Auriant Mining — Sales policy disguises extent of improvements

Auriant’s Q221 financial results were reported in the context of known production of 236.6kg from Tardan for the quarter (compared with our prior estimate of 208.0kg) and a largely known gold price. After a short maintenance stop in Q121, Q221 operational results were characterised by material outperformance relative to our prior expectations, as shown in the table below:

Of note were the following:

Exhibit 2 summarises Auriant’s Q221 results in the context of the prior quarter’s results and also our previous expectations. Relative to our prior expectations, the largest variances in Q2 results were a negative $0.2m variance in revenues (largely on account of the under-sale of gold relative to production noted above), a negative $0.4m variance in costs (largely on account of the higher level of tonnes processed, albeit at a lower unit cost), a negative $0.3m variance in depreciation and a negative $0.3m variance in the tax charge partially offset by a $0.2m positive variance in the general and administrative charge. Had all of Auriant’s gold produced during the quarter been sold however, we estimate that its pre-tax profit would have slightly exceeded our prior estimate at $3.4m ($2.76m + $0.64m) compared to $2.8m (actual, below) and $3.3m (prior estimate, below):

Although the effective tax rate of 29.5% was materially higher than our forecast rate of 15.6% (NB leading to a rise in the value of deferred tax assets on Auriant’s balance sheet of $288k), it was well within the normal range of variation historically observed at Auriant on a quarterly basis (see Exhibit 2). In addition, cash taxes of $162k were materially lower than the income statement charge of $813k and amounted to an effective cash tax rate of only 5.9%. Compared with a normalised estimate of cash flow from the income statement of $4.1m ($1.9m in earnings plus $2.2m depreciation) therefore, actual cash flow from operations amounted to $6.2m, of which only $1.0m was consumed in investing activities and the remainder used to pay interest, repay debt (including leases) and build cash.

On 21 December, Auriant announced total production guidance for 2021 of 900–930kg gold from Tardan and Solcocon combined (cf 953kg produced in FY20) from 350–380kt of ore processed through the Tardan CIL plant. This guidance was reiterated at the time of its Q221 results on 30 August. Assuming production of c 39kg from Solcocon (albeit this has proven to be susceptible to both weather-related risks and COVID-19 related risks in the past), this total implies production from the Tardan CIL plant in the range 861–891kg at a yield of c 2.40g/t and a head grade of c 2.61g/t. As in FY20, relatively little seasonal variation in production is anticipated at the Tardan CIL plant (in sharp contrast to the former heap leach operation).

As a result of test work conducted during the ramp-up phase, Auriant has upgraded the leaching tanks at Tardan (in Q419) 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 has allowed it to minimise its use of diesel generators on site and, on occasion, to stop using them altogether. Cash costs per tonne processed are nevertheless expected to be broadly unchanged in US dollar terms in FY21 relative to FY20 (eg $58.12/t cf $54.04/t – Edison calculation), reflecting higher volumes of stripping and exploration drilling and some inflationary pressures in local currency terms (given something of a ‘boom’ in resources investment in Russia in addition to normal staff salary indexation). At the same time, the value of the rouble relative to the US dollar has remained broadly stable, from RUB73.1640/US$ at the time of our last note (Fifth successive quarter of success, published on 11 June 2021) to RUB72.6537/US$ at the time of writing, while the oil price is currently 65.7% higher than it was this time last year and has been 57.4% higher so far this year, to date. Finally, as discussed previously, stripping costs delayed from FY20 are now being incurred in FY21.

Based on the production guidance provided by management for FY21 (and with the usual caveat surrounding quarterly predictions), our financial forecasts for Auriant for FY21 by quarter are as shown in Exhibit 3.

Relative to our prior forecasts, the main changes that we have made to our estimates are:

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 and the Kara-Beldyr projects according to the operational and financial parameters anticipated, we estimate that Auriant is capable of generating average cash flows of $63.3m, average earnings of $54.6m and average EPS of 38.1c in the 10 years from FY25–34, thus allowing it to pay maximum potential dividends to shareholders of 42.9 per share in the period FY26–34. Discounted at our customary 10% discount rate, such a stream of dividends has a value of $1.59 per share (cf $1.72/share previously), as shown in the exhibit below, rising to $2.56/share on the cusp of the company’s maiden dividend in FY26. Readers should note that near-term effects (ie the gold price, forex and Q221 results) were responsible for a 4c/share decline in our valuation, while the balance of the decline (9c) could be attributed to the decline in Auriant’s share price from SEK4.70 at the time of our last report (see Fifth successive quarter of success, published on 11 June 2021) to SEK3.84 currently, thereby increasing future assumed dilution (see ‘Sensitivities and risks’, below). In the absence of this factor, our valuation would have otherwise remained steady, at $1.69/share (cf $1.72/share previously).

Our approach to gold price forecasting, and the gold prices underlying our earnings and dividend assumptions, is set out in our note A golden future, published in June 2020. Readers should also note that our valuation specifically excludes any value attributable to Solcocon beyond FY21 on account of the variable nature of alluvial mining operations. However, it is possible that activities at Solcocon may be reconfigured in due course to incorporate hard rock mining and processing.

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

However, one specific risk that bears further, immediate consideration from an empirical perspective is funding. In this particular case, our valuation is sensitive to the price at which Auriant is assumed to raise an additional $20m in equity for Kara-Beldyr (assumed at the start of FY22) as follows:

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 compared to 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 would instead rise to $2.16/share at the start of FY21 (albeit with a correspondingly higher maximum debt level of $79.5m (cf $58.5m in the ‘base case’ scenario – see ‘Financials’ section, below).

At end-June 2021, Auriant had net debt of $60.3m (cf $64.2m at end-Q121 and $65.7m at end-Q420) on its balance sheet, but $61.9m (cf $66.1m at end-Q121 and $67.2m at end-Q420) if lease liabilities are included. While, at first glance, net debt has fallen by $3.9m during the quarter (excluding lease liabilities), we estimate that it would have fallen by $5.8m if all the gold produced during the quarter had been sold and by $9.8m if all the gold currently held in inventory as ‘finished products’ had also been sold. As noted in its results call with analysts on 30 August, the change in Auriant’s sales policy with respect to gold (from ‘maximised’ to ‘as needed’) has arisen as a consequence of its success in fully repaying earlier high cost debt (originally raised to help finance the CIL plant construction), which has resulted in a material reduction in interest rates from 9.5% in H120 to 4.9% in H121 and which has also now allowed it to refocus operationally on deferred stripping at the Tardan deposit. Hence early/accelerated debt repayment is no longer a priority for the company.

Assuming the company raises an additional SEK171.1m ($20m) in cash via equity funding at the start of FY22, we forecast that its net debt will evolve as follows until FY25, before being eliminated in FY26 (NB excluding any effect from unsold gold):

Note that the estimates above assume the start of Kara-Beldyr capex in H221. Otherwise, our estimate of Auriant’s maximum (future) net debt requirement of $58.5m (cf $55.9m previously) at end-FY23 equates to a leverage ratio (net debt/(net debt+equity)) of 51.3% (cf 48.2% previously).

Mining operations at Tardan continue to operate, to all intents and purposes, 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, quarantine measures are reported to have had an insignificant effect on the mine’s operations. Further measures will depend on employee test results. Even so, Auriant has launched a vaccination programme at Tardan. In H121, it vaccinated more than half of its workforce (261 people) and aims to make the vaccine available to all employees of the company in due course. In the meantime, management is confident that mining and gold production can be maintained at Tardan, although there could be temporary interruptions to some of the mine’s operations depending on the number of people infected at any one time 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.