My Background: I held shares of Thompson Creek (OTCQX:TCPTF) for several years prior to it being acquired so I have been following Mt. Milligan for a long time. It is important to note that the only thing holding back Mt. Milligan under TCPTF was poor management and a huge debt burden. Mt. Milligan was Thompson Creek's attempt to diversify away from a dying Molybdenum business but it was not able to ramp it up fast enough to overcome its debt. My investment is currently down 20% so, like many other former TCPTF shareholders, I must decide whether to cut my losses and run or give Centerra (OTCPK:CAGDF) a chance. This article summarizes why I have decided to hold my shares (for now).
Centerra is great value based on 2017 production estimates
To start, here is a look at the numbers based on 2017 guidance from Centerra as of Q4.
- Centerra estimates it will produce 715,000 to 795,000 ounces of gold at an all-in sustaining cost (including by-products) of $743 to $824.
- 35% of gold produced at Mt. Milligan must be sold to Royal Gold (NASDAQ:RGLD) at $435 per ounce.
- I will use the midpoint of Centerra projections on cost and production but from what I have seen so far, it seems to put out low estimates and then exceed them. It is also possible it will exceed expectations due to rising gold and copper prices.
The following are my calculations from info provided by Centerra in the recent Q4 news release:
My Revenue projection:
95,000 ounces of gold to RGLD at $435 = $41,325,000
655,000 ounces of gold to market at $1,225 (my estimate) = $802,375,000
My Expense projection:
750,000 ounces produced at all-in sustaining cost of $780 = $585,000,000
Roughly $845M in revenue - $585M in costs = $260M profit
My Valuation projection:
Using a multiple of 8, the projected market capitalization would be ($260M * 8) or $2B.
$2B market capitalization/291M shares outstanding would give us an estimated stock price for CAGDF of $7.11. That represents an approximate 40% increase from the current stock price of $5.00.
Note: I do not consider copper or Molybdenum production in this analysis because Centerra has estimated the Moly business to operate at roughly breakeven and copper production is figured into the all-in sustaining cost of gold production on a by-product basis. It should be noted that current copper prices are above the assumptions used in Centerra's estimates so the "all-in cost" of gold could be even less than stated above.
Why is this stock priced so cheap?
Before we start getting excited that we found an undervalued company, there is a reason why this stock trades at a discount!
At first glance, Centerra appears to have a healthy balance sheet but $250M of its cash is essentially frozen in Kyrgyzstan pending international arbitration. The company faces multiple environmental accusations in the country (totaling over $100M in claims) which Centerra believes is an attempt to impose new taxes and payments on the Kumtor project. The frozen cash can be used for Kumtor operations but cannot be used to fund operations in other countries or paid out to shareholders. Due to liquidity issues caused by the frozen cash, Centerra also had to freeze its dividend. This was a prudent decision and allows it to focus its cash flow on continuing to reduce dependency on Kumtor.
The company does have all necessary permits for 2017 operation of the Kumtor mine and expects a decision from international arbitration by mid-2017.
Mt. Milligan acquisition was a great move by Centerra especially due to decreased dependency on Kumtor to fund new projects
Mt. Milligan will provide over $100M per year in cash flow (my estimate based on Centerra 2017 guidance). While Mt. Milligan does not produce as much gold as the Kumtor mine, it does have a much lower all-in sustaining cost due to copper by-product. According to Centerra's presentation for the 2017 BMO mining conference, Mt. Milligan's all-in sustaining cost for 2017 is projected at $457 to $508 per ounce while Kumtor's is projected at $836 to $925. It is also important to note that Mt. Milligan greatly increased the company's reserves and is expected to sustain production for at least 20 years.
The importance of diversifying to two major mines producing and significant cash flow coming from a "safer" source like Canada cannot be overstated and I believe this is the best possible move Centerra could have made in 2016.
The next likely production is to come from Oksut in Turkey. Production could begin as early as mid-2018 if the company receives the last key "pastureland" permit by Q3 2017. It has already secured a $150M credit facility to develop this project. I believe this, in addition to cash flow from Mt. Milligan, will be sufficient to develop this project. The company estimates this mine will produce 150,000 ounces of gold per year for at least four years at an all-in cost of $490 per ounce. Production will continue for several years after the initial four but at a decreased rate.
Gatsuurt in Mongolia could also produce within a few years if permits can be obtained from the Mongolian government. This would add additional 100K+ ounces of gold per year.
All in all, Centerra has a strong pipeline which one Seeking Alpha writer projects will result in gold production of 1M ounces per year by 2020.
Based on producing $100M in cash flow per year, Mt. Milligan alone is worth at least $1B which is roughly two-third of the company's total current valuation. This cash flow also makes it much more likely Centerra can be successful developing the rest of its pipeline of projects. From a former TCPTF shareholder perspective, Centerra management brilliantly acquired exactly the type of asset it needed in Mt. Milligan and at a great price.
I view Mt. Milligan as the cornerstone asset of Centerra going forward which I believe has not been priced in by the market. Obviously, having cash flow from Canada is more stable and thus significantly more valuable than cash flow from Kyrgyzstan.
Based on numbers alone, CAGDF is about 40% undervalued which may be extreme given the new-found stability from Mt. Milligan although some discount must be provided due to the issues with the Kyrgyzstan government. It is possible in a worst-case scenario that the government seizes the mine and all the cash. Even if international arbitration sides with Centerra, there is no guarantee the government will honor it.
I recommend a small position due to 40% upside potential if a positive resolution is reached at Kumtor. Don't bet the farm on it though because the Kyrgyzstan government is highly unpredictable and there is no way to know for sure how this situation will be resolved!
Disclosure: I am/we are long CAGDF.
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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