Teranga Gold: I Am Optimistic In The Medium Term

Summary

• Teranga is a mid-cap gold mining company operating the Sabodala mine in Senegal.
• In my opinion, the company's shares are strongly undervalued today.
• In the medium term, Teranga share prices should be supported by the company's largest shareholder; since November 2017, this shareholder has purchased 2.05 million shares and is still buying.
• What is more, despite these positives, Teranga shares are the cheapest stocks among its African peers.

Most recently, I have constructed an index replicating the share price action of a few precious metals mining companies operating only in Africa. The index is comprised of the following plays: Teranga Gold (OTCQX:TGCDF), Roxgold (OTCQX:ROGFF), Randgold (GOLD), Endeavour Mining (OTCQX:EDVMF), Semafo (OTCPK:SEMFF), Perseus (OTCPK:PMNXF) and Golden Star (GSS). Interestingly, shares of these companies are in fashion once again:

(Source: Simple Digressions)

The chart above compares the Africa index to the VanEck Vectors Gold Miners ETF (GDX), a popular ETF representing a number of gold miners stocks. Note that after a period of outperformance (January 2016 - December 2016; the blue arrow), between December 2016 and June 2017, the African miners were out of fashion (the red arrow). Then, since the end of 2017, these shares have been attractive once again (the blue arrow on the right).

Investment thesis

Not many mining companies are able to pass a valuation test based on a discounted cash flow model. Due to relatively high gold prices, precious metals miners’ market values are well above their intrinsic values (calculated using the discounted cash flow models). However, Teranga Gold, a mid-cap African mining company, passes such a test. According to my own calculations, one share of Teranga is worth $5.65. This value was calculated using a discounted cash flow model applied to two projects owned by the company: the Sabodala mine and the Wahgnion development project.

What is more, in my opinion, there is a medium-term catalyst that can drive Teranga’s share prices up. In November 2017, the company’s largest shareholder announced his intention to purchase up to 5% of Teranga shares. Since that time, this shareholder has purchased as many as 2.05 million shares, and a possible result of his activity is shown here:

(Source: Simple Digressions)

As the chart shows, since the end of November 2017, Teranga shares have been outperforming the Africa index (the blue arrow). In my opinion, there is a good chance that this positive trend will continue.

Last but not least, in 2014, Franco-Nevada (FNV), the largest precious metals streaming company, signed a streaming agreement with Teranga. According to this agreement, Teranga is obliged to deliver part of Sabodala production to Franco-Nevada. Well, generally, each streaming agreement has a negative impact on a company’s economics, but in the case of Sabodala, I would also say this:

The fact that the world’s largest streaming company is betting on Sabodala gives credible evidence that this operation is a world-class asset.

Sabodala mine - The main asset

Sabodala is an open pit operation located in Senegal. The mine started its operations in 2009, and until the end of 2017, it produced 1.7 million ounces of gold:

(Source: Simple Digressions)

Guidance for 2018

Generally, this year the Sabodala mine should perform in a similar way as in 2017. For example, it should produce 210-225 thousand ounces of gold (233 thousand in 2017) at a similar cost.

Now, the Sabodala open pit mine consists of a number of gold deposits dispersed on a large area. The most important ones are as follows: Masato (holding 660 thousand ounces of gold classified as mineral reserves), Niakafiri East (550 thousand), Golouma West (250 thousand) and Sabodala (240 thousand). This year, the company is going to mine gold at one of its major deposits (Golouma West) and three minor ones (Kerekounda, Golouma South and Gora - these three deposits contain 240 thousand ounces of gold).

What is important, Sabodala’s production is very predictable, and the mine’s geological profile is well understood by company management. For example, Teranga produces gold strictly in line with the production schedule disclosed in Sabodala’s technical report.

Another example - the actual grades mined at Sabodala were in line with the grades disclosed in the mineral reserve estimate; what is more, the amount of ore mined was even higher, which makes me think that the mineral reserve estimate may be underestimated - look at the table below and the row marked in red:

(Source: Teranga (SEDAR, August 30, 2017))

This remark is pretty important, because it justifies using a lower discount rate to calculate the value of Sabodala.

Value of Sabodala

According to the technical report for Sabodala, the mine should operate until 2031 and produce 2.35 million ounces of gold (between 2018 and 2031). In 2023, the annual production coming from the main pits is supposed to shrink significantly (from 211 thousand ounces in 2022 to 141 thousand in 2023), but that year, an underground part of the mine should begin its operations. However, the underground mine will be relatively small - over its mine life, it should deliver 350 thousand ounces of gold (38.9 thousand ounces in annual production, on average).

Now, the technical report for Sabodala contains the detailed data that can be converted into a discounted cash flow model. Unfortunately, the company’s projections are based on the price of gold of $1,250 per ounce, which is well below the current gold price ($1,350 per ounce). Therefore, I have adjusted the data used by the company to the current price of gold and arrived at the Sabodala’s value of $483 million (using a discount rate of 5%).

Note: My model takes into account a streaming agreement signed with Franco-Nevada. According to this agreement, in 2018 and 2019, Teranga has to deliver 22.5 thousand ounces of gold to this streaming company; then, the company is obliged to deliver 6% of annual production over the remaining life of the mine.

Wahgnion gold project

In 2016, Teranga acquired Gryphon Minerals, an Australian exploration company holding a gold project located in Burkina Faso (the project, initially called Banfora, was later on renamed Wahgnion). At that time, according to Gryphon, the project’s after-tax net present value was $158 million (using a gold price of $1,250 per ounce and a discount rate of 5%) but now, after additional studies, the project’s value is $90 million. Well, I guess that Teranga investors were very disappointed to see this much lower value. However, it looks like the project’s economics may improve soon. Let me cite the company:

“The Company anticipates an improvement in the Wahgnion Gold Project’s economics following completion of the infill drill program designed to convert inferred resources to indicated resources and then potentially to reserves. Approximately 73,000 meters of drilling were completed in the fourth quarter and a reserves update is expected in mid 2018”

In other words, there is a good chance that we will see higher value of Wahgnion soon. However, according to the latest economic study, the project’s pre-tax net present value is $181 million, using the current price of gold of $1,350 per ounce. It means that, roughly speaking, the after-tax net present value of Wahgnion, adjusted to the current conditions, should stand at around $160 million.

This year, Teranga plans to spend $30 million on the Wahgnion development, but I expect that positive results of the latest drilling program may accelerate the project’s development.

Value of Teranga

Teranga’s two main value drivers are the Sabodala mine and the Wahgnion gold project. Assuming that:

• Sabodala’s value is $483 million, of which $435 million (90%) is attributable to Teranga (the remaining stake belongs to the government of Senegal)
• Wahgnion’s value is $160 million, of which $144 million (90%) is attributable to Teranga (the remaining stake belongs to the government of Burkina Faso)
• At the end of 2017, the company held debt of $61 million and cash of $88 million

... I have arrived at the following value of Teranga:

Teranga’s value = Net present value of Sabodala and Wahgnion + cash - debt = $606 million

Taking into account that at the end of 2017 the company’s share count was 107.34 million, one share of Teranga is worth $5.65. Today these shares are trading at $2.92, so they are significantly undervalued.

David Mimran wants to increase his holding in Teranga

Surely, the largest shareholder should know much about his company. And David Mimran, Teranga’s largest shareholder, is definitely well-informed about the value of his holding. Therefore, I was not surprised to see Mr. Mimran announcing his intention to purchase up to 5% of Teranga shares over the next twelve months, starting from November 2017.

At that time Gold Panda, one of the contributors on Seeking Alpha, discussed this announcement in this article. Today, I want to say that Mr. Mimran has been very active, and since November 2017, he has purchased as many as 2.05 million shares of Teranga (as of March 1, 2018).

Interestingly, there is a good chance that he will continue his purchases. According to my own calculations, there are 3.3 million additional shares to be purchased (to hit his target of 5%), so I am quite confident that the demand for Teranga shares, expressed by Mr. Mimran, should have a positive impact on the company’s share prices in the medium term (until November 2018).

Risks

As usual, there are a number of risk factors a prudent investor should keep in mind before investing in Teranga shares. Let me discuss a few of them.

Hedging policy

According to the company (2017 annual report, page 4):

“On September 11, 2017, the Company entered into forward gold sales contracts for a total of 131,000 ounces of gold with settlements commencing October 2017 through December 2018 at a gold price of $1,336 per ounce”

In other words, Teranga has hedged 60% of its 2018 production with forward gold sales contracts. It means that higher gold prices (above $1,336 per ounce) will have only a limited positive impact on the company’s results. Well, I am not a fan of precious metals mining companies using gold hedges during a bull market in gold. However, Teranga’s management thinks differently, and investors should keep this fact in mind.

Wahgnion gold project - Risks and a possible reward

I discussed the Wahgnion project in the section above, but here I want to repeat that this project looks a bit worse than in 2016 (when Teranga purchased Gryphon).

However, the project may also present upside potential - if Wahgnion reserves are higher than before (a new estimate should be released soon), it could be a major boost to the company.

On the other hand, to construct the Wahgnion mine, Teranga will need additional, external financing. That is another risk factor for the company.

Note: Apart from Sabodala and Wahgnion, the company owns a number of gold projects in Africa. However, these projects are at their early exploration / development stage, so I am not discussing them in this article.

Summary

In my opinion, Teranga shares are strongly undervalued now. According to my own calculations (but based on the company’s data), one share of Teranga is worth $5.65. What is more, using an EV / EBITDA multiple (a popular relative valuation measure), Teranga shares are the cheapest ones among African gold plays:

(Source: Simple Digressions)

Teranga’s largest shareholder has been aggressively purchasing the company’s shares since November 2017. According to my own calculations, this shareholder is in the middle of his purchasing program, so there is a good chance that the current strong demand for the company's shares will be continued. Hence, my positive opinion on Teranga in the medium term.

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.

Analyst’s Disclosure: I am/we are long GDX, CEF. 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.