Auriant Mining — Maintaining momentum

Auriant’s Q220 financial results were reported within the context of known production of 243kg for the quarter (cf 278kg in Q120) and a largely known gold price. In this case, however, they are also significant as they reflect the second full quarter of operations for the company’s new carbon-in-leach (CIL) plant, which was commissioned in November. In this respect, three factors are noteworthy:

In contrast to Q120, when 39kg (1,247oz) more gold was sold than was produced, in Q220 23kg (748oz) less gold was sold than was produced, creating a negative variance in revenue of $1.3m relative to potential. Nevertheless, the financial effects of the evolution of the Tardan operation from a heap leach to a CIL one were clearly visible in Auriant’s Q220 results (overleaf). In crude terms, output and revenue almost doubled relative to Q219, while costs declined by 14.6%. In addition to a summary of the results of operations in Q120, Exhibit 1 also presents our updated forecasts for the remainder 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 the remaining two quarters of the year and our updated full-year expectations.

Other notable features of the financial results for the quarter were the continuance of a low general and administrative cost and a high effective tax rate. However, in 2020, Tardan became a participant in the Regional Investment Projects programme and obtained the right to apply a reduced income tax rate of 17% and the mineral extraction tax at a nil rate. According to Russian legislation, tax losses are accumulated on the balance sheet and can be offset against future taxable earnings. Thus, in H120, the income tax charge of $1.5m was fully offset against the balance sheet amount of the deferred tax asset related to tax losses carried forward. Compared with free cash flow derived from the income statement of $12.1m ($8,562k H120 earnings plus $3,493k depreciation) therefore, actual cash flow from operations amounted to $14.7m, of which $2.2m was consumed in investing activities and the majority of the remainder used to repay debt.

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 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 (unchanged) expectation that its 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 Q220 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 948kg.

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 RUB70.9975/US$ at the time of our last note (see Emerging into broad sunlit uplands, published on 29 May 2020) to RUB73.7065/US$, and the general weakness in the oil price in FY20. In the light of this, we have reduced our central unit working cost for Tardan for the rest of the year, to $55.32/t cf $60.32/t previously, and cash costs of $55.58/t in Q220 (but $46.45/t if changes in working capital are taken into account). For the full year, this will translate into a cash cost of production of $631/oz (cf Edison’s estimates of $611/oz and $684/oz in H120 and Q220, respectively).

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 $1,892/oz and potentially as high as $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 $110bn per month, which equates to an expected increase in the gold price (using the historical correlation) of approximately $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 $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 $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, published in August 2019). During the period 2013–18, the gold price was relatively flat, averaging $1,270/oz. Its average price in 2018 was also $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 year 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 $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 $1,892/oz in flat nominal terms (ie declining in real terms) until the price (in real terms) crosses with the increased $1,271/oz 2018 price. At that point we assume that the price will flatten out (in real terms) at $1,494/oz (note that this may be contrasted with our prior methodologies for gold price forecasting, set out in our report Portents of economic weakness, Gold: Doves in the ascendant).

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 (and at our updated gold prices), we estimate that Auriant is capable of generating average cash flows of $63.4m (cf $49.4m previously), average earnings of $56.1m (cf $42.4m previously) and average EPS of 44.6c (cf 23.0c) in the nine-year period from FY25–33 (inclusive), thus allowing it to pay maximum potential dividends to shareholders of 47.8c per share (cf 25.9c). Discounted at our customary 10% discount rate, such a stream of dividends has a value of $1.76 per share (cf $0.83/share previously), as shown in the exhibit below, rising to $2.83/share (cf $1.46/share previously) on the cusp of the company’s maiden dividend in FY25.

Our ‘base case’ valuation of $1.76/share compares with one of $0.83 in May 2020 (see our note Emerging into broad sunlit uplands). The main underlying factors occasioning the increase in value include a higher long-term gold price (as above), a higher short-term gold price of $1,964/oz for the remainder of FY20 (cf $1,705/oz previously), a higher share price (SEK6.40 cf SEK4.40) and a reduced equity raising requirement ($20m cf $40m previously) in respect of the Kara-Beldyr project in the light of the higher gold price environment – these last two points, in particular, implying less future dilution to existing shareholders (see ‘Sensitivities’ section, below). 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 $20m ($40.0m previously) equity funding is conducted (in order to part fund Kara-Beldyr) 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 $2.07/share (albeit with a correspondingly higher maximum debt level of $100.9m (cf $77.6m in the ‘base case’ scenario, in the ‘Financials’ section, below)).

At end-June 2020, Auriant had net debt of $72.9m on its balance sheet, including a ‘lease payable’ item of $0.7m. 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 SEK172.8m ($20m cf $40.0m previously) in cash via equity funding in the near future, we expect its net debt will evolve as follows until FY24, before being eliminated in FY25:

Note that our estimate of Auriant’s maximum (future) net debt requirement of $77.6m at end-FY22 equates to a leverage ratio (net debt/(net debt+equity)) of 61.0% (cf $79.7m and 64.3% previously).

Relative to the 541 personnel that it employed at 30 June 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 tested positive, although all are reported to be asymptomatic and all have since returned to work after the appropriate period of quarantine, as determined by the authority responsible for the containment of the disease (Rospotrebnadzor).

Otherwise, the mine continues to operate as normal. 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. To date, 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, infected employees are released from observation once two negative test results at least one day apart have been obtained.