Goldman Sachs Investor Research - Discovery Metals Limited

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7 October 2010 Discovery Metals Limited RECOMMENDATION - Our Thinking RECOMMENDATION: HOLD Stock Code: DML Rationale: -ve Neut +ve Share Price: $ 1.28 Industry Structure: Valuation: $ 0.91 EVA Trend: Earnings Momentum: Catalysts: Price / Valuation: We are initiating coverage with a neutral recommendation and a 12-month target price of $1.50. Our positive view of copper is driven by our view that the market is moving to an ongoing deficit which will require a higher copper price, both to allow lower grade and less profitable greenfield projects to be developed over time and to destroy some demand from those areas where substitution can take place. DML controls a significant area of copper mineralisation within the Botswana Kalahari Copperbelt which is thought to be a continuation of the renowned Zambian Copperbelt. The geology appears to be well understood and DML is proposing a combined open pit and underground mining operation and, given the extensive strike continuity of the orebody, should be able to extend the mine life by progressively adding to the strike extent of mining. Whilst there has been only limited deeper drilling to date, the nature of the orebody (sharp geological cut-offs on the F/W and some mineralisation into the H/W) suggest that it will be amenable to mechanised underground mining at similar (or better) grade than the open pit. The two key operational risks that we can identify are the average strip ratio 15.9:1 (LOM) in the development case and the percentages of oxide and transition ore versus sulphide ore which will impact overall recoveries. We can identify with a strategy of limiting the open pit depth of mining to lower the waste stripping and thus LOM strip ratio (but this does mean that there will be a higher percentage of oxide and transition ore) and increasing the strike extent of the open pit, or more accurately strip mine, to maintain the overall open pit tonnage. The second key risk is the cost of actually moving a tonne of material. DML has synthesised a material movement cost of US$1.35/tonne which we find extremely low but acknowledge that the strip mining may allow less waste handling, leading to a lowering of waste haul distances, etc. Nonetheless, this unit cost/tonne is significantly lower than that of any of the other companies we cover. Corporate Structure • Discovery Metals is listed on the following markets: • Australian Stock Exchange (ASX: DML) - December 2003 • Botswana Stock Exchange (BSE: DML) - December 2006 • Alternative Investment Market (AIM: DME) - June 2007 • The company has a June year-end and reports in AUD. Goldman Sachs & Partners Australia Investment Research All figures in A$ unless otherwise advised 2
7 October 2010 Discovery Metals Limited Botswana Background (Snowden Technical Report) Background • Botswana was formerly a British Colony (Bechuanaland) which gained independence from Britain in 1966. Since then, Botswana has enjoyed consistent economic growth based principally on diamond mining (also potash, copper, iron ore, nickel, salt and silver) and tourism. • Similarly to both Zambia and Senegal, Botswana has had civilian governments since Independence without any coup d'etat. • Botswana occupies a land mass of ~587,000km 2 which is relatively flat (lowest point the junction of the Limpopo and Sashe rivers (513m) and the highest point the Tsodilo Hills in the extreme north west of the country (1,489m). The country has a semi-arid climate with warm winters and hot summers. • Botswana is land locked with Namibia to the west, Angola and Zambia to the north, Zimbabwe to the east and South Africa to the south. • Botswana is a parliamentary republic with an elected President (Head of State) and Government and a cabinet appointed by the President. Elections are for 5-year terms with the HOS able to be re-elected for a second term. • The economy is dominated by diamond mining, accounting for >33% of GDP and 70% - 80% of export earnings. Other mining, tourism, financial services, subsistence farming and cattle raising provide the balance of the economy. • Botswana's GDP of US$10.94bn (official exchange rate) or US$26bn at purchasing power parity breaks down as: Industry ............. 52.6% Services ............. 45.8% Agriculture ............ 1.6% • Prior to the Global Financial Crisis (GFC), Botswana had enjoyed strong GDP growth of 5.2% 2009; 2.9% 2008 and 4.4% 2007. • As with much of Africa, unofficial unemployment is ~40%, although official unemployment is much lower at 7.5% (2007) with HIV a major issue in the country and reportedly the 2nd highest in the world. • The official currency is the Pula which is essentially fixed to the South African Rand and the country has public debt of 17.9% of GDP (2009) up from 5.9% (2008); foreign debt of US$1.65bn but also foreign reserves of US$9.575bn (2009). • The Botswana legal system is based on Roman Dutch law but also includes local customary law with judicial review limited to matters of interpretation. Botswana Mining Code • Mining legislation in Botswana is covered by the Mines and Minerals Act, 1999 - based generally on Australian and Canadian models. Mineral rights are therefore vested in the Republic of Botswana. • The Act provides security of tenure and, although the previous right to free equity for the government has been abolished, it retains the right to earn up to 15% as a minority interest, with the government paying a pro-rata share for its interest. • Mining attracts a variable income tax rate (with the exception of diamonds - which have a separate agreement) which is typically 25%, but slides up to a maximum of 50% determined annually by reference to the company's profit ratio. • Royalties are calculated as a percentage of the gross market value of the mineral and are 3% for copper and 5% for silver. • Applications for mineral rights are made directly to the Minister of Mineral Resources and Water Affairs. There are four types of mineral rights in Botswana: a prospecting licence, a retention licence, a mining lease and a mineral permit and these can be granted to an individual or a company. Goldman Sachs & Partners Australia Investment Research All figures in A$ unless otherwise advised 3
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