Disclosure: The author is long RPMGF
Overview
Rye Patch Gold (TSX.V: RPM) (OTCQX:RPMGF) is a gold and silver exploration company with projects in Nevada and a market capitalization of ~$19.2 million. It owns exploration-stage properties in Nevada that include extremely promising holdings in the Cortez Trend, and a later stage project in the Oreana trend–Lincoln Hill–which is well on its way to becoming a producing mine. Rye Patch also owns a cash-flowing royalty on Coeur Mining’s (NYSE:CDE) Rochester property, which is adjacent to some of its properties along the Oreana Trend.
This cash-flow–more than C$1 million per quarter–along with Rye Patch’s ~C$6 million working capital position, make the company unique among exploration companies. Many exploration companies can’t do much investing without diluting shareholders, and given the bear market in mining shares this dilution is especially punitive. Meanwhile Rye Patch is spending $3.7 millionthis year on its operations. This includes: exploring several properties–Garden Gate Pass, Patty, and Lincoln Hill (specifically the Gold Ridge and Independence HIll Zones), and doing feasibility level metallurgical test-work at its advanced-stage Lincoln Hill Project. Finally, Rye Patch is so well capitalized, and the share price is so depressed relative to this capitalization that management has implemented a share repurchase program: it can purchase up to 5% of the company’s outstanding shares–~$1 million worth.
What makes Rye Patch Gold such an attractive stock is a combination of things:
- The fact that it has the capital with which to develop high quality assets.
- The fact that the market–cash and royalty cash-flow backed out–ascribes very little value to these assets in spite of their potential.
- The fact that Lincoln Hill already has a decent sized (and growing)resource that can be mined using simple heap leaching.
- The fact that the company’s Cortez Projects are extremely close to Barrick’s (NYSE:ABX) high-grade, multi-million ounce Cortez and Goldrush deposits.
- The fact that Rye Patch’s team has extensive experience and success in exploration, including in Nevada and in the Cortez Trend.
Of course Rye Patch is an exploration stage company, and while it has cash/cash-flow it will be spending it in order to develop its projects. This could turn out to be malinvestment, in which case Rye Patch shares will fall. Rye Patch is also sensitive to precious metals prices, and the downtrend of the past 4 years has not yet reversed. While I’m confident it will I’m unsure of the timing.
Given these points Rye Patch Gold is a speculative stock, albeit a very attractive one. A more detailed assessment of the company’s assets will help me illustrate how the risk/reward profiles of its various assess compliment each other well.
The Rochester Royalty
Rye Patch Gold’s is unique among small exploration companies in that it has an asset with a clearly quantifiable valuation– its NSR royalty on Coeur’s Rochester mine. The royalty entitles Rye Patch Gold to 3.4% of all of the gold and silver produced at Rochester minus refining fees up to 39.4 million silver equivalent ounces (1.34 million AgEq oz.).
Since the royalty is capped we have a very clear idea of its cash-flow potential. It is going to generate cash-flow for Rye Patch Gold for ~3.5 years. The company provides investors with this detailed year by year analysis of Rochester’s production and the cash-flow that will come from the royalty (note that Coeur is behind schedule).
(Source: Rye Patch Gold)
Gold and silver prices are clearly lower than these figures, with silver down ~40% and gold down ~17%, which means that the company’s gross royalty revenue will be 2/3 of the estimate given or ~$21 million. Rye Patch has reported royalty-related revenue in the past five quarters of ~$5 million. In Coeur’s latest SEC filing it estimates that its obligation to Rye Patch is $16.5 million (p. 11), which makes sense given the above figures.
While we have to discount this cash-flow, and while it will correlate to gold and silver prices it is a very low-risk source of income. Given that the company will be receiving all of it in the next few years it makes sense to simply assume that it is “cash” and discount its value. At $5.5 million per year for 3 years and a discount rate of 5% it is worth $15.7 million. If we add in the company’s working capital of C$6.4 million (US$5.4) (as of the end of December) we get $21 million.
Given these numbers it is evident that investors are essentially paying for the company’s cash and the cash-flow from the royalty, while they are getting the company’s gold and silver projects for free. Given the data available to us it is evident that these projects are certainly not worthless, and that Rye Patch has a high probability of increasing the value of these assets through additional exploration and by employing various de-risking and optimization measures in developing Lincoln Hill.
Lincoln Hill
The Lincoln Hill Project is the company’s most advanced, and it is the project that management is most focused on. Lincoln Hill has a defined gold and silver resource and a PEA for a low-capex/opex starter-pit. The mine will be a standard drill, blast haul, heap leach operation.
A: Location
The Lincoln Hill Project, like all of Rye Patch Gold’s projects, is located in Nevada. Nevada is one of the best places in the world to mine. It has mining friendly regulatory policies and infrastructure in place to minimize expenses and headaches. Rye Patch’s Oreana Trend properties–Lincoln Hill included–are located in an especially promising part of Nevada considering that so many mining companies operate nearby. We can see this on the following image, which I took from a larger mining map I have of Nevada created by Intierra RMG. To give you an idea of scale the road you see is Route 80 (red line), which is about 11 kilometers away from the Lincoln Hill Project.
This means that Rye Patch will have easy access to mining equipment and skilled labor. Prices of equipment and labor will also be relatively easy to predict.
B: Resources
According to the PEA, the Lincoln Hill deposit contains 364,000 measured and indicated gold ounces at about 0.4 gpt. and another 255,000 ounces of inferred resources at 0.38 gpt. It also contains 10.2 million ounces of measured and indicated silver at 11 gpt. and 8.2 million ounces of inferred silver at 12 gpt.
(Source: Lincoln Hill PEA)
Note, however, that the resource in the mine plan is generally higher grade, as you can see on the following table.
(Source: Ibid.)
Rye Patch’s Lincoln Hill starter-pit is so small relative to the current Lincoln Hill resource because it was designed using a gold price of $775/oz. and a silver price of $13.56/oz. Meanwhile the resource assumes a $1,350/oz. gold price and a $22/oz. silver price, meaning that it assumes that more of the resource is economical. The PEA mine plan pit and the resource pit are pictured on the following visual.
Thus, while small, the mine plan as it stands is going to be highly profitable, and investors can expect that additional resources can be mined given the gold price of ~$1,200/oz.
C: CAPEX
Given how small the starter-pit will be initial capex is expected to be minimal–just $18.2 million, which includes $4 million needed as working capital. Investors should keep in mind that as a preliminary estimate this number could be off by as much as 35%. If we are conservative and assume this figure rises 35% we get a new figure of $24.6 million. This is relatively low, even for a mine that is only expected to produce about 140,000 ounces of gold equivalent ounces. Also keep in mind that it is within reach of Rye Patch Gold considering its strong capital situation.
Investors should note that there will be approximately $12 million worth of sustaining capital charges. This is added to the company’s estimated opex on an all in sustaining cost basis.
OPEX
The mine’s operating expense is expected to be very low: just $11.46 per processed tonne of ore. If we include sustaining costs this comes to about $750/oz.
Valuing Lincoln Hill
Average production at Lincoln Hill over its first five years of production will be ~26,000 oz./year. The following table provides detailed estimates of year-by-year mining, production, and sales.
This means that the company can generate ~$11.7 million in annual operating cash-flow at $1,200/oz. gold or ~$9.1 million at $1,100/oz. gold. The following t
Note, however, that this cash-flow is weighted towards the beginning of the mine’s life. Investors should also note that there will be some residual production in years 6-7 even if the company cannot expand its production beyond the estimates put forth in the PEA, which given the company’s resource is extremely conservative. The project put forth in the PEA he project has an NPV of ~ $18 million at $1,100/oz. gold using an 8% discount rate and a $28 million NPV at $1,200/oz. gold.
Before moving on I should stress that Lincoln Hill should be seen as an exploration property, and the mine plan put forth in the PEA is almost certainly going to differ dramatically from the plan that management actually executes. As you can see from the following timeline Rye Patch plans on expanding the resource and revising the PEA before beginning a feasibility study.
(Source: Rye Patch Gold’s Recent Presentation)
In 2015 the company will be focused two adjacent exploration zones: the Silver Ridge and Independence Hill zones pictured below.
(Ibid)
Last year summer drilling revealed positive results in these two zones. I quote my Dec. 2014 interview with President/CEO Bill Howald:
Immediately to the south of Lincoln Hill is Independence Hill. We completed drilling and just released those results that show high grade mineralization at three out of four zones. We believe that we will be able to expand on these drilling results and ultimately enhance our current resource at Lincoln Hill.
Similarly, we released results from Silver Ridge that show gold and silver mineralization that starts at the surface and goes down ~20 meters at 1.2 grams, and we have a zone that is ~1.5 km in strike. Again, this can add significantly to the Lincoln Hill and enhance the PEA.
Internal to Lincoln Hill itself there are additional opportunities to expand the resource, and we plan on doing some infill drilling there in 2015. We’re currently doing an environmental assessment so that we can have an exploration plan of operations that will enable us to do the infill drilling as we drive the project towards a feasibility study. So not only will we be able to expand the resource but we will be able to move these resources into a higher category than where they are currently.
Investors should also note that the company recently bought land adjacent to the Lincoln Hill Project. It paid $500/acre for 1,655 acres (~$826,000), and Rye Patch owes a royalty ranging from 2.125% – 3.5% to the previous owner–New Nevada Resources LLC. This land extends the Silver Ridge exploration target while providing the company with land on which it can place infrastructure needed to operate the Lincoln Hill Mine.
Given these recent developments investors can expect the Lincoln Hill resource to be expanded, and this can lengthen the mine-life or allow for more production than is outlined in the PEA.
Investors can further expect that the recently announced metallurgical testwork will provide to be successful: expected recovery rates outlined in the PEA are much lower than Coeur’s recoveries at the nearby Rochester Project. Given the similarities between the ore bodies Rye Patch’s team is confident that they will be able to optimize recovery rates by crushing the ore or by altering the leach solution. This would increase the cost per tonne due to crushing but the result would be a more than offsetting increase in gold (and to a lesser extent silver) recovery rates. Right now the company can achieve 64% gold recoveries and 59% silver whereas Coeur Mining gets 92% gold and 61% for silver–44% and 3% improvements totaling a ~30% improvement given the project’s higher exposure to gold than to silver.
Even if we assume a 10% increase in overall opex the 30% increase in recoveries means that opex would improve to just $635/oz. while production would improve to 34,000 oz. per year on average. This increases cash-flow at $1,200/oz. gold to $19 million per year. Even a $10 million increase in capex means that the project’s NPV is $46 million. Meanwhile it would make sense to mine more gold given that improved recoveries improves opex and lowers the grade threshold for inclusion in the mine plan.
Other Exploration Projects
Rye Patch Gold has several exploration projects in two regions in Nevada. The first is the Oreana Trend where Lincoln Hill is located
(Source: Rye Patch Gold)
Key
- Wilco
- Lincoln Hill
- Gold Ridge
- X Claims
- South Coal Canyon
- Rochester NSR Model
We have already seen the Rochester property, owned by Coeur d’Alene.
The other project of particular importance here is the Wilco Project. While the resource is very promising investors should keep in mind that Newmont Mining (NYSE:NEM) has a 60% back-in right should Rye Patch complete a feasibility study. The following is from Rye Patch’s Mar. 4th 2010 PR
Rye Patch Gold’s interest in the Wilco project is subject to the back-in rights of a subsidiary of Newmont Mining Corporation (“Newmont”). If Rye Patch Gold completes a positive feasibility study on the Wilco project, Newmont will then have 120 days to exercise its back-in right to earn a 60% interest in the Wilco project which, if exercised, requires Newmont to contribute expenditures totaling US$15 million on the project prior to the 8th anniversary of exercising the back-in right. Newmont may also earn an additional 10% interest in the project (for a total 70% interest) by expending an additional US$5 million (for a total of US$20 million) on the property. If Newmont declines to exercise its back-in rights, or fails to exercise such rights within the 120-day time period, or fails to complete the necessary expenditures, Rye Patch Gold may complete the acquisition of the Wilco project by making a one-time payment to Newmont of US$2 million in cash (or half in cash and the remainder in Rye Patch Gold common shares, at Rye Patch Gold’s sole discretion), failing which the project reverts to Newmont. Thereafter, Newmont’s sole interest in the Wilco project will be a sliding scale 2% to 5% net smelter returns royalty (“NSR”) in respect of all gold, silver and platinum group metals production, as determined based on the prevailing gold price, and a 3.5% NSR in respect of production from all other minerals.
So while the project has value Rye Patch has little incentive to develop it now, especially considering that it has plenty of work to do on its other projects, which it owns outright.
Nevertheless the Wilco Project is promising, as it contains the company’s largest deposit: ~1.85 million ounces of gold and ~18 million ounces of silver:
Management believes that it will be able to extract this gold and silver every inexpensively. The heap leach is expected to cost just $1.30/tonne, and both the oxide and sulfide mills will cost about $7.25/tonne to operate. Recovery rates will be 70% for the oxide ore and 85% for the sulfide ore. With gold at $1,200/ounce or $38.5/gram each tonne of ore in the measured category is worth about $13, which exceeds milling and mining costs, and the ore in the indicated/inferred categories is worth about $10.50/tonne. So operationally speaking a hypothetical mine would generate cash-flow.
However this resource estimate is somewhat outdated: management releasedthe results of this past summer’s drilling program and they show new high grade zones (1-3 gpt. AuEq). The company identified a zone that’s ~1 mile in strike within the Colado resource and has drilled positive results within the gap between the Colado and Section Line resources. The gap drilling returned some potential high grade gold/silver mineralization and confirm continuity between the Section Line and Colado resources.
(Source: Rye Patch presentation)
The Cortez Trend
The company hasn’t done as much work on Cortez, however it is extremely promising seeing that it is near Barrick’s 15 million ounce mine there which produces ~900,000 ounces of gold per year. Barrick also has a massive development Project next door–Goldrush–that promises to be as profitable as the producing Cortez Project.
Rye Patch’s Garden Gate Pass Property has shown early promising signs with drill-holes yielding over 3 gpt. in some instances. Its Patty Project is a JV with Barrick and McEwen Mining on which the company is working to earn a 60% stake by spending $5 million over five years of drilling. Thanks to its capital position Rye Patch has enough money to satisfy this earn-in arrangement without raising any capital. If the project proves to be a failure Rye Patch can cut its losses and move on.
The Speculative Thesis for Rye Patch Gold
Rye Patch Gold stands alone among gold explorers. Not only does it have a large amount of cash and near-term royalty income that is almost as high as its market capitalization, but experienced people will be using this capital to develop what we’ve seen are promising exploration projects in one of the best mining jurisdictions in the world. We’ve also seen an acute attentiveness on the part of management to generate shareholder value, as is evidenced by the ongoing buy-back.
Thus the risk/reward is extremely compelling in many respects: there are many ways to win big and a clear downside. Barring an onslaught of selling that overwhelms the company’s buyback, this situation is ultimately unsustainable, and I believe that the stock will trade considerably higher in a near-constant gold price environment.
However Rye Patch is speculative: its success depends on whether or not management can grow the value of its properties with the cash it has. Ultimately, Rye Patch needs a recurring source of cash-flow, and it is still at the point where it is demonstrating that it has assets that can generate such a recurring source of cash-flow. Thus at this point in time the best strategy is to own the stock, and confirm that the company continues to provide evidence that it is heading towards these goals. Recent announcements such as the recovery optimization study exemplify the s