Luna Gold: A Takeover Is Likely Over The Next 6-12 Months

Aug.27.14 | About: Luna Gold (LGCUF)


Luna Gold is a junior mining company that produced 80,000 ounces of gold in 2013 and has a total resource base of 4.6 million ounces of gold in Brazil.

The company has struggled this year, suffering from cost overruns and above average rainfall during Brazil's wet season. Production guidance was lowered 10,000 ounces, with higher all-in costs.

Despite its struggles, Luna Gold is a strong takeover target as it has more than 4 million ounces of gold resources with further exploration and production upside.

Luna Gold (OTCQX:LGCUF) is a junior gold mining company which owns and operates the highly prospective, open-pit Aurizona gold mine and deposit in Brazil. While there are a number of mineralized bodies on the property, Luna has focused solely on the Piaba and Tatjuba deposits. The company has sustained positive cash flow from operations over the past two years, producing 79,000 ounces in 2013 while identifying two major mineralized structures at the Touro Target.

The company has had a ton of exploration success at Aurizona, increasing the resource base from just over 1 million ounces of gold in 2009 to more than 4 million ounces of gold today. In addition, the deposit has 2.36 million ounces of gold in the proven and probable categories.

While Luna Gold has had its challenges thus far in 2014, I think shares have huge potential upside and I feel the company remains an attractive takeover target for a larger miner.

Recent Stock Price: $.81

Shares Outstanding: 141 million

Market Cap: $123 million

52-Week Range: $.78 - $1.89

Credit: Yahoo Finance

Why Luna Gold?

The Aurizona mine is centered around the Piaba deposit, which contains a total of 3.6 million ounces of gold in measured and indicated categories at 1.39 g/t gold. In addition, Luna holds 1 million ounces of gold in the inferred category.

However, big exploration upside remains as the company recently launched a 3-5 year Brownfields exploration program to target new gold deposits on its 15,500 hectare land package.

In addition, Luna Gold owns 100% of the Greenfields deposit, a 220,000 hectare property which is located southwest of Aurizona. This deposit has the potential to hold far more gold ounces, but is very underexplored.

In addition, I feel that Luna Gold has huge production upside - with a 4+ million ounce gold deposit, Luna should be producing far more than 80,000 ounces of gold a year. Completion of a Phase I expansion would grow the company's total annual production to 115,000 to 125,000 ounces of gold annually. However, completion of a Phase II expansion would target yearly production between 200,000 to 300,000 ounces of gold - far greater than the company's current annual production figure of 80,000 ounces. This expansion would evaluate a range of process plant, mining fleet and infrastructure upgrades.

The bottom line is that Luna Gold has a ton of internal growth opportunities. Unfortunately, the company has had its share of issues so far in 2014.

Challenges at The Aurizona Mine

The challenges at Aurizona began at the start of the year:

- First quarter production 19,414 ounces of gold and was effected by an unscheduled week-long shutdown in January, as well as challenging mining conditions due to the wet season in Brazil, which lasts from January to June.

- However, second quarter came in even worse, with just 14,262 ounces of gold produced. This was due to above average rainfall during the quarter.

- The company announced revised guidance of 75,000 to 80,000 ounces on August 5, down from the original guidance of 85,000 to 95,000 ounces.

- Due to a combination of lower cash flow than budgeted for the first six months of 2014, and an increase in budgeted capital expenses of $13 million, the company decided to delay completion of the phase I expansion indefinitely.

- This news also hurts Sandstorm Gold (NYSEMKT:SAND), which owns a 17% gold stream on Aurizona at $404 per ounce.

However, it was soon after announced that Sandstorm would invest close to $20 million in Luna Gold by way of a non-brokered private placement financing, in addition to $10 million raised outside of Sandstorm.

But Sandstorm was also granted the right to appoint one member to Luna's board of directors, since it holds more than 20% in Luna Gold. Closing of the financing gives Luna Gold $36 million cash and $40 million working capital, while the company has $50 million debt.

- Sandstorm has also entered into gold stream negotiations with Luna Gold, which will potentially lower the gold stream to increase cash flow to Luna Gold. This would allow the company to continue the phase I expansion and give it enough funds to ramp up exploration.

Who Will Buyout Luna Gold?

As mentioned, I feel a takeover of Luna Gold, or a merger, is likely in the near-term as the company has had its production issues, but still holds tremendous exploration and production upside. A partner with deeper pockets could also be of great help. Luna Gold really needs someone to help realize Aurizona's full potential. I believe this would help unlock shareholder value.

Sandstorm Gold's CEO Nolan Watson said this on the company's most recent quarterly earnings, in regards to Sandstorm's large ownership in Luna Gold:

"Also, we have had questions on what our exit strategy for share position is. We believe that one day and probably sooner rather than later, the Aurizona projects will be a part of a larger company due to the mergers and growth or through the sale of Luna to larger company, at which point that would be a natural exit for us." (Source: Q2 Transcript). In this case, Sandstorm could make out pretty well on its investment in Luna Gold. Sandstorm could then potentially negotiate a lower gold stream with the new company.

I have to agree with Watson and I think the most likely suitors are Yamana Gold (NYSE:AUY), Alamos Gold (NYSE:AGI) and Kinross Gold (NYSE:KGC).

Yamana operates the Jacobina underground gold mine, the Fazenda Brasileiro underground gold mine, and the Chapada open-pit gold mine, all located in Brazil. Yamana also has three development properties in Brazil - C1 Santa Luz, Pillar, and Ernesto/Pau-a-Pique. The company's presence and experience in Brazil means taking over the Aurizona mine could be a relatively smooth, easy transition. The only reason it might not happen is the fact that Yamana just closed a large transaction with Barrick Gold (NYSE:ABX), purchasing Osisko Mining Corp's Malartic mine.

I think the next likely suitor for Luna Gold is Alamos Gold, which owns and operates the low-cost Mulatos Mine in Mexico. While Alamos has several development projects in Mexico and Turkey, the company has $390 million in cash, so I think it could have more than enough cash to complete a transaction that will grow its low-cost production profile.

Kinross in another company I think would be interested in Luna Gold. The company owns and operates the Paracatu operation, a large scale open pit mine in Paracatu, Brazil. The mine produced 500,380 ounces of gold in 2013, making it Brazil's largest gold producer. The mine is also low-cost, with $836/ounce cash costs in 2013. With $700 million cash and equivalents and $1.7 billion working capital, Kinross has more than enough funds to complete a transaction.

These are just a few potential takeover targets for Luna Gold, and I'm sure many more are out there.

Bottom Line: Luna Gold Is a Speculative Buy

Luna Gold's share price has suffered following the lowered guidance and higher than expected capital costs. However, Luna has a solid partner in Sandstorm Gold, raising $20 million via private placement. The company should have enough cash to work through its issues while re-starting exploration. The company has a ton of exploration upside - I feel there's potential to add at least 2-3 million more ounces of gold with further exploration, based on past drilling results and the fact that so much of its land holdings remain unexplored. A takeover or merger remains a strong possibility, which could unlock a ton of value for shareholders. I recently purchased shares of Luna Gold at $.80, and will add more on further weakness.

Disclosure: The author is long LGCUF, SAND.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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