Endeavour Mining - Building A Very Nice Production Profile

| About: Endeavour Mining (EDVMF)
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Introduction

In this article I'll have a closer look at Endeavour Mining (OTCQX:EDVMF), one of my preferred gold mining companies which has aggressively applied a growth strategy and plans to produce in excess of 450,000 ounces of gold next year which would be a fivefold increase from a production of 'just' 82,000 ounces in 2010.

As Endeavour's mines are all in Africa, the company has a higher risk profile than other producers in safer regions. But I do believe the potential rewards outweigh the risks at Endeavour Mining. In this article I'll have a look at its three producing mines and its Agbaou mine which is under construction and should be ready for production in Q1 2014. I'll also have a look at the company's balance sheet and its 2014 cash flow projection using different gold prices.

As Endeavour Mining is trading at just 3X the 2014 cash flow, the company isn't too expensive, considering another 150,000 ounces per year expansion in Burkina Faso seems to be fast tracked for production by 2016. The company is targeting an all-in sustainable cash cost of $1000 for next year, which would make Endeavour one of the producers in the lower cost range.

One big issue will be the grade control at Nzema and the low resources at Youga, and if the gold price stays at $1300/oz, I'm afraid both mines will be closed by the end of this decade, which would remove 165,000 ounces per year from Endeavour Mining's production profile, which I'm sure will be compensated by a new acquisition in the not so distant future.

Producing Mine number 1: Youga, Burkina Faso

Endeavour Mining owns 90% of the Youga mine in Burkina Faso, with the Burkinabe government holding the balance. Youga was Endeavour's first producing mine after it acquired Etruscan Resources back in 2010.

The Youga mine is expected to produce between 75,000 and 85,000 ounces this year and has a life of mine of another 6 years, but most of these years will be at a lower grade which will reduce the output and increase the cash cost. The total resource base currently stands at 16 million tonnes of approximately 1.5g/t. As this resource estimate includes 6.4 million tonnes at 1.9g/t, so the remaining 10 million tonnes have an average grade of just 1.2g/t, which will obviously have severe repercussions on the cash costs as the fixed costs will obviously stay relatively flat.

As Endeavour owns 90% of the mine, I'll use an attributable output of 70,000 ounces of gold for Endeavour Mining.

Producing mine 2: Nzema, Ghana

Endeavour Mining acquired 90% of the Nzema mine through its acquisition of ASX-listed Adamus Resources. The mine is expected to produce between 100,000 and 110,000 ounces this year which is supported by a 20 year mine life based on the resources of 2.4M ounces and approximately 7-8 years based on the reserve estimate containing about 800,000 ounces of gold.

In a later stage, Endeavour will also encounter some grade problems here, as the resource estimate excluding the reserves has an average grade of just 1.08g/t compared to the current reserve estimate of 1.9g/t. As Nzema produced at an average grade of just 1.31g/t in Q2, the company is very likely selling the gold at a loss or a tight break-even, as Nzema had a cash cost of $1072/oz in the last quarter.

As Endeavour owns 90%, I'll use an attributable output of 95,000 ounces net to Endeavour. On the negative side, Endeavour also inherited a hedgebook from the Adamus acquisition, and will be forced to sell approximately 1/3rd of the annual production of Nzema at $1061.75/oz. This will obviously put some pressure on the cash flow from Nzema.

Producing mine 3: Tabakoto, Mali

Avion Gold, which owned the Tabakoto mine in Mali was bought out by Endeavour Mining in an all-share deal last year. According to Endeavour, the Tabakoto operation was badly managed, and the company immediately implemented changes which sould have a substantial effect on the project's output and cash costs. Endeavour completed a mill expansion to 4,000 tpd, which is twice as much as the 2,000 tpd Avion Gold was milling at Tabakoto. Endeavour now expects to produce approximately 150,000 ounces of gold this year, and probably a bit more next year.

As Endeavour owns 80% of the mine, I'll use an attributable output of 120,000 ounces of gold for 2014, but it's likely this amount will be a bit higher as the company poured 15,000 ounces of gold in July. Unfortunately there's also a hedge book putting some pressure on the Tabakoto cash flow, as Endeavour has to sell 12,100 ounces of gold at just $900/oz in 2014 and another 6000 ounces at the same price in 2014.

Almost-producing mine 4: Agbaou, Ivory Coast

Endeavour Mining is currently finishing the construction works at the Agbaou project in Ivory coast, which should be in production by Q1 2014. This will be Endeavour's fourth producing mine in Africa and will spread the production risk amongst four different countries now.

Endeavour owns 85% of the project with the government of Ivory Coast holding the balance. The current planned mine life is 8 years at a production rate of 103,000 ounces of gold per annum, of which 87,500 ounces net to Endeavour Mining (I'll use 85,000 in my 2014 calculations).

Construction works are going as planned, as the plant is currently 81% completed and remains on track for commercial production in the first half of 2014. This will increase Endeavour's total attributable output to approximately 375,000 ounces of gold in 2014. I'm pretty sure the Endeavour team will hereafter focus on its near-term development project in Burkina Faso.

Almost ready for development: Houndé, Burkina Faso

Included in the Avion-deal was the Houndé project in Burkina Faso on which Endeavour completed a Preliminary Economic Assessment (PEA) in January of this year. The PEA outlines a production scenario of 160,000 ounces of gold per annum at a cash cost of $563/oz (145,000 ounces attributable to Endeavour Mining, as the government of Burkina Faso holds a 10% interest in the project). The NPV 5% came in at $288M, or approximately $0.70/ share of Endeavour.

The company decided to fast-track Houndé as it decided to skip the Pre-Feasibility Study and moved directly towards the Feasibility Study which is expected to be completed next quarter already. As Endeavour finished a 41,000 meter drill program which proved the excellent continuity of the mineralized zones, I'm not expecting any problems for the Feasibility Study.

I'm also pretty sure the company will start construction at Houndé in 2014 already, using a large part the operational cash flow it generates at its other four mines. Let's now see how much cash Endeavour will generate next year.

Sensitivity Analysis

In this paragraph I'll have a closer look at Endeavour's cash flow generation profile. I'll use a base case scenario of 340,000 ounces of gold (allowing for a correction for the Tabakoto and Nzema gold which has to be delivered at approximately the production cost). According the company's press release at the end of July, the all-in sustaining cash cost for 2014 is estimated to be $1000/oz, and I'll use an all-in cash cost of $1000/oz in order to calculate the expected free cash flow.

Gold Price

Cash Flow

1000

0

1100

34M

1200

68M

1300

102M

1400

136M

1500

170M

1750

255M

2000

340M

So at a current gold price of $1300/oz, Endeavour Mining is expected to make approximately $100M in free operating cash flow, and this increased by $34M for every $100 increase in the gold price.

A cash flow of $100M per annum obviously isn't enough to fund the construction works at the Houndé project, but the company has recently increased and extended its credit facility which is another piece of evidence pointing out that Endeavour will fast-track Houndé towards production.

By using an all-in cash cost of $800/oz and an output of 140,000 ounces of gold for Houndé, the next table is a pro forma calculation of Endeavour's future production profile and provides some insight in the operational cash flows from 2016. I will use a combined output of 510,000 ounces of gold attributable to Endeavour Mining (as its gold hedges at the Nzema and Tabakoto mines will have been eliminated and a sustaining cash cost of $1000/oz (which is a bit higher than I anticipate, as I think the Houndé project will reduce the overall all-in cash cost of the entire company.

Gold Price

Cash Flow

1000

0M

1100

51M

1200

102M

1300

153M

1400

204M

1500

255M

1750

282.5M

2000

510M

As you can see, Endeavour's production profile with Houndé offers excellent leverage to the gold price, as its pro forma production profile with Houndé shows an annual net operational cash flow of $255M at a gold price of $1500/oz, which is approximately $0.62/share.

The Balance Sheet

Let's now have a look at the company's balance sheet, and more importantly its debt position. As at the end of Q2, Endeavour had a working capital of $98.7M and a current ratio of 1.95. Total long-term liabilities were $360M, mainly consisting of a $200M credit facility.

This facility was increased by $300M and will be increased by a further $50M when the Agbaou mine starts production. The company already drew down the additional $100M and has a cash position of $150M as at the end of July. As Endeavour will have to spend approximately $70M on Agbaou from here on (including start-up working capital) and as I expect the company to generate $30M in cash from its operating mines, I'm expecting a pro forma cash balance of $110M at the end of this year.

If I add the expected cash flow from next year's production at $1300/oz and the $50M increase in the credit facility, Endeavour Mining would finish the year with a pro forma cash balance of $250M and possibly $275M if Tabakoto outperforms my expectations. If the Houndé construction phase would take 18 months, starting from Q1 2014, Endeavour Mining would be able to fully fund the Houndé capex out of its internal generated cash flow and the increased credit facility.

Investment Thesis

Endeavour Mining has proven it is able to successfully operate mines and turn inefficient mines around (for instance at Tabakoto). As the company is finalizing its construction works at the Agbaou project in Ivory coast, I expect its cash flow to increase considerably next year as the company will produce almost 400,000 ounces of gold attributable to Endeavour (several governments own a 10-15 or 20% interest in Endeavour's mines). Unfortunately the company has inherited a hedge of 44,000 ounces of gold for next year, at an average price of less than $1050/oz, which will put some pressure on the cash flow. These hedges are expected to be completed by 2017, after which the company will be able to sell its gold at spot prices.

At some of its mining projects, grade control will be extremely important, as the resources at Nzema and Youga have a considerably lower grade than the reserves, and if the gold price remains at just $1300/oz, those operations might have to shut down before the end of the decade.

All in all, I'm positive about the company's near term future, and it looks like Endeavour might be able to fund the $300M Houndé capex out of internally generated cash flow, which would increase its production by 145,000 ounces of gold per year (after deducting Burkina's 10% interest) which might compensate for the possible closure of the Youga and Nzema mines.

After taking an allowance for 44,000 hedged ounces, I expect next year's operational cash flow to be in the region of $100-105M based on a gold price of $1300/oz. Should gold increase to $1500/oz, the cash flow will increase to a very healthy $170M.

At the current share price, Endeavour Mining is trading at just 3 times its expected 2014 operational cash flow using an all-in cash cost, which definitely isn't expensive at all and seems to be caused by the African discount factor.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in OTCQX:EDVMF over 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.