A bit more than a month ago I covered African Gold Group (OTC:AGGFF), as this junior was one of the most undervalued stocks I knew in regard to its assets. Since October 23, 2014 when a remarkable and unrelated sell-off of a few days started, caused by Pinetree Capital (OTCPK:PNPFF), a diversified investment and merchant banking firm which needed cash fast, the share price recovered somewhat:
Share price 1 year period (in C$, ticker AGG.V on its mainboard)
Recovery gained traction when approaching, and especially announcing the release of the updated Preliminary Economic Assessment (PEA) results (see the November 25, 2014 news release). However, it bothered me that management never adequately addressed the introduction (if any) of an updated PEA instead of the promised Feasibility Study (FS) in the last news release before the PEA results were presented.
A FS represents a much more advanced level of engineering, calculation and project/resource description, this isn't something you replace just like that by a PEA. Very unusual to see things proceeding like this, and management failed to give me a decent explanation for this modus operandi when asked. Needless to say I'm not very pleased by all this. In this article, I will briefly repeat a description of the company and project and will focus on the three issues that have altered my opinion on this stock unfortunately:
- the updated resource
- the updated PEA
- the timelines and project representations used by management
followed by my opinion and the combined effects on my investment thesis.
All presented tables are own material, unless stated otherwise
All prices are in USD, unless stated otherwise.
African Gold Group owns several exploration projects in Mali and Ghana, its flagship being the Kobada project in Mali. The 'African discount' certainly applies to Mali at the moment because of the internal conflict, recent developments in nearby Burkina Faso and the Ebola outbreak next door; Ghana is one of relatively stable democracies in Africa and also to the top three of mining friendly countries in Africa.
The management is very experienced regarding working on West African gold projects, and recently appointed a new and experienced CEO/President, Mr. Declan Franzmann, with the intention of transitioning African Gold Group from an explorer/developer into a gold producer. Instrumental for the Kobada project is Mr. Pierre Lalande, who was former chief geologist of IAMGOLD and has about 40 years of experience in West Africa.
African Gold's cash position is $0.486M per September 30, 2014, the company has $1.27M current liabilities and no long-term debt. The company expects to be fully financed in order to release the FS in H1, 2015. As of December 5, 2014, African Gold Group has a share price of $0.045 and a market cap of $7.17M, based on 159.34M shares outstanding (185.53M FD).
The company management has considerable skin in the game (holding about 10%) which is always good to see, but has some well known large shareholders as well: Dundee Resources, Insight Capital, Sprott, and still some Pinetree as you probably know from my last article.
African Gold Group trades in much larger daily volumes on its main board in Canada, as AGG.V, so I would recommend trading by the Canadian listing.
Kobada project; infill drilling
As mentioned previously, African Gold Group is a gold explorer/developer with several projects in two countries in West Africa: Mali and Ghana. I will briefly describe its flagship Kobada project , as the company has its Ghana projects shelved for now, devoting all attention to bringing Kobada into production. The project is located in South Western Mali, and is shaping up to be a several kilometers long, large oxide/transitional/sulphide ore body, possibly enriched with a nugget effect which is rare. Several very large nuggets have been found so far in the area by artisanal workers, even up to 2.7kg, so this could provide upside potential as no such results have been encountered by drilling yet, and are not included in any resource estimate or study.
Kobada project; 2.7kg nugget found in 2008
Far away from the troubled North Eastern part, it has not experienced any problems or turmoil by rebels whatsoever yet, but there was an incident with illegal artisanal miners earlier this summer, causing damage to equipment and drill cores. At first, I thought of this incident as nothing unusual in a country with a lot of illegal artisanal mining, but these lost drill cores turned out to be important, as they were needed for resource definition and geotechnical testwork for the FS. Therefore, the company had to repair damages and redo the necessary drilling. This was one of the reasons to precede the upcoming FS with an updated PEA first.
Kobada project; completed drill program
As can be seen, the Kobada project is very large, and the company identified nine distinct parallel trends within 10 kilometers of the Kobada Deposit (next to seven other, earlier defined targets), based on a magnetic survey, and sees a lot of added potential because of this.
The company can't spend any equity dollars for additional resource development at this stage, but the considerable upside potential seems to be there. My fear is, that the company can't prove up this potential, as it will probably not be able to raise enough cash for a long time as I explain later on. The upside potential could be forgotten, or the company could be bought out for a very low offer, after a long period of forced inactivity after they run out of cash, which I expect to happen after the completion of the FS (scheduled for early 2015).
4. Updated Resource Estimate: Issue #1
The updated PEA came with an updated resource estimate as well, so it is useful to look at the development of the Kobada resource. Many years of drilling and infill drilling spaced at 25m (which should be enough for the upcoming FS) in 2012,2013 and 2014 have resulted in the following series of resource updates:
and to be complete the resource estimate for the nearby Foroko deposit:
The 2014 resource update is described in the news release for the updated PEA just over a week ago. Please note the considerable downsizing and highgrading of the Kobada deposit, as the Measured and Indicated (M&I) resource almost halved in size, and the other half was converted back to Inferred at the same cut-off grade of 0.3g/t Au. This can be considered as a huge setback in general and was unexpected by management, and was caused by applying a pit constrained estimate with shorter intervals (previous method wasn't pit constrained, adding tonnage but at lower grades).
CEO Declan Franzmann noticed right after being appointed earlier this year that the previous resource estimates weren't rigorous enough, also on the anticipated higher grade vein systems, so the company decided to redo the latest resource estimate, only to end up with a much smaller economic (M&I) resource unfortunately. This is the diluted in pit resource estimate, used for the recently updated PEA:
The company is still studying on the exact geological makeup of the deposit, and therefore chose to target a certain part of the mineralized envelope which is thought of to have the highest overall grade, and therefore had to include some Inferred resources, as a PEA allows a company to do so, and a FS doesn't. This will demand additional drilling, in fact the drilling which already had been done but also resulted in destroyed cores in the incident mentioned earlier. This drilling is scheduled in early 2015.
What to make of this? It was a good thing to review the resource estimate again, as the picture seemed to be too rosy. To hire a renowned geologist like John Dunlop for advice was probably a good thing to do as well. One of the founders, former management and current director Mike Nikiforuk told me they were reassessing the drill assays based on Multiple Indicated Krieging ("MIK"), resources being constrained by a pit shell, and shortened the drill interval composites to 3m from 10m thus creating much higher resolution on grade, and a higher grade as well. What happens with this is, that lower grade intercepts of the drill cores can be excluded when convenient. So when a 10m drill core has for example 2m of 2.2g/t, 5m of 0.4g/t and 3m of 1.2g/t intercepts (= 10m @ 1.0g/t Au), the 5m intercept is left out, increasing average grade to 1.6m over 2 seperate intercepts of 5m combined.
This comes in handy of course, but the company still has to handle the 5m @0.4g/t zone when mining later on, as it is an open pit operation, and you can't be selective like with underground, you have to excavate everything, and decide every time if it is waste or ore. This can be done by grade control drilling, or visual grade control by a geologist. But I can't imagine a geologist being present all the time, so a lot of grade control drilling has to be executed during excavation, and this is probably one of the reasons the AISC is so high (almost $800/oz), much higher than it should be for a predominantly gravity concentration, small mill operation.
Considering the significant decrease in M&I resources after years of drilling, the small pit constrained resource and the small annual production at a much higher grade, the company apparently got into trouble when a reality check had to be done for the upcoming FS. What's left is a small, complex deposit with a small operation, without any staged ramp up potential as the company even had to include non-economic Inferred resources at this late stage (right before the FS).
Based on this alone, I have to downgrade my bullish expectations for this project considerably, and no longer can foresee reserves of 1.5- 2M oz, with corresponding staged production scenarios like in my former estimates in my other articles. The Kobada geology seems to be much more complex than earlier anticipated unfortunately, and there will not be any cash left to prove up resources at other targets after the FS. Therefore, the Kobada project loses its appeal as a take over subject as well, as resources need to be at least 2.5-3M oz M&I at a good grade.
Kobada project; artisanal workings by local miners
5. Updated PEA: Issue #2
The updated PEA contained in concept most of what management promised me earlier, but there are notable differences on figures. The biggest differences were caused by a lot smaller average gold production (44koz versus 108koz) as there wasn't any staged ramp up, caused by a much smaller than expected in pit resource, and the earlier mentioned mill feed grade, which went up considerably (0.7g/t > 1.01g/t). I was a bit surprised by the relatively high cash costs, as AISC comes close to $800/oz Au, as I expected about $700/oz compared to other projects.
For example Robex had $717/oz in their 2014 FS for an almost identical project with 0.7g/t mill feed grade. The numbers compared to the 2011 PEA, the adjusted PEA (to have full capex calculated for NPV and IRR instead of half of it in the 2011 PEA), the hypothetical PEA (as estimated in my last article, with ramp up scenario) and the recently updated PEA look like this:
The used price of gold is significantly higher ($1250/oz, which is even higher than current levels ($1200/oz) which is always a no go as most studies use conservative levels in order to convince financiers > banks usually take off at least 20% of precious metal (NYSE:PM) prices to stress test PM project economics), and NPV5 and IRR are pre-tax numbers. I never quite understand the urge of certain junior mining companies to represent project economics just by pre-tax figures, as taxes simply and always have to be paid. To me it always looks like window dressing of some sort, as effects of corporate taxes aren't always obvious to a lot of investors.
In order to determine the influence of a higher gold price and corporate taxes, as Mali has a fairly high corporate tax of 35% (and a 10% state royalty included in AISC and a possible 5 year tax holiday commencing production), I ran the numbers on a price of gold of $1100/oz for the updated PEA metrics in order to avoid comparing apples and oranges, and to use a more realistic long term price of gold:
The after tax IRR looks like this:
Obviously an after tax NPV5 of $70.5M and an IRR of 27.7% look a little bit different at a gold price of $1100/oz, and all of a sudden project economics are no longer best-in-class, as they were better than Roxgold's or Truegold's to name a few of the better ones (IRR of 30-35%). Without the tax holiday option the after tax IRR goes even down to 23.2% (NPV5 of $57.7M), which would make this project just average. And I still didn't take into account the rather positive discount of 5%, as a risky country like Mali should actually have 8 or 10%. The study comparison table looks like this now:
In order to have the most realistic comparison, just look at the adjusted PEA and the updated PEA. The adjusted PEA corrected the 2011 PEA NPV and IRR figures for full capex as mentioned, so this was the actual PEA. My hypothetical PEA/FS assumed the conversion of far more M&I resources into pit constrained resources, but the opposite happened. All numbers come out less positive, except the mill feed grade. The high grading of the deposit was needed apparently, to maintain just above average economics (20% is the desired minimum for after tax IRR on gold/precious metals projects in good jurisdictions).
I mentioned the pre tax figures, which were the only figures presented in the news release (the first two mentionings of NPV and IRR carefully avoided the pre- or after tax labeling, only at the very end a table showed up, clarifying the pre-tax nature of things), whereas after tax is standard. Combined with the resource high grading this doesn't look good. For a country like Mali, a precious metal project really needs to have an astounding IRR in order to be worth taking the risks for investors and financiers. The 27.7% IRR isn't exactly astounding, it is just above average and therefore will nullify the advantage of a lower initial capex in my view.
Kobada project updated PEA;Mine plan
6. Timelines: Issue #3
In junior mining, missing schedules and timelines is nothing out of the ordinary. In fact, it is highly surprising when a company lives up to its scheduled dates, and very rare when they even manage to outpace their (realistic) timelines, especially in the phase between a PEA and commercial production. By the way, when this happens at serious projects, make sure to write down the names of management and company, and keep following them in their future endeavors, as this is often testament to very high quality people who have most or all of it under control.
African Gold Group appears to belong to the first group, unfortunately:
- I checked some old analysis on the company, and as far back as in March 2012, they promised to finish a FS at the end of 2012. Since then, the FS completion date has been delayed multiple times, although the resource has been expanded and increased in the mean time (and decreased for M&I again recently as mentioned).
- At the beginning of 2014, a Pre Feasibility Study (NYSE:PFS) was introduced to be completed at the end of H1, 2014.
- When I wrote an article in early July on the company, the PFS was expected in August this year, and a FS in November.
- Since then, nothing was heard from the PFS again and only the FS was mentioned in news releases.
- On October 29, 2014, a scoping study and PEA were mentioned all of a sudden, without any explanation. A scoping study is actually the Australian equivalent of a Canadian PEA so it is basically the same
- On November 25, 2014 the updated PEA (and scoping study, both terms were mixed at random in the news release) results were announced in a news release. Further drilling is necessary, which will be done in early 2015. After this, the FS will be completed, also in early 2015.
I didn't make too much of a deal of the covert introduction of a suprising updated PEA in my last analysis, as management promised me to come up with a good explanation at the announcement of updated PEA results, why they did what they did. However, nothing happened, and I am still waiting for the explanation for this covert PEA introduction, even after repeated discussions with them, and so do shareholders and investors as I noticed. A good motivation, to come clean on this, was really needed as I already had to ignore too many things here. Unfortunately this didn't happen, so credibility of management didn't strengthen these last months, to say the least.
Taking the smaller resource, the disappointing IRR and NPV and the peculiar timeline management into account, added to the ongoing Mali risks, my opinion is that this project needs a far more impressive IRR and NPV in order to be appealing for capex financiers. For some time to come, risks seem too high to arrange any kind of finance package. And because of this, there could be an issue for the company when they need some working capital after completing the FS, and try to go to the markets by private placements etc.
Kobada project; deposit area
Despite my changed outlook on the company and its project, and because it is very difficult to value African Gold Group for now, as Robex disappeared as a peer after shutting down and having to adjust their plant, I would still like to give an indication of future valuation at the time of commencing commercial production. The FS is scheduled for Q1, 2015, the following permitting takes 3 to 6 months, let's say hypothetical financing takes two quarters to finalize if possible at all, construction and ramp up takes another 3 quarters, some delay, in that case production could commence in Q4 2016.
Let's assume a standard equity/debt financing. I expect capex financing to consist out of 1/3 equity-2/3 debt, so $15.5M is equity. I assume a share price of $0.05 by then because of recent developments, or even a bit lower. An equity financing usually requires a minimum share price of $0.05, so interested parties should have to pay a premium in that case. This is not impossible as it happens frequently, as the TMX wants to help nano cap juniors where possible (as these juniors also provide for an annual $10-50k listing fee for the TMX Group of course).
The equity part causes an extra dilution of $13M / $0.05 = 260M extra shares, making up for a total of 159.34M + 260M = 419.34M outstanding shares. Assuming $31M debt and $5M cash, and an estimated value of $5M for the Ghana projects, and the NPV5 of $70.5m multiplied with an average 1.0 when commencing production, this results in a NAV of $49M.
As a reminder, NAV is:
Aggregate net present value (NYSE:NPV) of company's projects
+ Working capital (current assets minus current liabilities)
+ Value of other investments
+ Value of hedge book
When commencing production, this results in a target share price of $49.5M / 419.34M = $0.12 for a profit of 140% for Q4 2016, at a price of gold of $1100/oz.
Compared to my hypothetical staged PEA scenario, the NPV5 would be $193.4M, capex would be $40M, NAV would be $176M / 419.34M = $0.42 for a profit of 740% for Q4, 2016.
The impact of dilution is obviously huge, a stream or royalty deal would take away much of the profitability and cash flows, but would maintain a more tight share structure. For example a resulting estimated NPV of $50M would result in a NAV of $29M, and a target share price of $29M / 159.34M = $0.18 for a profit of 260%. Usually banks demand an extra equity component for financial safety during construction, until commercial production, so normally there will be some extra dilution accompanying the debt package, lowering this target.
This target is depending on the Mali conflict getting solved, the Ebola outbreak being terminated, and a further stabilization of the current situation in adjacent Burkina Faso.
Kobada project;exploration camp
8. Catalysts & Risks
The company is funded through the FS, has no debt, so financing is no problem for the short term. For the longer term this could be different as mentioned, as the profitability of the Kobada project has come down significantly, probably too low to counter country risks, and interest financiers for capex financing, and gather interest from investors for private placements etc.
The ending of the Mali conflict could have a positive impact on the share price. On the other hand, when the Mali conflict escalates into a civil war, it is best to stay away until the dust finally settles.
Although several issues reversed my investment thesis, catalysts are still possible of course, despite the higher risk profile of this company. The first and obvious catalyst in my view is the release of the long awaited for FS. Most important catalyst following this will be the arranging of capex financing, especially the equity part. This will be a major step into the right direction, but it remains Mali, with an ongoing Ebola outbreak to go with that. Other well-known risk items could be permitting and construction, although Mali is very supportive of mining.
I expect the price of gold to range between $1100-$1200/oz from now on until H1, 2015. The Fed stimulus is winding down further, indicators for the US economy seem to be improving, the dollar is on a plateau as Europe experiences another setback, commodities are extremely soft, as oil is dragging everything with it in its Saudi orchestrated downfall, inflation isn´t officially recognized yet in the Western Hemisphere, and the Ukraine tensions, Dutch repatriations of gold or Swiss referenda or any ongoing conflict doesn't seem to have any effect. Demand in China for physical gold keeps slowing down as well, so I see no clear positive or negative indicators for the gold price for now.
African Gold Group surprised me with their actions, and disappointing numbers. The Kobada project still has above average economics, but the magic of being one of the most profitable projects worldwide seems to be gone, and I doubt if what's left will be enough to attract financiers for capex financing or any other financing anytime soon.
This stock always has been speculative because of Mali and Ebola, but management antics and just above average economics have been thrown in the mix as well, making me close my Pinetree initiated sell-off position right after the run-up caused by the results of the updated PEA. I will stay on the sidelines now, and await the upcoming FS, permitting and first and foremost an eventual complete capex funding, and depending on valuation and how terms will pan out, a new position can't be ruled out by then, also depending on the Mali situation. I might be in for a long wait, just my 2 cents.
I hope you will find this article interesting and useful, and will have further interest in my upcoming articles on mining. To never miss a thing, please click on the bold link labeled "Follow" above the title at the top of this article to get an email notice of my new articles soon after they are published.
Kobada project; artisanal mining
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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 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.