Hillgrove Resources (HGO)

Transcription

1 Kasbah Resources Very cheap copper producer; Harder than expected ore encountered; crushing issues now fixed; 27 June 2012 Pieter Bruinstroop Three Key Points Recommendation BUY HGO is ramping up production at its Kanmantoo mine, in SA, largely in line with expectations. The only issue encountered has been that the ore has been harder than expected. As a result of extra crushing and lower grade commissioning ore, cash costs for its first full quarter were reported as $2.81/lb, compared with Life of Mine guidance of $1.61/lb. Octa Phillip s review of the cash costs by line item gave almost identical values after adjusting for lower head grade and an extra $3m in crushing costs. Octa Phillips revised valuation is now 32c and our recommendation remains BUY. In Brief Risk Rating High Current Share Price $ Month Price Target $0.32 Price Target Methodology NPV Total Return (Capital + Yield) DCF Valuation $0.32 Market capitalisation $87m Liquidity average daily $0.5m EPS Changes : Octa Phillip Lower start-up grade HGO began milling at Kanmantoo in November, with practical completion of the development achieved in December On 31 May 2012, HGO announced an upgrade of its Resource estimate, to 24.7Mt at 0.87% Cu, 0.15g/t Au and 2.3g/t Ag. For Measured + Indicated Resources. Average mined grade in the January quarter was 0.60% and 0.82% in the April quarter. However, mill feed grade average 0.62% Cu. Higher Processing Costs HGO has reported that the pore has been harder and heavier than estimated from the feasibility studies. Consequently extra crushing capacity has been required. HGO advised C1 cash costs of $2.81/lb for the April quarter. Octa Phillip s original estimate, which assumed a feed grade of 0.8% Cu, was $1.80/lb, which rose to $2.22/lb after adjusting for the lower feed grade. Each of our line items was consistent with the advice from HGO except for milling costs which was $1.11/lb compared with our estimate of 51c/lb, a difference of $3.0m for the quarter. Valuation HGO has re-affirmed their guidance of life of mine C1 cash costs of $1.61/lb. Octa Phillip s model estimates cash costs of $1.69/lb over the balance of reserves. Using current prices, our NPV is now 32c/share. We see significant upside potential from its near mine exploration and exploration in Indonesia. Investment View We project net cashflow from Kanmantoo plus the hedge book of $70m - $75m each year from next year. Our recommendation remains BUY. Financial Forecasts & Valuation Metrics Price Chart 60 c 50 c 40 c 30 c 20 c HGO share price ASX All Ords 10 c 0 c 38,000 35,000 32,000 29,000 26,000 23,000 20,000

2 : Kanmantoo HGO has recently brought Kanmantoo mine back into operation. Figure 1 : HGO s Kanmantoo mine, near Adelaide HGO is ramping up operations at the Kanmantoo copper mine, which is in South Australia, about 55km from Adelaide As shown in Figure 1, Kanmantoo is about 55km from Adelaide, just off the freeway, near the towns of Kanmantoo and Callington. As shown in Figure 2, Kanmantoo has 33Mt in Resources, grading 0.8% copper, 0.15g/t gold and 2.2g/t silver, for a total of 263kt of contained copper plus 154koz gold plus 2.2Moz of silver. The Reserve, which was last estimated in April 2010, was 14.8Mt at 0.85% Cu, 0.17g/t Au and 3.1g/t Ag. Kanmantoo has 263kt of copper in Resources, plus 154koz gold and 2.2Moz silver. Kanmantoo had been mined previously, from 1971 to 1976, by a joint venture of North Broken Hill, Broken Hill South and EZ Industries. Figure 3 shows the open pit as left by the earlier mining operation, Source :HGO Presentation, May 2012 Figure 2 : Kanmantoo Resource estimate, May 2012 including low grade and waste stockpiles. Figure 4 shows the style of mineralisation, with structurally controlled lenses of chalcopyrite mineralisation hosted within schist. Figure 4 also shows a number of zones of mineralisation within the Mining Lease. Source : HGO 31 May 2012 announcement Figure 3 : Kanmantoo : previously mined. Source : Hillgrove Resources Presentation, November 2010 Page 1

3 Figure 4 : Mineralisation at Kanmantoo Kanmantoo was previously mined from 1971 to It contained a number of sub-vertical lenses contained within schists There is significant mineralisation that is not in Resources as it has not been drilled. Source : Hillgrove Resources Presentation, November 2010 While the current reserve estimate is currently being revised, there has been significant drilling since the December 2011, which is the basis of the current resource. Development HGO acquired the ELs shown in Figure 1 in November A scoping study commenced in June 2004 and a Pre-Feasibility Study was started in March However, development was significantly delayed by the GFC in In July 2009., HGO sold the bulk of its gas interests for $176m (pre-tax) to focus on the development of Kanmantoo and its gold exploration in Indonesia. Figure 5 shows that the GO share price moved with the copper price, until mid Figure 5 : HGO share price v. copper price The HGO share price has generally moved with the copper price. One major break in this patter was in the final stages of feasibility when capital costs increased and extra equity needed to be raised in Source : IRESS, Octa Phillip In February 2010 the estimated capital cost was $98m. In October 2010, the estimated capital cost had increased to $144m and, despite the cash raised by the sale of its gas interests and, HGO needed to raise $65m in equity. Page 2

4 Operating Performance As shown in Figure 6, after the initial shock of the extra capital and extra equity required, the HGO share price largely tracked the copper price. Figure 6 : HGO share price v. copper price More recently, the final project capital came in about $10m more than previously advised And C1 cash costs in the April quarter came in at $2.81/lb Source : IRESS, Octa Phillip Figure 6 shows 2 significant exceptions to this pattern : The high cash costs were due to issues associated with the ore being harder than expected. Some low grade was fed into the mill to keep it ramping up And extra costs for crushing were incurred. On 8 November, 2011, HGO announced that it had received a further claim from the engineering contractor a further claim for about $10m in cost over-runs, which will paid progressively from May, when the project is expected to be cashflow positive; and On 31 May, with the release of the quarterly report for the 3 months to 30 April, HGO advised that its C1 cash costs had been $2.81/lb, as shown in Figure 7. Figure 7 : C1 cash costs, April 2012 Of the many variables estimated in our valuation of HGO, the company has either met or exceeded every one of our estimates (ore mined, ore to mill, gold grade, silver grade, recoveries of each of the metals) for both of the quarters reported, expect for the grade of the ore fed to the mill, and consequently the amount of copper produced, as shown in Figure 8. After inputting the actual values, Octa Phillip s estimated cash costs for the April quarter was $2.32/lb. Otherwise, costs were as expected,. We were in line with all the costs shown in Figure 7, except for processing which we estimated to be 51c/lb. Source : HGO ASX announcement, 31 May 2012 HGO had advised previously that the ore was harder than expected and the extra costs are due to the issues with crushing. Revised Cashflow and Valuation Our model shows that processing costs were about $2.8m higher in the April quarter than we expected. While HGO has affirmed its life of mine cost target, we have allowed for higher processing costs over the balance of this year. Page 3

5 Figure 8 : HGO s Kanmantoo operations : actual v. expected Kanmantoo s operations have performed as would be expected during a ramp up of a new operation Figure 8 shows in detail each of the major estimates made in Octa Phillip s modelling and also the actual results achieved to date, showing The Kanmantoo mien has generally performed as well as expected or better on most parameters; The copper grade of the ore fed to the mill was been significantly lower than the mined grade in the April quarter We understand that as the ore is harder than expected, in order to keep up the throughput and the production, as part of the commissioning and ramp-up, some lower grade ores were used Octa Phillip expects that as the crushing issues are resolved, then production will increase. Figure 8 also shows that Octa Phillip expects Kanmantoo to reach 2.7Mt/yr throughput, which HGO advise as a free expansion to the existing mill processing circuit of 2.4Mt/yr. Figure 9 shows that Octa Phillip expects costs to come down as the project ramps up, but also that we included extra processing costs totalling $3.5m, excluding the April quarter, for the balance of this year. Compared with guidance of $1.61/lb, Octa Phillip has estimated cash costs of $1.70/lb, after the April 2012 quarter, over the current reserves. Figure 9 : Octa Phillip s estimated cash costs Figure 9 also shows that we do not project costs to get down to HGO s original, and current, guidance of $1.61/lb. Figure 10 shows Octa Phillip s projected cashflows for HGO s Kanmantoo project. The cash costs are total cash costs, including the cash spent on stripping and mining and stockpiling low grade ore, rather than the costs that are expensed to the P&L. However, it treats the sales revenue as received in that quarter, when only 75% of the revenue is received at the time of the sale and the balance with the usual lag. Page 4

6 Figure 10 : Octa Phililp s projected quarterly cashflows for HGO s Kanmantoo mine Octa Philip projects that Kanmantoo s cashflow will turn positive in the current quarter Figure 10 shows that Octa Philip estimates that Kanmantoo was cashflow negative in the April quarter but swings to a net cash generator from the July quarter onwards, despite the extra payments to the contractor. Figure 11 shows that Octa Phillip projects strong cashflows for the life of the Kanmantoo mine Figure 11 : Octa Phililp s projected annual cashflows for HGO s s Kanmantoo mine Our projection does not, however, allow for expected expenditure on exploration in the Mining Lease and nearby areas, which Figure 4 indicates is highly prospective, confirmed by recent drilling results. Indonesia In addition to its operations at Kanmantoo, HGO has 2 exploration projects in Indonesia, as shown in Figure 12. HGO owns 80% of each of these projects, with the balance being held by local partners. Both IUPs (ie. exploration permits) are 1,000km 2 in area. Page 5

7 Figure 12 : HGO s Indonesian exploration projects HGO has 2 good exploration projects in Indonesia. Source : Hillgrove Resources, presentation, June 2012 At Sumba, which was formerly a BHP project, some very high grade gold chips has been extracted and drilling has yielded intercepts with widths that are likely to be mineable and gold grades that are likely to be economic, and some with silver. Activity at Bird s Head started in To date, 4 holes have been drilled on targets defined by magnetic and soil geochemistry. These have found disseminated copper sulphides with elevated copper and molybdenum values confirming porphyry-related mineralisation. It is very early days for these projects and we have not given any value, either positive or negative, to either project. Concluding Comments Figure 13 : Octa Philip s projections for HGO Figures 10 and 11 showed the operational details for HGO s only operation, the Kanmantoo mine. Figure 13 shows our projections at the corporate, or reported, level. Page 6

8 Figure 10 showed the commodity price assumptions used by Octa Phillip, which are basically the current spot price for each commodity. This is despite the fact that we are positive on copper given the low and declining stock levels, both exchange, as shown in Figure 14, and hidden stocks, while analysts generally project the current year to be another deficit year, and future years to be small surpluses in 2013 and 2014, before further projected deficits. Figure 14 : Copper price v. stocks Octa Phillip believes that the fundamentals of the copper market are strong,, with a further deficit in 2012 before small surpluses in the next 2 years, before swinging back to deficit. Source : IRESS, Octa Phillip Figure 15 shows Octa Phillip s asset based valuation of HGO, of 32c a share Figure 15 : Octa Phillip s valuation n of HGO, 32c a share Octa Phillip s base case valuation is 32c a share The Reserves referred to in Figure 15 are the prove and probably resources shown in Figure 2, while the Resources referred to in Figure 15 are the low-grade stockpiles, which are assumed to be processed after the probable resources are depleted, and Inferred Resources. This shows we have not given any value for the expected increase in Resources and consequently Reserves, that will follow after the current round of drilling, which has reported many good intercepts, has been completed. Page 7

9 Conclusions Octa Phillip s valuation is nearly 3x the share price. HGO s current Enterprise Value is about 2x Octa Phillip s projected cashflow of mature operations. Octa Phillip retains a BUY recommendation Octa Phillip s valuation of HGO is 32c a share, which is nearly 3x the current share price of 11c. Our valuation is based on roughly current prices. Figure 13 shows that we project that, even after $10m annual exploration expenditure on its Indonesian projects, HGO generates nearly half of tis current Enterprise Value in free cash each year. Octa Phillip believes that HGO has experienced commissioning and ramp-up issues which are within the range of normal expectations. We also firmly believe that these issues are able to be properly managed and as a result, that our projected cashflows should be achieved. Octa Philip retains a BUY recommendation on HGO. Page 8

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11 OFFICE LOCATIONS AND DISCLOSURE Melbourne Sydney Perth Gold Coast Adelaide Level 12, 15 William St Melbourne VIC 3000 Level 9, 56 Pitt Street Sydney NSW /140 St Georges Tce Perth WA 6000 Level 9, 1 Corporate Ct Bundall QLD 4217 Level 1, 16 Vardon Ave Adelaide SA 5000 Phone: Fax: Phone: Fax: Phone: Fax: Phone: Phone: Recommendation Criteria Investment View Octa Phillip Securities Investment View is based on an absolute 1-year total return equal to capital appreciation plus yield. Buy Hold Sell >20% 20% 5% <5% A Speculative recommendation is when a company has limited experience from which to derive a fundamental investment view. Risk Rating Octa Phillip Securities Limited has a four tier Risk Rating System consisting of: Very High, High, Medium and Low. The Risk Rating is a subjective rating based on: Management Track Record, Forecasting Risk, Industry Risk and Financial Risk including cash flow analysis. Disclosure of Economic Interests The views expressed in this research report accurately reflect the personal views of Pieter Bruinstroop about the subject issuer and its securities. No part of the analyst's compensation was, is or will be directly or indirectly related to any recommendation or view expressed in this report. The following person(s) do not hold an economic interest in the securities covered in this report or other securities issued by the subject issuer which may influence this report: the author of this report a member of the immediate family of the author of this report Disclaimer This publication has been prepared solely for the information of the particular person to whom it was supplied by Octa Phillip Securities Limited ( Octa Phillip ) AFSL This publication contains general securities advice. In preparing the advice, Octa Phillip has not taken into account the investment objectives, financial situation and particular needs of any particular person. Before making an investment decision on the basis of this advice, you need to consider, with or without the assistance of a securities adviser, whether the advice in this publication is appropriate in light of your particular investment needs, objectives and financial situation. Octa Phillip and its associates within the meaning of the Corporations Act may hold securities in the companies referred to in this publication. Octa Phillip believes that the advice and information herein is accurate and reliable, but no warranties of accuracy, reliability or completeness are given (except insofar as liability under any statute cannot be excluded). No responsibility for any errors or omissions or any negligence is accepted by Octa Phillip or any of its directors, employees or agents. This publication must not be distributed to retail investors outside of Australia. Disclosure of Corporate Involvement Octa Phillip seeks to do work with those companies it researches. Octa Phillip receives commissions from dealing in securities. As a result, investors should be aware that Octa Phillip may have a conflict of interest that could affect the objectivity of this report. Octa Phillip Securities reports are available on Bloomberg, Reuters, FactSet, Capital IQ and Page 10