Colt Resources: Gold And Tungsten In Portugal

| About: Colt Resources (COLTF)
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Summary

Colt Resources has an advanced stage gold and tungsten project in Portugal.

The NPV's of both assets aren't impressive, but there's a lot of upside exploration potential.

However, I have no position as I don't like the excessive management compensation which is much higher than peer explorers.

Introduction

In this article I'll have a closer look at Colt Resources (OTC:COLTF) which aims to develop its Boa Fe gold project and Tabuaco tungsten project in Portugal. I will start with a background of the gold and tungsten project, and as the company has completed a Preliminary Economic Assessment (PEA) on both projects, I will have some fun with calculating the NPV's of those projects using different scenario's.

Thereafter I will discuss the main risks of an investment in Colt and how the capital expenditures of the projects might be financed. Before moving over to my investment thesis at the end of this article, I'll explain why the total package of management compensation is a red flag for me and why I currently have no position in this company.

Source: corporate website

As trading on the US exchanges in shares of Colt Resources is pretty illiquid, I'd recommend to trade in Colt Resources through the facilities of the TSX Venture Exchange where the company is listed with 'GTP' as its ticker symbol, which stands for 'Gold and Tungsten in Portugal'.

All images in this article were directly sourced from the company's webpage, corporate presentation and technical reports of both projects.

Project 1: Boa Fe Gold, a background and sensitivity calculations

The Boa Fe gold project is located in Portugal's wonderful Alentejo region, approximately 60 miles east from Lisbon, which is the country's capital. The project is located on a 20 mile long shear zone and the current resource estimate containing 425,000 ounces of gold could/should easily be expanded by conducting further exploration work on the 100%-owned concessions.

Source: Technical report

Back in 2013, SRK Consulting completed a Preliminary Economic Assessment (PEA) on the Boa Fe project, to determine the viability of building a gold mine there. Four potential options were presented in the PEA to recover the gold, of which the last scenario using halogen to get the gold out of the ore seems to be the most viable option. Even though the total capital expenditure at $123M is a bit higher than the other scenarios, the average gold product is higher at an average of 51,500 ounces of gold per year in the first six years of its operation with a peak production of 74,000 ounces of gold in year 3.

Source: Corporate website

The total capital expenditure is $123M, but only $61M needs to be paid up-front as approximately half of the total capex consists of sustaining capex which is only incurred during the mine life and which will be funded through the cash flow generated by the gold sales. Let's now see what the NPV of the project is using a gold price of $1300/oz,a discount rate of 6% and a tax rate of 20% (the average tax rate in the PEA was a bit lower, but for the tungsten project I will use the base case rate of 25%). The initial mine life is just 8 years. Keep in mind these calculations are my own and should be considered back-of-the-envelope calculations and should just be used as a first step to your due diligence. All my calculations include G&A costs and sustaining capital expenditures.

Cash Flow per year

Corporate tax rate (20%)

after taks

Discount rate (6% per annum)

NPV6%

-62000000

-62000000

15000000

0%

15000000

1,00

15000000

14000000

0%

14000000

1,06

13207547

53000000

8%

48760000

1,12

43396226

28000000

20%

22400000

1,19

18807472

27000000

20%

21600000

1,26

17109223

16000000

20%

12800000

1,34

9564905

6500000

20%

5200000

1,42

3665795

-3300000

0%

-3300000

1,50

-2194688

56,556,480

So, at a gold price of $1300, the after-tax NPV is approximately $56.6M, which indicates the Boa Fe project is a cute little gold mine. Let's now see what the influence of a gold price of $1150 is on the NPV.

Cash Flow per year

Corporate tax rate (20%)

after taks

Discount rate (6% per annum)

NPV6%

-62000000

-62000000

9000000

0%

9000000

1,00

9000000

5000000

0%

5000000

1,06

4716981

38000000

0%

38000000

1,12

33819865

18000000

0%

18000000

1,19

15113147

15500000

20%

12400000

1,26

9821961

12000000

20%

9600000

1,34

7173678

500000

20%

400000

1,42

281984

-4000000

0%

-4000000

1,50

-2660228

15,267,389

By lowering the gold price by just 11.5% to $1150/oz, the project becomes a marginal project with an after-tax NPV6% of just $15.3M.

Let's now have a look at the positive scenario using a gold price of $1500/oz.

Cash Flow per year

Corporate tax rate (20%)

after taks

Discount rate (6% per annum)

NPV6%

-62000000

-62000000

23000000

0%

23000000

1,00

23000000

26000000

0%

26000000

1,06

24528302

63000000

15%

53550000

1,12

47659309

33000000

20%

26400000

1,19

22165949

31000000

20%

24800000

1,26

19643923

26000000

20%

20800000

1,34

15542970

8000000

20%

6400000

1,42

4511747

-3100000

0%

-3100000

1,50

-2061677

92,990,524

The after-tax NPV6% increases to $93M. Using a weighted average of these three scenario's, I end up with a fair value of approximately $55M. But that's not the end. As the Boa Fe project is located on a shear zone with a strike length of potentially 20 miles, there's additional room for extending the mine life. In the following scenario I'll go back to the $1300 gold price again and will deduct $4M per year in exploration expenditures in the first 5 years of the mine life, which I will expand to 12 years instead of 8.

Cash Flow per year

Corporate tax rate (20%)

after taks

Discount rate (6% per annum)

NPV6%

-62000000

-62000000

11000000

0%

11000000

1,00

11000000

10000000

0%

10000000

1,06

9433962

49000000

0%

49000000

1,12

43609826

24000000

20%

19200000

1,19

16120690

23000000

20%

18400000

1,26

14574523

14000000

20%

11200000

1,34

8369292

17000000

20%

13600000

1,42

9587463

17000000

20%

13600000

1,50

9044777

16000000

20%

12800000

1,59

8030878

15000000

20%

12000000

1,69

7102782

15000000

20%

12000000

1,79

6700737

9000000

20%

7200000

1,90

3792870

85,367,801

Under the expanded mine life, the after-tax NPV6% at a gold price of $1300/oz increases to $85.4M. If I'd now combine both end results in a 65/35 weighted average in favor of the extended mine life, the fair value of the Boa Fe project would be $75M.

Project 2: Tabuaco Tungsten, a background and sensitivity calculations

The Tabuaco project is located approximately 60 miles east of Porto and has a NI43-compliant resource estimate containing 1.5 million metric tonne units of tungsten.

Source: corporate presentation

In late 2013, SRK Consulting completed a PEA on the Tabuaco Tungsten project to determine the viability of the project based on the current NI43-compliant resource estimate of 2.7 million tonnes at 0.57%WO3 which results in approximately 1.5 million contained mtu's of tungsten (1 metric tonne unit contains 10 kilo). The total capex of the project is $81M, but only $55M is needed as initial capital expenditures which should be quite easy to fund. Approximately 1.24M mtu will be recovered during an initial 10 year mine life at an average cost of $183-235/mtu. In the PEA, SRK used a base case scenario of $400/mtu as tungsten price, but I'd like to paint a picture for a more conservative and more optimistic scenario. I'll first calculate the optimistic scenario using a tungsten price of $450/mtu which isn't unreasonable as you can see on the next image.

Source: Blackheath Resources company presentation

Cash Flow per year

Corporate tax rate (25%)

after taks

Discount rate (6% per annum)

NPV6%

-55000000

-55000000

24000000

0%

24000000

1,00

24000000

27000000

0%

27000000

1,06

25471698

35000000

25%

26250000

1,12

23362407

22000000

25%

16500000

1,19

13853718

26000000

25%

19500000

1,26

15445826

15000000

25%

11250000

1,34

8406654

23000000

25%

17250000

1,42

12160569

27500000

25%

20625000

1,50

13716803

19000000

25%

14250000

1,59

8940626

1000000

25%

750000

1,69

443924

90,802,226

Using an optimistic tungsten price of $450/mtu, the after-tax NPV6% of the project is $91M which is very decent. But let's now see what would happen at $325/mtu.

Cash Flow per year

Corporate tax rate (25%)

after tax

Discount rate (6% per annum)

NPV6%

-55000000

-55000000

12000000

0%

12000000

1,00

12000000

14000000

0%

14000000

1,06

13207547

22000000

0%

22000000

1,12

19579922

12000000

15%

10200000

1,19

8564117

15000000

25%

11250000

1,26

8911054

4000000

25%

3000000

1,34

2241775

11000000

25%

8250000

1,42

5815924

15000000

25%

11250000

1,50

7481893

9000000

25%

6750000

1,59

4235034

-4000000

25%

-3000000

1,69

-1775695

25,261,569

As you can see, a change of $125/mtu in the tungsten price has huge consequences for the after-tax NPV of the project which drops to $25.3M.

Let's now see what would happen under this ultra-conservative scenario if the mine life would be extended by another 6 years at 130,000 mtu per year. This is definitely not unlikely as the Tabuaco project is still open in all directions.

Cash Flow per year

Corporate tax rate (25%)

after tax

Discount rate (6% per annum)

NPV6%

-55000000

-55000000

12000000

0%

12000000

1,00

12000000

14000000

0%

14000000

1,06

13207547

22000000

0%

22000000

1,12

19579922

12000000

15%

10200000

1,19

8564117

15000000

25%

11250000

1,26

8911054

4000000

25%

3000000

1,34

2241775

11000000

25%

8250000

1,42

5815924

15000000

25%

11250000

1,50

7481893

9000000

25%

6750000

1,59

4235034

14000000

25%

10500000

1,69

6214934

13000000

25%

9750000

1,79

5444349

13000000

25%

9750000

1,90

5136178

12500000

25%

9375000

2,01

4659088

13000000

25%

9750000

2,13

4571180

12000000

25%

9000000

2,26

3980709

6000000

25%

4500000

2,40

1877693

58,921,395

An extended mine life has a very positive impact on the after-tax NPV6% of the project which increases to $59M. If I'd attribute a weight of 30% 10% and 60% to these three respective scenarios, the average fair value of Tabuaco is approximately $64.3M.

What are the main risks of an investment in Colt Resources?

Investing in Portugal isn't risky at all. The Portuguese government seems to be one of the first governments in the Eurozone which seems to be convinced that the mining industry is one of the potential ways out of the current crisis, which has been going on for years now. The country is very much open for foreign investment (the Chinese have for instance invested in the national electrical power company), and welcomes all investment in the mining sector (providing everybody plays by the rules). As such, I do think the geopolitical risk is quite low, especially because the projects held by Colt aren't greenfields exploration projects, but historically known projects, which reduces the permitting risk even further. That's why I feel comfortable using a discount rate of 6%.

A second risk is the commodity price risk, and this is probably the most important risk for Colt Resources as I established in the previous subtitles that both of its projects are quite levered to the price of the underlying commodities. A relatively slight change in the gold or tungsten price results in a huge swing in the net present value of the respective projects.

A third risk is the financing risk. However, as Colt's market capitalization is relatively decent and as none of both projects have a huge initial capital expenditure, I don't expect a lot of difficulties to get these projects financed. In the following subtitle I'll explain some of the financing options available to Colt Resources.

How will the gold and tungsten projects be financed?

As the initial capex of the gold project is just over $60M, I don't expect any problems to get it financed. As Portugal is seen as a safe and decent country, I think the rule of thumb of 1/3 equity and 2/3 debt is a valid one, which means Colt would have to raise 'just' $20M in equity to fund its share of the capex. As the current mine life is a bit short, I doubt the company will be able to sell a royalty so I'm afraid the only realistic option for Boa Fe is to issue new shares to raise the $20M. At the current share price, approximately 75M shares would have to be issued which would result in a dilution factor of 50%, which is very reasonable.

The company has made no secret of the fact it will try to find a strategic partner for the tungsten project which would be very willing to help out with the capital expenditures. This means that Colt Resources can solely focus on funding the Boa Fe gold project instead of juggling with two projects at the same time.

Management compensation - the reason why I have no position in this company

Even though I trust Portugal and both projects have merit and additional exploration potential, I was baffled when I looked at the management information circular to see the salary of the management team. I was really shocked to see that the CEO of a junior exploration company (a completed PEA doesn't change the fact that Colt is still an explorer) made $465,000 as base salary in 2012 which was more than double the salary he received in 2011.

Source: Management Information Circular, filed on SEDAR

On top of that, because of his move to go live in Portugal permanently, he received a $114,600 compensation for relocation expenses. Whilst I fully agree that it's a good move to relocate to Portugal to be closer to the company's project portfolio, the relocation expense of almost $115,000 was surprisingly high - considering he probably didn't rent a jumbo-jet from Atlas Worldwide (NASDAQ:AAWW) for his move.

And it doesn't stop with the CEO compensation. In 2012, the total base salary for all four named executive officers was approximately $1.25M per year, or on average in excess of $300,000 per executive per year. I'm a capitalist who thinks quality comes with a cost, but I'm not sure an exploration company without any revenue should pay such hefty salaries. I'm waiting for the management information circular for 2013 to see if these salaries have come down a bit, because at this moment, it's a real deal-breaker for me despite seeing value in the company's projects. I hope reality has set in in 2013 and that the salaries were reduced.

Investment thesis

I'm a firm believer of the mineral and geological potential of Portugal, and Colt's projects seem to indicate that both its gold and tungsten project seem to be viable at the current commodity prices. However, both projects are extremely depending on those prices and even a slight variation of 10-15% has huge consequences for the after-tax NPV6% of the project, as I have explained in this article. However, using several assumptions, the fair value for both projects is approximately $140M which is comfortably higher than the current market capitalization.

However, I'm a little bit disgusted by the management compensation. I realize that quality needs to be paid, but a base salary of almost half a million dollar for the CEO of an exploration company is a bridge too far for me, and I'm not sure the slogan 'by investors for investors' is appropriate. I'll keep an eye out for the updated management information circular to see if the base salary has come down again and that might change my opinion, as I do believe in the quality of the projects.

Disclosure: I 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.

Editor's Note: This article covers a stock trading at less than $1 per share and/or has less than a $100 million market cap. Please be aware of the risks associated with these stocks.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.