Endeavour Mining (OTCQX:EDVMF) is widely covered on Seeking Alpha, with most authors delivering positive articles on this company. I also think Endeavour is a decent and prospective African miner. The company rapidly increases its production, opens new mines, acquires other projects and miners. Let me show a few figures.
Endeavour has increased its gold production from 92,309 ounces in 2011 to 516,646 ounces in 2015, an increase of 460%. During the last five years, the company opened the following mines:
- 2011: Nzema in Ghana
- 2012: Tabakoto in Mali
- 2014: Agbaou in the Ivory Coast
- 2015: Ity in the Ivory Coast
Apart from these openings, this year the company sold its Youga operation in Burkina Faso and acquired True Gold, a company operating a newly constructed Karma mine in Burkina Faso.
Add to that a few mining projects at various stages of development (for example, Hounde project under construction, the Ity CIL project under investigation etc.) and Endeavour presents itself as an interesting Prospective West African miner.
However, in my opinion, there a few constraints that overshadow the bright picture of the company.
The quality of the company's assets varies significantly
Let me start with a picture delivered by the company:
Click to enlargeSource: Company presentation, slide 16.
The graph shows a number of African mines, taking into account their annual production and all-in sustaining costs of production. The mines belonging to Endeavour are circled in red. Note that three operating mines, Ity, Agbaou, and Karma, plus Hounde, which is a project under construction, are classified as low-cost small operations. The next two mines, Tabakoto and Nzema, are high-cost small operations. In my opinion, the graph above defines one of the main problems Endeavour is facing:
Apart from holding high-quality assets, Endeavour also holds problematic mines.
Let me dig a little bit deeper into this issue. I think that the Nzema mine is the biggest problem facing the company. It is not a typical mining operation. The ore processed at Nzema is supplemented by the third parties. For example, in 2015 as much as 43% of the total gold production at Nzema was extracted from the third party ores. This phenomenon has a negative impact on the Nzema's performance. The chart below shows the ore grades and recovery ratios reported by Nzema, starting from 2012:
It is clear that over the last two years the Nzema's quality has declined - grades and recovery ratios have gone down. As a result, now this Ghanaian mine delivers much worse results than a few years ago. For example, in 1Q 2016 Nzema made an operating loss of $6.1 million while in 1Q 2015 it made a smaller loss of $3.2 million (and a loss of just $46 thousand in 2015). In my opinion, this operation is set to be the company's laggard.
Another problematic mine, Tabakoto, is much better than Nzema. What is more, the company's management seems to be regaining control over this operation - in 1Q 2016 Tabakoto delivered quite decent results (an operating profit of $3.9 million versus a profit of $2.3 million in 1Q 2015).
Any company realizing projects under construction involves considerable risks.
Endeavour is currently busy with two new projects:
Karma: This mine was added to the company's portfolio through the acquisition of True Gold. Because this project is still classified as "Project under construction," it bears higher risks than the commercially operating mines. However, I think that it is a question of a short time until Karma announces commercial production. Therefore let me assume that this project is de-risked (carries only operating risks).
Hounde: This mine, located in Burkina Faso, should start its operations in late 2017. It is going to be the sixth and the biggest Endeavour operating mine, delivering an expected 190,000 ounces of gold in annual production, on average. As the graph 1 shows, Hounde will also be a low-cost operation. The project presents very decent economic measures: an internal rate of return of 31%, assuming the price of gold of $1,250 per ounce, and net present value of $359 million, using a discount rate of 5%. However, the company started its construction in April 2016, so there are many risks ahead. In my opinion, it is prudent to stay on the sidelines when any company is involved in a big construction works ($325 million in up-front capital spending), especially when a company's shares are fairly priced or even overvalued (and I believe that Endeavour shares are overvalued now - details below).
A growing company needs capital to finance its growth. Endeavour is no exception. Its rapid increase in production needs huge capital inflows. For example, since the beginning of 2012 the company has spent around $566 million to build its business. However, the company has financed its development mainly through internal financing ($423 million in cash flow from operations). At this point Endeavour is an exception, and a positive one. I think it is not easy to find a mining company, which is able to grow internally, taking no significant debt and selling no additional shares.
However, most recently Endeavour seems to be abandoning its excellent business model. While I understand that the acquisition of Societe des Mines d'Ity (holding the Ity mine) and True Gold in all share agreements makes sense (see the chart below showing share dilutions), I have serious doubts about the last decisions taken by the management.
Source: Simple Digressions.
Most recently Endeavour increased its share count by another 13.8 million. The first increase, by 7.5 million shares, was the exercise of an anti-dilution agreement signed with La Mancha Holding (a company controlling the Ity mine).
However, the last increase, announced on June 13, 2016 is hard to comprehend. The company wants to issue 6.25 million ordinary shares at a price of C$20 a piece for net proceeds of C$118.75 million, at least (there is an option to increase the issue by another 0.9 million shares). Endeavour intends to use the proceeds as follows:
- C$40 million - funding the two-year drilling program conducted on the premises located in the Ivory Coast, Burkina Faso and Mali
- C$70 million - funding development projects, especially the Ity carbon-in-leach processing facility
- C$8.75 million - general corporate purposes
So it seems that Endeavour needs around C$118.8 million (around USD $92.6 million) to finance its drilling programs and the Ity upgrade.
Now, let me calculate how much cash the company actually has.
According to 1Q 2016 financial statements, at the end of March 2016 Endeavour had cash of US$117 million. The La Mancha anti-dilution offering should bring around US$64.4 million to the company. And the last bought deal financing should add another US$92.6 million in cash.
Summarizing, after these two offerings Endeavour should have around USD $274 million in cash. Because the Hounde project was fully funded before these offerings, the company is going to have US$181.4 million in excessive cash (US$274 less total cash needs of US$92.6 million). The question is: "Did the last bought deal financing of 6.25 million shares make any sense?" In my opinion it did not. What is more, Endeavour is able to deliver significant free cash flows. For example, in 2015 it delivered US$54.7 million in free cash flow (defined as cash flow from operations less expenditures on mining interest). Lastly - the company carries little debt (in my opinion it does not need any cash to pay it off).
Summarizing - I perceive the last offering as harmful for the current shareholders.
To assess the value of Endeavour Mining shares, I am using a multiple of EV / EBITDA (enterprise value / earnings before interest, taxes, depreciation and amortization). In my opinion, this multiple is one of the best valuation measures used in capital - intensive sectors (and the precious metals sector is very capital - intensive).
Because Endeavour operates only in Western Africa, to set the right value of the multiple EV / EBITDA, I am using the two-factor model. Firstly I calculate the values of multiples at which the West African miners are currently trading. Then I calculate the average multiple at which the shares of Endeavour Mining were trading between 2012 and 2015. Finally, I average both multiples out.
The chart below shows the values at which the following West African miners are currently trading (I have excluded Endeavour from this calculation):
Source: Simple Digressions.
The chart depicts that the average multiple stands at 5.5. Another interesting fact: Endeavour shares are trading above the average multiple.
Further, between 2012 and 2015 Endeavour shares were trading at the average multiple of 5.0.
Therefore, to value the company's shares, I am using a multiple of 5.25.
2016 EBITDA projection
To construct projections of 2016 results I have applied the same method used to assess the value of B2 Gold (NYSEMKT:BTG) shares (see my article on BTG here). Without going into details, I have calculated the projected EBITDA for each of Endeavour's mines (including Karma). Below I present the final results:
Source: Simple Digressions
Note: All calculations are taking into account that the company owns the following stakes in each of its mines: Agbaou: 85%, Tabakoto: 80%, Nzema: 90%, Ity: 55%, Karma: 90%.
Now, using a multiple EV / EBITDA of 5.5, I find that the enterprise value of Endeavour stands at $1,223.9 million. The table below shows the way I have found the value of Endeavour shares:
Source: Simple Digressions.
As the table shows, Endeavour Mining shares are worth $13.8 a piece. Today, the company's shares are trading at $15.89 so, in my opinion, they are a little bit overvalued.
Endeavour Mining is a medium-sized gold miner operating in Western Africa. In my opinion, the company is one of the best miners operating in this region. Very quickly it was able to grow its business using internal ways of financing (no excessive debt and unnecessary shares dilution). However, in my opinion, the last bought deal financing makes no sense, resulting in unnecessary share dilution. Apart from that, the company has some problems with at least one of its mines (Nzema). Then, I think that the company's shares are currently overvalued (or, at least, fairly priced). Finally, taking into account that Endeavour is currently involved in quite risky construction works, I think that it is prudent to take profits off the table and sell at least part of share holdings in the company.
Note: I strongly encourage my readers to visit my blog. It is a continuation of my Seeking Alpha activity where you will find my comments on the current state of the gold market.
Disclosure: I am/we are long BTG.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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