Danakali. Maiden ore reserve underpins valuation upside. Maiden 1.1Bt ore reserve at Collulli

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1 Danakali Maiden ore reserve underpins valuation upside Company update Metals & mining Since the release of its PFS in February 2015, Danakali (DNK) has continued on its path towards production with the announcement of a maiden ore reserve of 1.1Bt, a successful A$6.1m equity raising, the appointment of a respected financial advisor to explore project funding options and achieved solid progress on the DFS. Year end Revenue (A$m) PBT* (A$m) EPS* (c) 06/ (5.0) (3.96) 0.0 N/A N/A 06/ (5.2) (3.35) 0.0 N/A N/A 12/15e** 0.0 (6.9) (2.29) 0.0 N/A N/A 12/16e 0.0 (4.5) (0.31) 0.0 N/A N/A Note: *PBT and EPS are normalised, excluding intangible amortisation, exceptional items and share-based payments. **Year end changes from June to December in current year. DPS (c) P/E (x) Yield 26 June 2015 Price A$0.47 Market cap A$82m A$/US$0.75 Net cash (A$m) at 29 May Shares in issue 174m Free float 59% Code DNK Primary exchange ASX Secondary exchange N/A Share price performance Maiden 1.1Bt ore reserve at Collulli In May this year Danakali (formerly South Boulder Mines) announced its maiden ore reserve estimate for Colluli of 1.1Bt of potassium-bearing 10% K 2O comprising 287Mt proved and 820Mt probable ore reserve. The equivalent contained K 2SO 4 (sulphate of potash) is approximately 205Mt. This positions Colluli as one of the largest undeveloped potash deposits globally and supports a production life of 200+ years, well over the 30-year project examined in the PFS. Endeavour Financial appointed to advise on project funding options, A$6.1m rights issue completed In June, Danakali announced the appointment of Endeavour Financial, a specialist mining finance advisory firm, to explore project funding options for Phase 1 (US$442m). Endeavour has particular expertise in providing funding solutions for projects in Africa, and has been involved in every mining finance deal in Eritrea. To progress the Colluli DFS apace and provide working capital, Danakali successfully completed a A$6.1m equity raising in May, comprising a rights issue and placement at A$0.25/share, a 20% discount to the prevailing share price at the time. Its shares have since performed strongly, rising to A$0.47 currently, testimony to market recognition of the quality of the Colluli project. Valuation: Large reserve supports significant upside In our report on the Colluli PFS published on 7 April 2015, we estimated an NPV for Colluli of US$897m assuming the 30-year life examined in the PFS. With a very large 1.1Bt reserve now proven, we have examined the valuation impact of a 60- year project life. Under this scenario we generate an NPV of US$998m, which supports an NPV for Danakali shares of A$1.07/share (10% discount rate, 60-year project life supported by the 1.1Bt reserve). % 1m 3m 12m Abs Rel (local) week high/low A$0.52 A$0.15 Business description Danakali is a development-stage company focused on developing its Colluli potash project in Eritrea. Colluli is held equally between Danakali and the Eritrean government. Next events DFS completion Analysts Q315 David George +44 (0) Charles Gibson +44 (0) mining@edisongroup.com Edison profile page Danakali is a research client of Edison Investment Research Limited

2 Business update Since we published our valuation report on Danakali s Colluli potash project following the release of the PFS, the company has continued to achieve milestones on its path to production. In this report we examine the significant developments announced in the last few months. Danakali was formerly known as South Boulder Mines, with the name change made to reflect the company s focus on the Colluli potash project in the vast and prospective Danakil basin in Eritrea. Maiden 1.1Bt ore reserve at Colluli On 19 May 2015 Danakali released its maiden JORC (2012) potassium salt ore reserve estimate. The reserve comprises 1.1Bt at 10% K 2O equivalent, made up of 287Mt of proven ore reserve and 820Mt of probable ore reserve. This is a significant upgrade in the quality of the resource, with 88% of the measured and indicated resource included in the ore reserve estimate. The conversion of such a large proportion of resource to reserve greatly enhances what were already robust project economics, with the company now able to examine in its definitive feasibility study (DFS) a much longer economic life than the 30 years tested in the PFS. In the valuation section of this report we have evaluated the impact on the Colluli project valuation if a 60-year life is assumed, but we note that a reserve of this size could potentially support a +200-year life operation. Exhibit 1: Colluli ore reserve estimate (JORC 2012) Proved Probable Total Occurrence Mt K2O Equiv. Mt K2O Equiv. Mt K2O Equiv. K2SO4 Equiv. K2SO4 Equiv. (Mt) Sylvinite Carnalite Kainitite Total Source: Danakali. Note: Equivalent K 2SO 4% (SOP) calculated by multiplying K 2O% by The mineral resource at Colluli remains at 1.289Bt and is inclusive of the ore reserve estimate shown in Exhibit 1. The conversion of 88% of the Colluli resource to reserve is high and is largely due to its shallow depth (ore body starts just 16m below surface), which will enable open pit mining. It compares to 52% conversion on average for underground mining resources and 22% on average for solution mining resources (source: DNK investor presentation 19 May 2015). The mineable material is increased substantially by open pit mining compared to underground mining as there is no resource loss for roof support, with room and pillar mining for potash typically sterilising approximately 50-55% of the resource. Compared to solution mining there are no complexities that reduce resource to reserve conversion significantly, such as losses from roof support, geological continuity and seam thickness issues, and issues with variable solubility of different salt types. As well as the high conversion of resource to reserve that Colluli enjoys due to its ability to be mined by open pit, other advantages of open pit mining include a better safety record than underground mining, it is easier to expand in a modular way, and the fact that different salts can be selectively and concurrently mined to achieve the required consistent feed grade to the processing plant. Danakali 26 June

3 Valuation update In our report on the Colluli PFS, we estimated an NPV for Colluli of US$897m (100% basis) assuming the 30-year life examined in the PFS. This was based on the construction of two modules of 425ktpa capacity each (Phase 2 commissioned in year 5) at a total capital cost of US$724m and an assumed long-term SOP price of US$588t FOB Anfile Bay. Our NPV compared relatively closely with the PFS NPV of US$846m. The minor difference is explained by the fact that our model relies on average annualised operating costs and production rates, whereas the company model would have a more detailed profile of these inputs; small differences in production ramp-up rates; and by necessity Edison's cash tax paid calculation relies on a less complex tax depreciation schedule than the company would use as a result of our knowledge of individual capital equipment depreciation schedules for tax purposes versus internal company knowledge. In respect of share valuation implications for Danakali, we calculated after allowing for an equity raising of US$133m (under the JV agreement Danakali is required to contribute 100% of the equity for Phase 1), at a 30% discount to the prevailing share price at the time (A32c/share) a base case NPV (10% discount rate) for Danakali shares of A$0.75/share. While Danakali has recently completed a small A$6.1m equity raising at a 20% discount, we believe a 30% discount assumption is appropriate for the much larger US$133m raising required for the project. As shown in Exhibit 1, the ore reserve contains 205Mt of SOP, clearly supportive of a project life well beyond the 30 years examined in the PFS, and gives management the option of exploring the valuation impact of a much longer-life project in the DFS, which is currently underway. We have run our model under a 60-year project life scenario to determine valuation implications for Danakali shares. We have assumed the required equity raising will be at a 30% discount to the prevailing share price, which has appreciated to A$0.47/share currently. In comparing the 60-year life scenario with the 30-year life PFS valuations, we have adjusted the latter to reflect the $6m equity raising and the share price appreciation since our last report. The results of this scenario are shown in Exhibit 2. Exhibit 2: Danakali 10%: PFS 30-year project life vs 60-year project life scenario PFS 30-year project life 60-year project life scenario DNK share of Phase 1 & 2 unfunded Colluli NPV (US$m) DNK attributable NPV after debt servicing (US$m) Shares in issue (m) Assumed equity raising (US$m) Assumed equity raising discount 30% 30% Assumed equity raising price (A$/sh) Shares issued (m) New shares on issue post raising (m) Attributable DNK NPV (A$/sh) Current share price (A$/sh) Potential upside 108.5% 127.7% Source: Danakali, Edison Investment Research. Note: A$/US$0.75. We estimate that an extension of the Colluli project life from 30 years (PFS basis) to 60 years based on the 1.1Bt reserve would increase the NPV (10% discount rate) of Danakali shares by c 9% to A$1.07/share, which represents 128% upside from the current share price. Exhibit 3 shows the sensitivities of the NPV over both periods to SOP price movements and higher discount rates. Danakali 26 June

4 Exhibit 3: Danakali NPV sensitivities to commodity changes, project life assumptions, discount rates, A$/share 10% discount rate 15% discount rate 20% discount rate SOP movement PFS 30-year project life 60-year life scenario PFS 30-year project life 60-year life scenario PFS 30-year project life 60-year life scenario +10% US$588/t (base) % Source: Edison Investment Research From Exhibit 3 it is clear that the NPV is very negatively sensitive to 5% increments in the discount rate applied, which is due to the large US$724m capital expenditure in the first five years to complete Phase 1 and 2; and the higher the discount rate, the lesser impact the 60-year project life scenario has because of the large discount factors that apply beyond 30 years once the discount rate materially exceeds 10%. Financials update Since the release of the PFS in March 2015, Danakali has announced two significant financial events. The first was a A$6.1m equity raising comprising a placement of m shares to Well Efficient of Hong Kong and Arlington Asset Management of London, which raised A$2.74m, and a one-for-12 non-renounceable partially underwritten pro rata rights issue, which raised A$3.35m. The equity raising was successful and increased the outstanding shares in issue to 174m (from 161m). Proceeds from the funding are being allocated to complete the DFS, the advancement of the major funding discussions for Colluli, building in-house capability to support project development and general working capital purposes. The raising was carried out at A$0.25/share, a 20% discount to the closing price on 22 April 2015, and the shares have since appreciated to A$0.46/share, which we believe is testimony to the high regard the market holds for Danakali s Colluli project. We have adjusted our forecasts shown in Exhibit 4 to reflect the impact of the A$6.1m raising, which has resulted in Danakali having around A$10m cash, sufficient to fund working capital and complete the DFS due in Q315. In addition, our forecasts assume the US$133m equity raising required to fund the project (along with debt finance) is completed in The second significant financial event was the appointment of Endeavour Financial, an independent London-based mining finance advisory firm, to assist in the evaluation of funding options for the Colluli project while the DFS is underway. In particular, Endeavour will focus on debt finance solutions as the major source of financing. Endeavour Financial has extensive experience in assisting companies to structure project funding solutions across diverse commodities, geographies and sources of financing. The firm has a proven track record in Africa and has assisted in securing finance for mining projects in Eritrea including, Bisha (Nevsun Resources) and Asmara (Sunridge). We view this as a positive development, as in the current environment funding sources for large capital expenditure projects for small mining companies is tight. Endeavour s track record in assisting small companies to source finance, particularly its success in Eritrea, delivers a strong advantage to Danakali. Danakali 26 June

5 Exhibit 4: Financial summary A$ e 2016e 2017e 2018e 2019e 31-December IFRS IFRS IFRS IFRS IFRS IFRS IFRS PROFIT & LOSS Revenue , ,200 Cost of Sales (1,580) (1,277) (2,250) (1,500) (1,500) (92,500) (120,500) Gross Profit (1,433) (1,170) (2,250) (1,500) (1,500) 162, ,700 EBITDA (1,433) (1,170) (2,250) (1,500) (1,500) 162, ,700 Operating Profit (before amort. and except.) (1,639) (1,456) (2,700) (1,800) (1,800) 142, ,056 Intangible Amortisation Share based payments (257) (581) Other (4,236) (4,155) (4,500) (3,000) (3,000) (3,000) (3,000) Exceptionals Operating Profit (6,132) (6,192) (7,200) (4,800) (4,800) 139, ,056 Net Interest (18) (20,094) (14,357) Profit Before Tax (norm) (5,043) (5,168) (6,922) (4,532) (4,818) 119, ,698 Profit Before Tax (FRS 3) (5,300) (5,748) (6,922) (4,532) (4,818) 119, ,698 Tax (45,433) (66,765) Profit After Tax (norm) (5,043) (5,168) (6,922) (4,532) (4,818) 74, ,933 Profit After Tax (FRS 3) (5,300) (5,748) (6,922) (4,532) (4,818) 74, ,933 Minority Interest ,461 2,266 2,409 (37,064) (54,466) Net income (normalised) (5,043) (4,294) (3,461) (2,266) (2,409) 37,064 54,466 Net income (FRS3) (5,300) (4,875) (3,461) (2,266) (2,409) 37,064 54,466 Average Number of Shares Outstanding (m) EPS - normalised (Ac) (4.0) (3.3) (2.3) (0.3) (0.3) EPS - normalised and fully diluted (Ac) (3.6) (3.3) (1.9) (0.3) (0.3) EPS - (IFRS) (Ac) (4.2) (3.8) (2.3) (0.3) (0.3) Dividend per share (Ac) Gross Margin N/A N/A N/A N/A N/A EBITDA Margin N/A N/A N/A N/A N/A Operating Margin (before GW and except.) N/A N/A N/A N/A N/A BALANCE SHEET Fixed Assets , , , ,538 Intangible Assets Tangible Assets , , , ,538 Investments Current Assets 14,392 9,406 14, ,885 54,773 Stocks Debtors ,885 54,773 Cash 14,260 9,275 13, Other Current Liabilities (731) (432) (370) (247) (247) (15,205) (19,808) Creditors (731) (432) (370) (247) (247) (15,205) (19,808) Short term borrowings Long Term Liabilities (13) 0 0 (367) (401,886) (287,147) (116,271) Long term borrowings (367) (401,886) (287,147) (116,271) Other long term liabilities (13) Net Assets 14,043 9,067 13, , , , ,232 CASH FLOW Operating Cash Flow (11,664) (5,674) (2,250) (1,500) (1,500) 162, ,700 Net Interest (18) (20,094) (14,357) Tax Capex (182) 0 0 (189,333) (400,000) (27,467) (27,467) Acquisitions/disposals Financing 3, , , Dividends Net Cash Flow (7,029) (4,985) 4,123 (13,765) (401,518) 114, ,876 Opening net debt/(cash) (21,288) (14,260) (9,275) (13,398) , ,147 HP finance leases initiated Other 0 (0) Closing net debt/(cash) (14,260) (9,275) (13,398) , , ,271 Source: Company accounts, Edison Investment Research. Note: Year end changes from June to December in current year, hence 2015e above relates to an 18-month period. Danakali 26 June

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