Regis Resources: Finally A Reason To Buy Again
- On surface, Regis Resources is fully valued.
- Which is a shame, since this is one of the most reliable gold miners to own.
- Hidden value is about to surface, finally making Regis Resources a BUY again.
About a year ago, we issued our last in-depth update on Regis Resources (OTCPK:RGRNF) and marvelled at how "Regis Resources has reclaimed its place among the top gold miners to invest in". And, by the same token, we noted how the company represented "Quality At A Price" after the market had re-applied a high premium to the share price. Since then, the company has continued to post one strong quarter after another, has been paying a sector-leading dividend, and has followed our script almost to the dot in addressing the last remaining concerns investors might have had with regards to the Duketon project.
A bargain Regis Resources is certainly not by any valuation metrics, and up until very recently, we would not have recommended an entry to growth-oriented investors as shares appeared fully valued. However, a couple of recent news releases followed by a few phone calls have changed our view, and we have come to believe that behind the disguise of an aptly valued and otherwise boring cash cow, the company has worked on a significant value-add about to be revealed in detail in just a few months' time.
And thus, we believe a strong bull case has emerged yet again for Regis Resources; the present article provides the details.
(Map of Duketon operations. Source: company presentation)
The Duketon operations include two mills, one at Moolart Well (aka. Duketon North); and another one at Garden Well (aka. Duketon South), with several open pit mines feeding into these mills.
In our last article, we explained how reserves at the ore sources for Moolart Well had been depleted to a point causing concerns among some investors. These concerns have since been alleviated as the newly acquired Gloster resource has been turned into a satellite mine and will contribute ore with a comparatively high grade for the next four years minimum, to be blended with ore from the original Moolart Well pit plus ore from a series of other projects under development within trucking distance of the Moolart Well mill.
At twice the capacity Garden Well, or Duketon South, has turned into the engine room it was originally designed to be. Recovery problems and reduced mining rates are well and truly issues of a distant past as this well-oiled operation churns out 50,000+ ounces of gold per quarter without fail and at industry leading costs.
Costs at both operations have remained well under control with all-in sustaining costs, or AISC, mostly remaining under the industry leading A$1,000/oz mark (or $760/oz in US-Dollars). Keep in mind that Regis Resources doesn't hide any cost items from these AISC either as this company has a refreshing habit of reporting news and data, good and bad alike, with clarity and transparency.
And in case anyone still remembers the 2014 pit flooding at Garden Well and Rosemont following a once-in-a-century deluge, and worries about a recurrence of the ensuing force majeure, then rest assured. The March quarter saw a number of significant rain events again with Moolart Well receiving the brunt of 280mm of precipitation during the quarter. Nearby Laverton airport recorded a daily peak of 100mm, versus the 130mm back in 2014. Regis Resources simply did not miss a beat, despite losing 19 haulage days at Moolart Well, and 12 mining days at Garden Well. This operation has been well and truly weather proved and operations have been further de-risked in the process.
The charts below speak volumes to this assertion. The first three charts show the impact of the weather events, with mining rates down, and tonnes milled down as well. However, gold production clocked in right on target as evidenced in the bottom right chart, thanks to the thorough preparations in anticipation of the typical Q1 storms.
The highlighted slight uptick in AISC for the March quarter has nothing to do with any weather-related challenges but rather, and contrary to first impression, it is a harbinger of good news. The company is bringing the Erlistoun deposit into production, and the increase in AISC relates to start-up stripping with a 39:1 waste to ore ratio. This will quickly decrease over coming months, and AISC will drop back under A$1,000/oz (remember what we said about cost accounting - start-up stripping was not hidden in growth capex as so many peers would have done).
And as Erlistoun comes online, the company is already readying the next deposit for contribution to the Duketon South operations. A maiden reserve for Toohey Well was released in June documenting 366,000 ounces at almost double the current head grade at Garden Well, and only a couple of kilometers from the mill. This reserve more than replaces total Duketon depletion for 2017, and it ensures the projected 10% annual production increase at Duketon will be achieved comfortably when the pit comes online in the March 2018 quarter.
Financially Regis Resources has returned to its old strength, with a strong balance sheet growing stronger with every quarter, and rewarding shareholders with sector-leading dividends yielding 5.3% at the current share price. As is common with ASX-listed companies the most current financial statements date back to the December quarter. Working capital stood at A$109M with A$94M in cash and no debt. At the end of March, the cash position stood at A$115M after paying out A$35M in interim dividends in Q1. With no dividends due in Q2 and extrapolating typical cash flows, we expect the cash position to increase to close to A$150M at the end of the June quarter, which also concludes the financial year for the company. By the end of the year, we expect the cash balance to come close to A$200M, already accounting for the mentioned production uptick at Duketon South, and a dividend at current levels.
So, what's not to like? Well, quite clearly the share price.
The market has recognized Regis Resources as the powerhouse it is and has applied a deserved but hefty premium for the quality of the Duketon project on top of the premium for the management team. Consequently, and at A$3.76 at the time of writing this is probably the most expensive Australian gold miner by any metric. If we follow the generally accepted thesis of Regis Resources focusing solely on the Duketon project that is.
However, we strongly believe this thesis is about to change.
McPhillamys Project - A Potentially Fatal Flaw Solved
At the end of the 2014 financial year, Regis Resources mothballed and booked a A$65M impairment charge against the McPhillamys project in New South Wales. This was a severe blow as it left Regis Resources without a tangible growth project. The market adjusted its view of the company accordingly and Regis Resources proceeded to focus on building out its Duketon gold project. Very little mention has been made of McPhillamys since then. "The project could not clear the company's hurdle rate at the prevailing gold prices" was the generally accepted thesis, and accordingly very little value was assigned to McPhillamys in analyst reports and other commentary.
We presume, that this commonly held view suited Regis Resources just fine, although we have held a different view all along: namely, that of McPhillamys being challenged due to very limited availability of process water. Mining operations in this part of Australia compete with agricultural users among others for scarce water and finding a sufficient and sustainable water source for a gold mine was never going to be easy. In fact, we still maintain that this issue was the main reason for Newmont Mining (NEM) to sell the project to Regis Resources a few years ago in the first place.
Our ears therefore pricked up when the company released news on the McPhillamys project on July 4 in the dry and factual manner we have come to expect from the company. As it turned out Regis Resources had secured not one but two options to obtain process water for McPhillamys.
- Option 1 – Water Supply from Mt Piper Power Station and Springvale Mine.
- Option 2 – Groundwater Access Licenses.
Option 1 is underpinned by an agreement with Centennial Coal and Energy Australia which operates the coal-fired Mt Piper power station near Lithgow, about 70km away from McPhillamys. The Springvale underground coal mine supplies coal to the nearby power station, and also produces water from controlling water levels at its underground workings. The power station itself sources cooling water from local dams, and the website dedicated to explaining the need for sourcing this water by Energy Australia is testimony to the scarcity of water in the general area. We discussed Regis Resources' announcement with an environmental engineer familiar with the coal mines and power stations in the greater Lithgow area and learned that this agreement represents in fact a win-win situation.
The water from these two sources needs to be treated before it can be released into the environment, and since the area is also a catchment for a large system of World Heritage listed National Parks the applicable rules are quite strict. By letting Regis Resources have the water free of charge the mine and power station operators rid themselves of the problem; and Regis Resources will need to include water treatment at a future McPhillamys mine in any case as part of its tailings management, so this deal won't add any significant cost.
(Mt Piper power station - Source)
When we said for free in the paragraph above, this is true with the one caveat that Regis Resources will need to organise transport of the water from the sources to the mine site. Moving water over long distances is a problem Australian engineers are quite familiar with. The undulating terrain between Lithgow and the mine site will probably favor a pipeline solution over a canal, and assuming a supply and lay rate of A$250/m the cost for such a pipeline would be in the A$25-30M range already including some contingency for feeding, discharge, and control stations.
We consider option 2 as the backup solution here, as the cost will probably be comparable, and using groundwater will almost certainly attract the attention of environmental groups, whereas the offtake of process water from the power generation facilities can be painted as improving on a potential environmental liability.
The market has shrugged this piece of news off, apparently still entertaining the view that McPhillamys will not go ahead at the present gold price. However, we believe that lack of water was the true culprit for shelving the project, and now that this potentially fatal flaw has been removed the project will be moved along swiftly. And since the market has not budged following the news release the eventual value creation and documentation thereof will be accretive to the share price.
And how accretive I hear readers ask? Well, the news release containing the information on the water sources also gave some hints and a few data points regarding Regis Resources' plans at McPhillamys. Nothing concrete, but sufficient to throw some numbers around and gain a ballpark feeling for what's in store.
McPhillamys Project - Economical Guesstimate
Regis Resources mentions water requirements of 4-5GLpa for a 7M tpa operation. This marks the first time the company has given any indication of throughput rates. Assuming 5% mining dilution, 90% metallurgical recovery, and accounting for the resource grade of 0.94g/t the 7M tpa number points towards an operation with an output of around 180,000 ounces of gold annually.
Regis Resources specializes in low-grade bulk mining operations amenable to simple CIL processing, and McPhillamys will certainly be no exception. In taking a stab at estimating the capex for such an operation of the mentioned size we can draw on operational data from Duketon, and also on the feasibility documentation released by Dacian Gold (OTCPK:DCCNF) in late 2016 for a very similar mine called Mt Morgans gold project, currently under development in Western Australia.
McPhillamys will be able to draw on a local work force, availability of grid power and other infrastructure. Adjusting for these advantages, but also adjusting for the difference in throughput when comparing the inputs to Dacian Gold's costing we estimate capex for McPhillamys in the A$300-400M range. Obviously, this estimate is based on a host of assumptions, including the size and nature of the mills, the tailings facility, and the mining costs. Nevertheless, that's the best we can do at this point in time.
At 180,000 ounce average annual production, and assuming 80% conversion from indicated resources to reserves the mine life will be pushing 10 years. And that's before consideration of 43,000m of drilling since the last resource update, and before consideration of the recently acquired satellite resources at Bald Hill and Discovery Ridge.
Extrapolating from the Duketon cost structure, and considering the advantageous location, availability of grid power, and expected low strip ratio we expect AISC to come in around the $1,000/oz mark again, with $1,200/oz as the upper limit for our models, yielding annual cash flows of A$70-100M at a gold price of A$1,600/oz ($1,120/oz in US denomination). As stated above, by the end of the year Regis Resources will be pushing A$200M in the treasury, and financing will presumably require debt in the order of A$200M; and this debt can be repaid within two to three years just from McPhillamys's cash flow alone.
Using the inputs above, and introducing some variations yields an NPV (5%) of $350M to $550M depending on how conservative one would like to be. Or put differently: at 501M shares on issue McPhillamys is worth between A$0.70 to A$1. Usually, we would argue that a multiple of less than 1 needs to be applied for a FS stage project, but given the premium the market is prepared to assign for Regis Resources we argue that a multiple of 1 is in fact a realistic expectation. Following this logic implies an upside of 19% to 27%.
Regis Resources has continued to perform base line studies throughout the mothball-period, and it has completed 43,000m of infill drilling. A resource update must be imminent, and we also expect a declaration of a mineral reserve. This by itself should already wake up the market and kick off a pricing-in of McPhillamy. Watch out for the corresponding news release sometimes in the September quarter.
Furthermore, this resource update will be feeding into a feasibility study, which Regis Resources is scheduling for release in late in 2017. This release will represent the moment of truth for our estimates in the section above; and it will demonstrate the value of McPhillamys to the market.
If this schedule appears too tight then keep in mind that water is scheduled to start flowing by mid-2019. Assuming a 1.5 year construction time as the bare minimum for a mine of this size, a development decision must be taken early in 2018.
Markets are currently slow to pick up on the developing McPhillamys story, quite possibly due to summer doldrums in the Northern hemisphere, and book squaring at the turn of financial years down-under. However, the listed catalysts are not far off at all, and in our view should be sufficient to instigate pricing in of McPhillamys.
Regis Resources is not only a best-in-class gold miner, it is also and perhaps foremost a solid and reliable business. This is a rare tag to have in the resource sector, and Mr Market is rewarding the company with an associated valuation premium. We have owned and held on to our position in Regis Resources for a rather long time now; but we haven't really had any reason to recommend an entry to our readers for over a year due to the rich valuation.
We believe this situation has just changed, as the market is still missing the significance of McPhillamy. We expect Regis Resources to trade higher once the value of McPhillamys becomes visible, and we see in the order of 25% upside as a result.
And with this in mind, we can call Regis Resources a BUY yet again.
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Analyst’s Disclosure: I am/we are long RGRNF. 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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