KEFI Minerals — Tulu Kapi project started and financings improved

Since our last update note (see Convertible loan note restructuring, published on 21 August 2019), KEFI has achieved a number of key milestones, including:

In addition to achieving these milestones, KEFI has also updated the market on its capital expenditure estimates – revealing only very small changes relative to our prior estimates – and announced that it has selected a bank loan proposal to fund capex, rather than the previously assumed bond lease proposal.

In addition to its capex update, on 2 December, KEFI announced that it had selected a bank loan proposal to fund capex, rather than the previously assumed bond lease proposal, and that a preliminary term sheet to this effect has already been signed and is subject to credit approval. The bank loan proposal is said to be more attractive and more straightforward to execute than the bond lease alternative. In addition, the proposed bank lenders are reported to be already working in Ethiopia and to be familiar with the local market and many of the Tulu Kapi project’s stakeholders. Hence, it is considered to be more compatible with the project consortium. Full finance close and drawdown is anticipated at the start of the local dry season and after the Ethiopian election in September (now rescheduled from May). There are no charges for KEFI’s rejection of the bond lease proposal. However, material savings are expected in the cost of debt servicing, administration and other charges, especially during the project development and start-up period.

This tactical adjustment reflects the fact that Ethiopia is now back on bankers’ radar screens having lifted its state of emergency in 2018 and delivered rapid and very positive reforms since then. KEFI management considers the banking proposal to be more conventional, with the added benefit that it is with parties committed to Ethiopia.

Note that a further US$10m equity contribution into Tulu Kapi is budgeted for KEFI, although this is intended to be funded from cash, a working capital facility being introduced and refunds on closing of full funding. It is expected to require minimal additional issues of shares of KEFI equity. Hence, for modelling purposes, we have assumed no more dilution than the 298m placing, settlement and remuneration shares (and 149m warrants) that have now been issued pursuant to KEFI’s announcement of 17 December. Once all of the contributions from ‘minority’ partners have been made, KEFI’s interest in the project will drop from 100% currently to an effective 45% stake.

Compared with our previous analysis in August 2019, the major changes in our valuation inherent to the above considerations are as follows:

Additional, exogenous factors include:

On the basis of the above assumptions, we calculate that Tulu Kapi is capable of generating free cash flow of c £48.8m per year (cf £53.9m previously) for seven years, from 2022 to 2028 (inclusive) – although we note that most of the decline is attributable to the change in the cable rate. With average (maximum potential) dividends of 1.51p/share (cf 1.11p/share previously; see below) for the five years from 2025 to 2029 inclusive (after deduction of a 55% ‘minority’ interest), this implies a valuation for KEFI of 3.54p/share (cf 5.50p/share previously) when discounted back to FY20 at a rate of 10% per year. This valuation then rises to a maximum of 5.71p/share in FY25, when we estimate that the first potential dividend could be paid to shareholders after all bank loans have been repaid.

Readers should note that the change in assumptions, from bond lease financing to bank loan financing (plus the absence of a stream), alters the timing of potential cash flows to KEFI shareholders quite materially (albeit to a much more conventional pattern), with the result that direct comparison with (maximum potential) dividends payable in previous notes should not be made. The bond lease option, in particular, would not have required so much debt to have been repaid before allowing distributions to shareholders. As a matter of interest for readers, had it done so, it would have reduced our prior valuation of 5.50p/share to 4.67p/share, even before adjusting for forex and the conversion price of shares between August and November 2019. Notwithstanding the apparent decline in our headline valuation of KEFI therefore, it is worth noting that the majority of the negative variance effectively arises from external factors (in this case, the cable rate and the rate at which the 5 August loan note was converted into KEFI shares), which were, to all intents and purposes, beyond management’s control. A summary, showing the major effects contributing to our altered 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 ignores the exploration and development of the pipeline of targets in KEFI’s portfolio. 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 3.54p/share rises to 7.57p/share.

On this basis alone (ie excluding any non-core assets – see below), we estimate that an investment in KEFI shares on 1 January 2020 at a price of 1.25p could generate an internal rate of return to investors of 30.1% over the nine years to 2029 in sterling terms.

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:

Our long-term gold price forecasts were set out in our report Portents of economic weakness: Gold – doves in the ascendant, published on 14 August 2019, and are summarised in the table below:

Trading above US$1,600/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$1,600/oz, our valuation of KEFI rises by 81.6%, from 3.54p/share to 6.43p/share, in which case an investment in KEFI shares at 1.25p on 1 January 2020 would generate an internal rate of return to its investor of 47.1% in sterling terms over the nine years to 2029 (cf 30.1% above).

In addition to developments at Tulu Kapi, KEFI has also reported the results of 29 drill holes (out of a total of 45 drilled to date – results from the balance being awaited) at its Hawiah deposit in Saudi Arabia.

The 95km2 Hawiah exploration licence is located in the south-west of the Arabian Shield on the 120km Mamilah-Wadi Bidah Volcanogenic Mineral belt (which is three times as long as the Bisha belt in Eritrea), on which BRGM and the USGS 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 comprise a polymetallic blend of copper, zinc, gold and silver. Highlights of the drilling include:

In addition, there was reported to be very limited apparent structural offset or deformation.

After the most recent phase of 19 drill holes (for which assay results are pending), sufficient drilling has now been completed to identify three separate zones, which may be summarised as follows:

In total, KEFI has completed 45 drill holes at Hawiah and estimates that it needs to do another 20 holes in order to define a resource there, which will take until (approximately) the end of April. While it is still very early stage – and self-evidently not JORC code-compliant – on the basis of the information provided to date, Edison offers the following order-of-magnitude estimate of the resource that might be represented by the drilling completed so far by KEFI at Hawiah.

At prevailing metals prices, the resource has a value equivalent to 343kt of contained copper or 1.2Moz of contained gold. Past experience suggests that the accuracy of such estimates is ±75%.

Nevertheless, as stated previously, there remains considerable blue-sky potential at Hawiah. Massive sulphides were reported to have been intersected in a drill hole 150m to the north of the Hawiah ridgeline, for example, confirming that the mineralised horizon continues at depth even beyond the northern surface exposure (in the ‘Crossroads extension area’). Geochemical analysis and volcaniclastic textures within the lodes have also indicated increasing proximity with depth to a potential vent source (primary feeder) for mineralisation yet to be identified where typically thicker massive sulphides and stockwork-style mineralisation may also be posited.

Similar potential also 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, which resulted in the delineation of 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.

Based on published literature, KEFI management believes that the Hawiah deposit appears analogous to 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 resource estimated by Edison in Exhibit 5 is the equivalent of 13.3Mt at a grade of 2.58% copper equivalent or 2.91g/t gold equivalent, such that each tonne of ore contains US$147 worth of combined metals. After mining dilution and metallurgical recoveries, this might reduce to c US$110 per tonne (75% of its in-situ value). At a posited all-in sustaining cost of US$70/t, this implies a margin of US$40/t and, at a mining rate of 1.0–1.3Mtpa over 10 years, this in turn could imply a cash margin of US$40-52m pa or US$400–520m over the life of operations (undiscounted etc). Within this context, KEFI anticipates that Hawiah could be advanced to a development decision at relatively low cost, owing to the continuous nature of the mineralisation, to which end it is seeking to delineate an initial mineral resource estimate over the course of the next six months.

In addition to the assets considered hitherto in this report, KEFI has a number of other assets that we estimate could add a further c 3.4c (2.7p) in value to its shares and 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 two major, immediate exploration targets: the Guji-Komto belt (a parallel structure to Tulu Kapi) and a separate gold-copper project to its north.

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:

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 37% 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 metallurgical tests conducted by 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 preliminary economic assessment (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 as follows:

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 completing a pre-feasibility study as well as investigating the potential to develop heap leach operations to fund construction of a CIL processing plant for the deeper (albeit refractory) sulphide ore.

KEFI had £0.7m in net debt on its balance sheet at 30 June 2019, after £2.2m in operating and investing cash outflows before working capital in H119. This cash burn rate compares to a comparable £5.6m and £6.9m for the full 2017 and 2018 financial years, respectively.

As stated previously, KEFI now plans to finance its US$188.4m 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 materially reduced maximum immediate aggregate net debt funding requirement overall of £99.1m (US$127.0m) cf US$144.9m previously in FY21, which (in our estimation) equates to a net debt:equity ratio of approximately 54:46 at the project level.