Alkane Resources — Reborn

Since our last note on the company (007 strikes it rich, 23 April), Alkane has announced a number of developments:

In our last note, of the combined entity, we placed a value of up to 170c on Alkane’s shares, comprising 25c/share for Tomingley plus cash and 52c for Dubbo. To this was added 14c for its investments in Calidus, Genesis and Ziron Tech (see our note Genesis of a golden opportunity, published on 24 September 2019) and at least 6c for its maiden Roswell and San Antonio resources. To this total of 97c could then be added up to a further 73c in value from contingent assets, the final valuation for which would depend on future exploration success (see Exhibit 15). Among other things, this note updates our valuation of Alkane in the wake of the Dubbo/ASM demerger.

The in specie distribution and transfer of Australian Strategic Materials (ASX: ASM) shares to ‘Alkane Eligible Shareholders’ and the ‘Sale Agent’ was completed on 28 July, in line with the timetable detailed in the Demerger Booklet released to the ASX on 17 June 2020. In keeping with Alkane’s then 595.2m shares in issue at the time of the demerger, the total number of ASM shares issued was 119.0m – consistent with the stated five for one demerger ratio. All other requirements for listing having been met, ASM’s first day of trading was Thursday 30 July.

A brief summary of the trading levels of each company in the immediate aftermath of the demerger is as follows:

Note that ASM’s share hit a recent (closing) high of A$2.48/share on 24 August.

On 25 August, Alkane announced its results to 30 June. While this was prior to the demerger, Alkane re-formatted its accounts to reflect AMS as a ‘group classified as held for distribution to owners’, with the main body of the accounts thereby being left to reflect Alkane’s gold operations and activities alone. Together with the pro-forma information provided in the Demerger Booklet, published on 17 June, Edison has endeavoured as much as possible to present both the past operating performance of Alkane, together with its future financial forecasts on the basis of its gold operations only.

After having upgraded its guidance after a better than expected output in Q120, since Q220 Alkane left its annual gold production forecast for FY20 unchanged at 30–35koz at an all-in sustaining cost (AISC) of A$1,250–1,400/oz. In the event, it produced 33,507oz in FY20 at an AISC of A$1,357/oz, notwithstanding the need to pause processing in December in order to accommodate an extended maintenance shutdown before restarting in mid-February. Perhaps more significantly, the first underground stope material was processed during the period, with both grade and metallurgical recoveries performing as expected, while underground development progressed to schedule.

Alkane has now provided production guidance for FY21 of 45–50koz gold at an AISC of A$1,450–1,600/oz, which we calculate is consistent with the following operating parameters over the course of the year and forms the basis of our updated forecasts in Exhibits 3 and 16.

Among other things, readers should note Edison’s short-term gold price forecast in Q121 and Q221 and our relatively conservative assumption that it will fall to US$1,749/oz (in real terms) in CY21 coupled with a US$/A$ rate that is lower/stronger (as far as the Australian dollar is concerned) than at any time since March 2019 (NB this forex rate recorded a recent peak of A$1.7408/US$ on 19 March 2020).

A summary of Alkane’s implied H220 forecast results in the context of recent half-year periods is provided in the table below. Readers should note the anomaly whereby Alkane’s H119, FY19 and H120 results were reported with its ASM numbers fully consolidated, but its FY20 results were reported with ASM reflected as ‘classified as held for distribution to owners’ and/or ‘discontinued’. The consequences of this are most obviously apparent in the line items entitled ‘loss after tax from discontinued operations’. However, this anomaly is not considered material enough to significantly detract from the overall trends apparent from the figures. Our updated forecasts for FY21, within the context of our quarterly forecasts, disclosed in Exhibit 2, above, are also provided:

While it can be seen that earnings in FY20 were somewhat below our expectations therefore, it should be noted that all of the negative variance could be attributed to a materially higher depreciation charge in H220 (largely as a consequence of higher capital expenditure) and that, in the absence of this item alone, results would otherwise have been better than our expectations, driven by better revenues and good control of costs.

On 18 August, Alkane reported its updated resource and reserve statement for FY20 (by this time excluding Dubbo resources). Among other things, the report was significant for showing a material increase in reserves and resources in both absolute and percentage terms:

Within the context of having ‘reasonable prospects for eventual economic extraction’, open pittable resources were restricted by an indicative optimised pit shell estimated at a gold price of A$2,000/oz (cf A$2,665/oz at the time of writing – see Exhibit 2) with the potential open pittable component assessed at a 0.5g/t gold cut-off. By contrast, the underground resource is restricted to material below the current final pit design, below the highest stope level currently designed, with potential for eventual economic extraction by underground mining methods assessed at a 1.3g/t cut-off (cf 2.5g/t in FY19). The reported ore reserve is based on the measured and indicated resources within the defined underground resource base at 1.3g/t, a gold price of A$2,000/oz and the application of the current site-based mine design. While a portion of the reserve and resource increase will inevitably have arisen as a result of lowering the underground cut-off grade (and the increase in both reserves and resources is most apparent underground – see Alkane’s announcement for full details), a cut-off grade of 1.3g/t at a gold price of A$2,000/oz nevertheless appears appropriate within the context of Q4 C1 site cash costs of A$62.39/t milled plus an additional A$24.61/t milled in additional AISC costs.

Full details of the changes in Tomingley’s reserves and resources are available in Alkane’s August announcement. A comparison of the totals in Exhibit 4 nevertheless demonstrates a 3.0Mt increase in resources and a 1.6Mt increase in reserves that, at a milling rate of 1.0Mtpa, are capable of supporting a 1.6 year increase in the life of operations at Tomingley and potentially up to a 3.0 year increase (excluding depletion and additional exploration at Tomingley’s extension areas such as Roswell, San Antonio etc – see below).

Whereas Tomingley had sufficient reserves to support operations for 1.4 years from mid-2019 therefore, it now has sufficient reserves to last for 3.0 years from mid-2020 (notwithstanding a year of mining and processing operations in the interim). Resources could then extend this by an additional 6.5 years (resources being reported inclusive of reserves; cf 5.0 years in FY19) – especially given that the average resource grade is higher than the average reserve grade and that this is especially true in the higher, measured and indicated categories of resources.

As a consequence of these increases, Edison has formally increased its immediate assumed life at Tomingley from the end of FY22 to the end of FY23.

The Tomingley Gold Project covers an area of approximately 440km2, stretching 60km north-south along the Newell Highway from the Tomingley mine in the north, through Peak Hill and almost to Parkes in the south.

Over the past two years, Alkane has conducted an extensive regional exploration programme with the aim of defining additional resources that have the potential to be mined either via open pit or underground methods and fed through the Tomingley gold plant. Note that, to this end, New South Wales state government approval has already been sought given for an underground exploration drive from Tomingley to the Roswell deposit, with equipment purchased, personnel recruited and land acquired to facilitate the rapid development of the project. In general, the programme has yielded broad, shallow, high-grade intercepts that demonstrate the potential for material project life extension (subject to resource confirmation, landholder agreements and regulatory approvals).

On 28 January, Alkane reported a maiden inferred mineral resource at Roswell, which is approximately 3km south of the Tomingley mine and processing facility. The San Antonio deposit is a continuation of the Roswell mineralised zone to the south of the Rosewood fault and, on 20 April, Alkane also announced a maiden resource at San Antonio.

Together, the Roswell and San Antonio resources comprise a 14,940kt resource at an average grade of 1.87g/t, containing 898koz gold. While the tonnage of the maiden resource at the San Antonio deposit lay between the upper and lower bands of Alkane’s exploration target, the maiden resource declared at Roswell exceeded its upper bound by 13.2% in terms of tonnage and by 17.4% in terms of contained gold at a 3.7% higher grade (at a cut-off of 0.5g/t).

Prior to its announcing the maiden Roswell and San Antonio resources, Alkane’s resources at Tomingley (TGO) were 6,439kt of ore containing 407koz gold at a grade of 2.0g/t as at end-FY19, which converted into 1,410kt of reserves containing 89koz gold at a grade of 2.0g/t. As such, the maiden resources at Roswell and San Antonio more than trebled Alkane’s then gold resource at Tomingley and, to all intents and purposes, met the lower limit of its exploration target at TGO including El Paso (see Exhibit 6).

In terms of mine life, at a milling rate of 1Mtpa, Roswell and San Antonio’s resources could therefore potentially add more than 14 years to the life of Tomingley’s operations. Pro-rata with Tomingley’s existing reserves and resources ratio, Roswell and San Antonio’s resources could convert into a reserve of 4.7Mt at 1.78g/t containing 255koz gold and therefore should be sufficient to support an additional 4.7 years of production. However, a reserve estimate performed solely on this basis may be unduly conservative. Whereas the Roswell and San Antonio resources are stated ‘pre-mining’, the Tomingley resource reflects a mature mine that has already mined out its open pit reserves and has started to mine its underground ones. On a similar, pre-mining basis, the resource at Tomingley was c 921koz, of which c 434koz have now been mined, with 610koz remaining in reserves (see Exhibit 4) and c 179koz included in the underground mine plan (Edison assumption), which suggests that a more appropriate conversion factor would be in the order of 60% (c 613/921), in which case, Roswell and San Antonio’s reserves combined could prove to be in the order of 9.0Mt, containing 539koz gold at a grade of 1.87g/t, and sufficient to support production for an additional circa nine years (cf Alkane’s target of 10 years, with exploration still ongoing). Note that the resources at Roswell and San Antonio will both have to be upgraded from the inferred category into the indicated category, before they are eligible for conversion into reserves, which is the aim of ongoing work at both deposits currently, where updated resource reports are expected to be announced in October.

In our report Gold stars and black holes, published in January 2019, we calculated an average value of in-situ resources quoted in the Australian market of US$24.08/oz, on which basis we would value the Roswell and San Antonio deposits (combined) at US$21.6m, or A$30.0m, or 5.0 Australian cents per share.

Exhibit 6 demonstrates the value that Alkane may immediately add to its operations via success at all of its prospects to the south of Tomingley (ie Roswell, San Antonio and also including El Paso) in the event that it hits its exploration targets:

These valuations are based purely on the in-situ value of the resources that Alkane is targeting for delineation. Self-evidently, these valuations are subject to increase to the extent that these resources are subsequently upgraded to reserves and included in the Tomingley mine plan.

To this end, further drilling is underway at Roswell to reduce the drill hole spacing from a nominal 40m to 20m to convert inferred resources into the indicated and (perhaps) measured categories. The resource delineated to date is a high-grade, large tonnage zone proximal to the Rosewood fault in the southern section of the tenement. There is also potential to test the depth extensions of the ore zone, while other exploration targets include the poorly constrained northern zone, where mineralisation is open to the west and at depth where grade and tonnage potential is on an improving trend. Some targets will also be tested from underground as the exploration drive from Tomingley is developed. At the same time, further infill and extensional drilling is underway at San Antonio with a view to defining both the continuity of the mineralisation to the south and west and the high-grade zones at depth.

On 13 February, Alkane reported the assay results of drill hole KSDD005 at its Boda prospect and, on 23 March and 22 April, the results of holes KSDD006, KSDD007 and KSDD008 and, on 19 May, the results of hole KSDD009 (100m to the south of hole KSDD008). The drilling was part of a 5,974m diamond core exploration programme to test the depth and strike extensions to the porphyry gold-copper mineralisation at Boda, which has now been completed.

Diamond core hole KSDD005 was located 200m vertically below KSDD003 and intersected an extensive (>700m true thickness) pyrite shell with chalcopyrite dominant core (c 300m thick), which is characteristic of the upper sections of an alkali porphyry mineralisation system. Litho-geochemistry conducted on the drill samples also supported this interpretation, displaying a pattern of outer propylitic and sodic alteration at the top of the hole evolving to a copper rich calc-potassic core and terminating in a propylitic chlorite and pyrite zone. Holes KSDD006 and KSDD007 were located 100m to the north and 100m to the south of the mineralisation defined by KSDD003 and KSDD005, respectively. Hole KSDD008 was located a further 100m to the south of hole KSDD007 and hole KSDD009 a further 100m to the south of hole KSDD008.

A summary of all five holes is as follows:

In general, the holes recorded several significant gold-copper intercepts, within an extensive, low-grade mineralised shell similar to Cadia East. Note that, for the purposes of Exhibit 7, multiple intersections have been amalgamated and grades averaged according to the width of the individual intersections.

In each case, the stratigraphic sequence and the style of alteration and mineralisation was also reported to bear similarities to sections of the Cadia East deposit. The width of the mineralisation in hole KSDD007 is interpreted as being the result of the channelling of fluids along margins from Group 1 monzonites possibly from a deeper causative porphyry source. As well as the potential for an inner potassic bornite rich core to the system, the deposit remains open both on strike and at depth.

The Northern Molong Porphyry Project is 100% owned by Alkane, covers c 115km2 of the northern Molong Volcanic Belt (MVB) and is around 80km to the north-east of its Tomingley Gold Mine, in the Central West of New South Wales (Exhibit 8).

To date, Alkane’s drill results at Boda have demonstrated both a similar stratigraphic sequence as well as style of alteration and mineralisation to Newcrest’s Cadia Province mines 110km to the south, although it is also more structurally complex. Nevertheless, together, the Cadia Province mines host a JORC-compliant mineral resource estimate of 36.8Moz Au at a grade of 0.36g/t Au and 8.2Mt of copper at a grade of 0.25% Cu (see Exhibit 10) plus silver and molybdenum and produced 843koz of gold last year at an AISC of US$160/oz Au (net of by-product credits).

The NMPP now comprises four exploration licences – Bodangora, Boda South, Kaiser and Finns Crossing – within which Alkane has defined five magnetic anomalies interpreted to be intrusive complexes – Kaiser, Boda, Comobella, Driell Creek and Finns Crossing – all within a 15km north-west to south-east trending corridor (Exhibit 9) and all close to road, rail, gas and water infrastructure. Importantly, the Boda anomaly correlates with a historical induced polarisation (IP) survey completed by CRA Exploration (now Rio Tinto) over the Boda Intrusive Complex (BIC), which showed a strong high chargeable anomaly along the northern edge of the survey area coincident with the magnetic anomaly. As a result, Alkane has recently completed a 70 line kilometre IP survey over the 6km strike extensions of the BIC to generate further drilling targets in the area.

Four of these targets have now been drill tested: Kaiser, Boda, Comobella and Glen Hollow. Exploration has identified the margins of major monzonite intrusive complexes that provide the primary control for porphyry and epithermal mineralisation with significant intersections being reported along the western margin of both the Kaiser Intrusive Complex (KIC) and the Boda Intrusive Complex (BIC). Specifically, gold mineralisation has been discovered at Kaiser, Boda and Glen Hollow (which is part of Comobella).

In general, holes KSDD005–7 increased both the grade and width of the porphyry mineralisation identified by hole KSDD003 (658.8m in aggregate at average grades of 0.41g/t Au and 0.18% Cu), including the high-grade gold-copper chalcopyrite core. Hole KSDD008 increased the width of the mineralisation, albeit at a slightly lower (but still consistent) grade.

From the drill hole results a number of observations can be made:

In purely empirical terms, using the same methodology as in our last note, the inclusion of hole KSDD009 in our analysis has caused us to reduce very slightly our assumed dimensions of the orebody. Nevertheless, the changes involved are small relative to the potential errors in the analysis, such that we are still happy to state that (given the information available) our best estimate of the overall size of the Boda deposit is 575–738Mt at an average gold grade of 0.34–0.35g/t containing 6.4–8.3Moz Au (plus copper) and containing a high-grade pod of in excess of 2.2Moz gold equivalent at a grade above its 3.0g/t cut-off.

Edison’s estimates, derived from data made public by a variety of sources, are provided in the table below and are also compared with the resources disclosed by Newcrest for Cadia Ridgeway (underground) and Cadia Province.

Clearly such an estimate is very far from being anything close to JORC code-compliant and experience would suggest that such estimates have an accuracy of approximately ±75%. However, the increasing number of results in the region of 6.4–8.3Moz contained gold increases our confidence that the ultimate resource estimate will be of this order of magnitude. If this does prove to be the case, then it would suggest a multi-million ounce gold deposit at Boda with a potential valuation (based on the US$24.08/oz average valuation of in-situ ounces calculated in our report Gold stars and black holes, published in January 2019) of A$0.36–0.47/share at updated forex rates and adjusted for the increased number of shares in issue at Alkane (cf 0.55/share previously).

In the meantime, a major reverse circulation (RC) and diamond core drilling programme has been started in order to further test the high-grade core and larger resource potential at Boda, as well as other regional targets defined by both the 3D-IP survey and existing Alkane data.

Since February, Alkane has been acting in response to information supplied by state and federal authorities and complying with recommended measures to combat COVID-19. These include heightened cleaning protocols, social distancing, stringent hygiene practices and health screening.

TGO is a predominantly a residential operation and only personnel and contractors essential to the safe operation of the mine are permitted on site. All non-essential travel has ceased.

At present, operations continue as planned. However, COVID-19 has the potential to interrupt operations in the event of any of the following:

As always, our valuation of Tomingley is based on the present value of our forecast life of operations dividend stream to investors in Alkane as a result of the execution of the Tomingley mine plans (now shorn of any contribution from Dubbo/ASM) discounted back to present value at a rate of 10% per year, excluding exploration expenditure.

Relative to our last note, we have now extended our life of operations at Tomingley by one year to the end of FY23, in line with the life implied by its updated reserve and resource statement (effective date 30 June 2020 – see Exhibit 4). In the aftermath of the demerger, our valuation of the dividend stream potentially available to Alkane shareholders from its immediate Tomingley operations is now A$0.186/share. However, to this must be added the value of residual resources at the end of the life of operations, which we estimate to be 0.4Moz with a current value of US$10.3m (A$14.3m), or A$0.024/share, to bring our total valuation of Tomingley to A$0.210/share (including cash). This may be rationalised as our prior valuation of Tomingley (see below) plus cash of A$0.25/share less A$20m (A$0.034/share) in cash demerged with Dubbo/ASM.

A graph of our expectations for Alkane’s EPS, DPS and valuation from the present to FY23 is as follows:

Note that the DPS columns in Exhibit 11 represent theoretical, maximum potential dividends payable, rather than actual dividends forecast and are used solely for valuation purposes. In reality, we would expect any dividend that could be payable (in FY21 for example) to instead be re-invested into the business, either in the form of exploration expenditure or capital expenditure to develop Alkane’s options at Tomingley further.

The above valuation compares with our pre-demerger valuation (including Dubbo/ASM) of A$0.77/share (see our note 007 strikes it rich, published on 23 April), of which A$0.25 in value was accounted for by Tomingley and cash and A$0.52 was accounted for by Dubbo. In that case, the equivalent graph of our expectations for Alkane’s EPS, DPS and valuation from the present to FY43 was as follows:

Our current valuation of Alkane is based on the present value of future dividends potentially payable to shareholders based on a three-year mine plan. However, Alkane reports that the approval process with the New South Wales government to allow the development of the San Antonio and Roswell deposits is ‘well underway’” Extensive consultation has taken place with local landholders and key government agencies and is in the process of being expanded to the broader community and stakeholders. At the same time, preliminary pit and underground designs have been prepared, surveys and testing to prepare an Environmental Impact Statement are underway and affected land either has been purchased or is under contract.

With the caveat that the exact cost parameters around extending the mine plan at Tomingley into Roswell and San Antonio are, as yet, unknown, we calculate that, as we increase the life of the operation, our valuation of the Tomingley portion of the business (based on discounted dividends) increases as follows:

Hence, increasing the life of Tomingley by nine years (ie the same as the amount implied by our conversion of Roswell and San Antonio resources into reserves on page 6) adds 24.3c to our valuation cf our 5.0c per share in-situ resource valuation, which approximates to less than two additional years’ worth of mining (ie below the bottom end of what might reasonably be expected given historical reserve to resource conversion ratios at Tomingley – see page 6). Note that updated resource statements for Roswell and San Antonio (including the promotion of existing resources from the inferred into the indicated category) are anticipated in October, as are updated mine plans.

As with all gold miners, Edison’s valuation of Tomingley is conducted in real terms at a flat nominal gold price of US$1,892/oz, which declines (in real terms) to a price of US$1,494/oz in 2025. Variations from this ‘base case’ scenario are considered in the table below:

In the event that the gold price remains at US$1,919/oz in flat real terms (the price at the time of writing), then our valuation of Alkane (based on the present value of potential dividends payable to Alkane shareholders) increases by 21.0%, from 18.6 to 22.5 Australian cents.

A summary of our updated valuation of Alkane within the context of all of its assets is as follows: