Golden Star Resources: Can This Small Gold Miner Survive?

| About: Golden Star (GSS)
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Perhaps the best thing one can say about Golden Star Resources (NYSEMKT:GSS) is that it's a cheap stock. Even after rising 25% earlier this week, it still trades at less than $0.50 per share. And while it is still off more than 75% from its 52-week high of $2.11 and more than 90% from the more than $6 reached in late 2010, that doesn't mean that it is inexpensive, or that it is even worth owning.

The company has been the epitome of what are commonly referred to as Murphy's Laws. Take your pick:

  • If anything can go wrong, it will.
  • If more than one thing can go wrong, it will inevitably be the one that does the most damage.

And if it wasn't for the fact that investors lose money when something goes wrong at Golden Star, the recent history would make for a great comedy routine. Almost two years ago I wrote the following:

This is a company that has been unable to get out of its own way despite the dramatic run-up in the price of gold over the last several years. Earlier this week Golden Star issued a press release lowering guidance for third quarter gold production. It is the latest in a series of events that looks more like a Monty Python skit than reality. Some company events over the past few years have included:

  • Major hardware problems with processing equipment and long delays in getting parts
  • High diesel fuel costs
  • Too little rainfall causing use restrictions/cost increases for hydroelectric power
  • Too much rainfall flooding its mining pit
  • Increases on government royalty payments
  • Poor timing on gold futures trading
  • September 1st the company issues a positive press release
  • September 14th, Q3 gold production guidance is lowered by 4,000 ounces while re-affirming previous projections for Q4

While some things change, others remain the same. On June 11th the company issued a press release titled "Golden Star Resources Publishes Positive Feasibility Study for Prestea Underground Mine West Reef Project." The study discussed the capital requirements necessary to access high yield ore. Less than a week later, the company issued a press release titled "Golden Star Provides Operational Update on Cost Reduction Measures, Mine Plan Re-Optimization and Capital Reallocation" detailing some of the spending cuts necessary due to the falling price of gold.

Gold Reserves

As the name suggests, Golden Star is a gold mining company. Most of its assets are tied to two active mines (Bogoso and Wassa) in Ghana, a West African country with a fairly stable government. The proven (.74 million ounces) and probable (3.57 million ounces) gold reserves as of the end of 2012 totaled 4.31 million ounces.

While the figure seems relatively small, it should be noted that proven and probable reserves are based in part on operating costs, the price of gold, and can be rapidly moving targets. For instance, at one of its mines the reserves dropped by 0.5 million ounces, even though the company only produced a total of 336,348 ounces from both mines during that period. The reserves at the other mine increased from 0.8 million ounces to 1.47 million ounces, largely due to extensive drilling and exploration results.

Since the reserves were established, the price of gold has dropped significantly. The current spot price is close to $1,200 per ounce. That compares to a price of $1,634 per ounce realized in the first quarter of 2013.

Mining Profitability

As noted above, the average price realized in the first quarter was $1,634 per ounce. Even at that price, and while selling 81,361 ounces, the company generated a loss of $6.6 million. In discussing the loss, President and CEO Sam Coetzer commented:

The first quarter was defined by predetermined activities which front loaded the fiscal year at Bogoso with high expenditures. With the dramatic reduction in the gold price experienced since mid-April, we plan to re-optimize our pits, review our tactical and capital spending plan for 2013, and review the viability of Bogoso. ...In the first quarter of 2013, the Company experienced significantly lower cash operating costs of $809/oz at Wassa/HBB, compared to $999/oz in the first quarter of 2012. Operating margins at Wassa/HBB were $22.0 million during the first quarter of 2013, up from $10.9 million in the first quarter of 2012. We believe this operation has great potential for Golden Star over the mid-term, as is evident in our recent drill results press released April 30, 2013.

Although the average cash operating costs at Wassa came in at $809 per ounce, the average per ounce for Bogoso was $1,531 per ounce and the average for both mines was $1,134 per ounce. That average cash cost is dangerously close to the current price of gold. And it's a major reason that the company was forced to re-evaluate its previously announced production and capital spending plans. Those revised plans were presented by company management in mid-June.

Capital Spending

The original capital spending was projected to be $141 million with $60 million categorized as sustaining and the remaining $81 million as developmental. The revised plans call for a reduction to $74 million with $40 million categorized as sustaining and $34 million as developmental. The company also noted that $11 million of sustaining capital had been spent and:

The sustaining capital requirement for the remainder of the year totals $29 million and is anticipated to be covered by the Company's existing cash ($51 million) and cash flow from operations.

While details about the sustaining capital budget were made available, the company "will update the market in the third quarter on the availability of development capital and the timing of pit development." There are obviously longer-term implications to delaying both sustaining and developmental capital plans. One of the significant developmental capital expenditures was for its Prestea Underground Mine, originally scheduled for developmental cap-ex of $26 million.

Prestea

The week before the revised capital spending plan was released, the company put out a press release detailing a "Feasibility Study for Prestea Underground Mine West Reef Project." The project could be expected to yield about 400,000 ounces of gold over a six-year period. It also would require capital spending of more than $150 million, including an allocation of $90.6 million initial capital, $35.8 million of capitalized operating cost and $23.7 million of sustaining capital.

The company has produced various profitability estimates for gold prices between $1,300 and $1,700 per ounce, but none that were in the low $1,200 per ounce range that occurred this past week.

The cash operating cost to produce gold from this project was estimated at $734 per ounce, and the payback period would be three years from the start of production (presumably for the base case gold price of $1,500 per ounce), but production would not even begin until after the three-year pre-development period.

Production Guidance

The reduced price of gold and the cost cutting measures resulted in full year production being reduced to 290,000-310,000 ounces, down from the original guidance of 320,000 to 350,000 ounces. The new guidance is also significantly below 2012 production of 336,348 ounces. Production through June 14, 2013 was 154,000 ounces.

When discussing the guidance for the rest of the year, Coetzer noted that November and December would be the two most challenging months of the year. In addition, the company has had a poor history of meeting its guidance, so I would expect a number towards the low end of guidance.

Financing

One of the major unknowns at this time revolves around financing future operations. While the sustaining capital plans seem to be taken care of, the rest has not yet been disclosed. During introductory comments at the recent analyst briefing, Coetzer said:

However, to provide extra support and to ensure that we have sufficient cash balance available, we will consider financing alternatives. Although we estimate that Golden Star has sufficient cash in hand for the remainder of 2013, it is prudent for us to make such an arrangement.

Some of the financing is expected to come from suppliers, but the more interesting focus was on developing Prestea. When pressed about financing alternatives, CFO Jeffrey Swinoga said:

Prestea Underground, as we mentioned, we are looking at that closely. We're going to be putting minimal capital into that until we have a financing, appropriate financing that would match the feasibility profile that we published. So as Sam mentioned, a number of in-store parties have approached us, and we're looking at them very closely. We have put over $70 million into Prestea Underground since we have purchased that. So it's a very good candidate for a project financing.

Summary

Golden Star is a company that has had more than its share of missteps. It has a plan to get it through the end of the year, but it remains a speculative play and very much subject to fluctuations in the price of gold. There are those that see gold falling below $1,200 per ounce, or even $1,050 by 2014, while others are less negative.

The future development of Prestea will be very important to Golden Star's long-term success, but it has to get to the production phase first. As the price of gold has spiraled downward, so have the prospects for Golden Star. This highly speculative play will be struggling to survive unless gold prices find a floor and begin to rebound.

Disclosure: I am long GSS. 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.