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The financial news has been buzzing in recent weeks about the carnage that investments in junior gold miners wrought on the portfolios of many big name investors and hedge funds last year. With the Junior Gold Miners ETF (NYSEARCA:GDXJ) down almost 40% in 2011, and long-term fundamentals pointing towards elevated gold prices in the intermediate future, there may be some bargains to scoop up in the sector. I decided to take a look at one particular junior gold miner, Keegan Resources (KGN), and attempt to determine if the stock is a gold mine or a money pit.

There are a number of different definitions for what makes a company a junior gold miner, but generally the term refers to a company that owns the rights to a

The financial news has been buzzing in recent weeks about the carnage that investments in junior gold miners wrought on the portfolios of many big name investors and hedge funds last year. With the Junior Gold Miners ETF (GDXJ) down almost 40% in 2011, and long-term fundamentals pointing towards elevated gold prices in the intermediate future, there may be some bargains to scoop up in the sector. I decided to take a look at one particular junior gold miner, Keegan Resources (KGN), and attempt to determine if the stock is a gold mine or a money pit.

There are a number of different definitions for what makes a company a junior gold miner, but generally the term refers to a company that owns the rights to a resource and is still developing the capacity to extract the resources. This makes any investment in a junior gold miner a speculative investment. Essentially, investors are supplying the equity that management needs to expand the business to profitability, and in the future, will be rewarded with a stake in that profitable business. To make a sound decision on whether or not to invest in a particular junior gold miner, investors need to look into the prospects and risks associated with the company’s projects to determine an intrinsic value for the company. If the company’s market value is less than its intrinsic value, it may be a worthwhile investment.

Keegan Resources is a mining company based in British Columbia, Canada, whose primary asset is the Esaase Gold Project in Ghana, Africa. The Esaase Project covers about 100 square kilometers in central Ghana. As of September 2011, the total measured and indicated resources at the project is equivalent to 3.64 million ounces of gold at a density of 1.1 grams of gold per ton of ore, with another 1.55 million ounces inferred at the same density. Keegan plans to develop an open pit mine on the site, but production will not begin until Q4 2014. Once production kicks into gear, the company plans to produce between 260,000 and 290,000 ounces of gold each year for a decade.

I went with a relatively rough and simple model for valuing the Esasse project, and by extent, the company. If an investor were to buy shares today, he could expect losses until 2015, when the company would begin generating a profit. Once production begins, the company forecasts that it will produce between 260,000 and 290,000 ounces of gold per year (so I went with an average of 275,000). Multiplying this quantity by a range of gold prices gives us a revenue forecast; taking out the company’s projected cost/ounce of gold after taxes and royalties (the company claims $771 with a margin of error of 25%; I went with $900 for a conservative scenario) gives us an approximation of annual earnings, which can be broken down to EPS based on the current share count (81,382,388).

At the end of the 10 year life span there will be no more gold and the cash flow from production will cease. This gives us a 13 year timetable for the investment, and lets us calculate a total lifetime earnings per share from the project. From the total earnings per share, we can get a sense of the net present value for the company’s future earnings. The table below shows my rough calculations based on a couple different price levels for gold. The price at the time of writing is highlighted in green.

And here’s a table depicting the project net present value and internal rate of return from the company’s investor publication (compare to the last column on the spreadsheet):

In effect, investing in Keegan Resources is making a leveraged bet on the price of gold. Changes in the price of gold (both positive and negative), will be magnified in Keegan’s earnings. For example, let’s say that gold sits at $1,250 an ounce and you buy positions in both the SPDR Gold Trust ETF (NYSEARCA:GLD) and KGN. If the price of gold appreciates 20% to $1,500, your GLD holdings will gain roughly 20%, but Keegan’s earnings will almost double. However, the inverse is also true; if gold prices fall, the profitability of the enterprise will crater. The long term fundamentals of gold, therefore, are of utmost importance to this investment thesis.

There is an argument to be made that the long term fundamentals suggest that gold prices could remain high in the intermediate to long term. The sovereign debt crises in Europe and the United States point towards inflationary pressure as countries print to finance excessive debt. While there are innumerable scenarios for the next decade, it seems most likely that given the choice between making difficult decisions and sacrifices to balance budgets or inflating fiat currencies to pay back debts, most policy-makers will choose the latter, because it is the more palatable option to their constituencies. Printing more money to pay back debts hurts the average person, but it is not as overt as directly cutting benefits or raising taxes, and it carries less of a risk of public outrage (see the austerity riots in Greece). The more governments print, the more valuable gold becomes as a store of value.

Keegan is still a speculative investment, however, and there are many risks associated with investing in the company and its Esaase project. The first risk is dilution. As of the writing, KGN has about $213 million in cash on its books from the equity financing it completed in Q1 2011, and has no long term debt. If management succeeds in bringing the project online on time and within the budget, there should be no problem with further dilution. If not, the company could be forced to sell more shares to cover expenses. Keegan’s management has a lot of industry experience, but because the project has yet to break significant ground, it is difficult to predict cost overruns or a realistic completion date.

There are also geopolitical risks associated with investing in Africa. The country of Ghana is the oldest democratic state in Africa, with a democratically elected two-party, three-legislature government that has ruled for over 50 years. Gold production is the top source of revenue for Ghana, and the government takes a pro-business and pro-infrastructure development stance when it comes to mining projects.

Keegan Resources has also started a community and social initiative to work with local leaders to benefit the local population. So far, the company has spent about $300,000 on projects to improve infrastructure in the local area, and plans on spending another $2.3 million through the life of the project, in addition to royalties paid to the government.

Keegan Resources is a speculative investment and its valuation is almost entirely dependent on the forecast price of gold for the next decade. Under current conditions, KGN seems to be attractively priced, but the true value of the stock will be determined not now, but over the course of the next 13 years. If you see elevated gold prices in the foreseeable future, there may be some value to be had in these bargain-basement shares. As always, though, be sure to do your own due diligence, and feel free to contribute to the discussion.

Disclaimer: This article is solely for the purpose of discussion. The author does not claim any financial expertise and any recommendations made or implied in this article should not be taken without further research or consulting your financial professional.

resource and is still developing the capacity to extract the resources. This makes any investment in a junior gold miner a speculative investment. Essentially, investors are supplying the equity that management needs to expand the business to profitability, and in the future, will be rewarded with a stake in that profitable business. To make a sound decision on whether or not to invest in a particular junior gold miner, investors need to look into the prospects and risks associated with the company’s projects to determine an intrinsic value for the company. If the company’s market value is less than its intrinsic value, it may be a worthwhile investment.

Keegan Resources is a mining company based in British Columbia, Canada, whose primary asset is the Esaase Gold Project in Ghana, Africa. The Esaase Project covers about 100 square kilometers in central Ghana. As of September 2011, the total measured and indicated resources at the project is equivalent to 3.64 million ounces of gold at a density of 1.1 grams of gold per ton of ore, with another 1.55 million ounces inferred at the same density. Keegan plans to develop an open pit mine on the site, but production will not begin until Q4 2014. Once production kicks into gear, the company plans to produce between 260,000 and 290,000 ounces of gold each year for a decade.

I went with a relatively rough and simple model for valuing the Esasse project, and by extent, the company. If an investor were to buy shares today, he could expect losses until 2015, when the company would begin generating a profit. Once production begins, the company forecasts that it will produce between 260,000 and 290,000 ounces of gold per year (so I went with an average of 275,000). Multiplying this quantity by a range of gold prices gives us a revenue forecast; taking out the company’s projected cost/ounce of gold after taxes and royalties (the company claims $771 with a margin of error of 25%; I went with $900 for a conservative scenario) gives us an approximation of annual earnings, which can be broken down to EPS based on the current share count (81,382,388).

At the end of the 10 year life span there will be no more gold and the cash flow from production will cease. This gives us a 13 year timetable for the investment, and lets us calculate a total lifetime earnings per share from the project. From the total earnings per share, we can get a sense of the net present value for the company’s future earnings. The table below shows my rough calculations based on a couple different price levels for gold. The price at the time of writing is highlighted in green.

Click to enlarge.


And here’s a table depicting the project net present value and internal rate of return from the company’s investor publication (compare to the last column on the spreadsheet):

In effect, investing in Keegan Resources is making a leveraged bet on the price of gold. Changes in the price of gold (both positive and negative), will be magnified in Keegan’s earnings. For example, let’s say that gold sits at $1,250 an ounce and you buy positions in both the SPDR Gold Trust ETF (GLD) and KGN. If the price of gold appreciates 20% to $1,500, your GLD holdings will gain roughly 20%, but Keegan’s earnings will almost double. However, the inverse is also true; if gold prices fall, the profitability of the enterprise will crater. The long term fundamentals of gold, therefore, are of utmost importance to this investment thesis.

There is an argument to be made that the long term fundamentals suggest that gold prices could remain high in the intermediate to long term. The sovereign debt crises in Europe and the United States point towards inflationary pressure as countries print to finance excessive debt. While there are innumerable scenarios for the next decade, it seems most likely that given the choice between making difficult decisions and sacrifices to balance budgets or inflating fiat currencies to pay back debts, most policy-makers will choose the latter, because it is the more palatable option to their constituencies. Printing more money to pay back debts hurts the average person, but it is not as overt as directly cutting benefits or raising taxes, and it carries less of a risk of public outrage (see the austerity riots in Greece). The more governments print, the more valuable gold becomes as a store of value.

Keegan is still a speculative investment, however, and there are many risks associated with investing in the company and its Esaase project. The first risk is dilution. As of the writing, KGN has about $213 million in cash on its books from the equity financing it completed in Q1 2011, and has no long term debt. If management succeeds in bringing the project online on time and within the budget, there should be no problem with further dilution. If not, the company could be forced to sell more shares to cover expenses. Keegan’s management has a lot of industry experience, but because the project has yet to break significant ground, it is difficult to predict cost overruns or a realistic completion date.

There are also geopolitical risks associated with investing in Africa. The country of Ghana is the oldest democratic state in Africa, with a democratically elected two-party, three-legislature government that has ruled for over 50 years. Gold production is the top source of revenue for Ghana, and the government takes a pro-business and pro-infrastructure development stance when it comes to mining projects.

Keegan Resources has also started a community and social initiative to work with local leaders to benefit the local population. So far, the company has spent about $300,000 on projects to improve infrastructure in the local area, and plans on spending another $2.3 million through the life of the project, in addition to royalties paid to the government.

Keegan Resources is a speculative investment and its valuation is almost entirely dependent on the forecast price of gold for the next decade. Under current conditions, KGN seems to be attractively priced, but the true value of the stock will be determined not now, but over the course of the next 13 years. If you see elevated gold prices in the foreseeable future, there may be some value to be had in these bargain-basement shares. As always, though, be sure to do your own due diligence, and feel free to contribute to the discussion.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in KGN and/or GDXJ over the next 72 hours.

Disclaimer: This article is solely for the purpose of discussion. The author does not claim any financial expertise and any recommendations made or implied in this article should not be taken without further research or consulting your financial professional.

Source: A Bet On Keegan Resources Is A Bet On Gold's Price