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