Auriant Mining — Turning into the home straight

Auriant’s Q320 financial results were reported within the context of known production of 229kg from Tardan for the quarter (cf 243kg in Q220 and 278kg in Q120) and a largely known gold price. While lower than in the previous two quarters, production was nevertheless consistent with the achievement of steady-state operations at the company’s new carbon-in-leach plant:

Exhibit 1 summarises Auriant’s Q320 results both within the context of the prior quarter’s results and also Edison’s prior expectations. Relative to our prior expectations, the largest variance in Q3 results was in the production of only 5kg of gold from alluvial operations at Solcocon cf our prior forecast of 25kg (and the company’s end-August production guidance of 20–40kg for FY20) as a consequence of the disruption to the contractor’s mine plan engendered by the coronavirus. This factor alone was responsible for 48% of the negative variance in revenue relative to our forecasts. However, the shortfall in revenue was inevitably partly offset by an absence of costs from Solcocon, plus an excellent cost performance at Tardan (see above), which resulted in gross profits being within 10% of our prior expectations. Other negative variances were of a somewhat one-off, or exceptional, nature, including contractual termination benefits payable in respect of the former CEO and chief geologist (included in general and administrative expenses) and the write off of a VAT refund asset within a subsidiary called LLC Rudtechnology (included in other operating expenses). The aggregate effect of these was to almost exactly double the negative variance of actual results relative to our forecasts at the EBIT level relative to the gross profit level in US dollar terms (see Exhibit 1). Nevertheless, compared with the prior year, the transformation in Auriant’s financial fortunes as a result of its development of a CIL plant in place of the former heap leach operation is readily apparent. For the nine months to end-September, EBITDA has increased by a factor of almost 6x, to $24.9m, while cash flows from operations have increased almost fourfold, to $23.0m.

Exhibit 1 also presents our updated forecasts for Q420, 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 quarter of the year and our updated full-year expectations. Relative to our prior forecasts, the main changes that we have made to our Q4 forecasts are:

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 Q320 no income tax was paid with the notional tax charge fully offset against the balance sheet amount of the deferred tax asset related to tax losses carried forward. Compared with a normalised estimate of cash flow from the income statement of $5.2m ($3.0m earnings plus $2.3 depreciation) therefore, actual cash flow from operations amounted to $8.3m (including evidence of diligent control of working capital), of which only $0.6m was consumed in investing activities and the majority of the remainder used to repay debt.

Auriant’s 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. These parameters form the basis of our financial and operating forecasts for the remainder of the year (see Exhibit 1). As a result, we are forecasting gold production for Tardan for FY20 to be at the top of management’s guidance range, at 936kg.

On 21 December, Auriant announced total production guidance for 2021 of 900–930kg gold from 350–380kt of ore processed through the CIL plant from the Pravoberezhniy deposit. The total includes an assumed c 30kg being produced at Solcocon, implying production from the Tardan CIL plant of c 885kg, a yield of 2.42g/t and a head grade of 2.64g/t. This is 7.7% lower than our previous forecast of 959kg gold produced from 320kt throughput, but is consistent with the recent performance of the mining operation and CIL plant and reflects the delay to stripping at Tardan in FY20 as a result of changes to mine sequencing necessitated by a licence restriction, which was fully lifted from 2 November 2020 onwards (see page 7). As in FY20, relatively little seasonal variation in production is anticipated (in sharp contrast to the former heap leach operation). However, both Q420 and Q121 will be slightly affected by a scheduled maintenance stop, which is reflected in our production expectations for these quarters (see Exhibit 2).

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 has allowed it to minimise its use of diesel generators on site or, possibly, to cease their use entirely. Both have a potentially beneficial effect on costs, as will the recent depreciation of the rouble, from RUB73.7065/US$ at the time of our last note (see Maintaining momentum, published on 3 September 2020) to RUB75.1712/US$, and the general weakness in the oil price in FY20.

Unit costs are expected to be broadly unchanged in US dollar terms in FY21 relative to FY20, albeit reflecting some inflationary pressures in local currency terms (given something of a ‘boom’ in resources investment in Russia) offset by a decline in the value of the rouble relative to the US dollar. However, staff costs appear likely to rise as a result of local inflation and salary indexation and, as a consequence, there is expected to be little or no improvement in budgeted exploration expenses

Stripping costs delayed from FY20 are now also expected to be incurred in FY21.

On the basis of the production guidance provided by management for FY21 (and with the usual caveat surrounding quarterly predictions), our financial forecasts for Auriant, for the year, by quarter, are as follows:

Owing to delays in progress occasioned by the coronavirus crisis, plus uncertainty surrounding the timing of the development of grid electricity in the region of Kara-Beldyr, we have put back our assumption regarding the likely timeline for the construction of the mine by one year, such that we are now expecting first production in FY24 and the first full year of production in FY25 (cf FY23 and FY24, respectively, previously).

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 $61.6m, average earnings of $52.7m and average EPS of 40.7c in the ten years from FY25–34 (inclusive), thus allowing it to pay maximum potential dividends to shareholders of 45.8c per share in the period FY26-FY34. Discounted at our customary 10% discount rate, such a stream of dividends has a value of $1.71 per share (cf $1.76/share previously), as shown in the exhibit below, rising to $2.75/share on the cusp of the company’s maiden dividend in FY26.

Note that our valuation specifically excludes any value attributable to Solcocon 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 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 equity funding relating to Kara-Beldry 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 $2.07/share (albeit with a correspondingly higher maximum debt level of $75.4m (cf $52.0m in the ‘base case’ scenario, in the ‘Financials’ section, below)).

At end-September 2020, Auriant had net debt of $67.0m on its balance sheet, a decline of $5.9m relative to the $72.9m that it had on its balance sheet at end-June (including leases payable). 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 SEK167.9m ($20m) in cash via equity funding in the near future, we forecast its net debt will evolve as follows until FY25, before being eliminated in FY26:

Note that our estimate of Auriant’s maximum (future) net debt requirement of $52.0m at end-FY22 equates to a leverage ratio (net debt/(net debt+equity)) of 48.3%.

Earlier in November, Auriant announced that its subsoil use rights at the Tardan deposit (which had been suspended since August 2019) had been restored in full by the Russian Subsoil Use Agency, Rosnedra.

The suspension followed an inspection carried out by the Russian state supervisory authority Rosprirodnadzor in July-August 2019. After the inspection, Tardan received an order that it should not carry out mining activities at the Tardan deposit until approved to do so by Rosnedra. This approval has now been granted and Rosnedra has therefore issued an order to remove the restrictions with immediate effect.

As previously noted by Edison, Tardan Gold challenged some of the findings of Rosprirodnadzor’s inspection in court. The court found that the inspection lacked legal grounds and that therefore Rosprirodnadzor’s findings had no legal effect. Nevertheless, Tardan has rectified several shortcomings identified during the inspection and Auriant notes that its subsidiary is now fully compliant with all applicable subsoil use and environmental laws and regulations.

Readers should note however that neither the original suspension nor its subsequent lifting had any material effect on the operations of Auriant, given that the ore for the CIL plant was supplied from the Pravoberezhny deposit (as distinct from the Tardan one), which was never affected by the restriction.

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, the quarantine measures are reported to have had an insignificant effect on the mine’s operations. Further measures will depend on employee 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.