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.
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:
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.
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.
Count Plus ('CUP') owns and partners with accounting and financial advisory firms, forming a network largely focused on Australia's eastern seaboard.
It provides value to partner firms in several ways:
Financial - Providing capital backing to member firms
Operational - management support, best practices and cost efficiencies via group buying
Strategic - support in terms of growth strategy, succession planning
The companies finances are unremarkable, with small losses being incurred the past couple of financial years. The balance sheet has been strengthened in recent years with the divestment of various investments and the reduction of debt. Commonwealth Bank ('CBA') owns almost 36% of CUP via their subsidiary Count Financial ('CF'), which they have disclosed they will divest in time.
CF's core business is to allow third-party accounting practices to provide financial advice to their clients, under CF's Australian Financial Services Licence. Historically, CF has relied heavily on receiving trail commissions and rebates on funds under advice with approximately 75% of revenue derived from this source. This revenue stream will be banned from the 1st of January 2021, as a consequence of recommendations put forth via the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.
Count Financial acquisition
CUP have agreed to purchase CF off CBA for a price of $2.5 million, relative to net tangible assets of $14.8 million. This 'bargain' sale price is reflective of restructuring costs and ongoing losses from Count Financial - CBA guided FY19 losses at $13 million post-tax.
As part of this deal, CBA agreed to reimburse CF for customer remediation or refunds stemming from historical misconduct, up to the value of $200 million. $144 million has been already recognised as a provision by CBA, so the actual net indemnity is for $56 million.
The deed specifies that the indemnity cap may be increased in 2 circumstances: $12.5 million in new customer remediation claims before deal completion; or should the customer remediation rate materially vary from a figure of 24% of historical CF revenue dating back to 2009. We note that the indemnity cap adjustment is not legally binding nor are the specific terms referred to defined. We also note the lack of disclosure from the CBA announcement regarding this 'good faith' adjustment and note that the cap adjustment is reliant on APRA and ASIC consultation. In effect, we don't believe that the cap will be ever adjusted.
Importantly, we note that the indemnity deed only indemnifies CF for the remediation of customer claims for 4 years post the deal's completion. Broadly speaking, the statute of limitations for claims in financial services litigation are generally 6 years from the date of a purported contravention; except in the case of statutory and negligence claims. We also note that there are some circumstances in where the statute of limitations periods may be extended, for example by a court of law.
The indemnity deed elegantly excises any future statutory liability via clever and specific wording. We note recent media commentary from ASIC regarding fresh litigation post-royal commission. The language from ASIC has been quite assertive in terms of bringing offenders to account. In particular, the recommendation that ASIC no longer settles cases before opening up a formal investigation we consider to be a material risk; as we consider it likely that CF under CBA ownership settled claims rather than engaging in litigation. Once again we highlight that the CBA indemnity is specifically for customer remediation only and does not cover statutory fines or penalties by ASIC.
Excess claims scenario
Should the CBA indemnity be insufficient to cover customer remediation payments, CUP have disclosed that they will not guarantee CF's business operations and as such will likely be liquidated.
Shareholders should also note that should CF liquidate in the case of customer remediation indemnities being insufficiently covered by CBA or fines incurred from ASIC, amounts paid from CF to CUP may be 'clawed back' during the liquidation under certain sections of the Corporations Act 2001.
Effectively CBA has shifted the reputational risk to CUP, in the case of winding up the company, for a relatively nominal fee. Should this occur, shareholders should questions whether the non-performance in terms of customer remediation for CF customers would affect the underlying businesses owned or those that are in a commercial relationship with the firm?
Count Financial revenues are expected to fall by 60% once all expected reforms stemming from the Royal Commission are enacted. The expected date of the ban is approximately 15 months away.
The new revenue model going forward relies on CUP increasing average revenue from member firms by over 3x current revenues. After running the numbers and conducting an analysis of competing firms we consider this forward assumption to be aggressive. The expert report on the acquisition itself mentions the inherent uncertainty of transitioning existing franchises to the new pricing model. As such we expect firm attrition to increase largely as a result of the new pricing structure.
There may be an increase in overhead expenses as Count Financial will lose the benefit of using CBA shared services including rent, IT & systems costs. CBA will provide services to manage claims and transition for a cost to Count Plus.
It is our opinion that even though prima facie CUP are acquiring CF for a 'bargin' price according to Net Tangible Asset calculations; the potential quantum and scale of contingent liabilities may prove that CBA stakeholders are the real beneficiaries over time.
Effectively, CUP have sold CBA a put option which caps CBA's downside financial risk to the detriment of CUP's shareholders should the risk eventuate.
CUP may turn things around longer-term in spite of the potential risks, but in the interim many question marks remain.
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.
Lynas (LYC:ASX) is a rare earth producer with operations in Malaysia and Australia; most recently in the news for being the target of an opportunistic takeover by the Australian conglomerate Wesfarmers (WES:ASX).
Whilst rare earths, contrary to their name, are not especially rare; they are difficult to produce commercially whilst being of exceptional importance in 'new age' technologies. Specific industries which rely heavily on rare earths include renewable energy, medical devices, electric vehicles among others. Demand is projected to grow strongly over the next 10 years.
There will be significant difficulty in meeting this projected new demand going forward, as rare earth production is highly capital intensive and there are large technical risks associated with a gradual ramp up to full nameplate production. Lynas have overcome a multitude of obstacles over the past decade to become the only significant producer outside China. This is underpinned by a Tier 1 resource at Mt Weld with a 25+ year mine life; an operational and efficient separation plant and valuable intellectual property obtained over a number of years. Recently, there was significant speculation that Lynas would have difficulties renewing their processing licence in Malaysia. Happily overnight, Dr. Mahathir the Malaysian president recognised the substantial social and financial benefits to the local community that Lynas' operations bring, and clearly articulated that their processing licence will be renewed.
The existing supply structure of the rare earths market leaves it extremely vulnerable to shocks caused by geopolitical events and decisions. In 2010, the Chinese government reduced the export quota of rare earths by 40% and unofficially banned exports to Japan; the second largest user of rare earths. This led to a massive surge in spot market prices, with the price of most rare earth elements increasing by 5 times in a short period of time. The recent trade talks between China and the USA have once again highlighted the potential re-occurrence of a similar situation, with much talk in the Chinese media of 'weaponising' it's rare earth endowment by denying the US access to these essential elements. We also note the lack of spot market supply outside of Chinese sources indicated in the graph below.
Whilst, we hope that cooler heads prevail between the US and China, we believe that there is a clear shift towards diversifying sources of rare earth supply from non-Chinese sources. We have seen great evidence of this via the flexible financial support extended to Lynas by JARE, a partnership between a Japanese government institution JOGMEC and a large Japanese trading company Sojitz. JARE will also be extending their financial support to fund Lynas growth opportunities discussed further below. In addition, there has been substantial rhetoric from the US media about the need to source rare earths from non-Chinese producers.
Independent of these issues Lynas also have some fantastic growth options, including a recent MOU signed with a small US producer who owns an existing site permitted for rare earth production. We anticipate that there will be significant US government support for this project; which may speed the commercialisation of this project. We believe the company's strategy to move into manufacturing higher value, downstream product is a sensible move and will greatly increase the strategic value of the company in the coming years
We rate the management team led by Amanda Lacaze very highly. Amanda has very ably and astutely led the company from the brink of insolvency at the time of her appointment to its transformation into the world-class rare earth producer it is today.
Investing is a difficult exercise for investors, big and small. Below we explore a number of examples and ways to mitigate your investment risk thereby increasing your chances of success.
1. Don't put all your eggs in one basket
Spread your investments across different assets and asset classes. While it may be simpler for an investor to invest solely in shares, a superior, less risky portfolio return may be achieved by investing in other asset classes such as fixed income and hybrids. There are a range of these products listed on the ASX or available via a specialist fixed income broker.
2. Don't be afraid to get a second opinion
It is important to trust your selected advisor's judgement but don't hesitate to obtain a second opinion from another professional. The small extra cost can repay itself countless times by helping to avoid a poor investment decision. In addition, examine the possible incentives being offered to the advisor. A good advisor should betransparent and disclose any incentives they may receive as a result of your investment.
Guvera was an unlisted music streaming service, which offered advisors up to $30,000 worth of referral fees or free options to raise money off their clients. This was in addition to subsidised trips to opulent fundraising events hosted by an associated company. The company raised approximately $180 million off investors before winding up, having never made a profit and wiping out the invested funds of over 3,000 investors.
3. Understand how your investments make money:
It is essential to understand conceptually how your investments make money and how returns are being generated. Without this level of understanding, investment risk is increased substantially especially in cases where leverage is utilised to generate more attractive returns. Whilst leverage can be beneficial in certain circumstances, it is often bad especially where used excessively.
Storm Financial was financial advisor aligned with a number of large financial institutions. Broadly, all of its clients were provided generic advice to mortgage their homes to the hilt and invest in indexed funds run by Storm's partners, with periodic re-balances and accentuated by margin loans provided by Storm's partners. In a rising market and conservative leverage this may have worked well for a time however, the GFC brutally exposed the flaws inherent in the business model. Towards the end of the jig, it turned out Storm was keeping it's clients permanently geared at 90% (ie. 90c of debt for every dollar invested) without notifying them of any increases in leverage; making its clients highly vulnerable to any downturn in the market. Storm and its partners were incentivised via a gamut of high fees including a large portion upfront and trailing commissions.
The GFC passed and 3,000 of Storm's clients were left destitute and many more badly affected with total losses estimated at $3 billion.
Scandalously, the principals of Storm were served with civil penalties of only $140,000 collectively; a slap on the wrist for those who destroyed the lives of so many.
4. Recognise the value of governance:
Good governance is critical for any successful investment. This covers aspects such as the use of internal controls and separation of duties within the organisation, the independence of the entity's auditor as well as accurate disclosure of related party transactions.
In addition, the value in the use of independent 3rd party providers should not be underestimated for investors in managed funds or schemes. Outsourced providers for administrative functions like unit pricing allows a 3rd party to critically assess the fund which theoretically reduces the risk of fraud. Independent auditors play an important role and their commentary should be read carefully.
A good board with the requisite processes, structure, and skills play the largest part in defining the entity's governance and culture.
In the entrepreneurial 1980's Laurie Connell's merchant bank, Rothwells, had a number of issues that were highlighted above. In particular, governance was exceptionally poor with Connell holding the position of both the managing director and chairman. The board of directors rarely met and investment practices were not enforced or reviewed. In addition, Connell's companies were the largest borrowers of Rothwell's funds however, these were cleared off the balance sheet before each audit date involving a number of mechanisms with friendly companies. The auditor, imported from Queensland to Western Australia, gave the accounts a clean bill of health until the end. Ironically, Qintex another 1980's Aussie fraud imported their auditors from Victoria to Queensland.
5. Private investments are far more difficult than public. Be wary of private entities held within a public structure.
Investments in private unlisted companies are far more difficult to assess and invest inthan public, listed opportunities. The major difference is the lack of liquidity in private investments. Generally, in a public listed investment; liquidity is available at an open and relatively transparent price. Private companies unless exceptionally attractive, generally struggle for secondary market liquidity and at a greater transactional price than the public markets.
Governance can be a big issue due to the lack of protection for minority investors, especially where no binding shareholder agreement exists. In addition, disclosure requirements vary significantly between private and public companies. Be wary of public listed companies that conglomerate private opportunities, without providing clear and transparent valuation metrics and disclosure for their downstream investments.
Blue Sky Alternative Investments is a recent example where a critical public report from an external party led to scrutiny from the wider investing community. Blue Sky was exposed for significant flaws in their disclosure, private investment valuations and performance calculations, which led to a loss of over 95% of its stock value from its peak in a period just over 12 months.
6. Beware products with a veil of secrecy. don't invest in products that you don't understand.
Beware of those bearing products that are sold with airs of exclusivity, veils of secrecy and little disclosure. In addition, be wary of schemes that appear to target a particular ethnic or religious segment of the population.
Bernard Madoff has been one of the highest profile scams of late, with investors losing an estimated $18 billion. Madoff ran a Ponzi scheme, which involved paying returns to existing investors from the incoming funds of new investors; he managed to run the scheme over a time span of decades using a number of mechanisms. Primary was the fact that he claimed his fund was by invitation only, and he required secrecy from his investors. This provided his operation with an aura of exclusivity, and ensured that most existing investors stayed 'invested'. His industry links and associations also provided a veneer of legitimacy.
He also targeted specifically Jewish individuals and associations and played upon his own Jewish identity to build affinity with investors. Finally, his claimed annual 'returns' were consistently around 10%, enabling him to stretch the scam out over decades.
7. Beware of investments that sound too good to be true.
Firepower International was a fraudulent company that claimed to have invented a fuel additive pill that led to lower pollution emissions, increased fuel efficiency, and a cleaner engine. Scientifically, they claimed to achieve this by burning more of the heavier elements in fuel. Investors only needed to possess a rudimentary, high school level understanding of chemistry to understand the sheer absurdity of these claims. The company had achieved a level of credibility given the support of the Australian government agency Austrade and various government ministers; as well as a widespread sports sponsorship campaign by the company itself.
The charade ended when ASIC began an investigation into the company, for raising funds without adequate disclosure to investors. Firepower had raised anywhere between $60-$100 million from investors via intermediaries. These investors were sold shares 'cheaply' in the cents, with the projection that the shares would trade in the dollars one day. Interestingly, there was no actual Australian company, with no shares legally issued; yet the product was being sold by registered financial intermediaries. All the sponsorship and government agreements were with a legal entity that did not exist.
Needless to say, investors lost their entire amount invested. The promoter of the company walked free with no financial penalties or jail time.
8. Use your common sense
Don't invest without reviewing the appropriate issue documents such as a prospectus or an information memorandum. When in doubt, ask a trusted advisor. Don't sign legal documents without prior review by a solicitor to ensure that you understand the risks and your legal liabilities and obligations to be fulfilled under the contract. Don't be blinded by high returns or promises, there is no 'free lunch'. Beware the charismatic promoter.
Land schemes have always been a particularly notorious segment in the Australian market for the improper raising of funds. Typically, the promoter of the scheme secures an option over a parcel of land; with investors required to complete the acquisition. Investors are promised a high return dependent on the rezoning of the land at an unknown point in the future. The promoter is usually the only party to have a full understanding of the trail of funds, the issuing of shares or units and the rezoning process itself. This sole point of responsibility generally leaves the scheme open to abuse, and many investors get burnt by these schemes every year.
9. Consider tax but don't make it the sole basis of your decisions
In the 1970s the Australian government began offering tax incentives for rural industries and in particular tree plantations. The vehicle generally used for these investments were managed investment schemes (MIS). One of the biggest attractions with an investment in an MIS was that it gave the investor an immediate large tax break and allowing the deferral of tax until the end of the MIS or exit of the investor.Conventionally a plantation is an unattractive with substantial costs incurred at the front end of the investment, maintenance expenditure required annually and an uncertain return (or loss) achieved after an uncertain time period; this also assumes there are no natural disasters in the interim.
These structural impediments along with too much debt and the pursuing of unprofitable schemes burned many investors in the late 2000s. Thousands of investors were affected by the collapse of Timbercorp and Great Southern Plantations, two of the largest operators in the space, along with a litany of smaller operators.
10. Avoid where possible complex and international structures.
Allco was a financial services group which floated a number of different listed vehicles in the 2000s. The companies were largely involved in businesses which dealt with property and infrastructure as well as heavy fixed assets such as rail, aviation, and infrastructure all on a global basis. Whilst each segment is simple enough, Allco's engaged in a mind-numbingly complex array of cross-holdings and interrelated transactions in which the associated companies financed each other. The disclosures in financial statements were extremely difficult to decipher even for the dedicated professional investor.
In addition to the heavy borrowings within the companies undertaken as a course of business, the core identities in the group also held their stock in the companies with a high degree of leverage. This provided a strong incentive to attempt to support the share prices of the various satellites. Long story short, the advent of the GFC reduced the value of the assets and the cash flow available within the Allco satellites; the principals of the group were forced to liquidate their holdings due to margin loans and the majority of the Allco satellites were wound up. Ultimately, approximately $3 billion of equity raised went up in smoke.
Pulling it all together
If an investor has no appetite or inclination to perform due diligence upon their investments, they should consider outsourcing part of their portfolio to a trusted professional advisor. We would recommend speaking to an independent financial planning practice, to alleviate any concerns around incentives.
In addition, skilled active fund managers should be identified and explored as part of this consultative process.
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 Resources (ASX:EAR) is a gold developer with it's operations based in Western Australia.
We believe that it provides the best exposure to ASX listed gold development plays, and is compelling value at the current market value of around $100 million. It is our opinion at the current gold price, the company is worth significantly more; especially considering it's exceptional project economics, strategic assets and exploration potential.
Echo's key differential advantage against other gold developers, is that it already owns almost all the key infrastructure required to operate a stand alone gold production operation. The Bronzewing Processing Hub is a 2 million tonne per annum processing plant, currently on care and maintenance, solely owned by Echo with a replacement value of approximately $120 million. Other key infrastructure available to Echo's operations are a 200 person mining camp, an operational airstrip, essential services (water, power, telecommunications) and an established network of haulage and access roads.
Having this infrastructure in place, heavily reduces the upfront capital expenditures ('capex') and time required to bring it's gold resources into production; making the project exceptionally attractive from a financial returns perspective. A Bankable Feasibility Study ('BFS') has been completed, demonstrating that the project requires pre-production capex of around $40 million to bring the project into production in a time frame of only 6 months. This is in contrast with similar projects, requiring between $130-160 million in pre-production capex depending on jurisdiction, and a time frame of 12-18 months to first gold production.
According to the BFS, at a gold price of AUD$1600, the project is projected to earn over it's lifetime of 8.5 years, a base pre-tax IRR of 155% and to payback it's initial capex within 12 months. Assuming a gold price of $1800, we modeled that the project would earn an IRR of around 300% and payback it's inital capex in around 7 months; almost unheard of economics for a commodity project. Taking a discounted equity multiple approach, we modeled that the project would return almost $8 for every $1 of capex spent over it's lifetime.
EAR's all in sustaining cost ('AISC') for the life of the mine is projected to be around $1270 an ounce however, we expect this figure to fall in the optimised BFS.
These figures account only for EAR's existing resource base; whilst ignoring it's significant exploration successes since the issuance of the BFS and future exploration potential. An optimised BFS is currently underway and due to be released in the March quarter. We anticipate this confirm the robust economics of the Yandal project, and lead very quickly to a Final Investment Decision. We expect there will no issues at all with debt funding the entire capex requirement given the exceptional economics of the project; and the company have iterated that discussions with multiple Tier 1 resource project funders have been undertaken.
We note that the company currently has a 1.7 million ounce mineral resource, with a JORC reserve of 856,000 ounces. We expect, given the recent excellent strikes at Mt Joel, that this figure has the potential to increase substantially. In addition, there is still vast exploration potential for the company at depth, with almost all exploration to date has been done near the surface (<200 metres below ground level). With the project expected to produce around 95,000 oz a year, any further discoveries or resources defined will have the potential to extend the life of the project materially.
EAR's fantastic potential has not gone unnoticed by larger competitors. North Star Gold (ASX:NST) have over time taken a stake of approximately 22% of the company; at an implied value over 50% higher than the current market value. NST have appointed an experienced development executive to act as a board nominee. We believe there is a strong possibility that NST may ultimately make a takeover bid for EAR for a number of reasons.
The Yandal project in it's current incarnation, is projected to produce around 95,000 ounces per annum. This equates to over 10% of NST projected forward production from it's various mines. With NST current capitalised at over $5 billion, this implies a value of around $500 million for EAR once the project is in production; and if the market attributes a multiple similar to NST which is unlikely for the company on a stand alone basis. If NST were to acquire EAR, this becomes more likely as the acquisition would materially improve NST's company wide production metrics, as well as consolidating a large portion of the area around it's flagship Jundee mine and securing the valuable infrastructure and existing gold resources held by EAR. The Bronzewing Processing Hub has a lot strategic value and when functional will open up a lot of stranded deposits within the area. This asset will still have value at the end of the life of mine as it's likely to be able to generate ongoing income via 3rd party tolling agreements; as well as being able to scale up in size.
EAR also possess around $65 million of carry forward tax losses that can be recouped before paying tax. This fact makes EAR an attractive candidate for a corporate acquisition. We also note the commonalities between the CEO's of the two companies. Both have studied and worked at different times, at the same educational institutes and the same companies. Both have operational mining backgrounds and we regard the existing EAR team as a good cultural fit for NST so attractive as a bolt on acquisition.
We note that EAR fulfills almost all of NST's stated acquisition criteria and we note that other transactions in the gold sector in recent times have been for higher prices per ounce of gold equivalent than EAR is currently valued by the market. It is our opinion that EAR shareholders could achieve significant upside at the current price, in a relatively short period of time.
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
When I first began my interest in investing I started with what is considered the bible to value investors: Security Analysis by Benjamin Graham. To be honest, I couldn't and still haven't finished the book as I found it very dry and uninteresting. Thankfully, there are a whole universe of investing books out there, and I list a number of books I found useful in my investing education.