Skeena Resources: Exciting Gold Development Story

Summary

• Skeena Resources has a large, high-grade gold project in British Columbia.
• The project has been advancing and appears headed for production.
• The company's exploration potential makes the upside potential very appealing.

This article was amended on 6/22/20 to reflect necessary factual updates following a conversation with a company representative.

Stock Name	Symbol (US)	Type	Category	Share Price (US)	FD Shares	FD Mkt Cap (6/18/2020)
Skeena Resources	OTCQX:SKREF	Gold	Late Stage Development	$1.14	187M	$214M

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I included Skeena Resources in my January post of the Top 10 Gold Stocks for 2020. In that post, stocks were only given a short analysis. So, I decided to give Skeena a second post with a longer analysis. Their market cap has broken out and is not as cheap as it was in January, but I think it still has significant upside potential.

Skeena is developing large (4 to 5 million oz.) high-grade long-life mine in an excellent location. In my opinion, the best place to mine gold is in Canada. I expect gold mines in Canada to sell at a premium in the future as locations become more important from a risk-reward viewpoint.

Skeena has nearly all of the factors you look for in development projects, which I will review at the bottom of the article. The key factors are the low valuation, high-grade, large resources, and location.

Company Overview

Skeena Resources is a development company focused in the Golden Triangle in British Columbia. They obtained the high-grade Eskay Creek mine from Barrick Gold in December, 2017 (Barrick still has a 51% option, discussed below). The Eskay Creek mine produced 3.3 million oz. (45 gpt) of gold and 160 million oz. (2,000 gpt) of silver. Eskay Creek operated from 1994 until 2008. It is one of the most famous underground mines in Canada because of its high grade.

When Barrick stopped mining at Eskay Creek in 2008, they left a lot of gold behind. Skeena plans to produce 300,000 oz. annually (including silver), and this total is likely to increase with exploration success (which they have been having).

Skeena has released a PEA with $233 million capex, with an after-tax NPV around $500 million. The IRR is very high, around 50% at $1,300 gold. This project is heading to production unless they run into some type of a permit issue. It’s a high-grade open pit, with approximately $750 cash costs per oz. and a grade of 4 to 5 gpt (including silver). They expect the resource to grow from 4 million oz. at 4 gpt to 5 million oz. at 5 gpt after they complete infill drilling. What is a 5 million oz. (5 gpt) open-pit worth in Canada?

They are cashed up, with about $15 million, and will continue to advance the project. A pre-feasibility study is due in 2021, then they will need to complete a feasibility and permitting. I don’t know how much permitting is required since it is a past-producing mine. Share dilution will be required, but I expect the share price to rise, making it easier to finance development.

In addition to Eskay Creek, they have another famous past-producing mine (Snip) in the Golden Triangle. Snip produced 1 million oz at 27 gpt from 1991 to 1999. If they can find another million ounces of high-grade gold, this could be their second mine. They appear to be making good progress identifying new areas to mine at Snip. One red flag is that Hochschild has an option to acquire 60% of Snip.

I expect this stock to go up in value significantly as they get closer to production. Part of the reason it is currently undervalued is the CEO has not built a mine before and investors are skeptical that they will build and operate the mine. The other reason is Barrick's option.

Perhaps, the biggest red flag is that Barrick has a 51% option, which will reduce their upside potential -- if Barrick takes the option. Barrick has until December 2020 to acquire the 51% option. They will have to pay Skeena 3x their costs to date, which will be around $75 million.

Does Barrick want to pay $75 million for 51% of the mine? The answer is probably yes. But this won’t be the end of the world for Skeena. They will then own 49% of a large gold mine that Barrick will be operating. They can then focus on Snip.

Barrick has a lot of leverage with their 51% option. I would not be surprised if the two companies make some type of unexpected deal this year. Perhaps Barrick will exchange their option for a large NSR.

Project Information

(refer to company presentation)

• Location: Canada (British Columbia / Golden Triangle).
• Premier Project: 4 million oz. at 5 gpt (Likely to increase in size).
• Open Pit. Underground potential.
• $233 million capex (Pre-feasibility coming in 2021).
• $750 per oz. cash costs / $1,150 all-in costs (My estimate for free cash flow).
• 300,000 oz. annual production.
• 90% recovery rate (my estimate).
• After-tax IRR (50% at $1,300 gold).
• Potential production in 2023 (my estimate).

Management

The CEO does not have experience building and operating mines. This is a red flag and a concern.

Balance Sheet

(refer to Sedar.com)

They have about $15 million in cash and no debt. They have enough cash to complete the pre-feasibility study and permitting in 2021. Expect a capital raise (share dilution) next year to pay for the feasibility study if Barrick does not take their 51% option.

I don't expect much more share dilution until they are ready for financing. I do expect the capex to be financed with about 1/3 equity (share dilution) and 2/3 debt. So, they will likely be assuming a significant amount of debt to pay for the capex, but with their cash flow, the debt should be paid back quickly.

Concerns/Red Flags

The main red flag is the Barrick 51% option, also the 60% Hochschild option. These options reduce their upside potential.

Their other two red flags are low insider ownership to prevent a takeover attempt, and the lack of management experience building and operating gold mines.

You could also consider the timeline to production a red flag. The full valuation for this stock will not occur for about 3-4 years until they reach full production.

Future Valuation

Note: I'm going to use two gold price scenarios and you can pick the one you prefer. I personally prefer the most optimistic scenario because I believe that when the next recession hits, gold will reach a new all-time high. I am using a free cash flow multiplier of 5, which I think is conservative if gold prices rise and there is good investor sentiment for gold miners.

Scenario #1 ($1,800 Gold Price)

• Estimated All-In Cost Per Oz.: $1,150
• Estimated future annual free cash flow: 300,000 oz. x $650 = $195 million
• Estimated future market cap: $195 million x 5 = $975 million
• Comparing the current market cap ($214 million) to the future market cap ($975 million), you get a potential 350% increase.

Scenario #2 ($2,200 Gold Price)

• Estimated All-In Cost Per Oz.: $1,150
• Estimated future annual free cash flow: 300,000 oz. x $1,050 = $315 million
• Estimated future market cap: $315 million x 5 = $1.5 billion
• Comparing the current market cap ($214 million) to the future market cap ($1.5 billion), you get a potential 600% increase.

Both scenarios are optimistic because I am not reducing the upside potential for the share dilution required to fund the capex. Also, this is a long-term expectation that they reach 300,000 oz. annual production. They likely won't reach that level for 3-4 years.

For scenario #2 (the most optimistic) valuation, it assumes that Skeena will reach 300,000 oz. of production and they will reach $315 million in free cash flow. This high cash flow is based on the assumption that gold prices will reach $2,200 per oz. and all-in costs (free cash flow) are $1,150 per oz. This is close to a best-case scenario for the long term.

Note: I don't think it is too optimistic to anticipate higher valuations than these two scenarios. I think it is plausible that quality mid-tier Canadian producers will receive cash flow multiples of at least 10, and 20 is not inconceivable. I was going to use a multiplier of 10 (which is my expectation), but decided to be more conservative. With a 10x multiplier, you can double the expected returns.

Conclusion

Skeena Resources has a high-grade gold development project that looks excellent. As a speculation bet, it could pay-off extremely well if gold prices rise and they do not get acquired.

This development story does not have everything you look for, but still has most of the factors. Let's review:

1) High upside potential. (Yes)

2) High insider ownership to prevent a hostile takeover. (No)

3) Quality management team. (No)

4) Desire by the company to get a high return for shareholders. (Unknown)

5) Low to moderate cash costs per oz. (Yes)

6) Low to moderate capex. (Yes)

7) Good entry price. (Yes)

8) Good buzz. (Yes)

9) Low downside risk. (Yes)

10) Long-life mine. (Yes)

11) Good grade. (Yes)

12) Good recovery rate. (Yes)

13) Good location. (Yes)

14) Good exploration potential. (Yes)

15) Good pipeline - potential second mine. (Yes)

Updates

I spoke with the Skeena Resources Investment Representative today. There are a few issues that I need to fix.

1. I thought that Barrick’s 51% option required $75 million, but it is actually 3x, so it is $225 million. Barrick will be able to acquire 51% of the project from December 2020 until December 2021. Skeena thinks it is possible that Barrick will accept an equity stake in Skeena Resources instead of exercising the 51% option. If this happens, Skeena’s valuation will be much higher.

2. They currently have $36 million in cash and not $15 million.

3. They recently hired Shane Williams as their COO. He has strong experience building and operating mines, and built and operated the large Lamaque gold project for Eldorado Gold.

Disclosure: I am/we are long SKREF. 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.