Description

CGA Mining is a 50 Cent Dollar any way you slice it. Valuing mid-tier gold mining companies is a fairly simple exercise: compute cash flow, compute market cap, adjust for any risks, and put on a peer group multiple. Do this with CGA Mining, and you will find a compelling investment.

Background

CGA Mining acquired the Masbate project from a financially distressed gold miner for $51M in March 2007. The project is located on Masbate Island in the northern Philippines. Since then, management has delivered resource definition, resource expansion, project feasibility studies, project financing through debt/equity, full construction with 0 lost time incidents, its first gold pour, and--hopefully--consistent gold production at below-average cash costs starting with 4Q CY09.

 The Masbate project previously produced gold for roughly 8 years, delivering about $1M oz before production ended due to low gold prices. When CGA inherited the project, Masbate showed a 6.7Moz resource including reserves of 2Moz. The resource currently stands at over 10M oz including 3Moz of reserves. Most of the resource is contained in measured and indicated ounces--proven to be there.

This time around

The team has spent $180M on constructing a plant with 4mtpa nameplate capacity, which is already running at 5mpta (610tph). Forecast run rate production of 200k oz per year based on 4mtpa should be comfortably met and exceeded. An optimized feasibility study released in 2007 estimated cash costs of $336 per oz using oil prices at $68 per barrel. The company intends to build coal-driven power generation during the next year to further reduce costs ($40/oz savings) and allow fixed energy costing. Since the release of this optimization study, LOM grades have been adjusted from 1.63g/t avg to 1.51g/t due to rescheduling of the mine sequencing. This is intended to smooth out grade distribution. Previously grade was somewhat more tilted towards the early years of the mine life. However, this reduction is grade will impact cash costs, as will increases in mining costs incurred since the 2007 study. Cash costs are now expected to be closer to $420/oz during the first 8 years of production. We believe these numbers are conservative.

First gold pour at Masbate was May 12th, and at Sept 18th 1 tonne of gold had been shipped (32k oz). By Sept 21st, the plant had ramped to full capacity, 610tph, roughly 5mpta. The ramp up took a long time as the company had a few technical hiccups to fix along the way to start-up. The main issue was a somewhat flawed refurb job on the main SAG mill. This mechanical error cost the company 5 weeks. Also, one of the 5 gen sets currently being used also needed to be switched out, resulting in more time lost. This is fairly typical in mining.

Resources

The project currently boasts 2.3M oz of reserves grading 1.51g/t at a cut-off grade of 0.7g/t, using a $700/oz gold price. As such, true reserves ounces at 1.51g/t are likely in the area of 3M oz, pointing towards significant expansion of throughput.

 Mining

 The Masate project is an open-pit project using a conventional grind to CIL circuit to process oxide ore. All mining is done through an EPC (fixed cost) contract with Leighton, the world's largest contract miner.

Hedges

The company has bought puts for 50,000 oz in yr 1 and has sold forward 50k oz of gold in each of years 2-5 at $860/oz.

Taxes

In its agreement with the Phillipine Governemnt, CGA will pay no taxes for the first 6 years of production. We value cash flow using a weighted tax rate of 10% to account for 35% income tax after year 6.

Next Steps

Ramp-up

The company is currently performing a myriad of optimization and expansion studies. First off, throughput is expected to soon be increased to 6.5mpta. This will most likely require the addition of a crusher and more CIL tanks, at a cost of roughly $5-10M all in. However, the company has been experimenting with additives to its CIL mix that have, on a bench level, reduced required gestation time for current Masbate ore (106 micron grind) from 24 hours to 6 hours. If this were to transfer to production-scale processes, no new tanks would be required and reagent use would drop dramatically, lowering costs.

Also, management on site believes the existing crushing circuit is capable of achieving 6.5mtpa capacity (nameplate capacity is 5.5mtpa). So, existing infrastructure might be sufficient. The installed power base of 30MW more than covers current power requirements of 18MW, so any expansion would be easy, possibly requiring a small upgrade to the gen sets.

After this, final ramp up of the project should see the full circuit processing 7.5mtpa, which is the permitted capacity of the project. This will likely necessitate incremental cap-ex of $10-15M.

Lastly, the aforementioned coal-fired gen system should come online within 18 months.

Exploration

The company has done very little exploration to date, as the focus has been 100% on getting to production. Going forward the company plans aggressive work building out both the reserves and the recent high-grade finds at Masbate. We believe there is serious potential for upside here, since recent exploration directly near the plant site has shown tonnage at significantly higher grades than the mine plan.

Management

The company is lead by Mark Savage, an American investment banker; Michael Carrick, a veteran mine builder; and Justine Magee, also a deal-maker. The team assembled to build and operate Masbate has worked together on projects around the world for the better part of 10 years, often under Carrick in various capacities.

The transaction to gain the asset was a distressed asset play engineered by Savage, and then the team was built around it. It is very much our belief that should an appropriate offer come, they would not hesitate to sell. In the meantime, they are looking for attractive late-stage projects that could benefit from their development acumen and be acquired cheaply. We also believe them to be open to accretive mergers.

Valuation

We model the valuation based on a multiple of cash flow, which is a fairly consistent metric among mid tier miners, ranging from roughly 14-20x. NAV is also a routinely used metric--however, multiples of NAV change rapidly depending on gold equity market sentiment. We think cash flow is more tangible. We include an NAV model with conservative estimates below. Once run rate production hits, we expect to see initial production of 200k oz/yr at $400 cash cost, with a ramp up to 280k oz/yr coming over the next 2 yrs, for 10yr average production of roughly 270k oz per year at cash costs of $400-450/oz. We believe higher throughput numbers and other optimization efforts will sustain cash costs in this range, if not lower them.

Using $1000/oz gold, 10% avg tax rate (first 6 years production will not be taxed), $8M for SG&A (conservative), $10M for exploration, $5M for interest (yr 1 interest payment closer to $9M, however debt will be paid off within 2yrs), $7M for maintenance capex, and $425 cash cost, we arrive at 10yr average free cash flow of roughly $110M. We believe a 10x multiple is more than fair, and applying it yields a valuation of roughly $1.1Bn, or double the current quote. The NAV (8%) at a 1.2X multiple, less net debt, is roughly double the current quote using fairly conservative estimates. During the recent bull market mid tier producers all traded above 2X NAV.

For additional research, we recommend Haywood Securities or BMO.

Comps

A cursory look at mid tier gold companies with similar production profiles shows CGA to be extremely undervalued in terms of multiples of cash flow and metrics like EV/oz of production. For example, try JAG, CEE, NGD, AGI.

One of the reasons for this discrepancy is the comparative lack of institutional following for CGA, which as done comparatively little capital raising (read paying for order flow) and has therefore garnered less interest. The company intends to start full scale promotion over the next 2 quarters as commercial production has now been achieved. The valuation gap will not last.

Risks/Assumptions

It is fair to note that this valuation assumes further addition of existing resources to reserves, and the determination that these will fit the mine plan. It assumes $1000/oz gold-we are gold bulls and think this to be conservative, so please take this fwiw. However, we think a 10x multiple is quite conservative. We also believe assumptions on cash cost are somewhat conservative.

CGA only has one major asset, though its two secondary assets definitely have value-we peg this at $30-50M. Also, Masbate is in the Phillippines, and some people have reservations about investing there.

In order to be re-valued, CGA will need to show consistent production over the next 1-2 quarters. Therefore, the timeline for this investment is to expect roughly a double within 5-8 months. Overall, we see the company as an excellent acquisition target for a large mid-tied producer with a diverse portfolio of mines that would eliminate the country risk carried by CGA.

We also believe that simply on its own merits the company is significantly undervalued.

Catalyst

Increased promotion

Commercial Production