(Editor's Note: Investors should be mindful of the risks of transacting in illiquid securities such as GUYFF. Guyana's listing in Toronto, GUY.TO, offers stronger liquidity.)
On Monday, June 9th Guyana Goldfields (OTCPK:GUYFF)--owner and developer of the Aurora Project in Guyana--announced that it has received a credit facility that is sufficiently large enough to fund the company through production. While the deal was somewhat dilutive to existing shareholders, who had to endure a C$44.4 million private placement at below market prices, this was excellent news for the company.
But while the stock spiked on Wednesday its performance has been relatively in-line with the broader sector since the June 9th announcement. In order to reflect the value of this secondary offering the stock should have risen substantially higher, and the fact that it hasn't means that there is a window of opportunity for investors.
With financing in place Guyana Goldfields has a lot more clarity, and things are looking good. The company is valued at about $320 million with approximately $110 million in the bank (which includes the $70 million it had as of April 30th plus the $40 million it raised in the secondary offering). It has another $203 million worth of expenses to go in order to finish constructing the open pit segment of its Aurora Project, although with a $185 million credit facility the company can easily withstand an unexpected increase in its initial capex.
As the company begins producing gold in the third quarter of next year it will have nearly all of the cash-flow it needs in order to finance the development of its underground operation, which will commence commercial production in 2017. Once this happens the company will be a cash-cow that generates well over $100 million in annual cash-flow--not bad for a $320 million company!
The great thing about Guyana Goldfields is that it offers good value even if the price of gold falls. While it doesn't make much sense for investors to buy the company's shares unless they believe that the price of gold will rise, it is good to know that the stock still has upside in this scenario. It also means that the upside potential at the current gold price is enormous, and it only grows as the price of gold rises.
Despite these positive there are a couple of risks. The first is that while commercial production commences next year the company still has three more years of high capital costs. In a low gold price environment this means borrowing more money and paying more interest. However as we will see below the current credit facility is sufficient to cover Guyana Goldfields' capex even if the gold price averages $1,100/ounce. In making this assertion I am making very conservative assumptions, the nature of which will be made clear below.
The second risk is the mine's location--it is located over 100 kilometers from "civilization." This means that the company has to essentially build a small town for its workers, who must also be trained. This will cost a lot of money, although my bullishness takes these concerns into consideration--I assume a rise in the company's estimated labor costs, and I also assume that its initial capex, as well as its sustaining capex will be higher than initially assumed.
Investors may also be concerned that the mine is located in Guyana. Mining investors who follow the popular Fraser Survey of Mining Executives know that Guyana is ranked 68/112 in the "policy potential index," which means that mining executives are hesitant to invest there because they are concerned about things such as regulations, property rights, taxes, and so on.
While these concerns aren't without merit we should keep a couple of things in mind before blindly avoiding an investment in Guyana Goldfields. The first is that the project has been fully permitted. Mining executives who express concerns over investing in a region take permitting into consideration, and this is a large part of the uphill battle that mining executives face. With permitting out of the way the regulatory risk has come down substantially.
Furthermore, if you look at the specific categories in the survey, you'll find that one of the things that really drags Guyana down as a nation is its lack of infrastructure. This is an issue that the company has had to face and has overcome, although it is easily quantifiable. Management has factored this into their economic assessment of the mine, which will still be a solid investment even at lower gold prices.
With these points in mind investors looking to find an inexpensive gold miner that offers leverage to the upside while providing downside protection in this volatile gold market should consider adding Guyana Goldfields' shares to their portfolios.
As investors come to see the value of the Aurora Project with financing in place I think they will bid shares up substantially from here. Assuming a 12% discount rate and a $1,250/ounce gold price the shares have about 60% upside. If gold slips to $1,100/ounce the stock still has about 10% upside from here.
Finally, as production approaches I suspect that investors will be more willing to pay a premium for Guyana Goldfields' shares. We have seen situations before where a large low-cost metal producer has traded substantially higher going into production. Take Tahoe Resources (NYSE:TAHO) for example. This stock doubled from when I recommended it in late June of last year to when I recommended investors sell it in March. The price of silver hadn't changed that much, nor did the intrinsic value of the company or the company's Escobal Project, but investors like the stock much more now that the company is producing even though the project is in high-risk Guatemala.
If we see something similar happen we can see Guyana Goldfields' shares double into production if we assume a gold price of $1,250/ounce and an 8% discount rate, although investor enthusiasm can easily push the shares higher.
As we look at the Aurora Project its enormous cash-flow potential, as well as its leverage to the gold price should become apparent to investors.
Aurora Project Overview
The Aurora Project, which is Guyana Goldfields' primary asset, is located in northern Guyana, right off of the Cuyuni River.
(Source: Aurora Feasibility Study)
Unfortunately, it is located in the proverbial "middle of nowhere." Due to the remote location of the Aurora Project, developing a robust and reliable infrastructure has been a critical element to its success. The project is fully accessible by an approximate 175-km long, all-weather access road and an airstrip; equipment and supplies are transported by road and personnel are flown in and out of the Aurora camp.
The Aurora Project has several mineralized regions, as the following image shows.
The company intends to begin operations at these regions one at a time, although at times there will be production at two or more of them.
This means that the company will be able to start operating without having developed the full project, and it will have cash-flow to continue expanding it (assuming gold prices don't fall too far from here).
Expansion here means developing the underground mine while operating the open-pit mine. This expansion will continue through 2017 even though commercial production will begin at the end of Q2 or the beginning of Q3 of next year.
The mine has a little over 8 million ounces of gold at four regions, with the bulk of this at Rory's Knoll (pictured above). About 3 million of these ounces are part of the open pit mine, while the remaining 5 million ounces are underground. The following table provides the details. Note that the resource grade of the open-pit gold is unusually high and this means that open-pit mining, which is the first part of the operation, will generate a lot of cash-flow that can go towards developing the underground mine. I have broken up the table for your convenience.
Of these 8 million ounces about 3.5 million have been classified as mineral reserves, which means that the company has deemed them economical to mine assuming a gold price of $1,300/ounce and other factors which I will mention below.
These are the ounces which have been included in the mine plan. Note that the remaining ounces might be produced assuming either a higher gold price or that further research indicates that they are economically viable to mine.
The mine will operate for a total of 17 years according to the current plan. The open pit operation will run from years 1-9 (2015 - 2023) and the underground operation starting in year 3 (2017), ramping up through year 5 (2019), and running through year 17 (2031). Production will start at around 125,000 ounces per year before ramping up to maximum production in years 4-9, with year 6 (2021) peaking at about 350,000 ounces. After the open pit operation ceases the underground mine will operate at about 145,000 ounces/year until dropping off in the last year. This is illustrated on the following chart.
(Source: Guyana Goldfields' June 2014 Presentation)
Going forward the mine is going to cost about $202 million to get from today until commercial production: the details are broken down below. This is in addition to $47 million already spent. This figure includes a 10% contingency, and is about 21% higher than the estimate provided in the feasibility study, which is broken down on the subsequent chart.
(Source: Aurora Feasibility Study)
While one might not want to include a contingency on the initial capex given that construction is underway and given that the current estimate is already higher than the original estimate, it is prudent to add one just in case. With a 10% contingency the new initial capex rises from $202 million to $222 million.
The expansion phase of the development is expected to cost about $153 million, although this only includes a $10 million contingency, which past experience suggests is insufficient. Since the initial capital cost estimate has risen by 21% despite the fact that only about a fifth of the capital has actually been spent, it seems that at least a 20% contingency need to be added to the estimated $143 million expense (ex-the added contingency), and 30% may be more accurate. This puts the expansion cost at about $186 million.
Production costs are going to be relatively low, although we need to make a couple of adjustment from the levels provided in the feasibility study. Also note that it is useful to look at the Aurora Project as 2 separate projects--an open pit project and an underground project--in estimating production costs.
The open pit operation is expected to have operating costs of $31.30/tonne of ore mined and processed. With the average grade of the open pit ore being roughly 2.5 gpt this means that it will cost $12.52 to mine a gram of gold, or $390/oz.
However we need to consider a couple of issues that could easily raise mining costs. The first is labor costs: as one would expect there are no trained miners in the middle of nowhere in Guyana, which doesn't have an extensive mining industry to begin with. The company is going to start by using expatriate labor while it trains "locals" (locals living over 100 kilometers away) in underground mining tasks. Since this expense comes with a great deal of uncertainty it is worth adding a contingency to the figure provided in the feasibility study.
The company doesn't separate labor out as a separate cost in its estimated cost of open pit mining (it does incorporate them in its underground estimates), although it does estimate that milling costs $1.24/tonne. Underground mining has labor costs that are about 19% of total mining costs, so using that as a reference we get roughly $2.56.tonne as the labor cost of mining, making the labor cost for the open pit operation $3.32. If we add a 10% contingency that brings the figure up by 50 cents so that operating costs are $31.80/tonne, which means it costs $12.72 to mine a gram of gold or $396 to mine an ounce of gold. So that doesn't make a huge difference.
I also think that energy cost estimates may be too low. The feasibility study is over a year old and energy prices have risen. This concern is especially acute now considering that there are geopolitical tensions in the Middle East and in Eastern Europe, and WTIC sits at just under $107/bbl. This ultimately ends up spilling into the entire energy complex. For this reason I want to increase the energy cost estimate in my analysis.
If we add a 15% contingency then for open pit mining we have to add $1.03/tonne for milling (electricity is the largest milling expense). While the company doesn't give power costs separately for open pit mining it should be about 25% of the mining cost, which means we need to add about $0.51/tonne. This brings the total up another $1.54/tonne to $33.34/tonne, $13.37/gram of gold, or $415/oz.
With recovery rates at about 95% this comes to $437/oz.
Other expenses include:
- The royalty is 8% or $104/oz. This brings production costs to $541/oz.
- Sustaining capital, which is small--about $10 million--for the open pit mine for its entire life or about $9/oz.
- Exploration and G&A, which is $44/oz.
This brings the total to $594/oz., which is incredibly low, although not surprising considering the high grade of the surface ore.
The underground operation is expected to have costs of $36.89/tonne. Labor is $4.24/tonne so if we add a 10% contingency we get $37.31/tonne. Energy is $11.20/tonne so the contingency brings the operating cost up to $38.43. Ore grade is 2.84 gpt. so mining costs come in at $13.53/gram or $421/oz. This comes to $443/oz. assuming 95% recovery rates.
The royalty adds $104/oz. which brings the total to $547/oz. Sustaining capital for the underground operation is much larger than it is for the open pit operation at a total of $316 million, or $134/oz. However, I am concerned that the sustaining capital estimate could be short considering that initial capex is coming in over budget, and so I feel it is necessary to add in a contingency. If it is 10% this brings th total cost to $348 million or $147/oz. This brings the total thus far to $694/oz. Finally exploration and G&A will add $44/oz, bringing the total to $738/oz.
The following table lists the amount of gold mined by open pit and underground methods on a year by year basis according to the feasibility study (I am using the chart that precedes my own table as a reference) and the average cost to mine an ounce of gold using the above figures. Note that a "year" for the sake of this chart will be from Q3 through Q2 of the next year. So 2015 is Q3 of 2015--when mining operations are supposed to start--through Q2 of 2016. When you see this data on the table from the feasibility study note that the mine is slightly behind schedule from when the company intended for it to begin.
Valuing The Aurora Project
With the above data we have enough information to estimate the value of the Aurora Project. With the recent financing agreement in place the company has access to $185 million in 2 tranches. The first is $160 million at 6.3%. This rate rises and falls with the 3-month LIBOR rate. The second, assuming that the company needs more capital than it has, is another $25 million at 6.8% (also 3-month LIBOR dependent).
We saw earlier that in my conservative scenario the company will need roughly $222 million. As of the end of April it had $70 million in cash. It also raised about $40 million in a recent secondary offering, bringing this total up to $110 million. Thus the company's additional $112 million capital need prior to commercial production is easily covered by the first tranche of the financing facility. Since LIBOR is variable we should be conservative and assume that it will be 7% for the duration of the facility, which is capped at 8 years. This will add a $7.8 million interest expense to the effective annual operating cost of Aurora, although note that this is not tax-deductible.
In calculating the project's NPV I will use 8% and 12% discount rates and $1,100/ounce, $1,250/ounce, and $1,400/ounce gold prices. Taxes are included and consist of 30% of earnings. Mine closure costs are $9 million and are added as an expense at the end of the mine's life. All figures are in millions of dollars.
Note that at $1,100/ounce gold the company will have to draw down the rest of the first tranche in the expansion phase, and so the interest will be $11.2 million.
Note that at $1,250/ounce gold the company will have to draw down $15 million more of its facility in order to cover expansion capex. Assuming the company doesn't pay it back until after 8 years it will owe $8.9 million in interest per year.
|Discount Rate/Gold Price||$1,100||$1,250||$1,400|
Valuing Guyana Gold
In addition to the Aurora Project Guyana Gold has the aforementioned $110 million in cash. It also has $6 million in liabilities meaning that we add $104 million to the aforementioned numbers.
Also keep in mind that the above mine plan calls for just 3.5 million ounces of gold production whereas the company has over 8 million ounces. Considering that the mine plan can be revised in order to include at least some of these ounces it is reasonable to assign some value to them. $10/ounce is conservative--there are projects that have no clear path towards production--just a resource estimate--that are valued at $10/ounce. Given that these additional ounces have a reasonable probability of being included in the mine plan at a later date $10/ounces is reasonable a fortiori. At $10/ounce we add another $45 million to the above figures.
With that in mind we get the following valuation matrix for Guyana Goldfields.
|Discount Rate/Gold Price||$1,100||$1,250||$1,400|
With financing in place Guyana Goldfields has a clear path to production that renders the stock significantly undervalued at $320 million. As the above matrix demonstrates this is the case even if we factor in several contingencies.
As production approaches and as more investors come to realize the amount of cash-flow that the company is going to generate I suspect that the stock will begin to rise sharply. We have already seen that it has 60% upside in a relatively conservative scenario. But this scenario understates the power of investor psychology, which can drive the shares substantially higher as production approaches--especially if the gold price rises.
Given these points there is little doubt in my mind that Guyana Goldfields is a solid investment opportunity at current levels, and the time to get in is now.
Disclosure: The author is long GUYFF. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.