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Medusa Mining - Low Cost Gold Producer

|Includes:Medusa Mining Ltd. (MDSMF)

I first posted this article on commodityshares.net. Medusa used to be listed on the TSX and is one of the lowest cost gold producers in the world

Medusa is an Australian company that has been focused on mining in the Philippines since 2006. It is part of the MSCI Australia 200 index as well as having a secondary full listing on the London stock exchange. The company has grown rapidly over the past five years and in the Financial Year to June 2011 produced 101,474 of gold at a cash cost of $189/oz and 60,595 oz at a cash cost of $261/oz in FY 2012. Management are forecasting 100,000 to 120,000 oz for the current FY at a cash cost of around $210/oz.

Medusa stands out from its peers due to its low cost of production, strong balance sheet, stable country of production and exploration potential. The company's corporate strategy is to become a mid-tier, 400,000 ounce per year, low-cost gold producer by 2015/16.

MML operates the Co-O narrow vein underground gold mine. At the end of 2010 they announced that they would be expanding the mine to produce around 200,000 oz pa from mid 2013. For the last year the mine has been running in "development" mode which partly accounts for the production fall in the last year. MML has also witnessed two natural events: a typhoon last December closed the road between the Co-O mine and mill, and an earthquake in February caused four leach tanks to tilt (these have since been replaced). The exceptional rain, described locally as a once in a lifetime event, did not affect the mine, but did impact production as a result.

The development of Co-O is going well and the Chairman's address at the recent AGM confirmed that the key Saga shaft is now in the final stages of construction and due for commissioning before the end of 2012. The Chairman has referred to this as a "game-changer" which is strong language from someone so reserved. Construction of a large new leach tank has been completed and commissioned and the foundations for the SAG mill, crusher and detoxification plant are now complete. The major equipment items are also on site.

MML now has a resource base of over 3m oz for the first time. 2m of these ounces are from Co-O (at an average grade of 10.1 g/t) and management are aiming to increase this to 2.5m oz, which will provide an on-going mine life of approximately 10 years based on an 80% conversion factor from resources to reserves through continuing development. The company strategy is to replenish at a minimum, the 200,000 oz of annual production. Being a narrow vein miner, MML will never have a huge reserve and this currently stands at 568,000 oz but management have issued a conceptual exploration target of 3-7m oz based on certain strike lengths, depth and aggregate vein widths. What is clear is that the mine is open at depth and should be producing for many years. In my view the Co-O mine stands out from others in an industry that is suffering from declining grades and rising costs. The geology is similar to the Diwalwal mine that is about 60km's away and has produced around 10m oz.

MML's second project is the Bananghilig open pit deposit, which has 1.1m oz of gold at an average grade of 1.63 g/t. They continue to drill the property and intersections have been very encouraging to date. MML aims to have a 1m oz reserve for an initial 5 year mine life, before producing a feasibility study in 2013. At this stage, management estimate Capex will be around $200m, which will be 100% self funded from Co-O's cashflow so there will be no debt or equity issued. Bananghilig is set to enter production in mid 2015 and this is forecast to double production in the 2016 FY to 400,000 oz. Management believe the deposit will be far larger than 1m oz and this is just a starter to get the deposit into production and generating cashflow as soon as possible.

Last year MML spent $37m on exploration, which was more than justified by the increased resource base. The budget for this year is $30m and there should be positive exploration news from both Co-O and Bananghilig. In addition, MML has 7 early stage copper projects and are hoping to prove up a resource at their Linging deposit, which they will look to monetise by selling on to a specialist copper miner. The company has said that some of the proceeds will be distributed to shareholders.

One slight cautionary note is the government review of the Phillipines mining industry was completed in July this year and guidelines for future changes to its operation issued by the President of the Philippines in Executive Order number 079. This will not have an immediate effect on Co-O but the company have cautioned that, under current guidelines, timely receipt of the permits Bananghilig will require the government to pass new tax measures aimed at increasing its revenue before construction permits can be issued. However, the company should have the approvals by the end of 2013, although it is possible that royalty payments could increase from 3% to 5% adding $50/oz to costs but would be offset by a new four year tax holiday. Despite this, the Philippines government is keen to revitalise mining and foreign investment is increasing with several projects having come into production.

As at end of June, Medusa had $51.3m of cash and gold on account and is debt free. Given the temporary production fall this is a healthy cash position. MML pay a dividend and although the final dividend was cut in the 2012 FY, the interim dividend is likely to be maintained, as production set is to increase. The board have indicated that they will review the dividend policy in 2014 once they have sufficient cash for Bananghilig.

Conclusion:

MML has strong growth prospects and is highly profitable, which explains why the current market capitalisation is around A$1bn. The top 20 shareholders account for around 64% of the company and 70% is owned by institutions. Based on 200,000 oz pa, cash costs of $200 and a gold price of $1700, MML will conservatively be generating profits of $200m in 2014. Analyst consensus forecasts are for eps of $0.72c to June 2013 and $1.16 to June 2014, which puts the shares on undemanding multiples of 8x and 5x. This is a significant discount to larger peers. As the sentiment towards the gold sector in general improves and the company starts moving towards their 200,000 oz pa, I would expect the shares to re-rate. In addition, as the second mine comes into fruition this could see a further re-rating as analysts start to factor this into their share price targets and the company is de-risked. The share price has been consolidating for the last 12 months and now is an attractive buying opportunity for those with a medium to long term time horizon. A PE of 12, which is not unreasonable for a growth stock, would give a share price of $14 - or a capital return of 140% from the current level. Having met management several times, I am confident they will deliver.

Disclosure: I am long OTCPK:MDSMF.

Stocks: MDSMF