Alacer Gold: Sulphide Project Completed On Time And Under Budget

Summary

• 2018 results are in and the 2019 outlook is impressive.
• The Çöpler sulphide expansion comes in on time and under budget, significantly increasing mine life at attractive all-in costs.
• Management brings the Çakmaktepe oxide deposit online.
• Alacer adds exploration and development prospects to its portfolio.
• This investment is exposed to certain risks, including its concentration in Turkey, debt profile, and underlying commodity price volatility.

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Introduction:

For those of you who are new to the name, Alacer Gold (OTCPK:ALIAF) is a mid-sized miner headquartered in Colorado. It owns an 80% stake in the Çöpler open-pit mine in eastern Turkey, with local Turkish company Lidya Mining owning the remaining 20%. Alacer’s primary listing is ASR on the Toronto Stock Exchange, and it is incorporated in the Yukon. Here at Contra the Heard, the stock has been owned since late 2014 and the average purchase price is roughly C$2.00.

The stock was purchased in 2014 to add gold sector exposure. At the time, and even currently, gold miners were unloved and fit well within our contrarian bailiwick. Alacer was debt free at the time, was operating Çöpler successfully, and had promising development potential. The analysis suggested Alacer could better than double if the development projects paid off. As is outlined below, these projects are now coming online and the stock is responding.

Latest Results and 2019 Outlook:

Last week, Alacer released its full-year 2018 results. The company produced 171,000 ounces of gold versus expectations of 160,000 to 230,000 ounces. It also did so at an All-in Sustaining Cost (AISC) of $609 per ounce. This was below the forecast $650 to $700 range. Meanwhile, revenues were up slightly, but net income declined. The more important story, though, was the outlook. In 2019, total production is expected to approximately double to between 320,000 and 380,000 ounces. Better yet, management expects to maintain a low AISC between $675 and $725. Doubling production without significantly increasing costs is a wonderful combination which will materially improve free cash flow. This dramatic change in Alacer’s business has been made possible by many important milestones achieved in the last year.

Existing Operations Get A Boost From Çöpler Sulphide Expansion:

The most important milestone in 2018 was the completion of the Çöpler sulphide expansion project. The goal of the expansion was to turn Çöpler from a mine that could only process oxide ore to one that can handle sulphide ore too. In layman’s terms, extracting gold from sulphide deposits is more complex than from oxide deposits, and requires additional steps to speed up the natural process and extract the gold.

To showcase their efforts, investors and analysts were invited to Çöpler in 2017 and 2018. I attended on behalf of Contra the Heard in 2017 and spent a few days on site with the investor relations and executive teams. While I was there, I was impressed by management’s conservatism and organization, as well as the detailed work being done by the contractors and employees. The scale of the project was incredible and is hard to appreciate without seeing it firsthand. In order to process the sulphide ore, Alacer has built something akin to a chemical plant. Construction commenced in 2016 and concluded on time in the latter half of 2018. The budget for the expansion was $744 million, but management reduced the capital cost estimate to $664 million; to date, $648 million has been spent. The remaining costs are associated with bringing the plant up to commercial production, which is expected to conclude in early 2019.

This outcome places Alacer’s employees, contractors, and executives in a rare club of those who can build a mine on time and under budget. Investors should enjoy the benefits of this achievement for years to come – a notable one being that the project increases the mine life by roughly 20 years, making it one of the longest-lived in the industry. Over that time, the sulphide ore is expected to produce four million ounces of gold at a low AISC of approximately $645 per ounce, generating $1.6 billion in free cash flow (assuming a gold price of $1,250).

In addition to completing a complex project on time and under budget, Alacer also finished a heap leach expansion in 2018. This will maximize the capacity of the existing oxide facility. The timing of this development is fortuitous, as only a few miles from Çöpler is an oxide deposit called Çakmaktepe. This ore body received Environmental Impact Assessment approval in the third quarter, and mining operations started shortly thereafter. Çakmaktepe will add to oxide production in 2019.

When we invested in ASR, it had one mineral source - Çöpler’s oxides - and one processing facility - Çöpler’s oxide plant. Now there are three material sources - Çöpler’s oxides, Çöpler’s sulphides, and Çakmaktepe’s oxides - as well as two processing facilities – Çöpler’s sulphide plant and Çöpler’s oxide plant. Moreover, the sulphide unit has two autoclaves, which reduces the odds of a widespread outage if one of them experiences operating issues. These measures reduce the operating risks associated with a single mine or single processing facility.

Future Exploration and Development Opportunities Hold Potential:

Source: Alacer Gold’s MD&A for Q4

Alacer has a handful of exploration targets around Çöpler and Çakmaktepe too, the most promising of which is the Ardich deposit. In December, a maiden resource estimate was released which had 294,000 measured and indicated ounces at a grade of 1.32. The next steps regarding Ardich are securing an additional permit for more exploratory drilling, continuing work on the Environmental Impact Assessment, and pushing ahead with permitting. Management appears excited by this discovery given its proximity to existing infrastructure and the extent of mineralization.

Çöpler’s backyard is also home to a gold and copper prospect called the Mavialtin Porphyry Belt, and another called Demirmağara. Employees and geologists will be drilling parts of the Mavialtin Porphyry Belt to get a better geological understanding of the area and are awaiting a Forestry permit to drill around Demirmağara. These deposits around Çöpler could slowly build this region into a genuine mining district.

Source: Alacer Gold’s MD&A for Q4 2018

Further afield, the enterprise has its eyes on a smattering of exploration targets and land auctions in Turkey, as well as a deposit called Gediktepe in western Turkey. Gediktepe holds gold, silver, copper and zinc. A prefeasibility study in 2016 suggested a mine life of at least a dozen years. Though a definitive feasibility study was originally expected in mid-2018, it has been delayed to an unspecified release date. Instead, management will release more prefeasibility analysis over the next few months. Given the delays, it is unclear what will happen or when. However, in the past, Gediktepe appeared to look material enough to support the construction of a mine.

One worthwhile observation with these different ore bodies is the ownership agreement between Alacer and its local Turkish partner. In some cases, Alacer owns 80% of these deposits, while in other cases, it is 50%. Therefore, in addition to remembering many long and confusing names (which have been known to change), potential investors must also take into account a complex web of varying ownership interests.

Risks For Investors:

The most frequently cited risk is Alacer’s concentration in Turkey. A failed coup in 2016 and a currency crisis last year did little to sooth those fears. Since the lira fell in mid-2018, Turkey has hiked interest rates and stabilized the situation. Longer term, more interest rate increases and structural reforms may be needed.

Though it is possible an asset like the Çöpler mine is nationalized, this appears extremely unlikely. President Erdoğan is a pro-business leader, interested in improving his country’s economic situation, and wants to encourage foreign direct investment. Nationalizing a mine would do the opposite and drive away capital.

While some investors will not invest in Turkey, we are comfortable with the risk. In addition to Erdoğan’s pragmatic economic approach, Çöpler is far from Kurdish territories, the refugee crisis, and the cities affected by terrorism. The labour force is highly educated, skilled, and low-cost due to the value of the lira. Roads lead to the mine, and a nearby hydroelectric facility delivers cheap, reliable electricity. The local community is engaged, entrepreneurial, and receptive to development. Best of all, Turkey appears mineral-rich but relatively underexplored which gives companies like Alacer – which has been there for two decades – a first mover advantage.

Another risk is the company’s debt profile. In order to fund the sulphide project, management opened a $350 million finance facility with a lending syndicate. This matures at the end of 2023. As of December 31, 2018, Alacer had fully drawn down on this amount. Fortunately, the repayment schedule appears manageable. Starting in March, the corporation will be required to repay 5%, or $17.5 million per quarter, and mandatory cash sweep conditions on excess cash flow are in place to accelerate repayment. Add on hedges equal to roughly 80% of the outstanding debt balance between 2019 and 2021, and the debt profile looks less scary.

Many mining stocks, including ASR, have rallied recently along with the price of gold. Though this could be a gold breakout, it is possible the commodity and mining shares retreat. Furthermore, prior to completing the sulphide expansion, ASR traded in a range between C$2.00 and C$3.20 for most of the last three years. Our assumption is that the stock will rerate much higher now that the sulphide project is complete, but we could be wrong and the old trading pattern may resume. This uncertainty regarding the stock’s post-sulphide trading range is one of the reasons why we consider it a hold over C$3.00. Still, the company is priced near book, is profitable, and could see meaningful price appreciation as the sulphide processor picks up steam.

Finally, the price of gold is another risk. If gold tanks, ASR will be hurt. However, as mentioned above, this company has low AISC and should be able to make money at much lower gold prices.

Conclusion:

Source: Alacer Gold’s Investor Presentation – Q4 2018 Conference Call

In 2018, Alacer achieved what few mining companies have been able to do – they built a mine on time and under budget. This is a huge accomplishment that should benefit shareholders for years to come. The Çöpler sulphide expansion project significantly increases the mine life and does so at a low AISC. In addition to completing this project, the company has commercialized an oxide deposit called Çakmaktepe which will leverage existing infrastructure. The organization also has a handful of interesting prospects such as the Ardich deposit which could add incremental production. Further afield and longer term, Alacer has other opportunities within Turkey such as Gediktepe. This organic growth story is rare within the mining industry and positions the organization well for future growth.

These characteristics offset many risks, including Alacer’s concentration in Turkey, the company’s debt profile, and exposure to commodity price volatility. The stock has been in both portfolios at Contra the Heard since late 2014 and our average cost is around C$2.00. Though the ticker has jumped recently and is above our buy limit, the stock continues to trade at roughly book value and could appreciate meaningfully given the scale of the sulphide project and other growth drivers.

Disclaimers:

The opinions expressed – imperfect and often subject to change – are not intended nor should be take as advice or guidance. Contra the Heard Investment Newsletter is not an investment advisor or financial advisor.

All amounts are in USD unless otherwise stated.

Analyst’s Disclosure: I am/we are long ALIAF. 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.