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Australian gold producers on the comeback trail
13 minute read
On a weekly basis in 2019, Finfeed will be weighing up the merits of three stocks with the same or very similar profiles.
The rationale behind this is double-edged. Firstly, we’re looking to provide our readers with a broad range of companies to consider, but we are also cognisant of the benefits of making like-for-like comparisons across operational efficiencies, barriers to entry, market presence, valuation metrics and potential opportunities.
We think this approach will provide a better understanding of sector dynamics, and perhaps highlight a stock that may be worth including in your portfolio — or even three, as we’ll be looking to identify quality companies with advantageous prospects in our search for value.
In keeping with this idea, today we present three Australian gold producers, each of which is poised to substantially grow production in coming years.
In terms of value, each company is trading at a discount to consensus forecasts at a time when the Australian dollar gold price of approximately $1740 per ounce is close to peak long-term levels.
This first article in the series is a companion piece to our guide to gold stocksof a few weeks ago. A part 2 if you will.
The price is right
In the six months to December 18, 2018, the gold price has fallen marginally from about US$1280 per ounce to US$1250 per ounce.
During that period, the AUD/USD has fallen from 74.5 cents to less than 71.7 cents, implying an Australian dollar gold price of $1740 per ounce as at December 19.
As at June 18, the Australian dollar gold price was $1722 per ounce.
Despite this resilient performance — particularly compared with the prices of commodities such as oil, base metals and even some 2017 market darling battery metals that have been sold down substantially — the S&P/ASX All Ordinaries Gold Index (XGD) fell from about 5200 points to a low of 4500 points in the last six months. And apart from an isolated spike in October, it only just pushed above the 5200 point mark on Tuesday.
Interestingly, as we write this article, the index has rallied 2.8% to approximately 5320 points.
However, this can largely be attributed to share price rallies by some of the index heavyweights such as Newcrest Mining (+2.1%), St Barbara (+4%), Evolution Mining (+2.8%) and Regis Resources (+3.6%).
By contrast, there is still plenty of value to be found in mid-tier producers, some of which were sold down more heavily than their larger peers in the last six months, but are yet to be identified as oversold.
It’s three companies that fit this mould that make up Finfeed’s inaugural trifecta.
Of course, the other factor to bear in mind for investors weighing up stocks in the sector is the predictable political and regulatory environment that exists in Australia, as opposed to some other jurisdictions such as Africa and parts of Asia and South-East Asia — another reason to target Australian stocks.
Because we are looking for companies that can immediately take advantage of the high Australian dollar gold price, we have focused on those that are currently in production rather than emerging producers.
However, each of the companies we examine here is in a position to grow production off an already strong base — something to bear in mind, given that the gold price rally appears to be driven by concerns over US economic growth, an issue that isn’t going to dissipate overnight.
The first stock is Dacian Gold (ASX:DCN) — and with a market cap of approximately $480 million, it is the largest of the three.
Running the ruler across Dacian is timely, given that the company has just increased its ore reserve at the Mount Morgans Gold Operation (MMGO) by 16% to 1.4 million ounces.
This has effectively increased production visibility at the Laverton, Western Australia project to at least fiscal 2025.
Management highlighted that the increase marked another important step in Dacian’s strategy to establish Mt Morgans as a circa 200,000 ounce-a-year operation with a mine life in excess of 10 years, and comes as the company remains on track to achieve commercial production at Mt Morgans this month.
Dacian highlights, as flagged in a company presentation:
Transitioning to commercial production is often a share price catalyst, and a 5% rally over the last two days may be the start of a recovery following some high volume buying throughout December.
However, the company’s shares are still trading well shy of the group’s consensus 12-month price target of $3.10.
While management’s key focus moving into the new year is to complete the ramp-up to commercial production at Mt Morgans, it will also be investing in an aggressive exploration program at the MMGO, as it believes the project will continue to yield new gold discoveries that will increase the group’s mine life and inherent valuation.
Importantly, Mount Morgans is a multi-mine operation which includes the Jupiter open pit deposit and the Westralia underground operation.
Following nearby exploration success, the company is well-placed to add mine life with one of the key prospects being Cameron Well, which has a maiden mineral Resource of 245,000 ounces.
Management estimates that near mine extensions at Westralia could deliver a five kilometre long ore system, with three kilometres already delineated.
As indicated below, high-grade mineralisation (+10 g/t) has been a feature of recent drilling.
Dacian’s valuation case looks very compelling with management guiding to production of approximately 200,000 ounces in fiscal 2019, and maintaining production in excess of that mark for more than 10 years.
It is a relatively low-cost operation at approximately $1000 per ounce, implying a hefty margin with the Australian dollar gold price sitting above $1700.
Consensus forecasts point to earnings per share (EPS) of 19 cents in fiscal 2019, but the company is really a 2020 story — that’s when Dacian is expected to deliver 125% EPS growth.
This implies EPS of 42.7 cents, placing the company on an extremely conservative PE multiple of 5.
It is worth noting that as far back as mid-2016 — when Dacian’s projects were a long way from production — they were highly valued, and with the Australian dollar gold price at that time sitting broadly in line with where it is today, the group’s market cap was in the vicinity of $400 million.
One could argue that well in excess of $80 million in value has been added since then, and perhaps its market capitalisation of $590 million as at June 30, 2018, is closer to fair value.
This implies a share price of $2.65, representing a midpoint between the company’s recent trading range and the consensus 12 month price target of $3.10.
As a guide, an increase to $2.65 per share would deliver a capital gain of 25% relative to the group’s current share price.
Westgold Resources (ASX:WGX) also has several levers to pull in terms of growing production across multiple mines, having established solid foundations to secure growing gold production, which will ensure the company’s long-term status as a major Australian gold producer.
Westgold operates four production facilities in WA: the Murchison gold operations, Fortnum Gold Project, Higginsville gold operations, and the recently started Cue Gold operations.
Once steady state production is achieved in the near future, Westgold will be a significant producer with multiple high-quality long-life projects.
The company has four processing hubs which produced 253,000 ounces of gold in fiscal 2018 at all in sustaining costs of $1463 per ounce.
However, the forward metrics are far more attractive, with fiscal 2019 production expected to be in a range between 300,000 and 320,000 ounces with all in sustaining costs falling considerably to a midpoint of $1325 per ounce based on management’s guidance range.
The company will get a substantial boost as the Big Bell Mine comes on stream, as it will add 100,000 ounces per annum, which should take fiscal 2020 production beyond the 350,000 per annum mark.
Costs should also continue to fall as production increases with management guiding to a mid-range of $1275 per ounce in fiscal 2020.
Not only does the company have multiple projects, but in some cases it is also operating more than one mine within the project.
Westgold strengthened its balance sheet and added to the quality of its gold portfolio in fiscal 2018 with the divestment of the South Kalgoorlie operations, a mature project with a 30 year-old plant.
The asset was sold for $80 million, allowing Westgold to realise a $62 million gain on disposal.
Here is a snapshot of the company’s operations, including its locations and contributions.
Big Bell offers genuine promise going forward as it already has a Probable Resource of 10 million tonnes grading nearly 3 grams per tonne for approximately 1 million ounces.
The mine is open at depth, suggesting that there is the potential for resource expansion, particularly given the relatively strong grades support the extraction of deeper mineralisation.
The Starlight Underground Mine at Fortnum also offers exploration upside, and the company has just advised of a promising drill hit of 78.26 metres at 5.23 grams per tonne from the northern-most down plunge hole from its ongoing drilling program beneath the current ore reserve.
Importantly, the intercept includes down-plunge continuity of the key higher grade zones that make up stoping areas within the mine.
These include separate intercepts of 15.5 metres at 14.8 grams per tonne, 3.4 metres at 13.9 grams per tonne and 4.3 metres at 5.7 grams per tonne.
Further drilling results are expected in the March quarter, perhaps providing share price momentum as the company shows early signs of recovering from intense selling over the last six months.
Only last week, the company hit an all-time low of 82.5 cents, but some high volume buying in recent days has seen it rally 10%, trading as high as 91.5 cents on Tuesday.
While the company has faced headwinds regarding a significant fall in quarter on quarter gold output at its Higginsville operation, this needs to be put into perspective.
Analysts at Bell Potter ran the ruler across the company when considering issues at Higginsville, but given the broader scheme of things, they only saw fit to reduce the price target from $2.15 to $1.85 — double its recent trading range.
While this is below the consensus 12 month price target of $2.05, perhaps Bell Potter’s more conservative take on the company is worth taking into account for investors looking to factor in a discount for the associated risk.
Merger creates new mid-tier gold producer
The proposed merger between Silver Lake Resources (ASX:SLR) and Doray Minerals (ASX:DRM) will see the emergence of a new multi-asset gold producer with complementary high-grade WA projects.
Given the merger has been unanimously recommended by the boards of both companies in the absence of a superior proposal, it would appear that the deal will be ratified in early 2019.
Looking at the two companies in isolation, Silver Lake increased gold sales by 10% in fiscal 2018 to 151,250 ounces while reducing costs by 5% to $1289 per ounce.
The company has extensive exploration programs underway at three of its mining centres, which are focused on advancing historical targets where there has been limited drilling.
The company has a strong track record of discovery, as indicated below.
Silver Lake’s ability to consistently grow production while taking a measured approach to exploration expenditure has resulted in strong cash generation in recent years.
In fiscal 2018, the company grew its operating cash flow by 26% to $80.8 million and finished the year with cash, bullion and listed investments of $114 million.
Given management’s fiscal 2019 production guidance of 145,000 ounces, the company’s mineral Resource of 3.7 million ounces and robust balance sheet, one would expect the group’s market capitalisation to be well above the current $260 million.
However, its shares have rallied more than 10% in December, and perhaps this is recognition of the valuation upside that lies in the stock, as well as a factoring in of the potential impact of transitioning to a true mid-tier gold producer with annualised production approaching 250,000 ounces and a Resource of 4.6 million ounces.
While the company’s share price has increased from about 47 cents to hit a high of 54 cents this week, this is still well shy of Hartleys’ 12 month price target of 79 cents which implies upside of nearly 50%.
With the merged entity having a sizeable market cap and the prospect of ramping up production beyond the 250,000 ounces per annum mark, its inclusion in the S&P/ASX 300 index appears likely.
Should this occur, there is the prospect of increased interest from larger institutional investors as they are often mandated to only invest in stocks within certain indices.
The heavily discounted share price reinforces the argument that many small to mid-cap gold stocks have substantial room for recovery following the recent sell-off.
The same can be said of Doray Minerals, with its current share price of approximately 34 cents well below the consensus 12 month price target of 62.5 cents.
Further illustrating the implied discount is its fiscal 2019 PE multiple of 5.8 relative to consensus forecasts of 5.9 cents per share.
Merger and acquisition activity often occurs when there is a significant disparity between asset valuations and implied share price values.
Premium grade Deflector Project highly complementary
With these metrics, Doray brings plenty to the merged entity, and the management of both companies will no doubt be expecting to create shareholder value by combining their operations.
This table highlights the potential impact based on a combined production scenario, also demonstrating how the group will be the fifth largest multi-asset Australian gold producer on the ASX (Resolute Mining and Perseus Resources’ main mines are in Africa).
One of the key benefits offered by Doray is the high-grade ore that will come from its Deflector Gold-Copper Mine.
This will be extremely complementary to the high volume lower grade ore that is generally characteristic of Silver Lake’s operations.
Doray has been very successful with the drill bit, having discovered 271,000 ounces at Deflector at a particularly low cost of $20 per ounce.
It is also worth noting that the gold grade at Deflector has increased 40% to 8.7 grams per tonne.
The deposit has a mineral Resource of 800,000 ounces of gold and 16,000 tonnes of copper, with the latter providing credits that drive down production costs.
Management is forecasting fiscal 2019 gold production to be in a range between 80,000 and 85,000 ounces, complemented by copper production of approximately 2500 tonnes.
Taking into account the benefits of copper production, Doray expects all in sustaining costs to fall from about $1200 per ounce in fiscal 2018 to a mid-range of approximately $1100 per ounce in fiscal 2019.
This is what the merged group will look like if one converts Doray’s gold and copper production into a gold equivalent commodity.