Centamin - Get Out While The Going Is Good

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About: Centamin PLC (CELTF)
by: Kees Dekker
Summary

The positive factors supporting the historical performance will soon come to an end.

Management's 5-year plan sacrifices long-term future.

Open-pit reserves need a much better gold price to be economical.

Executive Summary

This valuation is based on a cash flow model which uses the latest 5-year production plan of Centamin (LSE: CEY) (OTCPK:CELTF), combined with the long-term schedule in the 2015 feasibility study, to deplete the reserves of material destined to be treated in the Carbon-in-Leach (CIL) plant of the Sukari mine at a rate of approximately 11 million tonnes per annum. Using the gold price as per 17 November 2015 of US$1,070/oz, a net present value at a discount rate of 5% of minus US$89.2 million was arrived at, far more than the Enterprise Value of US$881.9 million for Centamin on that day.

The review of the technical and financial information comes to the following general conclusions:

  • Centamin's value is essentially determined by its 50% interest in the Sukari operation.
  • The mine is cash-generative even at the current gold price, allowing for return of funds to shareholders as dividends and share buy-backs as capital expenditure has dropped considerably.
  • The good cash performance is due to a combination of underground production with very good margins, open-pit mining at low stripping ratios, income tax exemption and profit sharing deferred until investments having been recovered and the mine coming into operation when the gold price was at US$1,000/oz rising to above US$1,600/oz for the period mid-2011 until end-2012.
  • The historical performance is as good as it gets as all the positive factors mentioned in the previous bullet point come to an end within the next few years.
  • Management has put a gloss over this in their latest 5-year production plan, artificially holding down the strip ratio and assuming continuation of underground mining at a very high level, without having the mineral reserves to sustain this.
  • Should this 5-year plan be implemented, the life of the operation will be curtailed to only these five years, unless there is a major increase in the gold price.
  • The table below illustrates that open-pit ore is uneconomical at current mined grade at the required strip ratio and a price of US$1,200/oz. The current good financial performance of Sukari can almost fully be attributed to underground mining.


This valuation has given the benefit of the doubt to future performance as shown in the table below, which lists the favourable and unfavourable assumptions in the valuation for determining the net free cash flow. Based on the discounted cash flow that can reasonably be expected from the 5-year cash flow at current spot gold prices, the value of the company is at best US$406 million, being US$66.0 million for the NPV5 of net free cash flow plus US$310 million net current assets. This equates to a share price of C$0.47.

Centamin Plc

Favourable Versus Unfavourable Bias in Assumptions for Valuation

Favourable

Unfavourable

Ignoring that the current lower gold grade compared to reserve grade could be due to dilution and lack of selectivity in mining

Cessation underground mining after depletion of current reserves + 420,000 tonnes

Incorporation fixed element in mining cost

Lower metallurgical recovery than current

Use of polynomial approach to variable mining cost escalation

No sharing of negative cash flow

Removal impact of capex on other projects from cash flow

No obvious capital provision for tailings dam expansion

Inclusion of sustaining capital cost as deduction for profit share

No further investments in working capital over the life of mine

No provision for closure and rehabilitation cost

Based on the available information, Centamin at its current price of C$1.24/share is very much overvalued.

Introduction

Centamin Plc ("Centamin") is an Australian mining and mineral exploration and development company that has been actively exploring in Egypt since 1995. The principal asset of Centamin is its 50% interest in the Sukari Mine, located in the Eastern Desert of Egypt, which started operating in mid-2009.

Centamin is listed on the Toronto Stock exchange since 5 April 2007 and on the London Stock Exchange (CEY) since November 2009.

The operating company of Sukari is Sukari Gold Mines ((SGM"), and is jointly owned by Pharaoh Gold Mines NL (PGM) a wholly owned subsidiary of Centamin, and the Egyptian Mineral Resource Authority (EMRA) on a 50/50 basis.

Figure 1_1 gives the location of the mineral holdings of Centamin in Northern Africa:

  • Sukari Gold Mine, Egypt - 50% beneficial interest
  • Batie West in Burkina Faso - 1.9 Moz Indicated and 1.3 Moz Inferred Resources
  • Cote d'Ivoire - licences in early stage exploration
  • Ethiopia - licences in early stage exploration

Figure 1_1

Location of the Mineral Holdings of Centamin Plc in Northern Africa

With a market capitalization of almost US$1.2 billion and a book value of US$48 million for Batie West, it is evident that the value of Centamin is determined by their interest in the Sukari mine. For this reason this report will only review the Egyptian operations.

The main sources of information are the following:

  • Centamin, 30 June 2015, Mineral Resource and Mineral Reserve Estimate for the Sukari Gold Project, Egypt
  • Centamin Plc, Management's Discussion and Analysis for the years 2007 - 2014 and for the June quarter 2015.
  • Centamin Plc, Annual Financial Statements for the years 2007 - 2014 and for the June quarter 2015.
  • Various Press Releases.
  • TSX stock information.
  • business-anti-corruption.com, Feb 2015, Egypt Country Profile.
  • Transparency International, 11 May 2015, Country Profile - Egypt.

Background to the Sukari Mine

The technical information is mostly contained in a NI.43-101 report by Centamin, using outside consultants as well, dated 16 June 2015 in support of an updated reserve estimation.

The Sukari project (Figure 2_1) is located in Egypt in the arid Eastern Desert some 30 km of Marsa Alam on the Red Sea.

Figure 2_1

Location of the Sukari Property in Egypt

A coastal highway runs along the west coast of the Red Sea from the border with Sudan in the south to Suez in the north, passing through Marsa Alam. From Cairo to Marsa Alam by highway is about 750 km, about ten hours by supply truck. From Marsa Alam the mine is reached by a combination of 20 km bitumen highway and 12 km gravel road.

There is a new international airport north of Marsa Alam.

Figure 2_2 shows the extent of the Sukari concession area, which covers an area of 160 km2, containing the Sukari mine site and surrounding prospects.

Figure 2_2

Extent of the Sukari Project Tenement Area

Centamin holds an interest in Sukari through its wholly owned subsidiary Pharaoh Gold Mine (PGM), through an agreement (the Concession Agreement), executed in 1994 with the Egyptian Geological Survey and Mining Authority (EGSMA, now the EMRA) and the Egyptian government. The Concession Agreement was declared into Law 222 of 1994 and came into effect on 29 January 1995.

In accordance with the Concession Agreement, a "Commercial Discovery" was declared in November 2001 following the submission of a feasibility study by PGM; EMRA and PGM then agreed on the borders of the area to be converted from exploration to exploitation lease comprising an area of 160 km2. The Minister of Petroleum approved a 30-year lease in respect of 160 km2 on 24 May 2005, extendable for a further 30 years upon PGM providing appropriate commercial justification.

Following demonstration of the commercial discovery, PGM and EMRA were required to establish an operating company in which each party holds 50%. This company, SGM, was incorporated under the laws of Egypt on 13 April 2006 to conduct exploration, development, exploitation and marketing operations in accordance with the Concession Agreement. Responsibility for the day-to-day management of SGM rests with the Sukari General Manager who is appointed by PGM.

It should be noted that the validity of the exploitation lease is currently the subject of litigation in the Egyptian courts, after the Administrative Court nullified the exploitation lease in October 2012, except for an area of 3 km2, which is now on appeal and with both the current authorities and Centamin contesting as being without merit.

Political Stability and Corruption in Egypt

The summary of the Country Profile of Transparency International on Egypt dated 11 May 2015 reads:

Egypt has entered the fourth year of a period of political instability unheard of since its independence, after massive demonstrations denounced the deep-rooted system of corruption plaguing the country and finally ousted former president Mubarak. The political unrest gave leeway to the security forces, who control significant portions of the economy, to widen their influence and install a military-backed regime. Human right violations, brutality and censorship have been aggravated in the last years, and the security forces operate largely with impunity.

It is challenging to assess whether the level of corruption has increased or declined in the country due to the rapidly changing context, but it is generally admitted that political corruption remains a major problem in Egypt with clientelistic networks playing a central role both in politics and in the economy. Corruption in the country's law enforcement agencies severely undermines the rule of law, and some recent abusive trials give the impression that the judiciary has become politicized.

Egypt has a relatively strong legal framework to prevent and stifle corruption, despite the notable lack of a comprehensive anti-corruption law, freedom of information law and whistleblower protection. The most important problem lies in the implementation of existing legislation. There are numerous institutions playing a role in fighting corruption, but their lack of coordination creates confusion and overlapping responsibilities. On anti-corruption day 2014, the government announced the launch of an anti-corruption strategy.

And according to Business Anti-Corruption Portal in a posting dated February 2015:

Corruption is an obstacle for businesses in Egypt. Bribery, embezzlement, tampering with official documents and extortion are among the forms of corruption encountered. A culture of nepotism and favouritism has tainted Egypt's economy and its investment climate. A poor legal framework and a widespread culture of corruption leave businesses reliant on strong connections and the use of middlemen, known as 'wasta', to operate, and well-connected businesses enjoy privileged treatment. Egypt's Penal Code criminalises several forms of corruption such as active and passive bribery and abuse of office, but existing legislation is unevenly enforced, leading government officials to act with impunity. Facilitation payments are an established part of 'getting things done', despite irregular payments and gifts being criminalised.

From the above, it is evident that doing business in Egypt can be risky. However, with the government essentially holding a 50% stake in the Sukari mine, risk is limited, even should others assume control of the government as the size of the holding makes renegotiation improbable.

History of the Sukari Project

In 1994, PGM negotiated an exploration and mining agreement (Concession Agreement), with the Egyptian Geological Survey and Mining Authority (EGSMA; now the Egyptian Mineral Resources Authority (EMRA)) and the Egyptian Government, to explore for gold and associated minerals in the Eastern Desert of Egypt. The Concession Agreement was declared into Law 222 of 1994 and came into effect on 29 January 1995 pursuant to which PGM had the right to explore and develop gold and associated metal deposits within the concession.

Work by PGM commenced in 1995 with the establishment of a camp and exploration work that culminated in drilling with the first programme commencing in April 1997.

In 2001 the first resources estimated by an independent party were declared, updated in April 2003 to 1.7 million ounces in the Measured and Indicated category using a cut-off grade on 0.5 g/t Au. After having successfully proven substantial quantities of ore, an open pit and underground mining operation was developed, which commenced commercial production in the middle of 2009.

Exploration and delineation drilling has continued uninterrupted resulting in a continuous increase of Measured and Indicated Resources until 2011 (see Figure 4_1).

Figure 4_1

Growth of Mineral Resources for Sukari

After 2011 on-mine exploration drilling has not been successful at replacing resources depleted through mining. The effect of drilling is mostly noticeable at increasing confidence levels in the available resources.

Table 4_1 shows the production performance since start of operations until 30 June 2015.

The company was unfortunately not consistent in the details it published with no numbers provided for grades mined and dump leach production before December 2010. The numbers for the high-grade stockpile, highlighted in yellow in the table, were arrived at by working backwards from the reserve figures applicable on 30 June 2015.

The table shows the following:

  • A total of 1.57 million ounces has been produced since start of operations.
  • Underground mining has accounted for 40% of the gold in the CIL plant feed, contributing substantially towards revenue.
  • Open-pit ore production seems to have reached steady state in 2013 at 11 million tonnes per annum (Mtpa), but waste rock removal is still ramping up.
  • Underground production seems to have reached steady state at 1.0 Mtpa.

Table 4_2 shows the financial performance since 1 June 2004 to determine the amount of cash used on Sukari and what the book value is of the assets reasonably associated with Sukari. The table is complicated by the fact that Centamin changed in 2006 the currency in which it reported from Australian Dollar to US Dollar.

From the table it is clear that the company is lately in a position where operations generate much cash and the need for investments have dropped to allow for return of funds to investors through share buy-backs and dividends. Cash generation in the first 9 months of 2015 is strong with the cash balance increasing by almost US$65 million, despite the poor gold price.

At the face value, Centamin is a very attractive gold mining company.

Geology of the Sukari Project Area

The unit that hosts the gold deposit is an intrusive that is 2.3 km long and 100 m to 600 m thick. Drill results indicated that the intrusive dips between 50° and 75° to the east. Four geographical zones have been designated from north to south: Pharaoh, Gazelle, Ra and Amun (Figure 5_1).

Figure 5_1

View Towards the Southeast of the Four Geographical Zones at Sukari

From field observation and core logging, it is evident that the Sukari intrusive has acted as a rigid body surrounded by weaker rocks when tectonic deformation took place. Footwall and hangingwall rocks have taken up strain by development of strong schistosity, almost certainly accompanied by large decreases in volume. The porphyry has taken up strain by development of predominantly brittle fault structures. These acted as conduits for the fluids that contained the gold.

Gold mineralisation within the Sukari intrusive is not continuous and its deposition has been influenced by major long-lived structures, the most important of which are tabular sheets of crackle breccia referred to as the Main Reef and Hapi Reef.

Figure 5_2 shows the two reef zones dipping within the host rock at a shallower angle (i.e. 35° to 50° east) than the Sukari intrusive itself.

Figure 5_2

Section 10550N Showing the Main Zone and Hapi Zone Within the Intrusive ("Porphyry")

A large volume of mineralisation is also associated with stacked brittle veins. These occur in zones proximal to the through-going mineralized shears, but they also occur remote from them.

Figure 5_3 illustrates the overall shape and size of the porphyry host and the geometry of the gold deposits.

Figure 5_3

Isometric View of the Gold Deposits

Gold mineralisation at Sukari is intimately related to sulphides; pyrite is the most abundant sulphide, followed by arsenopyrite. High gold grades are associated with increased arsenopyrite concentration. Scanning Electro Microscope (SEM) and mineralogical work, determined that high-purity gold occurs free in quartz, on the margins of pyrite and arsenopyrite crystals, and as micro-fracture filling.

This points to a high proportion of gold being amenable to cyanide leaching after milling without requiring more expensive methods to unlock the gold.

Geological Modelling and Estimated Mineral Resources

At the time of writing the 2015 feasibility study report, the Sukari resource drillhole database comprised approximately 579,319 m of drilling in 1,892 holes, including some holes abandoned because of drilling difficulties and some intervals that are awaiting assays.

Figure 6_1 shows the collar locations of the boreholes drilled, illustrating the dense nature of the borehole pattern with an average drillhole spacing of 20 m in the grid east direction and 25 m in the grid north direction.

Figure 6_1

Drill Location Map (as per 2015)

Due to very large variability in the sample results compared to average grade (the so-called co-efficient of variation "CV" being higher than 2.0), resource estimation using ordinary kriging ("OK") or inverse distance ("ID") weighting is not possible and Multiple Indicator Kriging (MIK) was applied. The parent cell dimension for the resource model is 25 m x 20 m x 5 m vertical. The block size was chosen as the Selective Mining Unit (SMU) of 5 m x 8 m by 10 m high, being the maximum selectivity possible given the equipment size used for mining at Sukari.

Of interest is that it was found that the CVs are very high for the southern porphyry (7.0 and 11.70) indicating that it will be difficult to maintain a high degree of selectivity in mining at there. In the northern porphyry the CV's at 3.1 and 4.1 are lower, but still very high.

Table 6_1 presents the resource estimate by MPR Geological Consultants PTY Ltd (MPR).


Figure 6_2 gives two typical cross sections through the block model at 0.3 g/t Au cut-off grade, approximately 1 km apart along strike (with the current pit outline in blue).The table shows that the resources are well defined with little present as Inferred resources. This implies that there is little potential for the stripping ratio established for Measured and Indicated resources in the pit shell to drop during actual mining when material from the Inferred category is sent for processing.

Figure 6_2

Cross Section 10,325N Through the Block Model

Cross Section 11,300N Through the Block Model

Given the relative minor contribution of underground mining, this report did not review the underground resource estimation. What is of interest is how much upside is available from Inferred Resources, which are not part of the current mine plan. Figure 6_3 shows visually the amount of Inferred resources at Amun and Ptah compared to Measured and Indicated Resources.

Figure 6_3

Location of Resource Categories for the Amun Underground Zone

Location of Resource Categories for the Ptah Underground Zone

From the figure it is evident that it will be difficult to extent mining at Amun as Inferred Resources there are very limited. Only at Ptah much Inferred Resource remain for upgrading to a level of confidence that make mine planning possible. This will require substantial additional drilling (and time). Not much information is available about the quality of these resources to determine whether they are attractive in grade and dimensions and whether they are of the same quality as those that have been mined to date.

Business Plan as Per 5-Year Plan and 2015 Feasibility Study

Mining and Mineral Reserves

SGM is conducting owner-mining open-pit operations at Sukari and employ Barminco Egypt as a contractor for underground mining.

Ore from open-pit mining is hauled to the ROM pad adjacent to the primary crusher. The majority of ore is direct tipped into the crusher, with provision for ore to be stockpiled for reclamation by a front-end-loader operated as part of the crushing and processing operation.

Table 7.1_1 gives the assumptions used for the pit optimisation.


The pit design has a total rock content of 1,579 million tonnes ("Mt"), comprising 1,350 Mt waste rock and 229 Mt ore at 1.09 g/t Au, yielding a strip ratio of 5.87:1 (waste to ore, with the latter including the dump leach ore).The pit optimisation modelling showed that, while the average grade is fairly constant over the range of pit shells, the mining inventory (tonnage) was very sensitive to gold price. This indicates that the ultimate size of the pit (and therefore reserve ounces) is highly sensitive to gold price and the mining cost assumptions. For example, a drop in the gold price from US$1,300/oz used to the current spot price of US$1,071/oz would remove 60 million tonnes from the ore inventory.

The estimate of underground Mineral Reserve is 2.7 Mt at 6.0 g/t for 0.5 million ounces gold. Underground mining is planned to source ore from stopes located within the designed final open-pit, and well above the final pit limits. A volume adjustment representing the stoping component of this 2.7 Mt was made to the resource model to account for the volume to be removed by the underground mineral reserve in advance of later open-pit mining. It should be noted that it will make pit operations later more tricky to prevent machinery dropping into the voids created by underground mining.

The open pit is to be mined in stages with Stage 1 and 2 complete. The mining sequence progresses through Stages 3, 4, 5, and 6, with Stage 7 comprising the final pit design. Sub-staging is used by the site when appropriate to meet short-term scheduling objectives with Stage 3 currently being mined as two sub-stages, Stage 3A and 3B (see Figure 7.1_1).

Figure 7.1_1

Open Pit Design Footprint Showing Phase 3 (Yellow), Phase 4 (Red), Phase 5 ((Blue)), Phase 6 (Light Blue) and Phase 7 (Light Green)

Figure 7.1_2 shows the open-pit outline upon completion of mining.

Figure 7.1_2

Pit Outline Upon Completion of Mining

Outline of the Ore Deposit Within the Final Pit

Table 7.1_2 summarises the estimated reserves for the open pit and underground operations.


The feasibility study documentation is somewhat vague in providing the mine production schedule and presents the quantities not in the format of tables but as two diagrams, reproduced in Figure 7.1_3 and Figure 7.1_4.Comparing Table 4 with Table 3 shows that the conversion rates of Measured and Indicated resources to reserves for both open pit and underground is almost 60%. With very little Inferred open-pit resources there is little upside in terms of extension of life, or reduction in stripping ratio. The 7.0 million tonnes of Inferred underground resources give theoretically the possibility of extending the life of the operations there by a number of years. To prove these up to sufficient detail and access them in time for a smooth continuation of productivity at a level of 1.0 Mtpa will be a tall order.

Figure 7.1_3

Total Open Pit Production (Ore + Waste) for the Various Mining Stages

Figure 7.1_4

Mill Feed Schedule - Open Pit Only

From the above it is apparent that mill feed would reach 11 Mtpa in 2018 with waste stripping at approximately 8:1. The grade over the life of mine is forecast to vary substantially, first dropping in 2018 with cessation of underground mining to increase again with pit deepening. In 2026 until 2028 the grade is low because of the impact of treating low-grade stockpile material. As the pit is deepened further, grades start improving again.

Subsequently a slide in the latest Centamin corporate presentation dated September 2015 (reproduced in Figure 7.1_5) gives the production forecast for the five years ending 2019.

The 5-year forecast substantially improves over the feasibility study plan by: the problem with the information in the table in Figure 7.1_5 is that it does not give enough detail to allow reconciliation of the numbers and it contains obvious mistakes. For example, in year 2015 and 2016 the ounces contained in open-pit mine production fall short of the ounces from open-pit production treated in the mill. This is aggravated by the fact the open-pit mine production exceeds the amount milled, pointing to the excess being (lower grade) dump leach tonnage.

  • Assuming continuation of underground mining at 1 Mtpa for an additional 2.3 Mt mined outside reserves.
  • Mining at a strip ratio, which is well below the LOM ratio of 5.9.
  • Mill feed grade substantially improving after 2015.
  • Dump leaching contribution of 10,000 ozs per annum.

Of further concern is the sharp increase in grade from open-pit material in 2016 compared to historically achieved. This may be due to a fortuitous increase in grade with depth (not evident from Figure 6_2), or because much higher dilution than modelled is being experienced and not incorporated in the plan. On page 11 of this report it was mentioned that the very high CV's would make it difficult to maintain a high degree of selectivity in mining.

Both the five-year plan and long term mining schedule include dump leaching of 28 million tonnes containing 170,000 ozs gold. This valuation has ignored the impact of dump leaching on net free cash flow as the revenue it will generate at a metallurgical recovery of 60% (US$122 million at a gold price of US$1,200/oz for US$4.35/t mined) will be approximately equal to the cost of mining (US$2/t) and treatment (US$1.85/t) plus a proportion of sustaining capital expenditure. The dump leach tonnage is therefore self-financing and the beneficial impact is through the reduction in the strip ratio.

This valuation has also ignored gold production from the dump leach stockpile, which has a grade of 0.31 g/t for 170,000 contained ounces (refer to Table 7.1_2). Much of this gold is part of material already fully leached, and with the balance forecast to give a 60% recovery. Without sufficient detail, gold production of this stockpile cannot properly be modelled.

With the above constraints, this valuation has adopted the latest five-year plan, except for restraining underground production to 3.12 million tonnes, 0.42 million tonnes more than in reserves, and amended the life of mine schedule thereafter to achieve full depletion of the open-pit reserves of CIL material (by assuming constant annual production of 10.94 Mtpa) and waste mining (by increasing the strip ratio in the middle period after 2019 to 7.53) and the same amount of contained gold as for the reserve figures by adjusting the grade profile after 2019 by a constant percentage upwards (i.e. 4.0%). The CIL stockpile of 9.84 million tonnes containing 178,000 ounces are assumed processed at the end of the LOM in year 20.

Table 7.1_3 shows the derived mining schedule over the 20-year life of mine (LOM) together with actual production figures for the last 2½ years (reported figures highlighted yellow).

The table illustrates that the strip ratio needs to jump considerably after the 2019 from the lower 4's to 7.53 to compensate for the below average stripping in the first five years.

Processing

The process route used for Sukari ore is crushing, milling to a particle size at which 80% (P80) passes 150 μm, flotation of a bulk sulphide concentrate that is milled finer to P80 12μm before cyanide leaching of the concentrate, adsorption of the gold onto active carbon, after which the precious metals as recovered as a gold doré bar for refining off site. This is a comprehensive process that is not cheap considering the low-grade nature of open-pit material.

The plant in its current configuration was constructed in four stages, first for treatment of oxide material at 4.6 Mtpa, then to be able to handle sulphide ore at 4.0 Mtpa, followed by installation of additional secondary crushing capacity to increase production to 5.0 Mtpa, and finally the construction of a parallel circuit that doubles capacity to 10 Mtpa. The plant is presently achieving throughputs higher than the rated plant capacity.

In parallel with the milling operation gold from low-grade oxide ore is recovered by dump leaching. In this case ore is directly hauled to a leach pad and sprinkled with a dilute cyanide solution for leaching. The pregnant solution is pumped to a series of carbon columns or to the Stage 1 processing plant.

Table 7.2_1 shows the plant production schedule based on the inputs in Table 7.1_3.

The long-term forecast has adopted the metallurgical recovery of 88% in the 5-year forecast, which compares low to recently achieved recoveries, probably reflecting the lower mill feed grade.

It should be noted that the current tailings dam facility has a capacity of 68 million tonnes of which by 30 September 2015 almost half has been used, leaving only enough capacity until the end of 2018.

Capital Expenditure

The LOM capital expenditure used for the valuation is summarised in Table 7.3_1.


As it is impossible to quantify the financial return of exploration, the author's valuation has ignored exploration capital expenditure after 2015 expenditure (fully committed), so as not to penalize the Sukari project.The numbers for the five years ending 31 December 2019 are derived from the corporate presentation in September 2015. This 5-year forecast assumes indefinite continuation of underground mining at a rate of 1 Mtpa ore with underground development absorbing US$32 million per annum. Given that only 2.7 million tonnes are in reserve the author's valuation terminates underground capital investment in 2017. This drops Sukari related sustaining capex to US$47 million, which has been maintained until year 2031, two years before open-pit operations cease. It is not clear from the Centamin forecast whether or not it includes a substantial provision for the required expansion of the tailings dam facility before 2018.

Operating Expenditure

Table 7.4_1 gives the historical financial performance, which was used to establish the operating cost structure of Centamin.


Open-pit mine production during the first nine months of 2015 was at approximately 59 million tonnes per annum (Mtpa), or at 60% of the long-term rate. To account for economies of scale 10% of the open-pit mining cost was estimated as fixed. The variable cost is then escalated to account for the deepening of the pit in line with the suggested ultimate cost of US$3.80/t moved at the end of the life of mine. To escalate the cost on a straight line basis would be not realistic as most of the material will come from shallower levels given the narrowing shape of the pit with depth. The operating cost for mining, processing and General and Administration have been derived from the reported numbers in the financial statements for these activities expressed in US$ per ounce. The drop in unit cost can be ascribed to economies of scale as production is ramping up.

To arrive at an algorithm to account for the escalation, an exponential and a binomial function were used to fit to the variable costs in year 1 (US$1.47/t moved) and year 19 (US$3.60/t moved) (refer to Figure 7.4_1).

Figure 7.4_1

Algorithms for the Variable Mining Cost Escalation Over Time

To give the project the benefit of the doubt the polynomial function, which gives overall lower costs, in particular in the earlier years, was used for Base Case cost modelling.

Underground mining cost was assumed to have reached steady state with the underground development substantially completed.

In the first 6 months of 2015, plant production had reached steady state at rated plant capacity which makes US$15.70/t treated in the CIL plant a reasonable long-term unit cost rate.

The General and Administration and Corporate expenses in the first nine months of 2015 have been assumed representative for long-term annual cost.

Royalties, Taxes and Profit Sharing

Royalty

The Government of Egypt receives a royalty of 3% of net sale revenue, payable in cash each calendar half year.

Income Taxes

Starting from the date of commercial production PGM will enjoy a 15-year exemption from taxes imposed by the Egyptian government. PGM and EMRA also agree that the operating company will in due course file an application to extend the tax-free period for a further 15 years.

Profit Share

EMRA is entitled to 50% of the "net operating profit surplus", subject to PGM being entitled to recover the following costs and expenses payable from sales revenue:

  • All current operating expenses incurred and paid after the initial commercial production;
  • Exploration costs, including those accumulated prior to the commencement of commercial production at the rate of 33.3% per annum;
  • Exploitation capital costs, including those accumulated prior to the commencement of commercial production at the rate of 33.3% per annum.

If costs recoverable by PGM exceed the sales revenue (excluding the royalty payable to the government) in any financial year, the excess shall be carried forward for recovery in the next financial year or years until fully recovered but in no case after the termination of the agreement.

After deduction of royalty payments and recoverable expenses, the remainder of the sale revenue will be shared equally between PGM and EMRA. Except that for the first and second years in which there are net proceeds for the entire year, an additional 10% of those proceeds shall be paid to PGM as incentive (PGM 60%, EMRA 40%). For each of the next two years, in which there are net proceeds for the entire year, 5% of the net proceeds shall be paid to PGM (PGM 55%, EMRA 45%), thereafter the net proceeds shall be shared equally (PGM 50%, EMRA 50%).

Figure 7.5_1 shows schematically the holding arrangement of Sukari Gold Mines.

Figure 7.5_1

Holding Arrangement of Sukari Gold Mines

The wording in the documentation does not make it clear whether or not capital expenditure is deductible, but the forecast cash flow in a slide of a presentation dated September 2015 indicates that profit sharing starts in 2017 (Figure 7.5_2). Without capital expenditure being allowed, profit sharing would start in 2016.

Figure 7.5_2

Cash Flow Forecast by Centamin Management at a Gold Price of US$1,200/oz

For this reason the model has assumed that profit sharing starts after the cash balance at 1 July 2015 plus additional net per cash generated exceeds US$400 million (as per Figure 7.5_2).

The model has assumed that profit sharing only applies for years with positive cash flow and negative cash flow being fully attributable to Centamin.

Working Capital Requirements

The cash flow model assumes that the net current assets at 30 September 2015 of US$310.3 million are sufficient and no additional investments are required.

The net current assets are assumed to be fully recovered at the end of life of mine.

Metal Prices Assumed

The valuation has adopted the metal prices on 17 November to determine how the Enterprise Value placed by the stock market on that day compares to the valuation of the discounted cash flow.

Evaluation Results

Table 7.8_1 summarizes the cash flow results for the life of mine and 5 years ending 31 December 2019 at spot prices on 17 November 2015 of US$1,071/oz gold (Base Case price).

  • The cessation of underground mining

The table shows that the net present value of the project at 5% discount rate (NPV5) is minus US$90.1 million for net free cash flow over the LOM of which plus US$96.5 million accrues in the first five years should the spot prices on 17 November 2015 apply for the life of the operation. Based on the above much value is destroyed after the first five years. A combination of negative factors result in net free cash flow that substantially negative, with the realisation of working capital in the last two years somewhat compensating for negative cash flow in ten years. The negative factors are:

  • The jump in stripping ratio to expose ore
  • The effect of deepening of the pit on variable mining cost
  • The impact of profit sharing effective starting after 2019 when the pre-payment credit has been used up.

Given that revenue is the largest number in the derivation of net free cash flow and the high contribution of mining cost on overall cost, a sensitivity analysis has been carried out for these two parameters at spot prices and the results shown in Figure 7.8_1.

Figure 7.8_1

Sensitivity of NPV5 to Gold Price and Mining Cost

The graphs show that NPV5 for polynomial variable mining cost escalation would turn positive for very small increases in the gold price and decreases in mining cost when assuming exponential escalation. At exponential cost escalation the value is substantial negative for the base-case gold price. A gold price of around US$1,500/oz is required to get to a NPV5 value of approximately US$1.0 billion.

Table 7.8_2 expresses the sensitivity of the project value as the change in Net Present Value per percentage point change in the economic main parameters.


Share Price Performance and Current Enterprise Value as examples of how the table should be read, for every percentage point increase in gold price (i.e., US$10.7/oz), the NPV5 increases by US$22.8 million and, for every percentage point increase in the mining cost (i.e. in 2016 US$0.0175/t moved higher), the NPV5 drops by US$18.0 million.

Figure 8_1 shows the share price history for Centamin on the TSX since it listed there on January 2007, compared to the gold price performance over that period.

Figure 8_1

Share Price Performance of Centamin Plc on the Toronto Stock Exchange

Gold Price Performance Since January 2008

The early ramp-up in share price coincided with announcements of successively higher resources, only to be interrupted because of the 2008 Credit Crisis, but soon to resume its rise as the mine started operating in mid-2009 and the size and confidence in resources kept growing in tandem with an ever-higher gold price. It is not clear from the press releases what the reason is for the decline in prices after mid-September 2010. The sharp drop in October 2012 follows the decision by the Administrative Court to cancel the exploitation license. The rising trend since mid-2013 is despite the poor performance in the gold price and distinguishes Centamin as one of the best gold counters one could have bought in 2013.

At a share price of C$1.24 on 17 November 2015, the company has with 1,152.11 million shares (according to the TSX) a market capitalisation of C$1,428.6 million, which at the exchange rate on that day of C$1.332 per U.S. dollar equals US$1,072.5 million. According to the quarterly statements for the period ending 30 June 2015, there are no warrants outstanding and the only share options applicable relate to 5.15 million "awards" to employees, which may take the form of nil cost options or have a nominal exercise price and are subject to satisfying applicable performance conditions.

At the end of the quarter the company had cash balances amounting to US$190.6 million and was debt-free.

The Enterprise Value assuming no dilution through the exercise of the options is as follows:

U$'million

Market Capitalization 1,072.5

Plus: Loans -

Cash at Banks and on Hand (190.6)

Enterprise Value 881.9

When the Enterprise Value is expressed as value of per attributable reserve ounce (50% of total), it amounts to only US$200, which is very generous in the current market, in particular as the reserves are generally of 'low to very low' grade for a milling operation.

Conclusions

The following general conclusions can be drawn:

  • Centamin's value is essentially determined by its 50% interest in the Sukari operation.
  • The mine is cash-generative even at the current gold price, allowing for return of funds to shareholders as dividends and share buy-backs as capital expenditure has dropped considerably.
  • The good cash performance is due to a combination of underground production with very good margins, open-pit mining at low stripping ratios, tax exemption and with profit sharing deferred until investments having been recovered, the mine coming into operation when the gold price was at US$1,000/oz rising to above US$1,600/oz for the period mid 2011 until end 2012.
  • The historical performance is as good as it gets as all the positive factors mentioned in the previous bullet point come to an end within the next few years.
  • Management has put a gloss over this in their latest 5-year production plan, artificially holding down the strip ratio and assuming continuation of underground mining at a very high level, without having the reserves to sustain this.
  • Should this plan be implemented, the life of the operation will be curtailed to five years if there is not a major increase in the gold price.
  • Table 9_1 illustrates that open-pit ore is uneconomic at current mined grade at the required strip ratio and a price of US$1,200/oz. The current good financial performance of Sukari can almost fully be attributed to underground mining.

  • Table 9_2 illustrates that the assumptions for determining the net free cash flow has been greatly biased to favouring the performance. Based on the discounted cash flow that can reasonably be expected from the 5-year cash flow at current spot gold prices, the value of the company is at best US$406 million, being US$96 million for the NPV5 of net free cash flow plus US$310 million net current assets. This equates to a share price of C$0.47.

Table 9_2

Centamin Plc

Favourable Versus Unfavourable Bias in Assumptions for Valuation

Favourable

Unfavourable

Ignoring that the current lower gold grade compared to reserve grade could be due to dilution and lack of selectivity in mining

Cessation underground mining after depletion of current reserves + 420,000 tonnes

Incorporation fixed element in mining cost

Lower metallurgical recovery than current

Use of polynomial approach to variable mining cost escalation

No sharing of negative cash flow

Removal impact of capex on other projects from cash flow

No obvious capital provision for tailings dam expansion

Inclusion of sustaining capital cost as deduction for profit share

No further investments in working capital over the life of mine

No provision for closure and rehabilitation cost

Based on the available information, Centamin at its current price of C$1.24/share is very much overvalued.

Disclosure: I/we 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.

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