Investors looking for an emerging producer with the capability to put a medium-sized gold deposit into production in a relatively politically stable jurisdiction, where costs are reasonable, and without having to dilute shareholders with a gazillion share issue, or bootstrap itself with a project financing, look no further.
The timing is probably good too.
Sabina Gold & Silver (TSX: T.SBB, Stock Forum) published a preliminary economic assessment completed by SRK on the Back River project recently.
The news release stated the following:
“PEA contemplates a scenario with concurrent open-pit and underground mining operations delivering mineralized material from the Llama, Umwelt, Goose and George deposits to a centralized 5,000 tonne per day ("tpd") processing facility located near the Umwelt deposit. Gold production is projected to average ~300,000 oz/year over 12.3 years for total production of 3,677,000 oz Au, beginning in late 2016 or early 2017.”
SRK concluded that the project may be economically viable and that Sabina should proceed to a pre-feasibility study. It calculated an after tax NPV-5% of about $650 million and an IRR of 25% (four-year payback) at a $1250 gold price ($1.1 billion and 32% IRR (pre–tax)), assuming cash operating costs of $542 per ounce, preproduction capital of $450 million, and sustaining capital of $388 million (plus a $100 million contingency).
Ore grade is expected to average from 5-6 g/t (w/90% recovery); the company notes that the results “demonstrate how valuable good grade is to a project, particularly in remote locations.”
SRK also recalculated the George resource to conform to a pit design, resulting in a small loss of ounces (roughly 200,000), though this year’s exploration is expected to add to the resource and hence its valuation. The prefeasibility is underway now too, and should be done in a year. Management also says, “Sabina will immediately file a Project Proposal with the Nunavut Water Board, which will commence the environmental assessment and permitting process with the Nunavut Impact Review Board.”
With about $150 million in working capital (almost half of that to be spent in 2012 mainly on expanding the resource), Sabina is funded through the feasibility and permitting stages. It may also be funded through production, depending on what it can get for its silver royalty from the sale of its Hackett River silver-copper-zinc project to Xstrata last year for $50 million upfront, $50 million in development over four years, and a 22.5% interest in the first 190 million ounces of silver payable from the project, assuming it ever goes into production. Based on a 2009 PEA for the project that translates into about 2.7 million ounces of silver received annually over 16 years, at no cost to Sabina. Xstrata is looking at ways to boost that production rate though, potentially resulting in as much as five million ounces of silver to Sabina each year.
Hacket River silver royalty worth from $250 and $800 million to fund Capex
We calculate this royalty to be worth $370 million today based on the parameters in the original PEA and using a conservative 10% discount rate. Imputing a risk adjustment for the possibility it does not reach production, a conservative valuation for this royalty in my opinion would fall in the neighborhood of $250 million today. Using a 5% discount rate this value would be closer to $405 million on a risk adjusted net present value basis. Please note that these are conservative numbers. Most valuations will ignore the risk adjustments and even the time to production on occasion. Excluding these factors, and using a 5% discount rate (the norm these days), a sell-side analyst could argue that the royalty is worth over $800 million, on a pre tax basis at that. But any of those values would take Sabina a long way toward production without it having to dilute at this low price. Not many companies can say that.
Additional pluses... and some minuses
The PEA “makes no allowances for benefits from the proposed BIPR project currently being proposed by Xstrata and Sabina.” In other words, they expect further positive impacts on the economics of the project from infrastructure synergies that it discovers with Xstrata (or others).
Mining will use conventional mining and processing methods, producing dore that will be shipped five kilometers to an airstrip “capable of servicing Hercules C-130 freight aircraft, as well as Boeing 737 Combi commercial jets” – which can cost from $15 up to $90 million to purchase (not sure if that is what they are doing exactly), and can carry up to two years worth of production from Back River at once.
That’s one of the benefits of gold mining. It is more difficult with base metals – less value per unit of relative weight.
Of course, while the PEA was a very good one from the standpoint of expected costs and economics, and compared to recent disappointments elsewhere, we have two observations to make. First, one obvious negative was SRK’s conclusion that the project “may” be economic, rather than stating that it has, say, “robust” economics. Perhaps it’s just a matter of improving confidence levels and converting resources to reserves. Second, we fully expect their cost estimates to rise in the future, either at feasibility stage, or in reality. On the other hand, the pit design was done at about $1000 gold (leaving lots of room to expand it), and the NPV was calculated using a $1250 gold price assumption, which is conservative.
Valuation sensitivities
At a more current gold price of around $1600 the project’s after-tax NPV nearly doubles to $1.2 billion; it comes in at around $900 million if you assume 20% inflation in capital and operating costs and a 5% discount rate. However you play with the numbers they look good relative to the company’s current market capitalization of around $377 million (161 million s/o), or its $230 million enterprise value.
Potential value at production
Our valuation assumes slightly higher costs, a 10% discount rate –and a higher gold price ($1550).
Thus our pre-tax NAV for the Hackett River and Back River projects, assuming they both start up at around the same time in 2016-17, is $600 million and $1.4 billion, respectively ($2 billion combined).
Those values represent “potential” values, specifically those yet to be realized by getting to production.
There are two other factors to account for:
1) Time value of the next four years
2) Risk of failing to achieve production
Risk adjusted valuation
Adjusting for the time value to production we get $370 and $877 million ($1.25 billion combined). And on a risk adjusted basis, those present values work out to $231 million and $351 million (~$582 million combined) in my framework (applying the rational speculation model), or roughly $3.61 per share.
That means, in our model, the stock is cheap below $3.61 per share (it is currently near $2/share).
But, if gold prices did nothing, and costs inflated a bit, by the time they get to production, their project NAV should approach $12 per share if all goes well. Nevertheless, that value still does not take into account higher gold prices (it assumes just $1550 gold), and we expect gold prices to double or triple in coming years. Nor does that valuation impute additional resource growth or other gold discoveries.
Our conservative one-year target on Sabina is $7-10, with the chance of a buyout higher.
For longer-term investors we wouldn’t be surprised to see this stock trading at $15-20 in two to three years.