Major Issues For Pretium Resources

Summary

• Shares of Pretium Resources have been obliterated over the last few months because of grade reconciliation issues at Brucejack.
• The current problem at Brucejack also potentially impacts whether the company will be in a position to buy back the stream on the mine and repay debt.
• It's going to be at least another 1-2 quarters before we have a firmer grasp of the situation.

Pretium Resources (PVG) has been punished over the last few months as the company's Brucejack mine in Canada is running into some potentially major issues. That steep drop in the shares in January took place after PVG released an operations update - in which it announced fourth quarter 2017 production results from Brucejack and also provided guidance for the first six months of 2018.

PVG data by YCharts

Issue #1

Gold production for Q4 came in at 70,281 ounces, that's down from the 82,203 ounces of gold produced in Q3. Considering that Brucejack is in the ramp-up stage, production should not be going backwards. Recoveries are running just slightly below expectations, but that's not where the problem is at as grade is the issue.

The company stated:

Grade reconciliation to the reserve model for the period August 1, 2017, to December 31, 2017, was approximately 75% to 80%.

According to the technical report, Au grade in year 1 is expected to be 15.4 g/t. If grade is coming in around 75-80%, then that equates to an ~11.5-12.0 g/t head grade. But PVG also wasn't able to access as many high-grade stopes, so actual mined grade was only about 8-9 g/t in the fourth quarter.

(Source: Pretium Resources)

Unfortunately, this wasn't an isolated quarter as the guidance that PVG is giving introduces even more uncertainty in terms of grade reconciliation and the mine plan. The company is forecasting gold production at Brucejack for the first half of 2018 to be in the range of 150,000 ounces to 200,000 ounces. That would put the total first year of gold production at 302,000 ounces to 352,000 ounces (July 1, 2017, to June 30, 2018). Brucejack should be producing over 100,000 ounces per quarter right now and was expected to hit over 400,000 ounces in its first year of production.

As for an explanation for this grade issue, Pretium stated:

During the period, ore from the stopes developed on the 1200-meter Level sill provided approximately 25% of mill feed. These stopes were mined in establishing the 1200-meter Level sill as part of the long-term mine plan and had a lower drill density than stopes on other levels of the mine. As the grade control program becomes operational and mining moves up from the 1200-meter Level into areas with higher drill density, reconciliation is expected to improve.

Basically, Pretium is saying that this 1,200 level provided a quarter of the production, but infill drilling wasn't as tightly spaced as higher up levels. Meaning, it thought the ore grade in some of these stopes would be better, but it didn't have as much certainty given the drill density. Pretium is stating that as it moves up to levels that have tighter spaced drilling, the grade should start to meet expectations. Whether that is the case remains to be seen.

Pretium is mining at the 1,200 to 1,320 level, which is in the VOK Middle mining block. This area does contain the lowest grade in the Valley of the Kings, but it still will be a major source of ore according to the mine plan (as it holds 2.7 million ounces of gold reserves). Or at least there were that many ounces according to the mine plan. The concern now is whether this figure is even accurate given the problem with grade reconciliation it is seeing in this section of the deposit.

(Source: Pretium Resources)

This diagram gives a better depiction of how these blocks are oriented.

(Source: Pretium Resources)

The first 5 years of production will be mostly from VOK Upper and Middle; it's extremely important that there aren't any major grade issues in the Middle block.

(Source: Pretium Resources)

Pretium believes this will be resolved once it opens up some additional mining horizons this year, which will give it access to more mining levels and the broadest range of stopes. This will allow it to "maximize stope blending" as it can mix in some of the richer grade material and smooth this all out. The "expectation" is that grade will start tracking along with the mine plan.

I also wanted to note that the company didn't give full production guidance for 2018; it only gave a forecast for H1. Not something that gives investors confidence, but it's probably prudent that the company didn't forecast any further out considering the uncertainty.

As a side note, I mentioned to subscribers of The Gold Edge last December:

One interesting piece of news was the company announced a few weeks ago that it's looking to increase the mine rate and mill capacity at Brucejack to 3,800 tonnes per day, up from 2,700 tonnes. One could look at this from a positive and negative point of view. Positive in that PVG sees even greater output potential given how mining is progressing, negative in that they could be increasing the mining and milling rate because they are seeing issues with grade and this will help get production up to expected levels (which would be a major red flag if the was the reason for the increase). Again, Q4 results will tell us a lot more.

Q4 results have told us a lot more. My concern was this ramp-up in tonnage was because of issues with the grade. While we still don't know if this is the case or not - as Pretium is certainly mining more tonnage than expected, and this could be a logical reason for expansion - it won't be too much longer before we find out.

Issue #2

The current problem at Brucejack also potentially impacts whether the company will be in a position to buy back the stream on the mine. More importantly, concerns about liquidity have now increased given the debt and low cash balance.

Pretium needs Brucejack to get back on track in order to satisfy all of its near-term debt obligations.

Below is the balance sheet as of December 31, 2017. Pretium's cash position at the end of last year was just $56.3 million. The current portion of long-term debt was $375 million; the vast majority of that debt is a senior secured credit facility that matures at the end of 2018. The good news for Pretium is it has an option to extend this maturity date for one year - for an extension fee of 2.5% of the principal amount, including accumulated interest. This at least defers payment on this large amount of debt. Under non-current liabilities, you will see there is also an additional $293 million of long-term debt. This is actually the amount due for the offtake and stream obligations, which are being recognized as debt instruments and derivative liabilities. The remaining debt is $76.6 million of convertible notes, which aren't due until 2022.

(Source: Pretium Resources)

Breaking this debt down further (but not including the convertible notes), you can see the offtake and stream obligations in more detail. Pretium doesn't technically have to buy these obligations back. It can just deliver the gold over the terms of the agreements (basically the current mine life) to satisfy what is owed. However, the company does have the right to repurchase these if it so chooses and would benefit if it does.

(Source: Pretium Resources)

Pretium has the right to repurchase the 8% stream obligation for $237 million on December 31, 2018, or it can defer that for another year but pay $272 million on December 31, 2019.

There is also another option where Pretium can reduce the stream obligation to:

• 3% on December 31, 2018 (and accelerate deliveries under the stream to January 1, 2019) for $150 million.
• or 4% on December 31, 2019 (in which case deliveries will commence on January 1, 2020) for a $150 million.

Brucejack is expected to produce 7.27 million ounces of gold over its life of mine. Take about 1 million ounces off of that total for the amount that will be part of this 8% stream (as the stream wouldn't likely kick in until 2020 if it went into effect). That's just over 500,000 ounces of gold that will go to Blackstone and Osisko Gold Royalties (OR) (each owns a 4% stream), which is a substantial amount of ounces.

Pretium would come out ahead on an NPV basis if it bought this stream back, and that's only using a $1,300 gold price over the life of mine. The more the price of gold increases, the more Pretium will gain by repurchasing this obligation (assuming margins also expand as the price of gold rises).

If Brucejack didn't have this significant stream attached, the project would command a higher premium and result in a higher market cap for PVG.

One could also argue that if PVG repurchased the current stream, then down the road, it would have the option to sell a stream or royalty on Brucejack for far more than it did a few years ago. If Brucejack does produce according to the mine plan from this point forward, then there is now more certainty with the project. This would allow Pretium to recognize a higher value for any future stream. Whereas the current stream agreement was made before the mine was even built, and uncertainty and risks were extremely elevated.

At the end of the day, there are many benefits to buying back this stream.

The offtake agreement requires it to deliver 100% of the refined gold from Brucejack (up to 7,067,000 ounces). However, Pretium can also reduce this obligation by up to 75% by paying $11 per remaining ounce by December 31, 2018, or $13 per ounce by December 31, 2019, on the then remaining undelivered gold ounces.

The "cheapest" option for Pretium is to buy back the stream and offtake by the end of this year. The problem is it will cost it ~$295 million, and at the moment, it doesn't have even close to that amount of cash to cover this. If the company waits until the end of 2019, then it gives it more financial flexibility and more time to build up cash reserves, but the price to buy back these obligations will be about $45 million higher.

According to the most recent conference call, Pretium is looking to refinance the current credit facility by the end of this year but mentioned using that 2.5% extension fee option to push back the due date by one year. It also stated: "We'll also look to extinguish the existing 8% stream that is due to start in January of 2020."

Bottom line, Pretium has some work to do not just on the operations side, but on the finance side as well.

We Need Another Quarter Or Two Of Results

We still don't know what Brucejack will produce going forward. The upper portion of the mine contains the highest grade ore, and if that area of the deposit hits expectations, then that will go a long way towards easing some concerns.

Mines usually go through teething problems at start-up. This is different (and much more serious) than issues typically seen, but there are still some areas that will be improved upon that could help with grade.

I also want to mention that PVG is guiding for as much as 200,000 ounces for the first half of this year. That would put production at Brucejack at about 100,000 ounces per quarter. If it can manage to hit that mark, then I expect the stock to rebound somewhat as the picture would look a little brighter at that point.

For now, it's a waiting game as it's going to be at least another 1-2 quarters before we have a firmer grasp of the situation. If problem #1 is resolved, then that takes care of problem #2. If problem #1 lingers or gets worse, then Pretium is going to be in trouble. It's too early to make a call, but there are a lot of red flags at the moment.

I would never pull against a company, and I would love to see PVG turn things around. But for now, I'm just on the sidelines, given the uncertainty with the mine and the current financial position of the company.

Analyst’s 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.