Silver Lake Resources (SVLKF.PK) is one of those Australian gold companies that has defied gravity in the gold mining industry. When the 2008 economic crisis hit the whole world, Silver Lake Resources managed to return more than 1,000% in gains starting from 2008 up to today (see chart below). The question is: How much can it still go up?
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Let's start analyzing the basics. Based on the annual report from June 2011, which was published in January 2012, the company had a book value of AUD 91 million, with a quarterly cash flow of around AUD 10 million/quarter and cash equivalents of AUD 82 million. Since then, a lot has happened in relation to mergers and acquisitions. In January 2012, Silver Lake Resources executed a merger implementation agreement with Phillips River Mining to acquire its assets. This AUD 20 million deal went through in March later that year. A few months later the company acquired Integra Mining (ITGRF.PK) at 44% premium. This deal is estimated at AUD 426 million in market capitalization. What's interesting to note is that Silver Lake Resources had an equity value lower than Integra Mining a year ago, but has still managed to acquire Integra Mining today.
This last deal transformed the company into a large gold producer with AUD 107 million in cash. Its production has doubled to 200,000 ounces/annum and will double again in two years. The book value has increased from AUD 91 million a year ago to a roughly estimated AUD 200 million today (Integra Mining had a book value of $165 million a year ago), while Silver Lake Resources' market cap increased from AUD 620 billion to AUD 1 billion today. Basically market price to book value doesn't mean anything here. What is important is the cash flow the company generates in the future. From its latest earnings report, we saw that net earnings were $31 million for financial year 2012, or a P/E of 22.
Integra Mining has a quarterly cash flow of $17 million/quarter. Silver Lake Resources had a quarterly cash flow of $10 million/quarter, as I stated before. Together, this gives it around $100 million/annum. If all of this cash were put on the equity side, we have a price to cash flow of 10. But the company is investing large amounts of its earnings in exploration projects like the Great Southern, Eelya, and Hollandaire areas. It's in the process of enhancing its production site at Mount Monger and in constructing its new property of Murchison, which is 60% complete and will start production in March 2013.
Once all of the items described above are concluded, it's estimated by the company that the current gold production of 200,000 ounces/annum will double to 400,000 ounces/annum in 2014. In other words, the cash flow will at least double in a year from now. Considering the enhancements of the economies of scale of the company, cash flow will probably be even higher than this estimate. An example of these economies of scale is that they can now combine their operations, use a shared infrastructure, use the two mills that are located in the same region, and have the option to buy their resources in bulk. This will result in a higher output with lower average cost of production.
The doubling of the cash flow will set the price-to-cash-flow ratio to 5 or less, which is comparable to top companies like Endeavour Silver (EXK) today. This is the reason why many banks and investment firms like UBS, Macquarie Capital, and Sprott Asset Management have shown substantial interest in Silver Lake Resources. Analysts generally have a buy rating on the company. A report from RBC Capital Markets last year estimated the price target of the company at $4.50/share.
Silver Lake Resources has a superb management team that has proven it can increase earnings at an unbelievably fast pace. This is reflected in the increasing market capitalization from 2008 until today, which is mostly based on the earnings future of the company. While the book value is much lower than its market capitalization, I believe earnings growth outshines the high price-to-book valuation. Based on the forward price to cash flow of 5, I estimate that the share price can go to $4.50/share in the short term (a 50% increase).