Red Eagle Mining Fair Stock Price, Downside 38%

| About: Red Eagle (RDEMF)


Red Eagle Mining Corporation is a well-financed gold mining company, which has just poured first gold at the Santa Rosa Gold Project in Colombia.

Santa Rosa Gold Project is a low-CAPEX (total capital costs are equal to $141,894) and low-cost asset, whose technical risks are rather low too.

A DCF-analysis has shown the project’s NPV of $74 million, equity value of $51 million and IRR of 47%, its valuation twice lower than its comparable companies.

Red Eagle has a subsidiary (CB Gold), which has acquired Santa Ana Silver Mine, and according to the initial valuation, this project will bring $37 million to Red Eagle.

The project on which Red Eagle (OTCQX:RDEMF) is working now is the Santa Rosa Gold Project, which is the largest gold mine in Colombia and the first gold mine operating under modern environmental permitting legislation. Orion Mine Finance provided $65m of construction finance for the project, which includes $5m private placement of common shares and a $60m secured credit facility. There are 405 thousand ounces of total gold reserves, from which 82 thousand ounces are proven. Red Eagle is going to produce 78 thousand ounces in 2017. The gold content in rock in this field is 6 gram per 1 tone. Santa Rosa project offers a great IRR, a very low preproduction capital requirement and an extremely low all-in sustaining cost. The Santa Rosa Gold Project was built on budget while maintaining a cash balance of $16 million. Commercial production is expected in the first quarter of 2017.

(The graph above is based on San Ramon Gold Mine Feasibility Study)

The main driver for Red Eagle's revenue is the gold price since there are almost no risks connected with amount of gold sold. It is positive that Red Eagle is a company with low technical risks but in the same time it carries high gold price risk. In that way, sensitivity analysis has shown that changes of gold prices by 10% led to the 39% change in enterprise value. Therefore, the share price also depends on gold a lot. However, in the same time investors should not be so worried about this question since the outlook for gold demand in 2016 remains optimistic. Gold continues to play a very effective role as a hedge, as stock valuations in the U.S. and elsewhere remain elevated, as investors have increased their risk exposure in search of returns amid a very low yield environment. Moreover, Asian markets continue to be strong drivers of gold demand with both India and China. We are likely to see further developments in the key Asian markets with the continuing introduction of the pro-gold schemes and potentially a gold exchange in India. Following the launch of the International Board by the Shanghai Gold Exchange (SGE) to open up the Chinese gold market to international investors, SGE's plans to introduce a yuan-denominated gold pricing mechanism to facilitate regional market trading are also likely to take shape in 2016.

On the base of DCF-analysis EBITDA-margin is predicted to be at rather high level at four years (63.5% in 2017-2018, around 37% in 2018-2021), which can be compared to advanced gold mining companies, and than it is expected to drop to the level of 9.8% in 2022 and 2.7 in 2024, which is normal for gold mining project.

Click to enlarge

(The graph above is based on the author's financial analysis)

Since costs and technical risks of the project are very low, payback period is short, and such indexes as IRR and EBITDA margin are high, the project itself is rather good.

Using World Bank commodity forecast data as gold prices prediction ($1219,4 in 2017 and then 2% decrease annually) and WACC of 6.55% as a discount rate, it can be found out that Santa Rosa project has an internal rate of return of 47% and payback period of 2.3 years, which can be considered a rather good result. However, comparison of the project NPV of $74 million with current market capitalization of $136 million refutes this fact.

WACC calculation is based on next assumptions:

Nevertheless, we should not forget about Santa Ana project. Its equity value prediction of $41 million (and enterprise value of $47 million), can change with time, since nowadays there is no precise data concerning this project because of uncertainty in its implementation period. Since Red Eagle owns 90% shares of the company, its equity value rises by $37 million, so its equity value is equal to $88 million.

So, DCF-analysis has shown enterprise value of $121 million ($74 million of Santa Rosa Gold Project + $47 million of Santa Ana Silver Project). Comparable companies approach has confirmed this result since estimated value of $121 million is rather close to median, which is equal to $167 million, using EV/Reserves multiple. If we calculate Red Eagles enterprise value, using EV/EBITDA multiple, we also find out that EV calculated in DCF-analysis also belongs to the EV's range (from $67 million to $250 million) calculated with multiples.

(The graph above is based on the Bloomberg data and the comparable companies analysis)

Today's stock price is $0.59 and the target price (which DCF-analysis shows) is $0.37, so a further downside of 38% can be seen. We can also notice that Red Eagle's share price is rather volatile, that is why comparing target price with the average makes sense. The thing is that usually mining companies have a tremendous growth in their stock price, when they firstly make their discoveries, then there is a drop during a mine building. The stock starts to come up again at the beginning of production phase.

The average annual price in 2016 is $0.49, which is 25% higher than the target price.

Taking $88 million as equity value and current number of shares outstanding of $241 million, the fair stock price should be at the level of $0.37, while current share piece is $0.58. In spite of this fact, investment idea is to hold shares since current prices are bided up by investors, which is typical for mining companies, when they move to production phase, and predicted NPV of Santa Ana project can change with time.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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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