European Minerals EPM.TO
December 06, 2005 - 9:27am EST by
2005 2006
Price: 0.74 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 126 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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European Minerals (TSE:EPM $0.74, OTC:EPMCF, AIM:EUM) is developing a simple highly profitable gold/copper mine in Kazakhstan that will begin production in 12/06. Conservative assumptions demonstrate that the valuation has a large margin of safety. Reasonably optimistic assumptions show very high potential appreciation.

Key Data (All amounts in US$ except per share amounts as noted)

Basic Shares O/S = 197mm
Basic Market Cap = $126mm
Fully Diluted Shares = 279mm (includes options + warrants at strike prices from C$0.43 to C$1.39)
Net Cash = $56mm at 9/30/05
Possible Exercise Proceeds = $84mm

Gold Reserves (P+P) = 2.3mm ounces
Gold Resources (P+P+M+I+I) = 3.8mm ounces
Copper Reserves = (P+P) 238mm pounds
Copper Resources (P+P+M+I+I) = 432mm pounds

2007 Gold Production = 141,000 ounces (15 year LOM average = 129,000 oz/yr)
2007 Copper Production = 40mm pounds (15 year LOM average = 14mm lbs/yr )
2007 EPS = C$0.32 ($508 gold and $1.60 copper)
2007 OCFPS = C$0.36 ($508 gold and $1.60 copper)
2007 FCFPS = C$0.31 ($508 gold and $1.60 copper, add depreciation, subtract loan amortization)
2007 Cash production cost = $9.89 per ton of material (mining+mill+treatment+refining)
2007 Cash production cost = -$157 per ounce of gold (indeed that is minus $157/oz if you credit copper sales at $1.60/lb)

Fully Diluted NAV per share (using undiscounted $508 gold and $1.60 copper discounted at 10% per year) = C$2.05
Fully Diluted NAV per share (using undiscounted $400 gold and $1 copper discounted at 10%) = C$1.18

EPM’s only significant asset, the Varvarinskoye mine project, is described in great detail in the secondary offering prospectus filed on SEDAR on 3/31/05 and in even greater detail in the Bankable Feasibility Study filed as a Technical Report on 3/31/05. I’ll provide a brief summary followed by a focus on the factors that will drive the shareholder return:


- A Soviet geologist first identified the Varvarinskoye ore deposit in 1936 and extensive exploration took place from 1985-1990. EPM (led by the current executive team) acquired the property in 1995 and commissioned a Bankable Feasibility Study in 1998. The project was uneconomic at the very low copper and gold prices during 1998-2002. Design parameters were optimized and a new feasibility study was completed in 2004 showing excellent feasibility and attractive economic return.

- The mine site is in flat rural terrain with convenient access to roads, rail, power, and experienced local employees (from other mines in the region). It’s a very simple low-cost location to build and operate a mine.

- The project has all necessary licenses and permits

- EPM has hired MDM Ferroman to build the mine under a fixed price lump sum turnkey contract. EPM has no exposure to possible cost overruns.

- The project has been fully financed. EPM raised $78mm in an equity offering March and just signed a $75mm debt facility. I estimate that EPM will have $15-$18mm in cash on hand (without any possible proceeds from option/warrant exercise) when the mine is completed.


Photos on the EPM web site show tremendous progress in the past six months. The company rushed to complete enough of the main structures to allow continued construction during the winter months. Achievement relied on some aggressive action by EPM management to pre-order vehicles last winter when the company didn’t have the money to pay for them and sign interim construction contracts while minor permitting and documentation issues were resolved. Many mining companies have suffered significant delays and cost increases as the current boom stretches suppliers. So far the Varvarinskoye mine in on time and on budget.


The independent feasibility study includes a very detailed life of mine financial projection in Table 16.13 on page 16.20. So far EPM expects no significant variations from the projected expenses. You can plug those numbers into a spreadsheet and experiment with the sensitivity to different commodity price assumptions, discount rates, and whatever. My C$2.05 NAV estimate incorporates the following changes and additions:

Commodity prices: Most precious metal analysts use a 0% discount rate for future gold company earnings. Most base metal analysts use a discount rate of about 10% for future copper company earnings. To value the mixed output of Varvarinskoye I used the current spot gold price ($508) for 15 years of gold production and the 2007 copper futures price (about $1.60) discounted 10% per year. On this basis 80% of the LOM economic value comes from gold, but the copper contribution is higher by design in the first four years (35%).

Kazakh taxes and royalties: Gold royalty is 1.2% of sales. Copper royalty is 1% of sales. Property tax is 1% of book value of fixed assets. I assumed corporate income tax at the Kazakh statutory rate of 30%. I did not estimate the benefit EPM will receive from investment tax credits and deferrals that will accelerate after-tax free cash flow and increase the total shareholder return.

Corporate overhead adds $2mm per year beyond the costs at the mine.

Interest expense is assumed to be an average rate of 7% on an initial loan balance of $75.4mm. I assumed amortization in seven equal annual installments beginning in 2007.

Fully diluted NAV assumes exercise of all options and warrants. My 2007 EPS forecast was based on 198mm shares (basic shares plus only those options and warrants currently in the money at a C$0.74 share price).


EPM just signed contracts for the debt facility in accordance with the term sheets agreed last March. A $28mm commercial loan will bear interest at LIBOR+280. A $45.4mm loan with an agency guarantee will bear interest at LIBOR+120. Complete details have not yet been disclosed in regulatory filings.

These very favorable rates came with a heavy gold hedge requirement. This morning EPM announced the forward sale of 443,000 ounces of gold at a fixed price of $574 per ounce. Full details have not been disclosed and I did not incorporate this price in my EPS forecast and NAV estimate.


The Fraser Institute survey ranks Kazakhstan’s mining country risk as moderately high, slightly less than California (environmental policy), and slightly more than South Africa (BEE and potential royalty changes). Transparency International ranks perceived corruption in Kazakhstan as high, comparable to Honduras, Zambia, and Vietnam. The ranking has improved in recent years, but it aint Kansas.

The practical experience of some foreign companies in Kazakhstan has been positive. Petrokazakhstan earned substantial profits, repatriated earnings, and rewarded shareholders with dividends and share repurchase. The company and its assets were sold at a fair price, lower than the value of oil reserves in North America, but substantially more than the price of Russian oil reserves. Nelson Resources sold at a similar valuation.

Centerra Gold shows that the market is willing to accord a high valuation to a well-managed mining company with most of its assets in Central Asia. In fact, at a P/NAV of 1.5 and reserve life of only 7 years, it looks to me like CG could make a highly accretive acquisition of EPM, but it’s been the same story for a year so I’m not betting on any deal.


While the basic mine plan leads to very attractive cash flow compared to the current share price, there are several ways that EPM should exceed those projections.

1) Reserves used in the mine plan do not include significant Measured and Indicated resources within the existing open-pit design. An on-site assay lab will survey material as it is mined and substantial ore currently defined too vaguely to qualify as “Reserves” will prove suitable for processing. Higher commodity prices will also allow some material deemed uneconomic (at $375 Au and $1 CU) to be profitably processed. Ultimate recoveries through the infrastructure currently under construction are likely to be close to 3mm ounces instead of the 2mm ounces used in the feasibility study. My EPS and NAV forecast copy the feasibility study and do not include any additional recovery.

2) EPM has a large exploration concession surrounding the Varvarinskoye site with excellent prospects for identifying additional resources. The company has Soviet survey data, geophysical surveys, and is currently processing results from 2005 exploration drilling.

3) In 2007 EPM will become an excellent platform for further growth. Exercise of warrants plus very high free cash flow from Varvarinskoye will provide the opportunity for exploration and development without any additional equity dilution. EPM’s management has 10 years of experience in Kazakhstan and intends to focus on new projects within the FSU.


EPM accomplished a lot in 2005, but admits that it paid insufficient attention to investors and analysts. Canaccord underwrote the March share offering, but has issued only one research comment in the past six months. Newsletters that had recommended EPM, such as Hard Rock Analyst and Gold Stocks Weekly, issued no updates.

EPM seemed to disappoint the market in ways that were obvious, but ultimately of little or no importance. Last week EPM signed its credit facility and construction contract in accordance with the term sheets signed in March. The delay had created significant uncertainty that could have been addressed through clearer communication. EPM takes an extremely conservative approach to disclosure of non-public information. It’s difficult to get information that is not material, but which would provide a greater sense of comfort with the company’s progress.

EPM says that it will give investors more attention and that there will be a better news flow in coming months, such as exploration results, reserves update, and project progress.


Commodity price. Higher is better and lower is worse, however the very low operating cost and significant hedge make EPM relatively insensitive to changes in commodity prices. Gold stock investors aggressively chase the companies with high operating costs (for the perceived commodity price leverage) during bullish frenzies. But the best long-term returns have come from low cost producers such as Goldcorp, Meridian, and Glamis.

Seasonality. Gold stock peaks in late 2003 and 2004 were followed by sharp falls in April-May 2004 and 2005. I’m not sure why that season was so poor for metals, but I know it was painful. EPM may be weak during that time; my personal plan is to hedge my junior gold investments with some kind of short position in senior gold stocks.

Construction problems. Delays would probably defer share price appreciation, but not reduce the long-term value.

Country Risk. Political risk seems to be an increasing worldwide problem for resource businesses. I think the best approach is to buy cheap and stay diversified.


1) Positive news (exploration, reserve update, project progress, analyst update)
2) Mine completion 12/06
3) High EPS and free cash flow in 2007
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