Adriatic Metals ('ADT') are a base metal developer in Bosnia & Herzegovina (BiH), with a world-class resource in a global scale mineral province.

The breakup of Yugoslavia and the consequent Bosnian war, along with high upfront costs for mining concessions has largely preserved the exploration opportunity in BiH despite a long, proud history of mining. As such, the area has barely been touched by modern exploration techniques which bode well given its geographic and geological locality. The team at ADT recognised the significant opportunity at hand and managed to secure a portfolio of high-quality assets via its first-mover advantage; it is still the only listed resource company globally with operations in the BiH.

The BiH is a stable, democratic nation with a favourable regulatory environment and supportive of mining. Foreign investors possess the same rights as locals, tax and royalty rates are very attractive and the costs of operating are extremely low. Serbia, which borders Bosnia, has attracted significant investment from a multitude of mining majors in a similar geological setting. ADT's founders discovered a warehouse of Yugoslav era technical reports dating back 30 years, providing valuable information on historical brownfield projects and exploration activities that allowed it to grasp the low hanging fruit in terms of prospectivity.

Consequently, the company has made a world-class, poly-metallic greenfield discovery in Rupice (9.4mt @10.1 g/t Au equivalent) along with significantly advancing a brownfield asset in Veovaca, collectively referred to as the Vares project. As a result, ADT was the ASX's best performing IPO in 2018. We believe the potential for further quality discoveries is high given the lack of systematic, modern exploration.

ADT has released a very detailed Scoping Study, highlighting the incredible economic potential of the Vares project. Broadly the project economic outcomes have been modeled by the company as follows:

Process Plant throughput: 800 ktpa
Initial capital expenditure: USD$178 million
FID to first production: 13 months
Payback period: 8 months
Post Tax NPV discounted at 8%: USD$916 million (approx AUD$1.3 billion)
Post Tax IRR: 107%

These are world-class metrics by any measure, with an economic capital intensity (initial CAPEX/NPV8) less than half of comparable projects we have examined.

We examined a couple of acquisitions for comparable projects (albeit with inferior economic returns) and noted that:
S32 acquired Arizona mining at a value approximately 70% of the project's NPV8 - at scoping study stage
Zijin acquired Nevsun at approximately 90% of NPV8 in neighboring Serbia - at pre-feasibility study stage.
ADT is currently trading at approximately 18% of NPV8 - at scoping study stage.

As such we believe any transaction would need to be priced at a minimum of 60% of NPV8 for the management team (who hold ~30% of the company) to even consider. Large miners like Rio Tinto, Lundin, Freeport McMoran and Zijin are active in neighboring countries and would find ADT a very attractive acquisition now that there has been demonstrable progress in terms of feasibility studies. There is a profound lack of quality projects available globally and this has driven up acquisition prices substantially over the last 10 years. We also note that base metals are at a cyclical low and ADT's ground is still very much under-explored, which will provide comfort to any potential acquirer.

Looking ahead we see several catalysts on the horizon:
London stock exchange listing in progress - we expect the LSE listing to cause ADTs value to rise  given the current valuation differential between Vares and similar projects
Further potential exploration upside from current and future drilling programs at Vares (4 rigs onsite) - has the potential to further improve project economics
Exploitation, operating and mining licences - all currently being progressed
Environmental and planning permits - all currently being progressed
Further geotechnical, mining, environmental and metallurgy studies leading to the completion of Definite Feasibility Study within 12 months.

Risks we see are:
Potential delays in permits and licences - this has been a minor issue in the past but appears to be proceeding more smoothly now.
Sovereign risk - we consider this to be in line with neighboring Serbia
Outcomes from further feasibility studies resulting in marginally higher CAPEX

We believe ADT is a very compelling, well-priced opportunity for the resource investor with material potential upside that may be realised via a takeover from a larger miner or by the company bringing the project into production in its own right.



Disclaimer: This article does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way. The author holds shares in ADT.

Towards the start of the 2019 calendar year, we identified a strong investment thematic in junior gold companies driven by the confluence of 3 primary ideas:

• A potential rise in gold prices based on geopolitical factors
• A weakening of the Australian Dollar based on macroeconomic factors
• A resource and mine life deficit amongst mid-tier Australian gold producers

This led us to the identification and subsequent investment in Echo Resources, which was consequently taken over by Northern Star for a return over 100% in less than 12 months.
We believe this thematic is still strong and in this wire, we discuss a number of qualitative factors that help assist us in identifying high-quality gold opportunities and outline 2 names that tick our boxes.
Generating our own ideasWhile it is very difficult to quantitatively screen companies due to the early-stage nature and non-financial characteristics of these companies, there are a number of different methods of discovering companies in this space. The most common of these are: sell-side (broker) research, industry comparisons and independent project assessors (typically covering later stage companies).
However, we tend to rely heavily on our own proprietary research library of almost 1000 primary research pieces to generate ideas and identify broad brush investment thematics. 
We largely avoid secondary research, but do find it useful on occasions to confirm and question the veracity of our own primary research efforts.
Geological factors1: Depth and scale
These factors are very important in determining whether a deposit may be economic. A general rule of thumb is that the deeper a deposit, the higher grade it needs to be economic – this is a function of higher mining costs at depth. This should be looked at in conjunction with the scale of a deposit, as generally the larger the scale the lower the cost.
2: Geometry and mineralisation style 
The shape of a deposit is an important indicator of potential mining cost for example, a gently dipping equidimensional (spread consistently in all directions) shaped deposit will almost always be cheaper to mine than a steeply dipping, planar deposit. Disseminated (spread uniformly) style mineralisation deposits are preferable to vein or reef hosted mineralisation from our perspective, again due to lower processing costs.
3: Historical context and potential exploration upside 
We have a preference towards ‘time capsule’ projects where little modern exploration has been conducted. This could be for a number of reasons including areas where mining exploration has been banned, or where exploration was not conducted due to a low commodity price environment. We consider that exploration upside is generally considerably larger with these particular projects, given the historical context.
Corporate factors1: Location/jurisdiction: 
This is important from an economic and strategic perspective. Government royalty rates can vary significantly between jurisdictions, along with the general legal and social environments. A resource situated near infrastructure will generally hold an advantage over a similar more isolated deposit. Being close to other producing mines allows optionality in terms of commercial outcomes for example, a smaller deposit that may not be large enough to support its own processing plant could potentially utilise a neighbouring mine’s processing plant for a fee.
2: Management team and corporate strategy 
Pursuing a prudent strategy can expedite the time needed to bring a deposit into production, and add considerable value to a project whilst mitigating risk. One common mistake we see is rushing into production too soon for marginal or higher-cost projects. Mineral production has its own skill set quite different from mineral exploration.
3: Overall economic evaluation 
To be robust and minimise downside, any economic studies on the deposit should use conservative assumptions and incorporate all costs. In the gold sector, a commonly used metric ‘AISC’ (all-in sustaining cost) is one of the most misquoted with each producing company using their own poetic licence to their quoted metric. Investors should perform their own calculations instead of relying on company provided AISC figures. In addition, we have a bias to project with relatively low capital intensity which usually results in a higher project IRR. Higher metallurgical recoveries are positive.
4: Ability to build relationships with credible larger counterparties: 
This is an important factor especially when considering commercial terms could be negotiated for production or exploration. A management team that can attract large partners to the company or its projects, adds credibility from our perspective.
5: Catalyst/s to rerate the stock: 
This is one of the more important elements in our process and can be either external, internal or multi-faceted. One must remember that the company cannot change the physical resources that may or may not lie within their ground and accordingly be very selective when investing in this space, taking a ‘resource first’ approach.
Preferred namesOur preferred names in the junior gold space are Yandal Resources (YRL:ASX) and Alice Queen (AQX:ASX).
Yandal Resources: Multiple catalystsYandal currently has a gold resource of approximately 200,000 ounces at their flagship Flushing Meadows deposit at a grade of 1.3 g/t. The deposit is at very shallow depths of less than 150m, is currently 1.8kms in length and is open at depth and in multiple directions. As such, we think there is strong potential for the size of this deposit to increase materially. This deposit, whilst planar and dipping is very shallow and likely to be able to be cheaply mined via an open pit. This tenement of 472 sq km has been historically held by majors during times of lower gold prices, and has had virtually no exploration over the past 20 years.
Yandal's projects are located in the Yilgarn Craton, Western Australia; this locality is thought to hold up to 30% of the world’s resources and is regarded as a Tier 1 jurisdiction. All the projects are located within trucking distance of multiple gold mills operated by 3rd parties, so can be commercialised rapidly. The quality and largely oxidised nature of the current resource ensures that this ore will be sought after by gold processors. The company intend on further building out its resource base via lower risk extension drilling and have recently started a program of 20,000 metres.
The management team are experienced, credible and focused having worked on the neighbouring projects that are held by Echo Resources. 
Northern Star, who have just acquired Echo, holds 15% of the company; with the Top 20 shareholders holding 80%. 
We think there are multiple potential catalysts for the company to rerate and believe the company will become increasingly attractive as they build out their resource base.
Alice Queen: More upside than downsideAlice Queen has a gold resource of around 500,000 ounces at its Horn Island project, in the Torres Strait, at a grade of 1.9g/t. The deposit is shallow with a maximum depth of 250m. Horn Island was reopened to mining activities in 2014, after a 25-year hiatus. 
Since then, AQX has lightly explored and applied modern exploration techniques to the project, attracting Saint Barbara (SBM:ASX) as a joint venture partner. What is so unique, is that SBM agreed to excise the existing 500,000-ounce deposit and associated infrastructure from the joint venture; with an option to buy into these areas for a 70% interest by paying ‘fair value’. We believe there exists significant potential at depth for the discovery of further gold resources, along with potential extensions at shallower depths.
Horn Island is located in the Torres Strait, Queensland. Northern Queensland hosts a gold endowment of around 40 million ounces, with 19 million hosted in Intrusion Related Gold System (IRGS) deposits; the system speculated to exist at Horn Island. The company intend on progressing the Horn Island project further in conjunction with SBM. The management team are committed, practical and focused; and have a world-class consultant team.
Horn Island has significant existing infrastructure in place including a deep water port, a domestic airport, and existing freshwater supply. We believe that this should translate into significant savings in terms of capital expenditure and consequent superior returns, should a mining operation recommence. 
The company have a proven track record of attracting and working with larger counterparties, having attracted SBM and Newcrest to its projects in the past. 
The company also hold very prospective exploration ground in NSW, less than 1 km from Alkane’s discovery at Boda; this was regarded as the best Australian porphyry discovery in 20 years.
Again, we see multiple catalysts for AQX to rerate notably, the exploration program being funded by SBM as well as further exploration success on the neighbouring tenements in NSW held by Alkane. 
Disclaimer: Datt Capital currently holds shares in AQX and YRL. 

​Alice Queen ('AQX') are a junior exploration company that hold 3 projects: 1 gold development project in the Horn Island gold deposit and 2 very prospective exploration projects in the Horn Island JV and the Lachlan Fold projects.

Horn Island gold deposit
AQX has defined a shallow, open pittable inferred resource of 492,000 ozs (7.96 Mt @ 1.9g/t), with a maximum depth of 250m. Horn Island has significant existing infrastructure in place including a deep water port, a domestic airport, and existing freshwater supply. It also is the logistical hub of the Torres Strait, being easily accessible from the mainland. Being a brownfield operation, it's likely that the company could potentially utilise some remnants of the old mining operations.

As part of our evaluation process for Horn Island, we made a number of assumptions to determine what a potential mining operation may look like. Readers should note that this is purely a hypothetical exercise, especially given the current inferred nature of the deposit.

Hypothetical Project Assumptions and Parameters:
80% of inferred JORC resources converted to Indicated or better status.
1 Million tonne per annum plant capacity
LOM of ~6.5 years
Average gold production per annum: ~56k oz
Gold price: AUD$2,000/oz
Recovery rate of 93%
Initial Capex: $60 million
All-in Sustaining Cost: ~AUD$1,200/oz
Discount rate: 8%
NPV using assumptions above: ~$160 million

We consider our assumptions reasonably conservative; for example, the company has disclosed that metallurgical recoveries from the ore are ~98% whereas we have assumed a lower figure of 93%. We also note that our assumptions are blunt, and do not consider any optimisation studies generally conducted as part of a Bankable Feasibility Study ('BFS') process.

As the company progresses the development of the deposit via additional infill drilling to upgrade the resource estimate to Indicated or better, we expect further value accretion. We expect that the company will conduct further studies on the deposit to a BFS standard. We estimate it will cost the company approximately $3.5-4.5 million to conduct the necessary works and studies to delivery a BFS for the deposit and take approximately 12-18 months to complete. This expenditure should provide significant value add for shareholders.

Having examined a large number of gold deposits, we consider inferred resources that have a higher degree of uncertainty, to be fairly valued at a range between 2.5-3.5% of in-ground value relative to the spot price for shallow deposits which are sub-250m in depth. This provides us a range between $55 and $77 per inferred ounce at a gold spot price of AUD$2,200. As such we consider that as a raw, undeveloped project the Horn Island gold deposit would be worth ~$30 million, possibly more considering the existing infrastructure in place.

Horn Island JV
St Barbara ('SBM') a mid-tier gold miner has entered into a JV with the right to earn 70% of the Horn Island Exploration Project, encompassing Horn Island and Prince of Wales Island, by sole funding $4 million over 36 months. The agreement specifically excludes the Horn Island gold deposit as well as the existing critical infrastructure and sites necessary to begin a mining operation. SBM has been granted an option to acquire a 70% in these areas for 'fair value'. SBM may withdraw after committing a minimum amount of $500,000 within the first 12 months of the JV. AQX has agreed not to commence mining operations at the Horn Island gold deposit during the term of the JV. However, further progressing the project to the completion of a BFS is allowed. AQX will manage SBM's ground operations on Horn Island for a fee under a services agreement.

The JV will be targeting Intrusion Related Gold System (IRGS) deposits. Out of a total discovered gold endowment in Northern Queensland of ~40 million ozs ('Mozs'), over 19 Mozs are contained within IRGS deposits in this region. It is believed that IRGS deposits are generated by the collision of major tectonic plates and are focused mainly on the Ring of Fire region around the Pacific Rim which hosts a gold endowment of over 100 Mozs. This proliferation extends into Queensland which was a tectonically active region 200 million years ago. We note that IRGS deposits are on average larger than types of gold-bearing systems; providing a potentially large reward for successful explorers. The sweet spot in terms of exploration for IRGS deposits is in the 200-500m depth range, where AQX has barely explored.

IRGS deposits can be discovered using a systematic approach including but not limited to: geochemical sampling, reverse magnetic analysis, interpretation of drill samples & multi-element metal zoning. We note that AQX has performed significant analysis works to date, performed by world-class technical consultants in Scott Halley (geochemistry), Gregg Morrison (IRGS specialist) and Ben McCormack (structural geology). We note that should an IRG system be proven to exist on Horn Island, Prince of Wales Island to the immediate west will represent an outstanding greenfield opportunity for the joint venture being 3 times as large within a similar geological setting.

Horn Island Conclusion
We note that the Horn Island JV agreement, allows SBM to acquire a 70% interest in the Horn Island gold deposit and associated infrastructure for 'fair value'. According to our research, recent transactions for commodity projects at the BFS stage have ranged between 40-70% of NPV8 value depending on various factors including capital requirements, depth of resource, commodity type etc.

As such, this may result in a significant bullet payment made to AQX, of an amount above the company's current market capitalisation, should SBM exercise this right and assuming AQX has completed a BFS.

Should SBM withdraw from the JV at any time, AQX will remain well placed to deliver the project in their own right having conducted the studies necessary to obtain project finance.

In summary, we believe that the Horn Island JV has the potential to deliver a multi-million-ounce resource in time, at depth. We believe the fact that SBM, within the JV agreement, restrains AQX from initiating a small scale mining operation is telling. We note that the company's discovery cost per oz is exceptional at under $20/oz, relative to the industry average of circa $30/oz. We believe this reflects the genuinely under-explored nature of Horn Island as well as the significant and thorough geological analysis the company conducts prior to major drilling works.

NSW Lachlan Fold Projects
AQX hold 4 exploration tenements that encompass the entire northern part of the Molong Volcanic Belt, on-trend with the globally significant Cadia-Ridgeway mine operated by Newcrest ('NCM'). The area is prospective for large scale Au/Cu porphyry deposits.

NCM entered into an exploration JV with AQX in 2017 covering some of these tenements. Under the terms of the prior JV agreement, NCM could earn up to an 80% interest in the Mendooran tenements over 9 years by spending $10 million. 3 diamond core holes were drilled under NCM JV, with no material results disclosed. We note that the NCM JV targeted the most accessible prospects, rather than the best prospects which lie within a State Conservation Area, where special permits are required. These permits were not in place for the term of the JV, although AQX has recently disclosed in their latest presentation that a land access agreement is near, with permission expected to be granted by the end of the calendar year.

NCM terminated the JV however, we consider this to be positive. Our preference when investing in junior explorers is that it retains a majority stake in their most prospective ground when engaging in a JV. This ensures that shareholders receive the appropriate benefit in the case of success. We have found that exploration projects can be 'lost' in the bureaucracy of a larger company, so we prefer companies that retain material exposure and control over their core prospects. We also noted that the Yarindury tenement was acquired after the NCM JV was executed, so was not included in the JV. The sedimentary cover in this tenement is shallower at around 200m depth, so believe that AQX can explore this tenement in their own right. AQX has disclosed that drilling will commence in the next couple of weeks on the northern targets at Yarindury.

Alkane's recent discovery strike at Boda, was the best porphyry exploration discovery hole in the Lachlan Fold Belt outside the Cadia, Cowal and North Parkes mines in the last 20 years; according to John Holliday, the discoverer of the world-class Cadia deposit and a technical consultant to AQX. The discovery strike of 502m @ 0.48g/t Au, 0.20% Cu from 211 metres in depth, ended in strong mineralisation to the end of hole. We believe this is exceptionally significant. The strike is exceptionally gold rich relative to other porphyry deposits, and we are encouraged by the fact that the copper grade appears to increase at depth. Importantly, a clear high-grade zone of approximately 361m of over 1g/t exists between 228m and 589m intervals. To put it into context, this high grade zone of strike was superior to the Cadia Hill discovery hole which struck 243m @ 1.21g/t Au. A lot more work needs to be conducted by Alkane to prove that a large deposit exists, but the potential for a large, commercial discovery is clear.

Large porphyry deposits are generally clustered, typified by the monstrous Cadia-Ridgeway complex which spans almost 20 sq km and enjoys a rich mineral endowment of 38 Mozs of Au & 8.3 Mt of Cu. With Yarindury only 700 metres away from Boda's discovery hole, we believe that there is very strong potential that the mineralisation that Alkane discovered at Boda, may extend onto the Yarindury tenement. Whilst still early days, we believe that the strike at Boda has added immense value to AQX's Lachlan Fold tenements and significantly increased the odds that AQX can perhaps make their own discovery.

We consider the upside potential and leverage to success within these tenements to be extremely large.


Conclusion
We consider that Alice Queen hold 3 very attractive projects: 1 gold development project in the Horn Island gold deposit and 2 very prospective exploration projects in the Horn Island JV and the Lachlan Fold projects.

It is our opinion that the company's value is strongly underpinned by the existing gold deposit on Horn Island which we consider in isolation to be worth the company's current market capitalisation of ~$30 million. We believe the market is ignoring the considerable potential upside from both the Horn Island JV and the Lachlan Fold projects. Successful exploration by the Horn Island JV will result in a clear and substantial monetisation event via SBM's right to purchase 70% of the Horn Island deposit. Successful exploration at the Lachlan Gold projects will result in enormous value creation for shareholders.

As such, we view Alice Queen as an attractive investment opportunity given the large, asymmetric potential upside balanced by what we perceive as limited downside. 



​
Disclaimer: This article does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way

Echo released a positive exploration update today for the next ~3.5% of the drilling program. So far only ~14% of the total 90,000 metre total program has been reported to date. 


Highlights of new results from the Corboys drill program include:
• 2m @ 5.64g/t Au from 44m; including 1m @ 9.94g/t Au from 45m (EARRC0060)
• 2m @ 4.81g/t Au from 40m (EARRC0068)
• 2m @ 7.48g/t Au from 14m (EARRC0069)
• 1m @ 11.80g/t Au from 25m (EARRC0071)
• 2m @ 7.89g/t Au from 23m (EARRC0073)
• 1m @ 9.61g/t Au from 47m (EARRC0075)
• 1m @ 5.08g/t Au from 104m (EARRCD0004A)
• 2m @ 4.38g/t Au from 26m (EARRC0081)
• 1m @ 4.78g/t Au from141m (EARRCD0005)
• 1m @ 4.82g/t Au from 56m (EARRCD0014)


In a nutshell, very nice grades from largely very shallow depths. 


These results are a mixture of infill and extention drilling at Corboys which is a shallow deposit over 1200m in strike length at shallow depths of largely <100m depth. The deposit remains open at depth and in all directions according to Echo. 


Exploratory drilling at Corboys SE appears to have been between Corboys and Corboys SE probably to test if the two deposits are connected. Corboys SE is approximately 1400m in length of prospective strike and the main potential ore body has not yet been tested by Echo. We suspect a similar deposit to Corboys may be defined in time at Corboys SE given the historical drill intercepts. 


Looking deeper into the Corboys JORC resource estimate, we discover a number of interesting facts. 
The resource estimate has a cut off grade of 1g/t based on a scoping study that assumed a gold price of AUD$1600/oz, with a cash production cost ~AUD$1200/oz.
Given the gold price now trades ~AUD$2200, we consider that a lower cutoff grade could be used, say 0.5g/t. This would have the immediate effect of raising JORC resources at Corboys to a total of ~168,000 ozs (128,670 oz indicated, 39,875 oz inferred. Source: Metaliko Resources Corboys update 23/8/2016) or by almost 35% vs an existing JORC of ~125,000 ozs.


In terms of geology, Corboys lies on the regionally significant Barwidgee shear zone, which contains a number of other deposits on trend. Interestingly, Northern Star appear to be increasingly interested in this geological setting taking a stake in Yandal Resources who hold the ground immediately north to Corboys on trend with this shear zone. 
We note this area has been lightly explored historically, especially at depths >100m. It will be interesting to see how the exploration program evolves and the consequent results going forward.



Disclaimer: This article is solely the opinion of the author and does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way

We mentioned in our previous article [link:bit.ly/datt-EAR], that at current gold prices Echo Resources ('EAR') has a Life of Mine of over 10 years. In this article we examine further a number of other factors to consider to put the proposed transaction into context.

Economic study on the Bronzewing project
We conducted an economic study of the Bronzewing project, using information from a wide range of public disclosures from the company itself and third parties. We examined the nature and attributes of the each specific deposit including ore type, recovery factors etc.

Our findings and key assumptions used:
- Life of Mine ('LOM'): 10.5 years
- Average gold price: AUD $2,200
- Average mill throughput: 1.75 million tonnes per annum
- Startup capex: $45 million
- Sustaining capex of $5 million per annum for production years 1-10
- Project LOM only for current, existing JORC resources. Does not include any resource upside from exploration, extension drilling etc.
- 6 months till first production

- Discount Rate: 8%
- Pre-tax NPV: $663 million
- Pre-tax IRR: 230%
- Post-tax NPV: $545 million


Comparison to MOD who were taken over by SFR in June 2019:
- LOM: ~11 years
- Exploration potential
- Riskier jurisdiction in Botswana vs Tier 1 Western Australia
- Acquisition cost of 55% of post-tax NPV (8% discount rate used)
- 24 months timeline till first copper production


What does this mean?
Current value of bid by NST: $242.6 million or 33c per share
Implied value: 44.5% of Post-tax NPV
This is a materially undervalued offer from NST to EAR shareholders

Implied value at 55% of Post-tax NPV: $300 million or ~41c per share
Implied value at 70% of Post-tax NPV: $382 million or ~52c per share


Why EAR warrants a higher relative price than MOD:
- Less capital required to bring into production
- Existing processing plant and equipment
- Less technical risk in design and delivery
- Shorter production timeline
- Superior Tier 1 jurisdiction
- Superior outlook for gold vs copper. Citigroup recently released an estimate that gold could rise over USD$2,000/oz in the near term. [link: http://bit.ly/2k8zxV0]
- Higher strategic value and ability to capture value using a hub-and-spoke methodology
- Production increases likely from the baseline case via NST's existing ore reserves mined but not processed
- Long lead time items for Bronzewing restart already been ordered
- EAR management have been proactive in discussions with numerous owners of stranded deposits within trucking distance of Bronzewing


Why NST need EAR
Potentially a higher 'true' AISC than indicated on marketing materials
We noticed an article in the Australian [link: http://bit.ly/2kx7yif] where the head of Gold Fields, Nick Holland, articulated that Australian gold miners are culpable in under-reporting their All-in-sustaining-costs ('AISC'). In particular, he pointed out that growth capital is typically not included in AISC calculations leading to inconsistent reporting in the gold industry. AISC is a metric not recognised by International Financial Reporting Standards (IFRS) and as such is an unaudited and unqualified opinion put forth by the issuing company. In NST's case, there is no transparency around which particular cost items are included within the AISC calculation despite it being a stated KPI to achieve a portion of the management teams short term incentives.

For example, NST have disclosed that they have largely replaced the mining fleet they inherited at Pogo; however, the company appear to have accounted for these fleet additions as 'growth capex' even though the machinery replaced were necessary for 'sustaining' operations. Our other question would be how NST have accounted for the depreciation or reduction of value for the mothballed mining fleet; and whether this should be included as part of any AISC calculation.

We note that NST are projecting an AISC between AUD$1200-1300/oz for FY20. Our own analysis for EAR suggests an LOM AISC of ~AUD$1,150 is achievable. As such, the acquisition of EAR would lower NST's overall claimed AISC whilst boosting overall production to over 1 million ozs per annum.
    
Governance and Accounting Practices
At NST, 3 independent directors are responsible for overseeing the audit and risk committees at board level. Their respective areas of expertise are in corporate advisory, funds management and business development. Whilst prima facie this may be appropriate, we find it unusual that a mineral production company has no individual board member with technical experience or expertise on it's audit or risk committees, given many of the core risks to the business stem from geological and material processing factors.

According to AASB 6, exploration expenditure should be expensed in the absence of a potential economic recovery of the funds expended. At Paulsens and Tanami, there have been various greenfield work programs however, a exploration expense has been not been incurred or expensed within the company's profit and loss statement as AASB 6 stipulates. A good primer on AASB 6 has been written by BDO and is accessible via the following link: http://bit.ly/2lJqjPI

The company do periodically transfer certain values from their exploration and evaluation accounts to mine properties. Mine properties, NST specifically disclose, relate to properties where a development decision has been made and acquired mineral interests. This implies that values carried in exploration and evaluation accounts are effectively for stranded resources which may potentially be economically viable at an unknown future date. The financial statements do disclose that values carried in this account are almost solely down to the opinion of the management team whether an area of interest is of continuing interest. 

This creates in effect a conflict of interest and the incentive to misrepresent the true value of these exploration carried amounts, especially where the respective board committee members may not have the capacity to accurately evaluate or estimate whether management figures are reasonable or realistic. 

To determine if the exploration carried figure of ~$266 million was appropriate, we examined NST's non-operational assets spread across various projects which comprise approximately 1.72 million ozs of estimated gold resources in the indicated or better status. This implies an in-ground value of ~$155 per oz for its non-operational resources. We note that this particular account accounts for over 16% of NST's total assets.

To put this into context, NST's offer for EAR is priced at ~$127 per oz for resources that can begin being monetized within 6 months at minimal cost and that come with all significant infrastructure in place.

This implies one of two potential outcomes where we conclude, NST are either:

1. Overstating their own exploration and evaluation account or;
2. Materially undervaluing EAR on a relative value basis to their own non-operational assets.

Conclusion
It is our opinion that Northern Star must materially raise their offer price to Echo Resources shareholders. We believe that Northern Star need Echo's assets and that it would be more beneficial for Echo Shareholders to remain as an independent producer than take the derisive bid put forth by Northern Star.

It is also our opinion that Northern Star should re-evaluate its accounting policy to provide more relevant and transparent information to the market. We note that EAR revised this same provision raised in their 2018 annual report and restated their 2017 figures on this adoption.


Disclaimer: This article is solely the opinion of the author and does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way

In February, we wrote an article on Echo Resources titled 'Is this the ASX's cheapest gold developer?' highlighting the company's unique asset base in one of Australia's best gold belts, the Yandal. We highlighted the strong potential for corporate consolidation in the prior article as well as some commonalities between the management teams themselves. Subsequently, between February and the present, the share price fluctuated between a low of 13c and a high of 23c.

On the 27th of August Northern Star Gold, one of Australia's most successful gold companies over the past 5 years, made an off-market, all-cash offer at 33c per share to Echo shareholders. This implies a fully diluted equity value for Echo of approximately $242 million. The takeover process will be implemented via a Bid Implementation Agreement which is essentially a 'friendly' takeover.

Whilst the offer is not unexpected, we believe that it undervalues Echo for several reasons.

The current gold price outlook and payback period
At the time of our article’s publication, the gold price was approximately AUD$1,845/oz vs a price over AUD$2,200/oz today. This represents a rise of over 23% and reflects the demand and attraction to defensive assets such as gold in today’s geopolitical and economic environment.

This rise in the gold price has massively improved already attractive project economics. Assuming current gold prices we project a pre-tax IRR of over 400% using only a 4-year mine life as per the latest Bankability Feasibility Study (‘BFS’).

Life of Project and BFS
As noted above, the latest BFS contemplates a project life of only 4 years vs a project life of 8.5 years in the older BFS. At the time of publication, this was a sound decision on the part of Echo’s management team, as stage 2 (the last 4.5 years) of the older BFS was only economic at a gold price of over $1,600/oz.

Today we believe that Echo’s project has a commercial mine life of over 10 years given its current resources, not including any near term upside from infill drilling from its various ongoing programs. We also note that resources at Corboys and Mt Joel which account for an additional 2 years of project life (over 200,000 ozs) are not considered in either BFS.

Including these existing economic resources into the project plan greatly increases the potential economic return to shareholders.

Strategic value of the Bronzewing Plant
The Bronzewing processing hub is a highly strategic asset situated in a Tier 1 jurisdiction with many stranded deposits throughout the region.

All major infrastructure is in place to support an operational restart within 6 months of a Final Investment Decision. Echo has estimated that the replacement value of this infrastructure is circa $120 million.

Whilst this consider that this estimate is reasonable in capturing hard replacement costs, we do not believe it captures soft elements such as engineering design works or time value. For instance, the plant can be operational within 6 months; whereas a greenfield plant by our estimates would .take up to 24 months to deliver to operational status.
 
The Bronzewing plant was designed in 1990, and there is considerable scope to improve throughput from 2mtpa capacity to over 3mtpa by addressing milling bottlenecks and engaging in process improvements. Echo independently, do have the capability to optimise the plant and increase the overall gold production rate from the baseline of 100,000 ozs per annum as per the BFS.

The Bronzewing plant once operational will effectively act as a fulcrum for the entire regions gold deposits. Using a hub and spoke model, Echo will be very well placed to capture a disproportionate share of value from stranded deposits in the region.

Further validating this point, we note that Northern Star have started to stockpile ore due to throughput constraints at their Jundee processing plant. This situation will be greatly exacerbated when mining at Northern Star’s satellite discoveries at Ramone commence in the near future.
 
Exploration results and infill resource definition still ongoing
Echo raised circa $18 million only 3 months ago to fund an exploration program of over 90,000m at scale on its numerous projects. We considered this an exciting opportunity and exposure to what we consider one of Australia’s most prospective gold belts, in a tier 1 jurisdiction.

The latest exploration disclosure reported no material discoveries at present. We do not consider this unusual given the assay results are for the initial 10% of the exploration program by metres drilled. We consider it unusual that the board are willing to forgo any potential upside that may be discovered from the remaining 90% of the exploration campaign.

Whilst we do acknowledge the risk that is part and parcel of mineral exploration, we note that any new  discoveries can be commercialised at incremental cost and extend the project life.

Exploration campaigns are by their nature flexible, as targets are often adjusted depending on results received from earlier parts of the campaign. Shareholders should not be disheartened by the lack of material discoveries at this early stage. Mineral explorers must be persistent and resilient.
 
Conclusion
From our analysis, we conclude that Echo Resources is the stand out takeover candidate in the Australian listed gold sector.

We believe that a higher offer would be looked upon favourably by Echo shareholders and greatly increase the probability of Northern Star being successful in their pursuit.
 
Disclosure: Interests associated with the author collectively own approximately 2.5% of Echo Resources share capital.

Valmec Ltd (ASX:VMX) is a diversified energy and infrastructure services group that provides essential services to the oil and gas, resources and infrastructure sector in Australia. We like the company's exposure to the growing sectors in infrastructure and energy pipeline; along with the clear revenue growth over time and its continued success in winning work contracts whilst maintaining disciplined margins.
There has been an emphasis on growing recurring, higher-margin revenue from the service division which contributed >50% of revenues for the latest half-year. This division was bolstered in 2018 by the purchase of a distressed specialist pipeline testing company which Valmec funded out of working capital. This acquisition has successfully been integrated into the company and now contributes a material amount of revenue to Valmec's service division.
There is a culture of capital discipline and risk control evident within the group itself. In particular, the enforceability of contracts in this sector is very important and Valmec have strong discipline in this aspect. We also noted the best in class personal safety rates, the company has gone almost 7 years (2,500+ days) with a LTIFR (lost time injury frequency rate) of Zero.
We attribute this to a culture of ownership and accountability driven by the fact that the Board and Management team own approximately 45% of the company providing good alignment with other shareholders. The company has a tight register with the top 20 shareholders holding ~74% of the shares on issue.
A valuable hidden assetThe company holds a 'hidden asset' in a potential settlement with John Holland over a disputed contract. The company made an announcement this morning guiding to $110 million in revenue and approximate EBITDA earnings of $8 million. They also confirmed that the John Holland litigation amounts are held at nil value on their balance sheet
The value of the summons is circa $11.6 million, plus costs and interest. John Holland has made a $2 million payment in 'good faith' previously. Any amounts recovered will drop straight to the bottom line and may result in capital management measures.
In their recent half-yearly, Valmec reported EBITDA of $3.2 million on revenue of almost $48 million. They have guided that significant growth is expected for the 2nd half of the year, along with a solid order book of work to the value of $80 million as well as over $500 million in potential contract revenue opportunities. 
We note that the company's growing scale has allowed it to bid on larger scope of works which provides greater visibility in terms of earnings.
A sound microcap opportunityWe see Valmec as a sound opportunity to obtain conservative, profitable exposure to the infrastructure and pipeline industries, along with a potential large kicker in the settlement of the John Holland litigation. At a market cap of only ~$30 million, Valmec may be a steal in time.