NP (attr.) Diluted Shares (m) EPS (c) DPS Calendarised Adj EPS (p) Calendarised Adj EPS (USc) Balance Sheet Tangible assets Intangibles Other assets Investments Non-current assets Stocks Trade and other receivables (debtors) Cash and cash equivalents Current assets Total Assets Provisions Other liabilities Long term borrowings Non-current liabilities Overdraft Trade and other payables (creditors) Tax liabilities Current liabilities Total Liabilities Net Assets Total Equity Net Debt/(Cash) BV Cash flow Operating profit Depreciation Other non-cash Working capital Net interest (paid) / received Tax paid Cashflow from operating activities Capex Other asset additions /investments loan granted / repaid Acquisitions and disposals Cashflow from investing activities Ordinary shares issued (net) Dividends paid Increase in borrowings Cashflow from financing activities Net cash increase/(decrease)

83 16 83 557 475 80 420

67.8 -64.5 -7.8 -4.4 -3.7 -8.1 -0.3 -8.1 -6.5 -14.6 0.3 -14.3 -14.3 235 -6.1 -

*Priced as at 11 Sep 09 2008A

79 18 79 641 500 100 430

49.4 -64.7 -7.7 -22.9 -7.4 -30.3 -22.7 -30.3 -2.3 -32.7 -86.9 -119.6 -119.6 246 -48.6 -

2009E

75 17 75 549 525 130 460

43.9 -33.7 -8.2 2.0 -7.5 -5.4 2.8 -5.4 -4.8 -10.2 -0.1 -10.4 -10.4 284 -3.6 -

90 18 90 457 551 130 490

54.9 -33.7 -8.2 13.0 -7.5 5.5 13.6 5.5 -2.9 2.6 -0.0 2.6 2.6 396 0.6 -

2011E

121 24 121 413 600 130 530

76.0 -42.7 -9.5 23.9 -7.5 16.4 25.9 16.4 -2.5 14.0 -0.0 13.9 -1.6 12.3 396 3.1 -

-3.0 -6.1

-26.2 -48.6

-2.6 -4.3

0.4 0.6

1.9 3.1

142.3 13.2 87.1 242.6 14.9 22.3 25.7 62.9 305.5 2.8 44.1 47.0 0.1 17.2 17.4 64.3 241.2 241.2 18.5 228.0

125.5 13.3 0.1 138.9 14.5 24.0 7.4 45.9 184.7 3.3 45.1 48.3 0.0 21.5 21.5 69.8 114.9 114.9 37.7 101.6

122.9 13.3 0.1 136.3 13.2 15.4 31.4 59.9 196.2 3.3 0.1 48.2 51.5 13.5 13.5 65.0 131.2 131.2 16.9 117.9

142.7 13.3 0.1 156.1 8.2 16.5 18.0 42.7 198.8 3.3 0.1 48.2 51.6 13.5 13.5 65.0 133.7 133.8 30.3 120.4

136.3 13.3 0.1 149.6 3.8 3.8 62.2 69.8 219.5 3.3 0.1 48.2 51.6 20.3 20.3 71.8 147.6 147.7 -14.0 134.3

-17.0 7.8 5.2 -1.9 2.1 -0.5 -4.3 -57.5 0.0 -57.5 35.0 35.0 -26.8

-40.4 7.7 8.2 0.5 -0.8 -0.4 -25.1 -33.0 28.8 -4.2 11.1 11.1 -18.2

-5.4 8.2 1.7 1.9 -1.8 -0.0 4.6 -5.6 0.0 -5.6 25.0 25.0 24.0

Source: Company data, Arbuthnot estimates

16

2010E

Arbuthnot Securities

5.5 8.2 3.9 -2.9 -0.0 14.6 -28.0 -28.0 -13.4

16.4 9.5 23.9 -2.5 -0.0 47.2 -3.0 -3.0 44.2

Year end December ($m)

2007A

2008A

2009E

2010E

2011E

0% -12% -21% -6% -6% 8% 0.0

-46% -61% -242% -21% -104% 33% 9.7

6% -12% -24% -7% -8% 13% -

25% 10% 5% 2% 2% 23% -

34% 22% 18% 10% 9% 0% -

2007 -2.5 -2.1 -5.1 1.1 -223.3 1,794

2008 -0.3 -1.8 -1.3 1.5 -3.2 1,770

2009 -3.0 -0.0 5.7 1.6 25.9 1,683

2010 19.7 -0.3 2.9 1.3 5.3 1,444

2011 4.1 0.9 1.0 0.9 2.8 1,097

Valuation summary Mineral Sands x

Equity 100% 100%

x Total NPV (10% discount rate) Combined Chk Other Net Debt (YE) Total

100%

$m 196 196

$c/shr 79 79

£m 120 120

£/shr 49 50

275

112

165

67

42 153

17 62

25 95

10 40

-10% -27% -23% 17% 2% 0%

0% 0% 0% 0% 0% 0%

10% 27% 23% -17% -2% 0%

Ratios EBITDA Margin Operating Margin PAT margin ROCE ROE Net Debt to Equity Interest cover Valuation Metrics (CY) Year end December P/E Yield (%) Net Cash Generation (%) P/CF (ops) EV/SALES EV/EBITDA EV/Production ($/t)

P/NPV

0.2 x

Sensitivities Sale Price Grade/Recovery Opex Capex Exchange Rate

-20% -54% -46% 35% 4% 0%

20% 55% 47% -34% -4% 0%

Valuation by Asset

Mineral Sands 100%

Production & Cash Costs

140

700.0

Production

120

600.0

Cash Costs

100

500.0

80

400.0

60

300.0

40

200.0

20

100.0

0

0.0 2007A

2008A

2009E

Reserves & Resources Reserves (P) Rutile Total Reserves

Resources (M,I,Inf) Rutile Total Resources EV/Reserves: EV/Resources:

Cash Costs (£/t)

Production Summary Rutile (kt) Ilmenite (kt) Total Rutile Production Nominal [$/t] Cash cost [$/t] Rutile Price [$/t] Ilmenite Price [$/t] Average Sale Price [$/t]

2007A

Production (kt)

Year end December ($m)

2010E Equity 100%

2011E

Tonnes (Mt) 259.1 259.1

Grade (%) 1.5 1.5

Rutile (kt) 3,825.1 3,825.1

426 425.7

1.4 1.4

5,826 5,826.3

(including reserves) 100%

($/t) ($/t)

18.9 12.4

Titanium Resources Group*

Arbuthnot Securities

14 September 2009

17

14 September 2009

Titanium Resources Group*

Analysis of the strategic environment Porter's five competitive forces model 18

Suppliers

Total

Bargaining power of suppliers HIGH/MEDIUM AND RISING

Buyers Bargaining power of buyers

2

• The mining industry has experienced an upturn over the last two years and consumables are in short supply, notably Tyres and parts. TRG is principally a dredging operation and is therefore not exposed to the same factors as most of the industry.

MEDIUM FALLING

Industry competitors Rivalry among existing firms LOW/MEDIUM AND RISING

4

• Rutile production is limited to a small number of companies, for most rutile is a by-product of ilmenite production. TRG is unique in being primarily a rutile producer. Its proximity to the European market should make it the preferred supplier into Europe. • The big players in the sector are Iluka and Rio Tinto. Both companies have aspirations to expand operations. Kumba recently acquired Ticor.

Substitutes Threat of substitute products LOW AND STABLE

• Natural Rutile is the cleanest source of TiO2 and the company has experienced no problem in getting sales contracts to date. It is the closest supplier to the European market. The market is projected to be in deficit out to 2012

Potential entrants Threat of new entrants

5

LOW/MEDIUM AND RISING

• Natural Rutile is the preferred source of TiO2 for the chloride pigment process. It is unlikely that it will be substituted. Upgraded Slag (UGS) is the closest competitor but requires a higher energy input to produce. LOW

5

LOW/MEDIUM

4

MEDIUM

3

HIGH/MEDIUM

2

HIGH

1

Attractive competitive forces

• Rio Tinto's QIT Fer et Titane project in Madagascar is due on line at the end of the decade. This is a UGS producer and may present competition for TRG.

Unattractive competitive forces

SWOT analysis Strengths • Proven mining and process methods • Reserves and Resources have been verified by numerous consultants • Off take agreements in place for Rutile • Largest Natural Rutile deposit in the World

Threats • Professional personnel and mining equipment in short supply globally. • Downturn in US housing market could reduce pigment demand • A pure rutile play without the advantages of Zircon sweetener • Increased rutile production could negatively impact market

18

Arbuthnot Securities

4

• While there are a number of new projects in the pipeline, most of these are for ilmenite which is not a direct competitor.

Source: Arbuthnot (adapted from Porter 1980 p.4); ‘Total box’ represents sum of five forces: 25 = attractive industry, 5 = competitive industry

Source: Arbuthnot

3

• Because of the past history at Sierra Rutile the company has to demonstrate that it can maintain supply. Prior to closure brought about by the civil war the market paid a premium for the produce from Sierra Rutile.

Weaknesses • • • • •

Remote Site Sierra Leone perceived as unstable location Marginal with a single dredge Largest shareholder not represented on the board Has yet to prove profitability

Opportunities • High operational gearing driven by production increase • Production can be further increased through reprocessing tailings and satellite deposits • Developing Asia becoming a growing consumer of TiO2 • Proximity of premium product to European markets • Increase supply to titanium sponge market

Titanium Resources Group*

14 September 2009

Arbuthnot Securities, Arbuthnot House, 20 Ropemaker Street, London EC2Y 9AR Email: [email protected] Chief executive Neil Kirton 020 7012 2108 Research Head of research Xavier Gunner 020 7012 2083 Alternative energy & technology David Cunningham 020 7012 2082 Emerging companies Robert Sanders 020 7012 2084 Oliver Cummings 020 7012 2078 Engineering; electronics; tech hardware; aerospace & defence Michael Blogg 020 7012 2091 Housebuilders & contractors Kate Moy 020 7012 2074 Mining John McGloin 020 7012 2090 Tim Dudley 020 7012 2097 Oil & Gas Dougie Youngson 020 7012 2098 Real estate Nan Rogers 020 7012 2096 Support services: recruitment, automotive & related tech Xavier Gunner 020 7012 2083 Support services: consultancy, managed services David Brockton 020 7012 2093 Transport Gerald Khoo 020 7012 2089 Special situations Sneha Shah 020 7012 2081

Sales and trading Sales Simon Wickham (Head of sales) David George Melanie Sharp Nicholas Feldman Jonathan Clements Darren Winter Matt Hasson (Natural resources) Sales trading Paul Kersey (Head of sales trading) David Llewellyn Lisa Letham Mark Barnes Trading Bobby Tipping (Head of trading) Andy Lewis Edward Malone Investment funds Sales Rupert Stevenson (Head of investment funds) Matthew Kinkead Adam Gill Trading Calum Summers (Market making) Darren Papper Research Chris Young

020 7012 2038 020 7012 2039 020 7012 2092 020 7012 2045 020 7012 2044 020 7012 2042 020 7012 2037 020 7012 2030 020 7012 2031 020 7012 2029 020 7012 2019 020 7012 2017 020 7012 2028 020 7012 2027

020 7012 2014 020 7012 2013 020 7012 2025 020 7012 2009 020 7012 2015 020 7012 2016

Explanation of recommendations Our analysts award a Strong Buy rating in those cases where they believe there will be total shareholder return - defined as the absolute rise in share prices plus dividend payment - in excess of 20% over a 12-month period. We assign a stock a Buy recommendation where our analysts believe there will be a total shareholder return of 10% or more over a 12-month period. We apply a Neutral recommendation where we anticipate a shareholder return of between plus 10% and minus 10%. We assign a Reduce recommendation where we anticipate a shareholder return of between minus 10% and minus 20%. Our Sell recommendation implies an expected shareholder loss over a 12-month period of 20% or more. Analysts have assigned a 'trading view' to stocks that they think might move materially within the following ten trading days; possibly in response to a move in currency, sentiment, or a specific event. The trading view is a short-term suggestion and does not contradict the 'recommendation'. Arbuthnot acts as a market maker or liquidity provider for this company. Arbuthnot has provided investment banking services to this company within the last 12 months. The company has seen this research but no material changes have been made as a result. Unless otherwise stated, the author of this research is the first analyst listed on the front cover of this document. Analysts’ remuneration is based on a number of factors, including the overall results of Arbuthnot Securities, to which a contribution is made by investment banking activities. Analysts’ remuneration is not based on expressing a specific view or recommendation on an issuer, security or industry. This research is classified as being a "marketing communication" as defined by the FSA’s Handbook. This is principally because analysts at Arbuthnot Securities are involved in investment banking activities and pitches for new business and consequently this research has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Therefore, the research is not subject to any prohibition on dealing ahead of the dissemination of investment research. Nevertheless, the Firm's Conflict of Interest Management Policy prohibits dealing ahead of research, except in the normal course of market making and to satisfy unsolicited client orders. Please refer to www.arbuthnotsecurities.co.uk for a summary of our conflict of interest management policy in relation to research. This includes organisational controls (departmental structure, a Chinese wall between corporate finance and other departments, etc), procedures on the supervision and remuneration of analysts, a prohibition on analysts receiving inducements for favourable research, editorial controls and review procedures over research recommendations and a prohibition on analysts undertaking personal account dealings in companies covered by them.

Arbuthnot recommendation proportions in last quarter All stocks excluding AIM Strong Buy Buy Neutral Reduce Sell

10.8% 56.5% 23.3% 9.5% 0.0%

Corporate stocks excluding AIM Strong Buy 34.5% Buy 55.2% Neutral 3.4% Reduce 6.9% Sell 0.0%

Source: Arbuthnot Arbuthnot Securities Limited is authorised and regulated by The Financial Services Authority (FSA, 25 The North Colonnade, Canary Wharf, London E14 5HS) and is a member of The London Stock Exchange. Arbuthnot is the trading name of Arbuthnot Securities Limited. Registered Office: Arbuthnot House 20 Ropemaker Street London EC2Y 9AR. Registered in England Number: 762818 This document has been approved by Arbuthnot Securities Limited (‘Arbuthnot’) for communication to professional clients (as defined in the FSA Handbook) and to persons who, if they were clients of Arbuthnot, would be professional clients. Any recommendations contained in this document are intended solely for such persons. This document is not intended for use by persons who are retail clients of Arbuthnot or, who would if they were clients of Arbuthnot, be retail clients, who should consult their investment adviser before following any recommendations contained herein. In any event this document should not be regarded by the person to whom it is communicated as a substitute by the recipient of the recipient’s own judgement and does not constitute investment advice (as defined in the FSA Handbook). This document is based on information obtained from sources which we believe to be reliable, however it is not guaranteed as to accuracy or completeness by Arbuthnot, and is not to be construed as a representation by Arbuthnot. Expressions of opinion herein are subject to change without notice. This document is not and should not be construed as an offer or the solicitation of an offer to buy or sell any securities. Arbuthnot and its associated companies and/or their officers, directors and employees may from time to time purchase, subscribe for, or add to or dispose of any shares or other securities (or interests) discussed herein. Any US recipients of this document are believed, by Arbuthnot, to be major US institutional investors only. Any US institution wishing to obtain further information or to effect a transaction in any security discussed herein should do so only through the correspondent US brokerdealer of Arbuthnot, Auerbach Grayson & Company Incorporated, which accepts responsibility for its contents.

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19

Company valuation ratios (x)

2009E

2010E

1.0 16.5 2.6 na -0.4 12.4 0.2 0.3 -2.1 -0.3 -1.0 0.1 18

1.1 4.4 0.7 19.3 2.2 -5.0 0.2 0.3 2.1 0.3 1.2

EV/Sales EV/EBITDA EV/EBITDA REL P/E P/E rel P/CEPS P/NAV EV/IC ROIC (%) ROIC/WACC VORR EV/Sales/G Industry attractiveness /25

Share price and recommendation tracker graph (two years) N R 10 d B 34d 10 0 90 80 70 60 50 40 30 20 10 0

Source: Arbuthnot estimates; growth rates from last actual

S ep

D ec B

M ar

J un

SB

S ep

D ec NR

T IT A N IU M R E S O U R C E S G P .

M ar B

J un

Sep

N P R IC E T A R G E T

Source: Thomson Financial, Arbuthnot

Summary financial data, year to Dec ($m)

2008A

2009E

2010E

2011E

49.4 -22.7 -61.3 -30.3 2.3 -32.7 -1.1 28.0 -21.8 -119.6 -2.8 -48.6 701.3 0.0 283.6 246.1

43.9 2.8 -12.4 -5.4 4.8 -10.2 1.1 28.0 -3.9 -10.4 0.6 -3.6 -92.5 0.0 396.0 284.0

54.9 13.6 10.0 5.5 2.9 2.6 0.3 28.0 3.9 2.6 3.1 0.6 -117.7 0.0 396.0 396.5

76.0 25.9 21.6 16.4 2.5 14.0 0.2 28.0 11.8 13.9 5.0 3.1 382.0 0.0 396.0 396.5

Operating cashflow Depreciation Provision utilisation Change in working capital Cash tax paid Capex Asset disposals Cash earnings CEPS (c)

-15.2 -7.7

10.3 -8.2

21.1 -8.2

33.4 -9.5

0.5 -0.4 -33.0 28.8 -49.4 -20.1

1.9 0.0 -5.6 0.0 2.9 1.0

3.9 0.0 -28.0 0.0 -9.8 -2.5

23.9 0.0 -3.0 0.0 27.9 7.0

Fixed tangible assets Goodwill Other assets Total assets Current liabilities Long-term liabilities All liabilities Net debt Gearing (%)

125.5 13.3 45.9 184.7 21.5 48.3 69.8 37.7 32.8

122.9 13.3 60.0 196.2 13.5 51.5 65.0 16.9 12.9

142.7 13.3 42.7 198.8 13.5 51.6 65.0 30.3 22.6

136.3 13.3 69.9 219.5 20.3 51.6 71.8 -14.0 -9.5

Sales EBITDA Operating Margin (%) EBIT Interest charge PBT Tax rate (%) Underlying tax rate NOPLAT Profit after tax Reported EPS (c) Underlying EPS (c) Underlying EPS YoY growth (%) DPS (c) Basic no. of shares (m) Fully diluted no. of shares (m)

Source: Company data, Arbuthnot estimates

20

Arbuthnot Securities