Proceedings looked decidedly rosy this past February when Detour Gold (OTCPK:DRGDF) started production at their 100% owned Detour Lake Mine in northeastern Ontario. This mine has some enormous metrics: 15.6M ounces of reserves, projected average annual gold production of almost 660,000 ounces for a minimum of 21.5 years and a large prospective land package that promises more deposits to exploit in due time. First gold was poured soon after the mentioned announcement and guidance for 2013 remained unchanged for 350,000 to 400,000 ounces of at a total cash cost of $800 to $900 once commercial production was declared.
The latest technical report on the Detour Lake mine dates back to October 2012. The base case considered in this report assumes rather optimistic gold price assumptions and found an NPV (5%) of $1.12B and an IRR of 12.4% after tax. The mine is estimated to pay $872M in income taxes and $368M in mining taxes. Pre-production capital expenditures were estimated at $1.45B and life-of-mine sustaining capital is estimated at $1.2B. This is a decidedly low-grade high-tonnage operation. The reserve grade is just over 1 g/t and the required mill throughput is 55,000 tons per day.
The study also included a sensitivity study, which showed that variations of capital expenditure or operating cost had little influence on the overall economics of the project. Variations in the price of gold and the exchange rate between Canadian and US dollars on the other hand were shown to have a significant impact.
(All photos taken from company website)
Detour Gold is listed on the Toronto Stock Exchange. Shares trade in the US via the pink sheets with ample liquidity for retail purposes. About 118M shares are currently outstanding. Billionaire John Paulson's hedge fund owns about 15% of the company and institutional holdings total almost 80% according to the Detour's latest investor presentation. At the present share price of $11 the market capitalization computes to $1.3B. Taking into account the $524M in long-term debt and the $210M in cash at mid-year then the company is valued approximately at 1.4 times the NPV of the mine. Compared to other opportunities in the current market this seems rather high.
The company has a declared focus on its existing Detour Lake asset in the famous Abitibi belt north of Timmins and has no aspirations to venture afield. Detour Gold appears to have a strong drive to create growth organically from the large and prospective Detour Lake property. Another resource and reserve upgrade is scheduled for later this year and should show a further increase in in-situ ounces.
Towards the end of March this year when Detour Gold was trading around $20 analyst Brian Sylvester of Macquarie Private Wealth stated:
"Detour Gold has come through the valley of death and is on its way to production in about six months. Its capital risk is almost out of the way. The company is capitalized now and it looks quite cheap by most measures."
Cashed up the company certainly was, after having closed a $135M senior secured credit facility and most would have assumed at the time that the company will make it to commercial production without further shareholder dilution. Alas, it was not to be. On May 25 the company announced closure of a $153M bought deal at a share price of $8.75 (Canadian, but exchange rate was almost parity back then). The offering was oversubscribed and eventually closed in June raising $176M. So much for picking the bottom for maximum damage to the share registry. Long-term shareholders suddenly owned 17% less of the company.
Finally, this week better news arrived and the company announced that commercial production has been achieved at Detour Lake after "the mill had operated for a period of 60 consecutive days at an average of 75% or more of the designed production capacity, equivalent to 41,250 tpd." One has to briefly stop and admire the feat of taking this massive asset from discovery to production in only six years. Alas, the good news did not come without a downer: new guidance for the year was set at 270,000 ounces at cash cost of approximately $1,100 per ounce post-commercial production.
The market reaction to the announcement has been a shoulder-shrug so far and the share price has been performing in line with peers since mid-year.
At the end of the second quarter the company had poured close to 75,000 ounces leaving 195,000 ounces to be poured in the second half of the year. At cash costs of $1,100 we can't see free cash flow from production at current spot price levels when adopting an all-in sustaining cost point of view. In fact, we assume that the company will be producing at a loss for the rest of the year taking into account sustaining costs and remaining ramp-up costs and capital costs. At the end of June the company had $207M in cash available. $68M will be necessary in the second half for sustaining costs. With these numbers in mind we see a distinct possibility that the company might need to ask Mr. Market for more cash before this year is over. Our presumption is supported by the following comment from the Q2/MD&A:
"The Detour Lake mine attained commercial production in the third quarter of 2013. However, this may not, in itself, be sufficient to fully fund operations, required sustaining capital expenditures, corporate costs and debt service payments. […] As a result of the significant decrease and continued volatility in the price of gold, as well as the ongoing unpredictable ramp-up period of the Detour Lake mine, the Company may require, or decide that it would prefer to have, additional funding in place to ensure the uninterrupted operation of the mine during this continued difficult-to-predict gold price environment."
Detour Gold is highly leveraged to the gold price and joining John Paulson on the share registry at the current time includes the distinct risk of being diluted in a cash raise later this year or early in 2014. On the positive side, the company has a strong institutional investor base and should be able to raise the required funds if necessary.
On the other hand, due to this high leverage the company's share price should react very strongly to a gold price rally. Investors wishing to bet on such a rally might find Detour Gold an attractive, if risky, vehicle. If the rally eventuates with sufficient force then another cash raise might not be necessary, and the share price should respond to eventual free cash flow from production.