KEFI Gold and Copper — Rose gold

KEFI Minerals is a gold junior that, to date, has specialised in discovery and acquisition on either side of the Arabian-Nubian Shield (ANS). The ANS spans the African and Arabian plates and is the source of some of man’s earliest known mining activities, including the Mahd adh Dhahab (‘Cradle of Gold’) mine, which is the leading gold mining area in the Arabian peninsula. Currently, KEFI’s flagship Tulu Kapi project (1.7Moz in resources) is Ethiopia’s only ‘ready-to-start’ industrial mining project, located away from security hotspots and in a country on a continent that has been among the least affected in the world by COVID-19. It also has 34% interests in its discoveries on the other side of the ANS, namely Jibal Qutman and Hawiah (together 1.9Moz AuE) in Saudi Arabia, which is in the process of liberalising its mining legislative framework.

Assuming that KEFI executes its development according to plan at Edison’s long-term gold price assumptions, we calculate that Tulu Kapi is capable of generating free cash flow of c £65.2m per year for seven years, from 2022 to 2028 (inclusive). With average (maximum potential) dividends of 1.62p/share for the four years from 2025 to 2028, this implies a valuation for KEFI of 4.05p/share when discounted back to FY20 at a rate of 10% per year. This valuation then rises to a maximum of 5.62p/share in FY24 on the cusp of KEFI’s first material dividend and to 8.18p/share if KEFI is successfully able to leverage its cash flow from the mine into its other assets in the region.

In the event that the gold price remains at its current level of US$1,884/oz (in real terms) over the course of Tulu Kapi’s productive life, our valuation of KEFI increases by 68.9% from 4.05p/share to 6.84p/share. In this case, an investment in KEFI shares at 1.99p on 1 January 2020 would generate an internal rate of return to its investor of 39.6% in sterling terms over the ten years to 2029.

In addition to Hawiah and Tulu Kapi, KEFI has a number of other ‘next level’ assets that we estimate could add a further c 4.92–11.21 (3.83–8.74p) in value to its shares. These are described on pages 11–13 of this report.

KEFI had £2.1m in net cash on its balance sheet as at 30 June 2020 (cf net debt of £0.8m as at 31 December 2019), after strengthening its balance sheet by raising £3.7m in equity in May and also after £3.8m in operating and investing cash outflows before working capital in H1 (cf £5.3m in FY19 and £2.2m in H119). To date in FY20, the company has instituted a programme of disciplined capital management, which we estimate has the ability to reduce its underlying cash burn rate to an annualised rate of £1.0m pa. Henceforward, as Tulu Kapi shifts from project development to project execution, KEFI plans to finance its US$188.5m capex funding requirement principally via a bank loan of US$110–120m and project-level equity (US$58m in addition to the US$60m in equity already invested) and a subordinated working capital (ore stockpile) banking facility (US$17.7–27.7m). If all funding sources are considered, we forecast a maximum net debt funding requirement overall of £102.0m (US$130.9m) in FY21, which (according to our calculations) equates to a net debt:equity ratio of approximately 54:46 at the project level.

Since our last note, KEFI has continued to advance towards its goal of achieving production in FY22. Recently, this has included:

Throughout this time, the company has consistently maintained its goal of formally agreeing its full funding structure with all consortium participants in October 2020, ahead of construction in FY21 and first gold production in FY22. As such, development activities have continued as planned, despite COVID-19. For items on the critical path, such as the integration of interconnecting roads and power infrastructure:

For ore processing infrastructure:

Within this context, KEFI’s goals have remained unchanged, despite its previously planned Ethiopian partner’s (ANS) inability to meet its 30 June deadline for its initial investment into the project. As a result, KEFI’s subsidiary, TKGM, has served notice that it may replace ANS, either in part of in full, with other investors, including the potential for an expanded role for specialist mining financiers. Among other things, this might involve reducing the number of shares in the project issued to third parties and increasing the funds raised by TKGM from specialist financiers. Consequently, along with its partner, the Government of Ethiopia, KEFI has made it clear that it is now focusing on retaining a much higher ownership position in TKGM (perhaps as high as 60%) in order to maximise returns to its shareholders.

In the meantime, from early 2020, KEFI implemented a programme of disciplined capital management. Among other things, this has involved:

In addition to developments at Tulu Kapi, KEFI has consistently reiterated its goal that it would report a (maiden) mineral resource estimate at Hawiah in August – a goal that it achieved, when it announced a 19.3Mt resource on 19 August.

Whereas KEFI had initially indicated that it anticipated the total resource to be in the order of 12Mt, in July it increased its estimate to 20Mt. This compared with Edison’s prior estimate (made in March) of 13.3Mt.

The entire deposit comprises three separate zones, which may be summarised as follows:

A comparison between the maiden resource announced by KEFI on 19 August and Edison’s prior estimate of the potential resource inventory at Hawiah based on the results of the assays already disclosed to the public in March is as follows:

In general, it can be seen that, while Edison’s tonnage estimates proved conservative, they were tolerably accurate in terms of metal content (given that, from experience, Edison places a level of accuracy of ±75% on its resource estimates). At prevailing metals prices (US$6,579/t Cu, US$2,424/t Zn, US$1,884/oz Au and US$23.69/oz Ag), the resource contains total metal to a value of US$2.3bn, or the equivalent of 349kt of contained copper or 1.2Moz of contained gold.

The 95km2 Hawiah exploration licence is located in the south-west of the Arabian Shield on the 120km Wadi Bidah Volcanogenic Mineral belt (which is three times as long as the Bisha belt in Eritrea – see Nevsun), on which BRGM and the USGS1 documented approximately 24 volcanogenic massive sulphide (VMS) deposits and historical workings. The Wadi-Bidah Mineral District is almost unique among the world’s VMS belts in that it remains, to all intents and purposes, undrilled.

In its most recent two phases of exploration, KEFI determined that the Hawiah mineralisation is entirely open at depth, that the VMS style of mineralisation is continuously present directly beneath 4km of the gossanous ridgeline and that it is the source of an extensive and exceptionally strong geophysical anomaly. The massive sulphides intersected in its drill programme are reported to reflect a dominantly pyritic stratiform body containing a variable polymetallic blend of copper, zinc, gold and silver. Highlights of the drilling include:

Nevertheless, there remains considerable blue-sky potential at Hawiah. To date, the orebody has only been drilled to 350m below ground and remains open at depth. The down-dip continuation of the Camp Lode is of particular interest in this respect, where drilling results to date have reported grade and thickness increasing significantly with depth. The deepest two holes (HWD_005 and HWD_059) returned 1.27% copper over a true width of 9m and 1.55% copper over a true width of 8.7m, respectively and, if intersected in line with expectations, would extend mineralisation to a depth of c 800m and may indicated that resources are nearing the source (vent) of the VMS, where higher grade and thicker massive sulphides and stockwork-style mineralisation may typically be found. Geochemical analysis and volcaniclastic textures within the lodes have also indicated increasing proximity with depth to a potential primary feeder source. Below the Central Zone may also have strong resource potential, as indicated by a strong induced polarisation (IP) anomaly, and planned drilling is targeting mineralisation at a depth of c 450m (cf c 80m tested to date via only a few scout drill holes). Finally, massive sulphides were reported to have been intersected in a drill hole 150m to the north of the Hawiah ridgeline, confirming that the mineralised horizon continues at depth even beyond the northern surface exposure (in the ‘Crossroads extension area’).

Similar potential exists in the upper levels of the deposit, where the gossan portion of the mineralised zone is challenging to sample by drilling by virtue of the weathering patterns and the numerous cavity zones encountered. BRGM drilled these gossans in the 1980s, as a result of which it delineated a resource of 1.2Mt at a grade of 6.4g/t, containing 254koz gold, and management confirms that this oxidised portion of the deposit, which has demonstrated high levels of gold mineralisation, will also be further investigated. To date, initial drilling of these areas has returned an average grade of 1.7g/t gold across seven drill holes with an average vertical depth of 35m.

Based on published literature, KEFI management believes that the Hawiah deposit appears analogous to (albeit already bigger than) the Al Masane polymetallic VMS mine in southern Saudi Arabia, which has reported proven and probable reserves of 7.21Mt at grades of 1.42% copper, 5.31% zinc, 1.19g/t gold and 40.2g/t silver, and a similar metal composition and structural and geological settings. The discovery of the stockwork zone that fed the structure now being drilled would also bring into focus a potentially larger bulk-mineable target analogous to the Jabal Sayid mine operated by Barrick to the north of Hawiah.

The resource reported by KEFI in Exhibit 1 is the equivalent of 19.3Mt at a grade of 1.86% copper equivalent or 1.91g/t gold equivalent, such that each tonne of ore contains US$119 worth of combined metals (at the prices shown on page 4 after Exhibit 1).

Since announcing its maiden resource in August, KEFI has prioritised the completion of a PEA at Hawiah. The PEA was conducted by the KEFI planning team, supported by internationally recognised specialists, including SRK, and included technical analysis, high-level assessments and trade-off studies to establish the likely key components of the mine’s potential development. Among other things, these included:

The full details of KEFI’s PEA announcement may be found here and Edison has used the operating details provided to construct Edison’s own operating and financial model of the project, both to validate the financial conclusions of KEFI’s model and also to adjust it to reflect Edison’s own long-term assumptions regarding (for example) long-term metals prices. A comparison of the major differences between KEFI’s assumptions and Edison’s is as follows:

Note that, unless specifically indicated to the contrary in the table above, readers may assume that Edison’s assumptions are the same as those detailed in KEFI’s PEA announcement. In addition, in constructing its model, Edison had to make the following assumptions, which were otherwise not specifically disclosed in KEFI’s announcement:

Saudi Arabian depreciation is typically conducted over 10 years. However, it may be as low as four to five years for certain machinery items. For the purposes of its model, Edison has assumed that depreciation is conducted over seven years (being the initial life of the proposed mine) and that assets remain fully depreciated at that point, even if the mine’s life is then extended by up to 10 years (see below). We have also ignored accumulated tax losses that would be available.

In its own model, KEFI considers a ‘base case’ scenario, in which the mine operates at a throughput rate of 2.0Mtpa for seven years and an ‘extended’ scenario, in which an further 20Mt is added to the mining inventory ‘at the average grade of the Camp Lode below the 1070m RL elevation’. In the absence of detailed knowledge about the average grade of the Camp Lode, Edison has assumed that this addition to the mining inventory will allow the mining operation to continue at Hawiah for a further 10 years at run-of-mine grades the same as those in the first seven years of the mine’s life (namely 0.87% Cu, 0.78% Zn, 0.53g/t Au and 9.9g/t Ag – see KEFI’s Hawiah PEA announcement).

On the basis of these assumptions, the financial outcomes generated by Edison from its model compare with those generated by KEFI, for both scenarios, as follows:

Several features of these outcomes are noteworthy:

In consequence and owing to the tabular and continuous nature of the mineralisation, KEFI anticipates that Hawiah can be advanced to a development decision quickly and at relatively low cost. In particular, if the resource can be expanded to make the ‘extended mine life scenario’ a reality, then KEFI expects that 75% of the project funding could be eligible for debt finance, thereby increasing the project’s (leveraged) post-tax IRR to in excess of 50%.

Following completion of the PEA, KEFI’s immediate priorities towards Hawiah are now as follows:

To these ends, the directors of KEFI’s joint venture company in Saudi Arabia, G&M, have resolved to trigger the next stage of the project, comprising:

In our last note on the gold price (see A golden future, published on 11 June 2020), Edison argued that the recent, sharp increases in the total US monetary base might be expected to support a (nominal) gold price of US$1,892/oz and potentially as high as US$3,000/oz. While there is a historically strong and statistically significant correlation of 0.909 between the gold price and the total US monetary base from 1967 to 2018 however, there is very little visibility as to how, or to what extent, the total US monetary base may be expected to evolve. Currently, we know that it is expanding at a rate of approximately US$110bn per month, which equates to an expected increase in the gold price (using the historical correlation) of approximately US$500/oz per annum. Anecdotally, the total US monetary base may probably be expected to continue to increase for a time until the COVID-19 crisis has been managed and then to flatten off for a discrete period until a period of tapering is attempted by the Federal Reserve (in a similar fashion to the aftermath of the global financial crisis). However, neither the extent of any increases nor the extent of any subsequent tapering nor the timing of either is easy to judge. In consequence, Edison’s strategy now is to maintain a flat, nominal gold price of US$1,892/oz into the future from FY21. Note that this may be contrasted with our previous approach to gold price forecasts (see Portents of economic weakness: Gold – doves in the ascendant, published on 14 August 2019), the results of which were as set out in the table below:

In the absence of more general deflation, a flat, nominal gold price of US$1,892/oz is, self-evidently, a declining gold price in real terms, which is an unlikely long-term scenario, given that the gold price has historically increased by 2.0% per annum in real terms from 1914 to 2018 (see Portents of economic weakness, Gold: Doves in the ascendant). During the period 2013–18, the gold price was relatively flat, averaging US$1,270/oz. Its average price in 2018 was also US$1,271/oz – both of these levels arguably having been supported by the marginal cost of production. If this level is then increased at 2% per annum from 2018, it may be compared with the flat nominal (declining real) price scenario previously described, as shown in the exhibit below:

As may be seen from the chart above, the two lines cross between 2025 and 2026 at a level fractionally below US$1,500/oz. All Edison’s gold company valuations are conducted in real terms. Consequently, and in the absence of much immediate visibility as to the evolution of the total US monetary base, Edison’s new gold price scenario for valuation purposes is for the gold price to remain at US$1,892/oz in flat nominal terms (ie declining in real terms) until the price (in real terms) crosses with the increased US$1,271/oz 2018 price. At that point we assume that the price will flatten out (in real terms) at US$1,494/oz (note that this may be contrasted with our prior methodologies for gold price forecasting, which were set out in our report Portents of economic weakness, Gold: Doves in the ascendant).

On the basis of the above assumptions, we calculate that Tulu Kapi is capable of generating free cash flow of c £65.2m per year (cf £48.8m previously) for seven years, from 2022 to 2028 (inclusive). With average (maximum potential) dividends of 1.62p/share (cf 1.51p/share previously; NB now using the higher number of shares since the May equity raising) for the four years from 2025 to 2028 inclusive (after deduction of a 55% ‘minority’ interest – see below), this implies a valuation for KEFI of 4.05p/share (cf 3.54p/share previously) when discounted back to FY20 at a rate of 10% per year. This valuation then rises to a maximum of 5.62p/share in FY24 on the cusp of KEFI’s first material dividend in FY25:

A summary, showing the major factors contributing to our updated valuation of KEFI (in sterling terms), is as follows:

Note, however, that this valuation is based on the projected dividend flow resulting from the execution of the Tulu Kapi project alone and does not include any value above 45% ownership of Tulu Kapi or any value for the exploration and development of the pipeline of targets in KEFI’s portfolio (see below). If KEFI is successfully able to leverage its cash flow from the mine into its other assets in the region, then our updated valuation of 4.05p/share rises to 8.18p/share.

On this basis alone (ie excluding any ‘next level’ assets – see below), we estimate that an investment in KEFI shares on 1 January 2020 at a price of 1.99p could generate an internal rate of return to investors of 25.6% over the 10 years to 2029 (inclusive) in sterling terms.

Edison’s valuations of KEFI, above (including central general & administrative expenses etc), compare with KEFI’s project-based valuation of Tulu Kapi, at a range of different gold prices, as follows:

Notwithstanding our valuation of KEFI based on its primary asset, there are a number of considerations that could cause this to increase, which are briefly summarised as follows.

Trading close to US$1,900/oz currently under the influence of both a re-expansion of the US total monetary base plus the perceived threat from the coronavirus, the price of gold is self-evidently above our forecast real prices for all of the years from CY22 onwards when KEFI is expected to enter production (note that all of Edison’s valuations in the mining sector are conducted on the basis of real prices, costs and interest rates). In the event that the gold price were to remain at US$1,884/oz (in real terms), our valuation of KEFI would rise by 68.9%, from 4.05p/share to 6.84p/share, in which case an investment in KEFI shares at 1.99p on 1 January 2020 would generate an internal rate of return to its investor of 39.6% in sterling terms over the 10 years to 2029 (cf 25.6% above).

Our valuation of KEFI is based on the net present value of (maximum potential) dividends payable to KEFI shareholders after the deduction of a 55% ‘minority’ interest to reflect the most recent equity funding arrangements for which detail was available. Recently however, KEFI has indicated that ANS’s inability to meet its 30 June deadline for its initial investment into the project could result in its being replaced and KEFI reducing the number of shares in the project issued to third parties and increasing the funds raised by TKGM from specialist financiers. In this event, it has suggested that existing KEFI shareholders’ ultimate interest in Tulu Kapi could be increased from the currently anticipated 45% perhaps to as high as 60%. If that were to be the case and all other things were to remain equal, then our valuation of the company increases by 33.3% (ie 60/45) from 4.05p/share to 5.40p/share.

In addition to Hawiah and Tulu Kapi, KEFI has a number of other assets that we estimate could add a further c 4.92–11.21 (3.83–8.74p) in value to its shares and which are summarised below.

An area of over 1,000km2 adjacent to Tulu Kapi has been reserved for exploration by KEFI upon commencement of development, with a view to adding satellite deposits to development and production plans. Within this, KEFI has one immediate, major exploration target, being the Guji-Komto belt, which is a parallel structure to Tulu Kapi.

The Guji-Komto belt represents a series of old gold workings on a parallel strike to Tulu Kapi extending continuously for over 9km to the west of the Tulu Kapi pit. The most extensive historical workings are located at the Komto 1 prospect and prior exploration drilling by Nyota had already extended the limits of mineralisation by up to 4km. At 1.3–1.5g/t in-situ, the grade of this mineralisation was considered too low to be included in the development plan for the mine. However, impressive widths and their oxide nature potentially qualify it as the basis of an incremental heap leach operation via the exploitation of a series of open pits in the style of a ‘string of pearls’. Preliminary estimates by management indicate that c 250koz of gold could be amenable to exploitation, with low-grade material being directed to heap leach pads and high-grade material to the existing carbon-in-leach (CIL) plant at Tulu Kapi. Such an operation, based on preliminary management estimates, could produce c 40koz gold a year over five years for a relatively small incremental capital outlay of c US$30.4m (on account of infrastructure already being in place to service Tulu Kapi) and could have a net present value in the order of US$26–47m at the gold prices shown below (note that these are illustrative numbers and are subject to the results of exploration and development studies):

The gold price range over which valuations were conducted suggests that these calculations were performed in the ‘old’ 2013–18 gold price environment. While the following analysis – comparing the calculated NPV10 with the gold price – is presented with a number of caveats (in particular that cost assumptions remain unchanged), it nevertheless serves to illustrate the fact that, at a gold price of US$1,494/oz, Guji-Komto could be worth in the order of US$66.1m (or 3.36 US cents per existing KEFI share) or potentially as much as US$104.9m (or 5.34 US cents per existing KEFI share) at a flat, long-term, real gold price of US$1,884/oz.

Jibal Qutman comprises four licences covering c 100km2 in the central southern region of Saudi Arabia, on the Nabitah-Tathlith fault zone of the Arabian-Nubian Shield (a 300km-long structure with multiple outcrops at surface) and along which BRGM mapped over 40 mineral occurrences and/or ancient mines. KEFI’s management likens the area to Western Australia and, in particular, Kalgoorlie, before it was pegged, but without the attendant problems of a settled population and private land ownership. G&M (the local operating company in which KEFI has a 34% beneficial interest) was granted the Jibal Qutman exploration licence in June 2013 and it has subsequently lodged a mining licence application.

Gold mineralisation at Jibal Qutman itself is hosted in a series of quartz veins in six separate ore bodies, denoted the Main Zone, the South Zone, the West Zone, 3K Hill, 5K Hill and Pyrite Hill. The main vein dips to the east at an angle of c 45°, surrounded by parallel veins that form stringer zones around it. Jibal Qutman has now been drilled out and, during this process, the sulphide portion of its resource was found to be refractory on account of the presence of carbon. As a result, KEFI focused its exploration activities on the oxide portion of the resource and delineated a potential mineable resource of 6.6Mt at a grade of 0.95g/t, containing c 200koz gold, at a stripping ratio of 2.2 (cf grades of c 0.8g/t at comparable, nearby assets). Column leach tests conducted by metallurgical consultants ALS indicated gold recoveries of c 73%, as a result of which KEFI envisages developing the area via a string of pits mining oxidised material for heap leach processing.

In May 2015, a PEA on the deposit was completed on the basis of a 1.5Mtpa heap leach operation, producing 139koz gold over an initial 4.5-year mine life (average 30.9koz pa) at an average metallurgical recovery of 69% and capex and opex of US$30m and US$597/oz, respectively. A summary of the results of the PEA is provided in the table below for both the existing resource and a potentially trebled resource. In addition to the formal results, which are shown for gold prices of US$1,150/oz and US$1,300/oz, Edison has also included its estimates of the same results at long-term, flat, real gold prices of US$1,494/oz and US$1,884/oz (using the same methodology – and with the same caveats – as adopted in Exhibit 11):

In due course, it is anticipated that the addition of adjoining licences could support a proportionally larger production base using a modular development model (eg 2–4x that currently assessed) as well as reducing operational risk.

Note that the above analysis on the basis of a trebled resource also assumed a similar factor applied to capex whereas, in reality, there would probably be scope for capex savings as well as higher grades from alternative ore sources. In the immediate future, KEFI’s objectives at Jibal Qutman include tenure confirmation under the new mining regulations via the grant of a mining licence, completing a pre-feasibility study and investigating the potential to develop heap leach operations to fund construction of a CIL processing plant for the deeper (albeit refractory) sulphide ore.

Including short-term debt, KEFI had £2.1m in net cash on its balance sheet as at 30 June 2020 (cf £0.8m in net debt as at 31 December 2019), after £3.8m in operating and investing cash outflows before working capital (cf £5.3m in FY19 and £2.2m in H119). This cash burn rate compares to comparable figures of £6.2m and £6.9m for the full 2017 and 2018 financial years, respectively.

At the start of the coronavirus crisis in early 2020, KEFI instituted a programme of disciplined capital management involving, among other things:

In the short term, we believe that these measures – plus judicious management of working capital – have the ability to reduce KEFI’s underlying cash burn rate to c £0.5m in H220. In the meantime, the company has also strengthened its balance sheet by raising £3.7m in equity in May via the issue of 569.2m shares at a price of 0.65p/share.

As stated previously, KEFI now plans to finance its US$188.5m capex funding requirement principally via a bank loan of US$110–120m and project-level equity (US$58m in addition to the US$60m equity already invested) and a subordinated working capital (ore stockpile) banking facility (US$17.7–27.7m). If all funding sources are considered, we forecast a maximum net debt funding requirement overall of £102.0m, or US$130.9m (cf US$127.0m previously) in FY21, which (in our estimation) equates to a net debt:equity ratio of approximately 54:46 at the project level.