Caledonia Mining (CALVF) was my stock of the year pick for 2011. Unfortunately the stock did not meet the goal of appreciating 100% in a twelve month period. In fact the stock has dropped approximately 50% since I recommended it. Interestingly the company fundamentals have, in my view, continued to improve as the stock price has declined.
From the company website; "Caledonia is an African focused mining and exploration company with an operating gold mine in Zimbabwe, a copper-cobalt exploration project in Zambia and two platinum-nickel exploration projects in South Africa." The company's primary asset is the Blanket gold mine located in Zimbabwe. The mine should produce 40,000 oz. of gold in 2012 at a cash cost slightly above $600 per ounce. This is one of the lowest cash costs in Africa.
The company produced slightly less than 40k ounces last year and that production yielded a gross profit of $29.1 million and cashflow of $17.4 million. The current market cap of the company is around $33 million so the company is trading at 2x cashflow and has a current P/E ratio of around 2.5. This is a profitable gold mining company.
So why has the price dropped if the mine performance and financials are performing well. Several reasons:
- General weakness in gold equities, especially gold juniors and companies with single mines and production lower than 100k ounces per year.
- The company's main asset is located in Zimbabwe which is not viewed positively by foreign investors.
- Political uncertainty around elections, and Black Indigenisation policy.
However there are mitigating circumstances to each of the above in my view. Changes in any of the above could lead to revaluation:
- The world economic situation which is one of slow growth and over indebted countries, especially in the west, may lead to governments pursuing monetary policies that are conducive to a higher gold price i.e. continued currency debasement. We are seeing continuing signs of this with the ECB cutting rates last week, the Bank of England engaging in another round of QE (money printing, the Peoples Bank of China cutting rates, and the central bank in Denmark adopting a negative rate policy due to Euro deposits pouring into the country seeking a safe haven. I expect these type of policy responses to continue which should be long term bullish for the gold price.
- The political situation in Zimbabwe is more complicated than what is generally reported outside the country. Robert Mugabe is 88 years old and is currently in Singapore, it is speculated to receive treatment for prostate cancer. His party Zanu-PF has in the last few years come under considerable pressure from competing parties in Zimbabwe and from pressure by outside entities like its neighbor South Africa and the UK to sit down with the opposition and write a new constitution and to hold elections. In fact there have been many reports of inter-party fracturing inside Zanu-PF and even party members splitting from Mugabe as politicians position for a post Mugabe Zimbabwe. The trend is clear in that we and I am sure Zanu-PF have seen the Arab Spring revolutions in North Africa and the movement in Africa away from autocratic rule to more participatory types of government. Suffice to say that when old Bob sheds this mortal coil there could be a signifcant revaluation of Zimbabwe and company's that have operations there.
- As stated above the country is moving towards elections although Zanu-PF has done much to delay them in order to give itself time to position itself for an outcome that does not significantly diminish its power and control of cronyism that has benefited its members. Nevertheless the pressure is on and it is my view that if free and fair elections are held that the MDC (Movement for Democratic Change) would have a greatly increased role in government. It is important to remember that Zanu-PF and MDC have a tenuous power sharing agreement currently in place. The prime minister of Zimbabwe is Morgan Tsvangirai and that several cabinet members and the central bank president are MDC officials. This is the prime reason that inflation was quashed in the last few years and the economy is growing at 6-8%. I suspect if elections were held today MDC would be the majority.
- On the subject of Black Indigenisation; this is a policy to transfer 51% ownership of large enterprises to control by black Zimbabweans. I think many outside the country have construed this as resource nationalization. However, if for example, we look at the deal Caledonia struck the company made a good deal. The deal is structured as such: "Signing an agreement with the National Indigenisation and Economic Empowerment Fund to sell a 16 per cent stake in its Blanket Mine for US$11.7 million. This is part of a wider accord to transfer 51 per cent of gold mine to indigenous Zimbabweans for a total of US$30.1 million. Caledonia has agreed to sell 15 per cent to a local consortium and 10 per cent to the Blanket Mine Employee Trust. Meanwhile, a 10 per cent share of the mine will be donated to the Gwanda Community Share Ownership Trust. The company has agreed to finance the deals at a rate of 10 per cent above the 12-month London interbank offered rate, with the loans being repaid from future dividends." Basically the company has transferred 51% to various Zimbabwean entities for around $30 million which the company will finance by carrying a note on at a rate of 10%+ to be paid out of the profits of the Blanket mine. The company management retains day to day operating control of the mine. Although not the optimum from a shareholder perspective that is a long way from nationalization.
- One last catalyst is that the company has a large opportunity to increase production and to find additional mineralization at the Blanket mine and the surrounding properties. Lets face it, due to the political situation in Zimbabwe the country and the mining industry has been starved for capital and the country is severely underexplored.
The Caledonia story is a bit complicated for many speculators so they would rather not even bother. However, I think the story is compelling and the company is so cheap it could literally buy itself with two years of cashflow. That means it is so cheap it is almost risk free. There are several issues, any one of which if resolved positively could lead to a significant revaluation of the shares. I have been and continue to accumulate shares on any drops to $.07 cents or below.
Disclosure: I am long CALVF.OB.