GOLDEN STAR RESOURCES LTD GSS
December 20, 2009 - 11:53pm EST by
casper719
2009 2010
Price: 3.08 EPS n/a n/a
Shares Out. (in M): 256 P/E n/a n/a
Market Cap (in $M): 788 P/FCF 10x 5x
Net Debt (in $M): 30 EBIT 140 217
TEV ($): 818 TEV/EBIT 5.8x 3.8x

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Description

If demand is how you get paid on gold, supply is your margin of safety.

If you believe that gold production is impaired and that there is a high market floor to gold prices, then the market is incorrectly valuing production profiles, reserves and cost characteristics for the gold mining industry. The market is focused on the demand driven investment thesis due to endless talk of dollar devaluation/inflation etc. I am in full agreement that this creates upward pressure on the price of gold and probably drives the majority of the upside over the next 5 years. However, in the context of valuing miners, and stock picking, it misses the point since long term price assumptions drive valuation significantly more than a short term spike. Despite constant talk of peak oil, when was the last time you heard anyone mention peak gold? There is a lack of emphasis and focus on the significant supply driven story. This will result in a systemic and dramatic shift in the supply curve. This shift will create a permanent and significant floor on future prices, and leads to disparities between winners and losers given different production and exploration profiles in an industry increasingly struggling to replace reserves.

Sellside analysts are not to blame as they have few alternatives to a "sensible" cost curve, but their NAV models, which generally drive 75%+ of valuation estimates, are only as relevant as the accuracy of the cost curve they use. All these curves call for gold prices to peak 10-20% above spot in the next 1-3 years followed by a decline to a steady state 10-20% below spot. Then, typically, P/NAV multiples end up being used like PE multiples to factor in the quality of the company and other intangibles, rather than primarily for the true purpose of capturing gold mining optionality (which in theory balances out this cost curve deficiency in high cost producers). This creates a double counting effect on premium low-cost producers such as Goldcorp, Yamana or Angico-Eagle and to a lesser effect, the large names in general. This double counting effect is, to a large degree why there is such a discrepancy today in gold mining valuations as high-quality/low-cost assets are overvalued compared to low-quality/high-cost assets as the market equates cost to risk; this is another version of the  broader false volatility/risk paradigm. This bias has further been reinforced by decades of mean reverting, poor gold price performance and correspondingly bankrupt high cost producers. However, a systemic shift in supply trends turns today's high cost producers into reasonably low cost producers in a future industry framework.

Given this view on mispricing in the gold mining industry, those miners who are punished for having low-quality but not flawed assets with substantial reserves already in production (best suited to capture rising prices today, without the considerable risk of development/start up costs) in politically safe areas are most attractive. Golden Star Resources best fits this criteria. The company finally completed a ramp up in production in 2009 after years of logistical and operational issues. Golden Star now has many years of consistent "plateau" production ahead. It is my opinion that Golden Star represents the perfect combination of these characteristics.

  • Most of the disconnect in the price of Golden Star is in extreme optionality for higher prices. An $100 increase in gold increases FCF/share by roughly 17 cents.
  • The market underestimates the company's reserve expansion potential, which is highly sensitive to the 3-year rolling gold price used to calculate reserves.
  • There is still a level of skepticism, perhaps a "shell shocked" sell side consensus lingering, for what has been a long time and chronically disappointing "show me" stock.

A short description of Norseman Gold, a company very similar to Golden Star is included in the comments. But I have searched across all the liquid (let alone American listed) producing miners, and nowhere can I find politically safe ounces at these valuations like with Golden Star and nothing close to the size of the company.

Gold Supply Fundamentals: Peak Gold
The demand case for gold is rather simple and was well described by biv320 last year and highline1040 again this year. Einhorn's recent speech also covered the subject quite well. Tudor's most recent letter had an excellent overall analysis of gold. There is a wealth of good literature on the argument for gold, and has been for a long time. The demand thesis in general is most likely reasonably accepted on the Street. However, it is not fully priced as like many glacial shifts people notice but don't adequately respond. The entirety of the supply case is much less understood or accepted. The conventional largely correct with commodities is that they always revert to the marginal cost of production in the long run. Given the ingrained experience of most of today's large portfolio managers that "grew up" in the investment climate of the 80's and 90's, this is considered true for gold. However, a potential flaw in this reasoning results when marginal costs never really stabilize. This is a large reason why gold prices remain still at $1,100. People believe that though the price might have to get a little higher first, there will be supply market mechanisms that balance this situation; this just isn't true. Many money managers still largely ignore the industry, and while they may be short-term demand bullish on gold, they are under aware of any other scenarios, particularly the sustainability of the trend if supply cannot stabilize demand.

Therefore, there is not just a 5-10 year demand/inflation/US bankruptcy story in gold, but a broader multi-cycle trend still in its infancy. Looked at over longer stretches of history, aggregate gold demand can be related to population. Hockey sticked by the industrial revolution, demand and supply have kept a rather neat relationship throughout most of the history of civilization. In general, each person "consumes" an amount of gold, and the price in broad terms is defined by gold's scarcity to monetary supply. However, we are at an inflection point. For the rest of the century, demographics portend increasing population and wealth. Gold supply, as explained below, has meaningfully if not completely peaked and will soon begin declining permanently perhaps eventually at an increasing rate (except possibly in the face of extremely high prices). Gold is in a sustained long-term period of outperformance as an asset class and will have better real returns than it did last century.

One could argue, and I would concur, that this is a general trend across all commodities; gold is not unique. However, with every other commodity the analysis is complicated by the commodities consumption and substitution effects. Worldwide reserve estimates are also more defined and simpler to model in gold  as its peak production is likely present and definitive in most of the major producers. Especially compared to oil, gold is a closed system. Therefore this analysis is more provable than more other commodities today. 

Rather than going on a lengthy discussion of the specific facts behind the supply problems facing gold, I recommend this exhaustive analysis by Jean Laherrere, a geologist with a long career in the oil industry who applied his research on Hubbert commodity theories to gold. Additionally, the most comprehensive collection of mining production and reserves is found in the USGS study, the source of much of the data in Laherrere's report.

Part 1- http://europe.theoildrum.com/node/5989

Part 2- http://europe.theoildrum.com/node/5995

USGS study- http://minerals.usgs.gov/minerals/pubs/commodity/gold/myb1-2007-gold.pdf

Most of the figures in this report speak for themselves, however to summarize;

-Most of the world's gold production comes from countries that are past peak production with the top 7 producers (South Africa, US, Australia, Peru, Russia, and Canada) all in decline (except China because they have accelerated their gold production along with other resources). Excluding unreliable history on Russia, by far the largest historical producers (South Africa, Canada, US, Australia) have been in decline for 40, 20, 10 and 10 years respectively; these are not inconclusive trends. Other major producers (such as Ghana, Mali, Mexico, Chile and PNG) are not, nor ever will be large enough to make up the difference as the group that is still growing accounts for just 15% of total production. 

-Most of the world's gold comes from places where resources are well-defined so that accurate remaining resource figures can be established. These trends point to reasonably well defined estimates of total cumulative world production that is likely to be between 200k-250k tons compared to about 160k in cumulative production today. This definitively limits what kind of future production can be expected in years to come. One can extrapolate that if supply follows approximately a bell curve, the path is towards a steady imminent decline.

-Incremental mineral discoveries have been at substantially poorer grades. Without prices at least at today's levels, future grades (sub 1g/t) are only economical at increasingly rare multi-mineral large deposits due to the necessary scale. Even with either scale or high prices there are technological/environmental issues increasingly becoming factors (discussed below).

-A steep decline in the discovery of large deposits is another large problem for maintaining supply and another key data point for peak production. The economics of small projects are exponentially inferior; it obvious that a 2m oz/year Grasberg is exponentially better than 10 small scale 200k oz/year mines. There are not many Grasbergs left in the world, nor will they be easy to develop given they are likely to be located in politically or environmentally inhospitable places (and such projects require more stability given the capital invested). Such a case study on environmental obstruction is the Pebble mine (geologically similar to Grasberg) in Alaska.

South Africa

Of special note, South African gold mining is a particularly cautionary tale, perhaps the grandest example for any area of resource production in history. Saudi Arabia should be taking note. In 1970, South African production peaked at 1,000 tons annually or almost 75% of the world's gold production. Today, South Africa accounts for about 250 tons or 10% of world production. The Withwatersrand deposit, the Ghawar of gold by a factor of 10, has been responsible for almost half of all the gold mined in the last 6,000 years. The deposit is permanently impaired and recent reports indicate recoverable reserves are likely 10-20% of the official South African reserve estimates of 36k tons. This is very significant, as South Africa's official reserves still account for half of the world's reserves. The strains of a massive resource on its last leg are already playing out. Costs, logistical issues, and environmental concerns are spiraling out of control as some mines reach world record depths of 4000 meters. It is interesting to read about the logistics of these mines, how they cool down the 140F temperature which is already unusually cold compared with most places in the world with massive refrigeration for example. Many of these mines operate at costs over $700/oz (though a strong rand has had some effect on this). It is certainly not a massive mistake by the market that all the South African miners trade where they did in 2002, at paltry multiples to likely drastically overstated reserves. News out of South Africa is not new, people have been saying all of this for at least 10-15 years, but the degree of the accelerating decline is shocking.

http://mineweb.co.za/mineweb/view/mineweb/en/page34?oid=93062&sn=Detail

Peak cheap energy/oil locks in peak gold given lack of technological improvement and rising environmental standards

The counterargument to declining grades is that we will become more efficient at extracting lower grade ore. This was in large part what happened in the 70's and 80's when higher prices combined with new open pit techniques and CIL/heap leach technology lead to large new economical mining areas like the Carlin trend in Nevada (the "invisible" gold). Perhaps technological process today is underestimated and some similar breakthrough will have the same effect. Maybe someone can find an economical way to harvest the "vast" quantities of gold in the ocean.

Certainly there will be incremental improvements in efficiency of processing plants and equipment. The problem is most of the roadblocks to new technology are physics. How do we invent ways to mine miles underground, haul ore further, or move and process gold more efficiently? The answer to most solutions for getting to more gold ore is going to be more energy. So unless there's an answer for the world's energy problems, energy costs will be a strong floor to gold prices. With degrading ore quality, energy limitations become increasingly relevant barring efficiency improvements. This makes the profitability of existing mines less susceptible to oil prices as spikes affect the viability of more old mines.

The environmental issues with gold mining should not be taken lightly. The impact of gold mining on the environment is particularly severe due to the significant amount of ore necessary and the byproducts from processing (cyanide and mercury most notably). As ore grades continue to decline, the environmental impact inevitably grows. There may come a point when developing countries join the developed world in weighing trade-offs to large scale mining. While higher gold prices will certainly temper this effect, there will have an incremental impact on exploration and bringing new production online.

One has to wonder what would happen if the climate change movement ever takes interest in the vast and increasing energy usage by the gold industry. While gold has an economic value as a reserve currency, other than its relative price to money there is no economic difference to the world's utility whether there exists 150k tons or 200k. There is the same opposition to fossil fuels today (perversely more) but of course that is a battle carbon emission people will not win. However, there may be a point when many societies shut off gold mining for the purpose of conserving more important resources thus cutting off the recovery potential of otherwise economically viable low grade ore?

Political Risk

There are still places for expanding production but most of these mines exist in incrementally risky areas of the world. Mines are particularly costly to develop and most of these countries don't have the sophistication to do this. Longer term, this high grade untapped gold in the Congo and Venezuala to name notable examples will surely come out of the ground, but over the next decade, this is a key issue. Companies like Crystellex have been praying for Chavez environmental permits for a very long time, yet the company traded for years at over 10 times today's price. Political issues should in general temper what would otherwise be supply growth that could cushion declining production from the major gold producers.

There have been a couple recent VIC ideas that have essentially been bottom feeding on these alluring quantities of unproven M&I&I resources in very politically unfavorable places. Case by case there maybe be interesting spots. However in general, I view this as the wrong strategy, these companies are cheap on Ev/resource multiples for good reason. Frequently these aren't ways to profit off rising gold prices at all. There are so many still reasonably cheap small miners in moderate to safe countries that will go up many times in price should the bullish gold thesis play out that the risk isn't worth at the least the opportunity cost.

Here is a comprehensive survey asking miners to evaluate countries.

http://www.fraserinstitute.org/researchandpublications/publications/6534.aspx

Final Thoughts about Gold Prices

With declining mine supply and central banks becoming net buyers, (as they last were smartly in the early 80's since unless your last name is Brown it was infinitely smarter politically to sell gold in 2000 than now), recycling is the mechanism that will settle the market with gold prices rising. Recycling in recent years has been about 30% of total supply. However, since it does not add supply at lower prices it helps reinforce a floor (recycling also is likely to become more resistant to moderately high prices as higher gold prices become accepted in public conscious just like political will to sell).

It is a common false assumption that all the gold ever mined still exists. It is estimated that approximately 15% or 24k tons have been used for dissipative industrial purposes or otherwise have been lost. This leaves about 30k tons in central banks and the remaining 105k in jewelry/investment. Tudor suggests annual production today represents 4% of available supply. I'm not sure what assumptions they is using for that as if jewelry/investment is "technically" all available the number would be slightly over 2%.

There is a dynamic of gold mining operations that when prices go up, many mines switch to lower grade ore to preserve mine life, which lowers production temporarily. It's hard to say to what extent, but this has contributed to the d supply declined this decade (and likewise artificially increased peak production in the late 90's as miners desperately attempted to remain profitable). This is why pinpointing a true year gold production peaked/peaks is both impossible and irrelevant. The takeaway though is it creates a strange situation where higher prices can put even more downward pressure on supply over the short-term.

Golden Star Resources

From its inception in the late 1980's, Golden Star was a pure exploration company focused on the Guiana shield with a successful track record (developing notably Cambior's Rosebel and Omai mines). In 1999, the company made a strategic shift to become a producer and began acquiring an 85km continuous stretch of Ghana's historically rich Ashanti Trend from a collection of companies. These purchases included two previously operated mines, Bogoso-Prestea and Wassa. In 2005 they acquired with a 20% stake in the combined entity, St Jude a West African Ghana miner for their main assets, the Benso and Hwini-Butre properties. The Wassa mine is located 20 miles east of Bogoso/Prestea while Benso/Hwini-Butri are located 25 and 40 miles south of Wassa respectively.

Bogoso/Prestea

The Bogata/Prestea complex was first developed by BHP Billiton in 1991. However, employing an older method of converting refractory ore called roasting, BHP never efficiently recovered the sulfide ores and this part of the operation ceased in 1994. Sulfide or refractory ore is any ore that cannot be recovered with conventional techniques like cyanide leaching due to the sulfide content. Before refractory ore can be recovered with cyanide leaching, the ore has to be pre-treated to remove the sulfide minerals and carbon that interfere with leaching. Oxide ores continued to be mined when GSS purchased the mine in 1999.

When GSS purchased the mine and 1.5M ton oxide mill they resumed the mining of oxide reserves, which represented all of GSS production until Wassa came online in 2005. Oxide ore on permitted sites was mined until early 2008. In 2003, GSS set in motion a plan to resume mining refractory ores through a 3.5M ton BIOX plant. The BIOX system, licensed from Ashanti solves the sulphide problem in refractory ores with bacteria that "scrub" the ore so it can then be processed normally.

The recovery rates are critical to the profitability/production at Bogoso. Bogoso has shown the ability to achieve recovery rates between 69% and 74% on a monthly basis. The difference amounts to roughly 15k additional oz and $40 in cash costs annually. Recovery rates have been trending higher recently apart from a temporary blip due to ore composition in the last quarter and tonnage is now approaching capacity of 3.5M. In general, Bogoso operations have been steadily improving and at least 200k oz annually at 650 cash costs should is achievable going forward.

In the 2008 reserve review, Bogoso refractory reserves were 2m oz at 3.2g/t. M&I resources totaled 1.3m oz at 2.6g/t. However the real story is that net of depletion, Bogoso "lost" almost 1.5m oz of refractory reserves from 2007 to 2008 primarily due to higher estimates of recovery cost given operational performance and energy costs in 2008. Like operating leverage, reserve additions from economic cutoffs are similar and thus, Bogoso reserves (and mine life) are also highly leveraged to gold prices. There are a lot of moving pieces in analyzing reserve potential and mine life at Bogoso/Prestea but the key conclusion is particularly as economic cut offs rise the refractory portion of Bogoso will be a long lived mine with significantly over 10 years of production remaining. There should be significant upward revisions to Bogoso reserves in the next 10k in early 2010 given higher gold cut offs (3 year rolling average gold price will be around 800 vs 700 last year) and improved costs/recoveries from last year. The repatriation of a large portion of these "lost reserves" should provide a catalyst to a revaluation of the Bogoso mine.

Non-refractory reserves (about half at Prestea South) totaled 450,000 at 2.7g/t. I estimate production to be roughly 50,000 oz/year when resumed and the oxide mill with current reserves should provide 5-6 years of production. There is probably not too much upside to these numbers as the Prestea sites are well explored, these figures also include some adjacent sites and almost all of the remaining M&I resources at Bogoso/Prestea are refractory. However, further use of the oxide mill could come from Prestea Underground in the future.

Wassa and Benso/Hwini-Butre

Wassa was initially developed in 1997 but low grades and prices shut it down just 2 years later. GSS purchased the property in 2001 out of bankruptcy. Production at Wassa resumed in 2005 with an upgraded 3M ton mill. The Benso/Hwini-Butre mine was purchased in 2005 and developed from 2006-2008. A haul road to Benso was completed in Q4 2008, and an extension to Hwini-Butre is nearing completion. Since completion of the haul road last year the substantially higher grade ore has been hauled and blended with Wassa ore to fill out mill capacity. HBB ore grades are over 3g/t compared to roughly 1g/t at Wassa which has substantially increased production and lowered costs as shown below. Wassa should continue to perform well and yield slightly over 200k oz/year with cash costs under 500/oz, varying with the quantity and grade of ore hauled from HBB.

In the 2008 reserve review, Wassa had 220k oz at 1.2g/t and HBB had 700k oz at 4.1g/t. Adding in 440k oz of M&I resources at a 25% discount and netting for depletion in 2009, I estimate Wassa/HBB has about 1m oz of gold remaining at an average grade of 2-2.5g/t. At production of slightly over 200k oz/year with minimal resource expansion at Wassa but good expansion potential at HBB in addition to some added reserves from higher economic cutoffs, I estimate the Wassa/HBB mine life to be 7-10 years. Additional potential mining sites (Manso and Chichiwelli) in haul distance could increase the years the Wassa mill could be used.

Problems

From 2005-2008 GSS ran into significant issues which created a large, and for a long time deserved, discount to peers. These issues are primarily in the past.

1. The BIOX plant encountered significant construction and startup delays postponing commercial production for over a year until June 2007. Even after production began, as the largest facility of its kind and still a rather new technology, the plant suffered from considerable startup inefficiencies and lower than expected recovery rates. Results improved significantly this year, though still under initial expectations, such that this should no longer be such an overhang on valuation but as proved by the last quarter results remain uneven.

2. In the summer of 2006 Ghana, which relies significantly on hydroelectric power, experienced a severe drought which both caused rationing and higher electricity prices. The poor power infrastructure also suffers from irregular voltage levels that trip circuit breakers and thus cause some lost days of production. In response GSS and a consortium of other miners (Newmont, Ashanti) constructed a power plant which can provide about half of Golden Star's power needs and finally came online Q2 2009. GSS has also built a diesel fueled backup power plant at Bogaso. Additionally this summer, following the political overhang of Ghana's elections, the countries gold producers negotiated a reduction in the very high power costs from $0.14kwh to $0.10kwh corresponding to a $40 cost reduction at Bogoso and $20 at Wassa. Power issues also create disturbances in the operations of the bacteria at the BIOX plant. While this continues to be a crucial issue both on costs and production consistency, GSS has proactively taken steps and successfully decreased their exposure to uncertainties of the Ghana power grid. I expect continued incremental improvements.

3. General energy costs in 2008 capped off their troubles, effectively creating the perfect storm for GSS and initially masking the turnaround of the previous issues and grade improvements at Wassa from new HBB ore. With higher than average sensitivity to energy costs (particularly with lower than steady state production), cash costs followed (all time high) gold prices throughout most of 2008. While this is arguely the biggest risk for GSS, significant operational improvements since oil peaked last summer put GSS on much strong footing for the next time. More importantly I don't envision gold being close to 800 the next time oil goes near 150. That seems extremely unlikely to repeat for so many reasons, such as discussed above.

Reserve and Production Expansion

GSS had a 10m exploration budget for 2009 and expects similar expenditures next year the focus shifts to growing reserves. They bought the largest multipurpose rig in the region to reduce otherwise contract drilling costs. Their concentrated area of properties and undeveloped adjacent sites provide significant potential for reserve expansion outside existing mines within hauling distance to their mills.

Beyond the mostly depleted oxide ore at Prestea, there are additional oxide reserves at Prestea South, currently reserved at about 400k oz (about half of which is oxide). Prestea South is a commercial viable and near ready mine that Golden Star plans to restart soon to make use of their now dormant oxide mill at Borgata-Prestea. The obstacle is a permit that is held up due to a public hearing management hopes to resolve in the next few months though this has been running behind schedule already. When they do eventually clear permitting, a 6 month construction period puts a target start date of late 2010/2011.

Prestea Underground shut down in 2002 after operating for a century and producing 9m oz. Current resource estimates of M&I&I are roughly 1.5m oz. However any value going forward from this is uncertain as management's most recent study in 2008 of the return on the approximate 100m in infrastructure investments was not sufficient at the time (a 2008 study). The mine also suffers from illegal miners who previously caused damage to the mine collapsing a shaft. After the 2008 review, GSS wrote down the carrying value from 45m to 0 but continues to keep the mine under maintenance. My understanding is there is still value in this location (the writeoff was more an accounting adjustment) given higher gold prices and after focusing on more important projects.

Exploration

GSS still holds exploration properties from their past in the Guinean Shield/Brazil as well as in West Africa from the St Jude acquisition. These projects have been relatively on the back burner given the focus required at Bogoso/Wassa. Further, their West African properties exist in less savory countries and none are close to a prefeasibility study. Both of their key properties in South America are more advanced. The Saramacca mine in Suriname, a 50/50 JV with Newmont, shows particular promise and has resulted in over $6m invested by Newmont. Their Paul Isnard mine in French Guiana has almost 1moz inferred in their last survey. Best guess is the collective value of their properties, JV agreements, and assorted leftover minority stakes are worth $20-50m.

Political Risk

Ghana is very friendly for mining and a relatively stable country. The gold industry, the second largest in Africa only to South Africa, makes up approximately 4% of GDP and a 1/3 of all exports. A almost true democracy since 1992, Ghana consistently ranks in the top decile in sub Saharan rankings of governance, political stability and rule of law on par with leading peers like South Africa and Botswana. A recent mining report on 25 top mining countries ranked Ghana 7th behind only developed countries such as US, Canada, Australia and Brazil. When people think Ghana they think Africa and that it must be relatively risky; in this case political risk is reasonably low and likely slightly mispriced. However, as noted above the country's infrastructure is lacking and in the past has been detrimental to GSS.

http://www.dolbear.com/publications-countryranks.php

Last month Ghana's finance minister made some comments about doubling royalty rates to 6% and "to engage the mining industry on dividend payments, tax exemptions and fiscal regime". Newmont then postured that the consequences of a royalty hike would be severe on returns to investment etc. Not that the market discounted the news when it occurred anyway, but I believe this is overblown. The existing royalty terms in Ghana actually call for a sliding scale from 3% to 6% when operating margins reach 70% limiting the marginal impact for much higher prices, the chief reason for buying GSS. I believe even at today's prices Ghana was not seeing this higher rate in most mines, certainly not Bogoso, and that frustration is the driver of the change coming from a review that began in 2008. Although it's not a done deal, I model this to take effect in 2011 as if not this, it's likely there will be some modest increase in payments to Ghana down the road. Ghana also currently has a carried 10% interest in all mines. It should be noted though that GSS recouped approximately the cost this royalty change would incur when power rates were renegotiated earlier this year.

Valuation

 

 

2008Q1

2008Q2

2008Q3

2008Q4

2009Q1

2009Q2

2009Q3

Gold Price Realized

 

926

900

866

808

904

928

967

Gold Sold (Ounces)

 

68,035

76,662

70,283

86,144

96,971

99,011

107,433

Total Cash Cost ($)

 

674

727

894

648

603

588

615

 

 

 

 

 

 

 

 

 

Wassa

 

 

 

 

 

 

 

 

Grade (g/t)

 

1.14

1.20

1.26

2.19

2.28

2.62

3.12

Mined (t)

 

926,773

856,238

721,947

592,000

947,000

637,000

559,519

Recovery 

 

93%

93%

92%

95%

96%

95%

96%

OZ Mined

 

31,590

30,722

26,906

39,599

66,642

50,975

53,881

Cash Operating Costs

 

448

560

793

426

397

502

470

 

 

 

 

 

 

 

 

 

Bogoso Sulfide

 

 

 

 

 

 

 

 

Grade (g/t)

 

2.67

2.94

2.73

2.78

3.00

2.66

2.98

Mined (t)

 

584,308

438,487

731,261

558,000

653,000

727,000

797,347

Recovery 

 

59%

70%

68%

71%

72%

72%

69%

OZ Mined

 

29,593

29,013

43,645

35,410

45,348

44,765

52,711

Cash Operating Costs

 

769

843

903

799

813

624

704

Base case production for GSS is 400,000 oz with overall upside to roughly 500,000 oz over the next 2-3 years from the restart of the oxide mill at Prestea and incremental improvements to Bogoso and Wassa. I have given Bogoso credit for slight further operational improvement and stability as well as 2 years of additional mine life from current reserves at Wassa from HBB exploration. Cash cost assumptions are slightly above management consensus and moderately below what is capable optimally at Bogoso (which is probably 600 cash costs at current oil prices). GSS is more sensitive to energy than most companies and that is reflected in the 3% per year escalating cash costs starting in 2012. I assign an additonal $100m to NAV for their assortment of exploration projects, other Ghana sites, Prestea Underground and any remaining mine life Bogoso could have. I think these are conservative and easily beatable assumptions given what GSS has shown their mines can do this year.

 

2009E

2010E

2011E

2012E

2013E

2014E

2015E

2016E

2017E

2018E

2019E

Gold Price Realized

969

1,200

1,000

1,000

1,000

1,000

1,000

1,000

1,000

1,000

1,000

Gold Sold (Ounces)

406,209

425,032

461,745

488,458

484,465

480,471

476,478

448,523

351,090

290,815

190,975

Cash Operating Cost

578

565

562

578

596

615

634

660

698

740

818

Royalties (% Gold Price)

3%

3%

6%

6%

6%

6%

6%

6%

6%

6%

6%

Royalties ($/oz)

29

36

60

60

60

60

60

60

60

60

60

Total Cash Cost ($)

607

601

622

638

656

675

694

720

758

800

878

 

 

 

 

 

 

 

 

 

 

 

 

Wassa/HBB

 

 

 

 

 

 

 

 

 

 

 

Grade (g/t)

2.67

2.80

2.80

2.80

2.75

2.70

2.65

2.60

2.55

2.50

 

Mined (t 000s)

2,743

2,600

2,600

2,600

2,600

2,600

2,600

2,300

1,700

1,300

 

Recovery 

96%

96%

96%

96%

96%

96%

96%

96%

96%

96%

 

Ounces Mined

224,642

223,640

223,640

223,640

219,646

215,653

211,659

183,704

133,170

99,839

 

Cash Operating Costs

450

470

470

484

499

514

529

545

561

578

 

Bogoso Sulfide

 

 

 

 

 

 

 

 

 

 

 

Grade (g/t)

2.88

2.90

2.90

2.90

2.90

2.90

2.90

2.90

2.85

2.75

2.65

Mined (t 000s)

2,927

3,000

3,100

3,200

3,200

3,200

3,200

3,200

3,000

3,000

3,000

Recovery 

71%

72%

72%

72%

72%

72%

72%

72%

72%

72%

72%

Ounces Mined

192,473

201,392

208,105

214,818

214,818

214,818

214,818

214,818

197,920

190,975

184,031

Cash Operating Costs

695

670

670

690

711

732

754

777

800

824

849

Bogoso Oxide

 

 

 

 

 

 

 

 

 

 

 

Ounces Mined

 

 

30,000

50,000

50,000

50,000

50,000

50,000

20,000

 

 

Cash Operating Costs

 

 

500

515

530

546

563

580

597

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2009E

2010E

2011E

2012E

2013E

2014E

2015E

2016E

2017E

2018E

2019E

Revenue ($ in millions)

398

510

462

488

484

480

476

449

351

291

191

SGA

14

15

15

15

15

15

15

15

15

15

15

Cost

235

240

260

282

289

295

302

296

245

215

156

Interest

15

15

15

15

 

 

 

 

 

 

 

EBT

135

240

172

176

181

170

159

138

91

61

20

Tax

 

 

 

 

 

43

40

34

23

15

5

Exploration

10

10

12

12

12

12

12

10

10

5

0

Capex

45

25

20

15

15

15

15

15

10

10

10

Free Cash Flow

80

205

140

149

154

101

93

78

48

31

5

FCF/share

0.31

0.79

0.54

0.57

0.59

0.39

0.36

0.30

0.19

0.12

0.02

 

I believe NAV valuation is in the end a poor way to reach valuation decisions on miners, but can be helpful in framing the assets. NAV strikes me like black sholes for options, since you really know either variable you are just making up numbers given an equation; I would rather think in terms of future gold price since the constant we do know is today's the GSS stock price and use NAV as a downside measure. A very conservative assumption NAV, discounted at 8% with no premium assuming a gold price of 1,200 in 2010 solves for fair value with a long term gold price of 1000. This may be a little high because such a gold scenario probably would give GSS somewhat of a break on rising costs not in the model. However, its not surprising that GSS needs such a high price given the peer leading operating leverage.

However, I really dont worry about low gold prices with GSS. It is simply a hazard to be accepted. Most gold stocks are to be bought for optimal upside to gold, not to see if we can find the next great value arbitrage or special situation. The margin of safety is in the gold outlook, not the company.

As the table below shows, the FCF ramifications of even modest increases make GSS incredibly cheap. Even remaining at today's spot prices of $1,100, it is a steal at under 5x 2011 FCF. Most importantly, I don't personally mind being in a "greater fool" investment, if I'm not a fool for having gotten involved initially. I believe GSS has the groundwork to be a stock that goes from being hated to way overloved. It has already started building chart momentum loves. Looking at the cash GSS is capable of earning in a "gold mania" scenario, then giving it an aggressive multiple particularly BECAUSE of its exceptionally high beta, i think GSS could end up north of 20-30. Easy!

Gold Price

2010

2011

2012

700

      (0.03)

       0.01

       0.01

800

       0.13

       0.18

       0.20

900

       0.30

       0.36

       0.39

1,000

       0.46

       0.54

       0.57

1,100

       0.62

       0.72

       0.76

1,200

       0.79

       0.89

       0.95

1,300

       0.95

       1.07

       1.14

1,400

       1.12

       1.25

       1.33

1,500

       1.28

       1.43

       1.51

2,000

       2.10

       2.32

       2.45

2,500

       2.91

       3.20

       3.39

Conclusion

After years of problems I believe 2009 was the year Golden Star finally got all the moving pieces in order, righted the ship and significant shook its label as a "show me" stock. This will be the first year in the last 5 they meet and don't come in significantly under guidance. Challenges remain, particularly with Bogoso continuing to be more difficult and expensive than most mines outside of South Africa to operate. However, the problems going forward are most likely to result in choppy results, not outright performance under base expectations. With the significant operational issues behind, sound liquidity and no major capex ahead management can now focus on value creation not damage control; notably adding reserves at Bogoso and HBB and resuming production at the Prestea oxide mill working towards an upward goal of 500,000 oz and longer lived assets. Rising gold prices, particularly their effect on the 3 year moving average of gold cut offs for adding reserves and people's perception of a base gold price combined with the high degree of leverage should should make Golden Star increasingly attractive and narrow their current market discount. While choppy performance and high cost mines could continue to impair the extent of a revaluation, even if gold remains in a trading range for the next few years, 4-5x FCF should provide its own catalyst for a reasonable return. 

Catalyst

Gold Prices

Release of new reserve estimates, repatriation of lost reserves due to lower costs and higher gold cutoffs

Continued operational improvements and more quarters of consistent production

Prestea South Permit and restart of Prestea oxide mill

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