Endeavour Mining — First indications of exploration success

On 21 November, Endeavour announced a major greenfield discovery in the Cote d’Ivoire, with 1.1Moz indicated and 1.9Moz inferred resources successfully delineated at Tanda-Iguela. The maiden total mineral resource of 3Moz averages c 2g/t (with higher grade mineralisation occurrences boasting an average grade of more than 3g/t) at the Assafou deposit and ranks it as one of the most significant discoveries made in West Africa in the last decade. The discovery was made within a very short (under 15 months) timeframe and at a very low discovery cost of less than US$10 per indicated ounce. The total defined area spans three kilometres in length and 350m in width and extends more than 300m from surface. To date, the delineated resource encompasses only 20% of the identified mineralised system and remains open at both strike and at depth. Moving forward, Endeavour expects to undertake an aggressive 70,000m drill programme in 2023 to both delineate further resources at Assafou and test new targets, of which the company has outlined at least 10 on the property. Initial metallurgical tests suggest a high gold recovery rate, above 95%, with data highlighting a low-cost approach to recovery.

Updated figures at Ity, released by Endeavour on 29 November 2022, display a 17% increase in its M&I resources totalling 101Mt at 1.62g/t Au containing 5.2Moz. Following the ongoing exploratory drilling programme (during 2022, 51,181 meters of drilling was completed at Ity, mainly within a 20km radius from the plant), the company has confirmed continuity of the mineralised system, which hosts seven deposits, located near the processing plant, resulting in a new single resource model for the area, with mineralisation remaining open at multiple deposits. Drilling has also confirmed the presence of a large mineralised system covering the Le Plaque area, located 7km from the processing plant. Finally, a significant discovery was made at the Gbampleu target, located 22km from the processing plant, as several high-grade and thick mineralised lenses were identified. With 0.8Moz gold delineated in this current year (2022) and c 2.0Moz in the past two years, Endeavour is well on the way to achieving its target of discovering 3.5–4.5Moz of indicated resources at Ity in 2021–25.

On 30 September 2021, Endeavour announced a new five-year exploration discovery target of 15.0–20.0Moz of gold in the indicated category of resources at an average cost of less than US$25/oz. Full details of Endeavour’s announcement are included in its initial news release. A summary of the target, on a mine-by-mine basis, including year to date 2022 results, is as follows:

Within the context of its targets, Ity has already outlined an increased M&I resource in 2022, expanding its contained gold by 0.7Moz (or 16%) from 4.5Moz cf 5.2Moz after just one year of drilling. Similar results over the following four years would yield a pro-rata increase in resources of 3.5Moz (ie the lower limit of its target range). We also note the first data released for Tanda-Iguela, exhibiting 1.1Moz of contained gold, which equates to 73% of the lower limit of its target range of 1.5–2.0Moz, after just one year of exploration.

In general, Endeavour’s aims remain to continue to extend the lives of its core assets beyond its 10-year target. In addition, it has now achieved one of its objectives in the discovery of at least one more new standalone project via greenfield exploration, in the form of the Tanda-Iguela property in Côte d’Ivoire. Results for all other assets will be published in early 2023.

By their nature, the targets outlined in Endeavour’s announcement are conceptual. Nevertheless, a number of features of its programme are noteworthy:

A summary of Endeavour’s Q322 results is provided in the table below, showing both its headline and its underlying results:

Items included in the reconciliation between adjusted net earnings attributable and total net and comprehensive earnings are losses from discontinued operations, gains/losses on financial instruments, other expenses and acquisition costs (all shown independently in the table above), plus the tax impact of adjusting items, non-cash and other adjustments and the minority interest attributable to the adjusting items (not shown independently). Unlike before, deferred tax effects and share-based payments are no longer included in the adjustments to total net and comprehensive earnings.

Gold produced and sold was roughly in line with Q222, with Q322 outperforming our production and sales estimates by 9.2% and 7.7%, respectively, leading to a positive variance of US$28.5m (or 5.3%) in revenue, relative to our prior expectations, driven by better-than-expected performances at Houndé, Ity and Wahgnion in particular. However, the positive variance in revenue was ultimately offset by an 8.2% negative variance in operating costs, a 6.7% negative variance in depreciation (almost exclusively attributable to Houndé), a 136% negative variance in (albeit largely discretionary) exploration costs and a 37.0% negative variance in net interest.

As in Q222, Q322 results were distorted by an exceptional gain on financial instruments of US$60.1m (largely unrealised gains on hedging contracts) and a tax charge inflated by an unusually large US$48m withholding tax payment linked to the upstreaming of cash to redeem the company’s convertible bond in February 2023, which increased Endeavour’s effective tax rate during the quarter to a preternaturally high 49.2%. Stripping out the effect of the financial gain but including the realised gains on gold hedges of US$19.7m (among other items), adjusted net EPS from continuing operations amounted to US$0.147/share (cf our prior forecast of US$0.208/share).

A comparison between Endeavour’s actual results and both our and the market’s prior forecasts for the quarter is as follows:

Endeavour’s Q322 results put it solidly on track to meet the top end of its guidance for the year of 1,315–1,400koz of production at an AISC of US$880–930/oz. In addition to incorporating its Q322 actual results into our full-year forecast, we have updated our gold price forecast to reflect a fractionally higher gold price in Q4 (US$1,727/oz cf US$1,713/oz previously). We have also attempted to forecast the effect of realised hedging gains/losses on earnings in the form of an estimate of the intrinsic value of these contracts for the quarter included in ‘Profit/(loss) on financial instruments’. As a result (and with the usual caveat around quarterly estimates), our updated forecast for adjusted net earnings attributable to shareholders for FY22 for Endeavour in the wake of its Q322 results is now as follows:

Readers are reminded that Endeavour changed its definition of cash costs in Q420 to include royalties. The decision was made so that Endeavour may be more consistent in reporting within the context of its peer group. For reasons of comparability with past results, however, as well as ease of forecasting (given that royalties are reported as a standalone item distinct from operating expenses), we are continuing to calculate total cash costs in Exhibits 2 and 4 excluding royalties.

A comparison between our quarterly and full-year forecast and consensus forecasts for FY22 adjusted net EPS is as follows:

Self-evidently, one of the main assumptions behind our forecasts is that there are no major deleterious effects to ongoing operations as a result of the COVID-19 pandemic. We also assume no collateral escalation of war between Russia and Ukraine into West Africa. To date, the effect of COVID-19 on Endeavour’s operations in West Africa has been negligible and is expected to remain so, as the company has now been able to vaccinate more than 50% of its workforce in an ongoing programme of pandemic mitigation. In addition, Endeavour has further mitigated future risks as far as possible by setting itself up to operate under level 2 COVID-19 restrictions (see our update note published on 17 December 2020) and by preparing multiple different levels in its pits from which to produce, thereby affording it maximum operational flexibility in the future.

Endeavour is a multi-asset company that has shown a willingness and desire to trade assets to maintain production, reduce costs and maximise returns to shareholders (eg the sale of Youga in FY16, Nzema in FY17, Tabakoto in FY18, Agbaou in FY20 and Karma in FY22, and the acquisition of SEMAFO in FY20 and Teranga in FY21). Historically, rather than our customary method of discounting maximum potential dividends over the life of operations back to FY22, in the case of Endeavour, we have instead opted to discount five years of forecast cash flows in FY22–26 back to FY22 and then to apply an ex-growth terminal multiple of 10x (consistent with using a standardised discount rate of 10%) to forecast cash flows in that year (ie FY26). In the normal course of events, exploration expenditure would have been excluded from such a calculation on the basis that it is an investment. In the case of Endeavour, however, it was included on the grounds that it was a critical component of ongoing business performance in its ability to continually expand and extend the lives of its mines.

In the wake of the Q322 results, our estimate of cash flows in FY26 has been updated to US$4.24/share (cf US$4.27/share previously) – only really reflecting a modest rephasing of capex relating to the Fetekro/Lafigué project – which implies a terminal valuation of the company at end-FY26 of US$42.44/share (cf US$42.75/share previously) if calculated using a discount rate of 10%. In conjunction with forecast intervening cash flows, this terminal valuation then discounts back to a present valuation of US$35.02/share (cf US$35.54/share previously) at the start of FY22, as follows:

Given its elevation into the ranks of the world’s foremost producers of gold, however, we believe Endeavour can increasingly attract lower-cost finance and, as such, a CAPM-derived WACC can also be considered. In this case, long-term nominal equity returns have been 9% and 30-year break-evens are expecting an inflation rate of 2.3754% (source: Bloomberg, 21 November) cf 2.2625% previously. These two measures imply an expected real equity return of 6.47% (1.09/1.023754) and applying this to our forecast cash flows would imply a terminal valuation for Endeavour of US$65.59/share (cf US$64.88/share previously) and a current valuation of US$57.63/share (cf US$57.15/share previously).

In the meantime, Endeavour’s valuation remains at a material discount to those of its peer group, as shown in Exhibit 7, below.

Endeavour’s valuation on a series of commonly used measures, relative to a selection of gold mining majors (the ranks of which it has now joined since its takeovers of SEMAFO and Teranga have been completed), is as follows:

Of note is that, without exception, Endeavour’s valuation is materially lower than the averages of the majors on all of the measures shown in Exhibit 7, regardless of whether Edison or consensus forecasts are used. On an individual basis, it is cheaper than its senior gold mining peers on at least 41 out of 54 (76%) valuation measures if Edison forecasts are used and 42 out of 54 (78%) valuation measures if consensus forecasts are used. Reverse engineered, the average valuation measures of its peers imply an average share price for Endeavour of US$30.67, or C$41.93 (or £25.02), per share.

According to its Q322 balance sheet, Endeavour had net debt of US$48.1m (including leases) as at end-September, after US$36.7m in share repurchases during the quarter. This net cash figure compares with net cash and debt figures at the end of recent, comparable quarters as follows:

This debt figure of US$48.1m includes lease liabilities of US$50.7m and an option premium of US$8.3m, which, if excluded, would result in an alternative net cash position of US$10.9m. This is equivalent to, but differs slightly from, the US$2.5m net cash figure calculated by Endeavour and quoted in its announcements owing to the discounting, variously, of certain committed future payments to present value. It also excludes US$31.8m held in the form of ‘restricted cash’ and US$40.0m in shares of Allied Gold received as consideration for the sale of Agbaou, both held in ‘non-current other financial assets’.

Note that, for the purposes of our financial modelling in Exhibit 8 and for simplicity’s sake, we have assumed that the consolidation of Endeavour’s and Teranga’s balance sheets took place retrospectively on 31 December 2020.