|Shares Out. (in M):||187||P/E||8||4.0|
|Market Cap (in $M):||337||P/FCF||8||4.0|
|Net Debt (in $M):||-20||EBIT||72||135|
|TEV (in $M):||317||TEV/EBIT||4.4||2.3|
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Caijiaying is a zinc, gold, silver and lead mine located approximately 250 kilometers north-west of Beijing in the People’s Republic of China. Griffin holds an 88.8% equity interest in the Caijiaying Mine with the remaining interest held by the local government. This joint venture is known as Hebei Hua Ao Mining Industry Co. Ltd. (“Hebei Hua Ao”). The mine was commissioned on time and within budget in 2005 with an initial design production throughput of 200,000 tons of ore per annum. Production capacity has gradually increased to 1 million tons of ore per annum. Currently, the mine’s production comes from a section called Zone III. In 2014, management expanded the capacity of the processing mill to 1.5 million tons of ore per annum in hopes that the company would receive a license to mine Zone II, which is adjacent to Zone III.
After an excruciatingly long process, the company announced last week that it has completed the most important phase in the granting of the new mining license over Zone II. Hebei Hua Ao will now be entitled to conduct mining activities in Zone II and the Mining Ministry will prioritize the final documentation approvals for the mining license. The Ministry should grant the final permit by the end of August. It is worth noting that once this happens, Griffin will become the first foreign-owned company to receive a mining license under the current regulatory system in China.
Griffin’s shares rose a bit subsequent to the announcement but have under-reacted to the news. We believe this is due to a large Griffin shareholder -- a hedge fund that ceased operations last month – selling shares. This hedge fund has reportedly sold millions of shares subsequent to the announcement and has only a small number of shares remaining.
We think the stock should be trading 2x higher than it is currently with the potential for a 4-5x over time, if not more. Our investment thesis is as follows:
1) Low-Cost Mine. Arizona Mining has a slide in its investor deck that lays out the mining costs for all of the zinc mines in SNL Metals & Mining’s database. The chart shows 96 zinc mines with costs ranging from 39 cents per pound to $1.10 per pound. Griffin’s mine is not on this slide but if it were, it would be the standout low-cost producer with a cash cost of 28 cents per pound. A more comprehensive study by Wood Mackenzie puts the Caijiaying Mine’s cost structure lower than 88% of all of the zinc mines in the world. Due to its low cost operations, Griffin has been profitable in every year that it has maintained uninterrupted production.
2) Balance Sheet. Last December, Griffin paid down the last of its debt and we project that the company will exit 2018 with $30-40 million of cash on its balance sheet, or 16-22 pence per share of net cash. We estimate Griffin will have spent $10 million in 2018 to bring Zone II into production.
3) Exploratory Drilling. The mining industry is notorious for having highly promotional and press release-happy management teams. Griffin’s management is the opposite. The company has not updated its reserve report since June 2013 despite an active in-fill drilling program. Griffin’s last annual report refers to its geologists improving the structural model for the deposit. This certainly suggests that the resource could be up-sized. In addition, the company has been conducting exploration drilling in lands adjacent to Zones II and III and in an area 11 kilometers north west of Caijiaying. Management is particularly focused on an area called Sangongdi and believes that the mineralogy there is similar to that at Caijiaying. We believe a favorable resource update or successful drilling results at Sangongdi could re-rate the shares.
4) Favorable Chinese Supply Dynamics. China is the world’s largest producer of zinc concentrate, accounting for approximately 40% of the world’s global supply. China’s zinc production has declined slightly over the past couple of years due to declining ore grades and increasingly stringent environmental regulations. Chinese mining companies had extracted the highest-grade material out of their mines first, and are now mining in areas with lower grades. Due in large part to this “highgrading,” a leading geologist we consulted believes Chinese mine production is entering a long period of decline.
5) Supportive Zinc Fundamentals. Recently, consternation over new mine supply in addition to trade war fears have brought the zinc price down from a high of $1.63/lb. to $1.17/lb. We view this move as likely temporary. Western analysts cannot get any reliable information regarding Chinese zinc supply so they punt and project that Chinese supply will rise modestly over the next several years. Since there is more information regarding mines outside China, the focus is primarily on those mines. There are some mines coming into production outside of China over the next year or two. However, three of these mines, which represent 77% of the annualized incremental production base over the next year, are viewed rather skeptically by mining executives as they are either very low-grade and/or have serious metallurgical issues. Any hiccups in these mines or Chinese supply will extend the market deficit well into the next decade. Even though a recently published Goldman Sachs research report takes a rosy view of this new production and ignores the Chinese production issues, it concludes that zinc prices should average $1.27-$1.50/lb. over the next year before settling into a long-term average price of $1.22/lb. For purpose of valuation, we are using the current zinc price of $1.17/lb. although this could prove to be very conservative.
6) Incentivized Board and Management Team. Adam Usdan, a successful New York-based money manager, owns approximately 20% of the company’s stock. He sits on the board and has been accumulating shares over the past 20 years. Mladen Ninkov, CEO and member of the board, has a large stake in the company and is a value-oriented manager who frequently quotes Warren Buffet in his company’s annual reports.
7) Valuation. We struggle to find a cheaper mining equity in the world. Griffin should increase the production run-rate to 1.5m tons per annum in the beginning of next year. At this rate, it will be generating EBITDA and net income of $145 million and $95 million, respectively. Currently, its market capitalization is $353 million. Netting out the projected cash at the end of the year, puts the 2019 P/E multiple at 3.7x. Over the next twelve months, management believes that production capacity could expand to 2 million tons without meaningful capital expenditures. Under this scenario, net income would increase to $118 million and our target price would increase to £5 assuming a 12x P/E multiple. Finally, we would like to reiterate that any additional resource update and/or discovery could result in significant additional upside.
8) Takeout Target. The trading value of Griffin is a fraction where the stock would be valued by a potential acquirer. Large Chinese mining companies should be attracted to Griffin’s growing zinc production and prospective land base. Moreover, the Chinese government is committed to promoting foreign investment in the mining sector. This could encourage one of the major worldwide mining companies to view Griffin as a nice entrée into the Chinese market. The valuations that mining companies in China fetch in sales has historically been quite attractive. For instance, Eldorado Gold Corp. sold its Chinese gold assets in 2016 to Yintai Resources at a very healthy sub-4% discount rate. It is worth noting that in a sign of how eager major mining companies are to acquire zinc assets, in June, South 32 bought Arizona Mining for $1.5 billion. Arizona is an exploration company with no producing mining assets, and many in the industry have questioned whether the resource will turn into a profitable mine.
We think a reasonable take-out valuation for Griffin would be in the $1.25-$1.5 billion range, or £5-£6 per share, before factoring in any exploration upside. This is approximately a 7% discount rate based on current zinc prices. Please note that we view the current zinc price as at or below the long-term price that a potential acquirer would use in a deal valuation.
|2017||2018||New Run Rate|
|Ore Mined (000's)||920.168||920.168||1500||2000|
|% of tonnage||4.5%||4.5%||4.3%||4.3%|
|oz per ton||0.02||0.02||0.02||0.02|
|% of tonnage||0.1%||0.1%||0.1%||0.1%|
|oz per ton||0.41||0.41||0.41||0.41|
|Less Resource Tax||(6.3)||(6.5)||(10.0)||(12.9)|
|Less Admin COGS||(18.5)||(18.5)||(18.5)||(18.5)|
|Less Variable COGS||(38.0)||(37.8)||(36.0)||(60.8)|
|Less Interest Expense||(2.2)||0.0||0.0||0.0|
|Less Taxes @ 29%||(17.9)||(19.5)||(39.2)||(48.2)|
|% of Profit Attributable to GFM||88.80%||88.80%||88.80%||88.80%|
|Net Income Attributable||$38.8||$42.5||$85.1||$104.9|
|Value per Share||$5.42||$6.67|
|Value in GBP||GBP 4.07||GBP 5.02|
** Mining license approval
** Resource and exploration Drilling Uppdate
** Initiation of a dividend or buyback plan
** Higher run rate of production reached
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