Auriant Mining — Emerging into broad sunlit uplands

Auriant’s Q120 financial results were reported within the context of known production of 278kg for the quarter (see Exhibit 1) and a largely known gold price. In this case, however, they are also significant as they reflect the first full quarter of operations for the company’s new carbon-in-leach plant, which was commissioned in November. In this respect, four factors are important:

Auriant’s financial results for the quarter were augmented by the fact that 39kg (1,247oz) of gold was sold in excess of production, which will have added approximately US$2.0m to revenues (at the average price of gold) during the period. Nevertheless, the financial effects of the evolution of the Tardan operation from a heap leach to a CIL one is clearly visible in Auriant’s Q120 results below/overleaf – in crude terms, output tripled and revenues quadrupled, while costs only doubled cf Q119. In addition to a summary of the results of operations in Q120, Exhibit 1 also presents its updated forecasts for the rest of FY20, by quarter, albeit with the caveat that the quarterly financial results of mining companies are prone to material volatility. As such, these forecasts should be seen as indicative, rather than prescriptive, especially with respect to individual quarters. Nevertheless, they also demonstrate the reconciliation between our forecasts for all three remaining quarters of the year and our updated full-year expectations.

Other notable features of the financial results for the quarter were the low general and administrative cost pro-rata to our full-year expectation and a low marginal tax rate, while the net interest charge was close to our (pro-rata) expectation for the full-year.

Compared with free cash flow derived from the income statement of US$7.5m (US$5,895k plus US$1,647k), actual cash flow from operations amounted to US$7.9m (ie there was a decline in working capital), of which cash consumed in investing activities was only US$1.3m (approximately flat cf US$1.2m in Q119). As a result, comparing the balance sheet of 31 March with that of 31 December, we calculate that net debt (including lease obligations) at Auriant declined by US$10.6m over the quarter, from US$84.1m to US$73.5m.

Auriant produced 115kg of gold in January – the equivalent of 1,380kg on an annualised basis. Since February, however, Auriant has been feeding blended high- and low-grade ore to the plant, as opposed to just high-grade ore only in January, to ensure a steady transition to year-round average grades. Even so, it produced 75kg (900kg annualised) in February and 88kg (1,056kg annualised) in March.

Auriant’s official guidance for Tardan for 2020 is for production of 900–940kg (average 225–235kg per quarter) gold from 350–380kt (average 87.5–95kt per quarter) of ore processed – implying a yield of 2.37–2.69g/t and a likely plant feed grade of 2.58–2.92g/t and compares with Auriant’s expectation that it’s mined grade will average 2.71g/t in FY20. This grade range forms the basis of our financial and operating forecasts for the remainder of the year (see Exhibit 1). In the light of Q120 results, however – and with the worst of the weather now behind it – we expect plant throughput to remain towards the top end of its range, albeit with a likely provisional break in processing in Q4 to allow for scheduled maintenance. As a result, we are forecasting gold production for Tardan for FY20 to be at the top of (or even slightly above) management’s guidance range, at 960kg.

As a result of test-work conducted during the ramp-up phase, Auriant has upgraded the leaching tanks at Tardan to improve ore oxidation to ensure stable processing results. In addition, in December 2019, the company agreed a new energy deal to increase the power allocation to the Tardan CIL plant by 25% from 2.0MW to 2.5MW using a newly built 35kV power line, which will allow it to minimise its use of diesel generators on site or, possibly, to cease their use entirely. Both will have a potentially beneficial effect on costs, as will the recent depreciation of the rouble, from RUB66.075/US$ at the time of our last note (see Auriant Mining, Tardan CIL at capacity, published on 4 March 2020) to RUB70.9975/US$ and the recent weakness in the oil price. For the moment however, we are maintaining our central unit working cost for Tardan for the rest of the year, of US$60.32/t (cf cash costs of US$48.96/t in Q120 – but US$59.28/t if changes in working capital are taken into account). For the full year, this will translate into a cash cost of production of US$673/oz, although we recognise this is inherently conservative and represents a potential upside risk to our financial forecasts in Exhibits 1 and 6.

In common with our standard practice, our valuation of Auriant has been performed via the discounting of maximum potential future dividends at a discount rate of 10%, assuming all excess cash generated is distributed to shareholders only after all debt has been repaid.

On the basis that management executes the Tardan CIL project and the Kara-Beldyr project according to the operational and financial parameters anticipated, we estimate that Auriant is capable of generating average cash flows of $49.4m (cf $49.2m previously), average earnings of $42.4m (cf $42.2m previously) and average EPS of 23.0c (cf 21.0c) in the nine-year period from FY25–33 (inclusive), thus allowing it to pay maximum potential dividends to shareholders of 25.9c per share (cf 23.0c) in the period FY26–33 (inclusive). Discounted at our customary 10% discount rate, such a stream of dividends has a value of $0.83 per share (cf $0.72/share previously), as shown in the exhibit below, rising to $1.46/share (cf $1.28/share previously) on the cusp of the company’s maiden dividend in FY26.

Our ‘base case’ valuation of $0.83/share compares with one of $0.72 in March 2020 (see our note Tardan CIL at capacity). The main underlying factors occasioning the increase in value include a slightly higher gold price of US$1,705/oz (cf US$1,572/oz previously) for the remainder of FY20 and a higher share price (SEK4.40 cf SEK3.69), implying less future dilution associated with an assumed $40m equity raising in the near future (see ‘Sensitivities’ section). Note that our valuation specifically excludes any value attributable to Solcocon on account of the variable nature of alluvial mining operations. However, it is not impossible that activities at Solcocon could be reconfigured in the future to incorporate hard rock mining and processing via a carbon-in-pulp plant.

In qualitative terms, the principal risks to which Auriant is immediately exposed include geographical/sovereign (including regulatory risk), geological, metallurgical, engineering, funding, financing and management. In general terms, these may be summarised as execution risk, namely management’s ability to bring the Kara-Beldyr project in particular to account within its geographical jurisdiction at the required technical and economic parameters. Once in production, however, these risks will reduce and be partially replaced by others, such as commercial, commodity price, foreign exchange and global economic risks.

One specific risk – funding – bears further, immediate consideration from an empirical perspective. In this particular case, our valuation sensitivity to the price at which an assumed $40.0m equity funding is conducted is shown in the exhibit below:

Readers should note that (assuming conversion before FY26) the above table effectively also provides an analysis of Auriant being funded by way of a convertible bond (cf conventional equity) with a conversion price at one of those shown (typically at a premium to the existing share price cf conventional equity at a discount) and a coupon close to the company’s cost of debt. In the event of such a convertible remaining unconverted, however, and therefore behaving like conventional debt, our valuation of Auriant instead rises to $1.22/share (albeit with a correspondingly higher maximum debt level of $130.1m cf $79.7m in the ‘base case’ scenario, see the ‘Financials’ section).

We set out our long-term gold price forecasts in Portents of economic weakness: Gold – doves in the ascendant, published on 14 August 2019 (ie before the COVID-19 crisis and before the Fed’s reaction in the form of a materially expanded asset base), and they are summarised in the table below.

Trading close to $1,700/oz currently under the influence of both a re-expansion of the US total monetary base plus the perceived threat to the world economy from the coronavirus, the price of gold is self-evidently above our forecast real prices for all of the years from CY20 onwards. If the gold price were to remain at $1,705/oz for the life of its operations, our valuation of Auriant rises by 76.3%, from $0.83/share to $1.45/share, in which case an investment in Auriant shares at a price of SEK4.40 on 1 January 2020 would generate an IRR to investors of 28.5% in US dollar terms over the 16 years from 2020 to 2035 (inclusive), which is the life of operations.

At end-March 2020, Auriant had net debt of $72.7m on its balance sheet, excluding a ‘lease payable’ item of $0.8m. This compares with net debt on its balance sheet of $82.7m at end-December 2019 excluding a ‘lease payable’ item of $1.4m. Assuming the company raises an additional SEK385.1m ($40.0m) in cash via equity funding in the near future, we expect its net debt will evolve as follows until FY25, before being eliminated in FY26:

Note that our estimate of Auriant’s maximum net debt requirement of $79.7m at end-FY23 equates to a leverage ratio (net debt/(net debt+equity)) of 64.3% (cf 70.8% previously).

Relative to the 550 employees that it had at 31 March 2020, Auriant has received results of COVID-19 tests from 271 employees (ie approximately half of the total) working at the Tardan mine, which were carried out as part of a government initiative to contain the spread of the new coronavirus in the region. Out of 271 employees tested, 26 have tested positive, although all are reported to be asymptomatic. In the meantime, Tardan has implemented quarantine measures in accordance with the instructions of the Russian authority Rospotrebnadzor responsible for the containment of COVID-19. A summary of the current situation at the mine is as follows:

Otherwise, the mine continues to operate as normal, with workers who have been placed in observation replaced by other employees. All personnel on site are subject to daily temperature checks and the mandatory use of personal protective equipment to minimise the risk of infection. Intensive disinfection measures have also been implemented. At present, the quarantine measures are reported to have had an insignificant effect on the mine’s operations. Further measures will depend on subsequent test results. In the meantime, however, management is confident that mining and gold production can continue at Tardan, although there may be temporary interruptions to some of the mine’s operations depending on the number of people who are infected and their positions at the mine. In accordance with Rospotrebnadzor’s instructions, the infected employees will be released from observation once two negative test results at least one day apart have been obtained.