The Mining Report: Some of the experts we have interviewed for the The Mining Report and The Gold Report is that a $1,250–1,350/ounce ($1,250–1,350/oz) gold price can be expected in the short term. Do you agree?
Filipe Martins: At GMP, we forecast a $1,350/oz gold price from roughly 2015, but we think there is a real risk that the gold price could fall before it rises, given the threat of higher borrowing costs. Most recently, we haven't seen the increases in physical demand from China and India that normally follow gold price dips. This is a cause for concern.
TMR: Assuming a gold price of $1,300/oz, will investors gravitate strongly to those companies with the lowest all-in cash costs?
FM: All-in sustaining costs don't show the entire picture. We prefer to compare producers on a like-to-like, bottom-line cash basis, with focus on balance sheet strength and improvement in net debt. It's all about free cash flow yields going forward. In turn, cash needs to translate into strong dividend yields in order to pull investors away from other asset classes.
The gold sector as a whole has responded well to the lower gold price. Companies have recut mine plans and have tightened their economic assumptions to focus on grade and profitability, rather than big net asset values (NAVs). A case in point is AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE), which has delivered close to five flawless quarters and reduced all-in sustaining costs by circa $500/oz (to around $1,000–1,050/oz) under new CEO Srinivasan Venkatakrishnan.
TMR: Would you consider AngloGold Ashanti to be something of a model for the gold majors?
FM: Yes, at an operational level. However, it has suspended its dividend and still has a long way to go before returning cash back to investors. The last big catalyst for the stock is converting problem-child asset, Obuasi in Ghana, from a $150–200 million ($150–200M) cash burn to a potential $2 billion ($2B) NAV asset. Finally, it needs to derisk its balance sheet to support disciplined growth and dividends.
TMR: Which other operators have impressed you?
FM: Within our coverage, Randgold Resources Ltd. (GOLD:NASDAQ; RRS:LSE) also stands out. The Kibali gold mine in the Democratic Republic of Congo (DRC) has been a success and is self-funding from here. The company has very little debt and world-class assets with a strong ability to build cash from here. With no further growth projects beyond Kibali, Randgold is committed to returning cash to shareholders. We believe that is what is backstopping the stock's premium valuation of 2.5x price/NAV, almost double its peers. There is huge scope for ounces to grow in the Congo, despite being a higher-risk geopolitical jurisdiction. It remains one of the best frontier jurisdictions for multimillion-ounce discoveries. We certainly think Randgold is fully valued at its current level, however.
Among producers with smaller market caps, Centamin Plc (CEE:TSX; CNT:ASX, CEY:LSE) and SEMAFO Inc. (SMF:TSX; SMF:OMX) stand out. Both are debt free and operate high-quality assets, Sukari and Mana respectively, with long mine lives. We see them comfortably supporting 5% dividend yield streams from 2015, streams that could be sustained at spot gold prices over double-digit mine lives.
Next best are Endeavour Mining Corp. (EDV:TSX; EVR:ASX) and Shanta Gold Ltd. (SHG:LSE). They're targeting $1,000–1,100/oz all-in sustaining cash costs or 15% all-in sustaining cash margins—a target, we think, all producers should be working to meet. They carry some balance-sheet risk but are inexpensive in price/NAV terms. That said, they are free cash flow-generative and able to improve their net debt positions. We'll have to wait a little longer for this to translate into bigger dividend yields.
TMR: Besides net cash position and cash flows, which other qualities do you look for in gold producers?
FM: Among the producers, ideally we look for the Holy Grail—companies that are cheap, growing and cash flow-generative. In developers, we look for high internal rate of return (IRR) projects, so high-grade deposits with low capital intensity, preferably in low-risk jurisdictions.
TMR: What about management?
FM: Disciplined management teams with track records of building and operating mines are key. Experience adds credibility to capex and opex numbers.
Producers with first-class management teams include Centamin, SEMAFO, Endeavour and Shanta. SEMAFO also has a pretty good track record of discovering ounces, not least the recent discovery of Siou and Fofina, which has completely transformed Mana.
TMR: What about near-term gold producers?
FM: I prefer Roxgold Inc. (ROG:TSX.V) and its Yaramoko project in Burkina Faso. It's the highest-grade development asset on the continent outside of South Africa, with one of the highest IRRs. Its COO, Paul Criddle, is a solid mine builder. He's built 4+ million-tons-per-annum mines, including North Mara, Sabodala and Edikan. When you consider B2Gold Corp.'s (BTG:NYSE; BTO:TSX; B2G:NSX) acquisition of Papillon Resources Ltd., it proves our investment thesis that quality assets attract good valuation even through the bottom of the cycle. Yaramoko comfortably supports all-in sustaining costs of sub-$700/oz, which many investors gravitate toward. Having already attracted $75M in debt, it needs only a small amount of additional funding to reach production.
TMR: What are your opinions of other West African near-term gold producers?
FM: Asanko Gold Inc. (AKG:TSX; AKG:NYSE.MKT) just announced the commencement of phase 1 construction at its Asanko gold mine. The company acquired Obotan project through the PMI Gold acquisition. We like Obotan. It has pretty robust economics at US$1,300/oz gold, and on Aug. 26 Asanko eliminated a 2% net smelter royalty on the project. Obotan is in our top five best undeveloped gold assets in Africa.
We also like Amara Mining Plc's (AMA:LSE) Yaoure gold development project in Côte d'Ivoire. The preliminary economic assessment outlines an 8 million ton (8 Mt), carbon-in-pulp plant processing 1.4 grams per ton (1.4 g/t) material at 95% recovery for 300,000–320,000 oz production over a 12-year mine life. It has a big mineral mining inventory at 4.2 million ounces with a reasonable 5:1 strip. Recent drilling, though, suggests that reserve quantum, grade and strip should all improve.
Capex is $410M, and that includes close to $90M of mining fleet, which we think could be optimized. It has all-in sustaining costs of sub-$700/oz and excellent infrastructure on site with low-cost hydropower. It's the next best undeveloped project after Obotan and Papillon, which are funded to production. Yaoure is able to support a 20+% IRR post acquisition and build capex, which is quite rare.
TMR: The companies you have mentioned are all in Africa. So it's safe to say you are bullish on that continent?
FM: Africa remains one of the most mining-friendly continents. There is little to no precedent of nationalization, unlike Latin America. The only thing that holds back Africa is headline risk, which rarely impacts operations but can still drive significant share price volatility. Recent examples include political instability in Egypt and Mali, the threat of punitive mining code changes in Côte d'Ivoire and the DRC, and surprise levies in Kenya. We note that headline risk is typically higher in the run-up to general elections, but the election season is largely behind us now in West Africa. The next 12–24 months should reveal greater political stability and a better environment for investors.
TMR: Which African country is most mining friendly?
FM: Whether it is in the form of royalties, profit sharing, taxes, free carries or buy-ins, Côte d'Ivoire, Liberia and Mali rank as the three lowest-cost gold jurisdictions. Overall, though, we prefer Burkina Faso, Côte d'Ivoire and Senegal, given their combination of underexplored but prolific gold belts, stable politics and inexpensive fiscal code.
Burkina Faso has permitted close to eight mines in almost as many years. We have recently seen the permitting of satellite operations at SEMAFO's Mana and Amara's Kalsaka operations in record time. Roxgold should soon follow, with first pour targeted for Q4/15.
TMR: It's commonplace that increased mining company activity leads to demands for higher government revenues. Do we see this in West Africa currently?
FM: With gold down to $1,250–1,300/oz, West African governments have come to realize that gold companies aren't making the big profits anymore. Reporting all-in sustaining costs has also helped. It's not surprising that Côte d'Ivoire has introduced a very competitive code, or that Ghana has scrapped its superprofits tax. Senegal is planning to change its code, but given that it only has one mine in operation, Teranga Gold Corp.'s (TGZ:TSX; TGZ:ASX) Sabodala, it's unlikely the new code will be overly punitive.
TMR: What's your opinion of Teranga?
FM: It has a quality asset, not least because it operates the only mill on Sabodala, which has a replacement value north of $500M. Senegal is very prospective in our view. There are multimillion-ounce deposits close to Sabodala's mill, such as Randgold's Massawa deposit and Mako, which is a high-grade open pit held by a private company, Toro Gold Ltd.
That said, we were a bit disappointed with Teranga's takeover of Oromin Explorations. We believe the deal failed to materially improve the asset quality, given the price paid, and the current mine plan is lumpy in terms of stripping and grade, which hampers its ability to deliver a steady stream of cash flow. Another concern is the company's stream financing deal with Franco-Nevada Corp. (FNV:TSX; FNV:NYSE). While the cost of the stream is NAV neutral on reserve ounces, we believe it's punitive on future quality ounces discovered, and detracts potential buyers.
TMR: On May 1, Teranga closed a $30M financing. What is its cash position?
FM: It has $28.4M in cash, and this looks to be tight going into H1/15 under the current unoptimized mine plan, which is, of course, subject to change with future reserve drilling.
TMR: Teranga shares reached about $1.20 earlier this year and then lost half their value. They're now at $0.85/share. In which direction will they move?
FM: I have a $0.70/share price target.
TMR: You praised SEMAFO's management. Would you talk about its decision to concentrate exclusively on Mana?
FM: We believe it was the correct strategy. This decision followed its exploration success on its Siou deposit. The Siou and Fofina satellites have transformed Mana into a high-grade, high-margin operation. The Q2/14 results show what Mana is capable of: a 30% free cash flow margin and a 10% free cash-flow yield. We expect margins to improve with the changeover to grid powering expected in Q4/14.
SEMAFO's management team is disciplined and conservative; they're not going to overpay for ounces and have a good exploration track record. The next catalyst for a share revaluation is the resumption of dividends and exploration success along the 15-kilometer anomaly at Pompoi Nord, which is within trucking distance to the mill.
TMR: SEMAFO's stock was battered for years. As recently as last fall, it was under $2/share. Not long ago, it topped $5/share. Where do you see the stock going?
FM: On a price:NAV basis, the share price looks a bit toppy, but if it can pay a 3% dividend yield—remember, this is a debt-free company—and if Pompoi Nord turns out as well as Siou, then this is $6–8/share stock.
TMR: Earlier, you had nice things to say about Endeavour, which has mines in Mali, Ghana, Burkina Faso and Côte d'Ivoire. Tell us more about this company.
FM: We really like Endeavour. It's cheap. It's growing. It's free cash flow-generative. It ticks all the boxes. The company does have debt to repay before it can return cash to shareholders or reinvest in accretive mergers and acquisitions deals. It has a strong track record in the latter, not least Tabakoto, where we see a lot of potential value upside from exploration.
TMR: Endeavour doubled its share price this year.
FM: It's still cheap at $0.93/share. We currently have a CA$1.55 price target.
TMR: You also cover African companies with mineral sands, copper and titanium deposits. Which companies are most interesting in those sectors?
FM: I'll start with mineral sands. Kenmare Resources Plc (KMR:LSE) announced its H1/14 financials Aug. 27. At first glance cash looks tight, and shares fell 6%. The key data point, though, is opex and capex continue to trend lower. This is a sector that's under a huge amount of pressure, not least because demand and prices for titanium feedstock have come down off 2011 highs. Ilmenite seems to be the feedstock that is most under pressure. If you look at ilmenite pricing against the Kenmare share price, you see that it gives you good exposure on the way up. We're very much of the view that the way to play the TiO2 space, at least right now, is to back the higher-grade titanium feedstock miners given stronger exposure to a recovering U.S. economy.
One positive we do see is recent data from producers like Tronox Ltd. (TROXW:OTCMKTS), a vertically integrated feedstock pigment producer, which show that pigment-plant utilization rates are all on the rise, sales volumes are increasing and prices are stabilizing. But I don't think we'll see a price recovery until 2015. If you want to play the near-term U.S. recovery, you want to invest in the higher-grade TiO2 feedstocks—rutile and chloride. Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK) dominates, with ~80% of chloride feedstock market, but offers investors little pure-play exposure with only ~4% of EBITDA generated by its TiO2 business, hence our preference for mid-cap mineral sand producers.
TMR: Which other mineral sands companies do you cover?
FM: Mineral Deposits Ltd. (MDL:ASX) and Base Resources Ltd. (BSE:LSE). They have low-cost assets and good exposure to high-grade TiO2 feedstocks. We believe they're both very well funded to commission and ramp up their respective mines. So you are able to see through H2/14 and come out on the other side in 2015, when we're expecting the TiO2 recovery to gather pace.
Kenmare is sitting on a world-class asset, but cash is looking tight. It doesn't have the balance-sheet strength that Base Resources and Mineral Deposits have, nor the near-term cash flow.
TMR: You also cover Tiger Resources Ltd.'s (TGS:ASX) Kipoi copper project in the Congo.
FM: This company has been cash flow-generative. It has raised well over $300M in debt and equity to acquire the Gécamines', the parastatal copper mining company, minority stake, and also to build the solvent-extraction and electro-winning (SXEW) facility, which it is commissioning now. Our biggest concern is that it still must spend $200M to finance further expansion, which brings with it capex, build and commissioning risks.
The recently announced deal to acquire the 40% minority stake owned by Gécamines is mechanically accretive to our NAV. More important, it should make it significantly easier to sell Kipoi to a trade buyer. So right now, we are more positive on the name given the proposed equity and debt financing provides financial headroom going forward.
TMR: Reservoir Minerals Inc. (RMC:TSX.V) has resources in Africa, but I wanted to ask about its Timok project in Serbia. What's your view of that?
FM: It is one of my preferred copper-gold exploration stocks. It currently holds a 45% interest in Timok, which is in a joint venture (JV) with Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE). The terms of the JV are very attractive in that Freeport fully funds all exploration and feasibility work, yet Reservoir will retain 25% of the project once it publishes a bankable feasibility study. Even more compelling is that Reservoir can publish its own resource estimates and undertake feasibility work without having to wait for Freeport.
Reservoir's CEO, Simon Ingram, is a very competent geologist. Timok's maiden resource is 65 Mt at 2.6% copper and 1.5 g/t gold, one of the highest-grade recent discoveries anywhere. Our numbers show that it is worth roughly US$2B or $10/share attributable to Reservoir. Even better is that Timok's high-grade subset includes 4.5 Mt at 11% copper and 7.5 g/t gold or $900/ton of recoverable value. With long porphyry drill intervals beneath the high sulphidation cap, we believe Timok has an immediate head start over all the other low-grade, big capex porphyrys out there.
TMR: On a different subject, you're bullish on graphite. What does projected demand tell us about the future of this sector?
FM: In the graphite space, supply-and-demand fundamentals in the medium to long term are compelling. Graphite is used mostly in industrial applications like refractories, which will continue to grow in line with global GDP. But the big demand shift has been to high-end applications like lithium-ion batteries, which looks set to grow at a 10% compounded annual growth rate. This is what is driving the demand for the larger flake-size graphite.
To satisfy demand growth, we estimate the world needs one new graphite mine every year, assuming an average mine size of 25–30 Ktpa. Looking at the long list of graphite developers that have emerged, it's about choosing the graphite project with the right size fraction, the best in situ rock value that produces a saleable produce. So you want to be in the large to jumbo flake size, but you also want easy processing, cheap mining costs and the graphite concentrate to be of the highest purity without requiring any acid treatment to upgrade it.
TMR: What's your favorite project in that sector?
FM: Energizer Resources Inc. (EGZ:TSX.V; ENZR:OTCQX) in Madagascar. This country has always produced a very high-quality graphite concentrate.
TMR: A few years ago, Energizer touted its Madagascar vanadium deposit. Why the shift in focus to graphite?
FM: Junior explorers must spend wisely, and vanadium is a much smaller market than graphite with more complex metallurgy to crack. The company has taken the right approach in shifting its attention to Molo. Energizer's share price ascribes zero for its vanadium project, which we view as an option investors get for free.
TMR: When can we expect production at Molo?
FM: Being conservative, I'm saying 2017. This gives Energizer the opportunity to deliver bulk samples to end-users to secure a definitive offtake. In my experience, memorandums of understanding (MOUs) rarely translate into anything binding. Ultimately, it will be the end-users who will decide which graphite development project sees production.
We think Energizer stands the best chance of securing a definite offtake from end-users and can thus best attract the debt financing Molo will require. It's simple to mine and simple in terms of metallurgy. It has a low strip ratio and doesn't require acid treatment to improve its purity. It has a good flake size distribution and has already produced 13 tons of graphite concentrate. We expect a definite offtake by H1/15.
TMR: Filipe, thank you for your time and your insights.
