|Shares Out. (in M):||122||P/E||7||0|
|Market Cap (in $M):||52||P/FCF||0||0|
|Net Debt (in $M):||-17||EBIT||9||0|
|TEV (in $M):||35||TEV/EBIT||4||0|
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Superior Gold is a small cap gold miner in Western Australia, that owns 100% of the Plutonic gold mine. Currently, i.e. at C$ 0.54 the company has a market cap of U$$ 52m; in light of a net cash position if US$ 17m, the EV is just U$ 35m.
Underlying H1 free cash flow was US$ 6.8m, thus annualized FCF of US$13.4m or a yield of 38% based on EV, thus already at the H1 average realized gold price of U$ 1790 the share is highly attractive. In early September the Chairman of the board bought 0.4% of share capital at a price of CAD 0.56, which confirms our case.
That said, Superior is a high cost producer, thus there is strong leverage to the gold price and additionally huge optionality due to a number of company specific factors:
AISC improvement, last two quarters already show positive trend and expect more substantial improvements in 2022 which should lead to AISC of below US$ 1300 sometime in H2 2022 (currently around US$ 1500).
Exploration upside, they reported a number of strong drill results in the last 5 quarters
In-House growth project, main pit pushback NPV5 U$ 84m
Strong asset base, 1 spare mill on care and maintenance, potential for toll milling, outright sale of mill etc.
Why does this opportunity exist?:
Chris Bradbrook, the former CEO, acquired Plutonic in October 2016 for A$ 46m in cash and contingent payments of another A$ 20m from Northern Star and IPOed the mine as Superior Gold on the TSX in March 2017.
The first couple of quarters were actually pretty successful, from Q4 2016 to Q3 2018, the mine generated cash flow from operations of US$ 38m, i.e. more than the 2016 purchase price of U$ 35m.
Bradbook however did not invest into the Plutonic underground mine, but rather choose to push for growth in opening the Hermes Open Pit. The under-investment in the cash-flowing asset, particularly stope development, coupled with a poor operational handling let to AISC cost peaking in Q4 2020 at U$ 1685. Already after the Q3 2019 cost spike Bradbrook outlined a turnaround plan targeting AISC of U$ 1025 to U$1150. However with no progress towards that goal in H1 2020 and his abysmal decision to cap the gold price upside with the November 2019 gold loan & accompanying hedges of the gold price the stock got punished.
The gold loan, whose repayment is included in the operating cash flow, is also the reason, why the free cash flow potential of Plutonic is not yet visible if you only have a casual look at the figures (cash only rose by US$ 0.2m in H1 to US$ 17.4m at 30.06.21). Furthermore, Northern Star has started to exit is position June 29, with the sale of 5.2% of shares outstanding at C$ 0.63; thus there remaining stake of 9.9% is seen as share overhang.
New management, from July 2020 to end of June 2021 Tamara Brown took over, she not only increased investments in equipment (2 trucks, 2 loaders, additional drill rig) but also commissioned a PEA for the push back of the main pit. As Tamara’s background is IR she always stressed the need for a technically versed CEO.
With Chris Jordaan, who had several top positions at Newcrest, most recently as Programme Director for the transformation of the PNG operations and before General Manager of the Lihir mine, a large and complex operation (ca. 4500 employees) as well as having CEO experience.
They hired Russel Cole, Chris’s successor as GM of Lihir, as General Manager for Plutonic & COO as of July 1 .
Both Russel and Chris will be based in Perth. Thus their top management is now finally also in Western Australia. Bear in mind the former COO Keith Boyle was based in Canada. So they will not only save the cost of 1 senior executive, they should also become more efficient with a leaner team close to the mine.
Already in March 2020 they hired Ettienne du Plessis as new chief geologist, he knew the Plutonic orebody from his Barrick days and thus his return should be seen as testament to the potential of the mine. In the last couple of quarters Superior has released a couple of very promising drill results.
In the last two quarters they have shown a decent improvement of stope grade of their underground operations. Even assuming the Q2 stope grade of 3,26 g/t, which is pretty much the average of the last three quarters, to remain unchanged, we expect costs to come down as they started to mine two prior producing open pits, as of June Plutonic East and later the Perch pit. Thus low grade stockpile (0.4 g/t) will be replaced with higher grade material (Plutonic East ca 0.8g/t, Perch above 1.0g/t albeit at a worse strip ratio). This enables them to grow production and should lead to AISC of around US$ 1480 in Q3 and a further improvement to just under US$ 1450 in Q4. Bear in mind, both these figures are below management guidance of US$ 1500 to US$ 1600 AISC in the current year.
The big price is however once they open the new Western Mining Front. They have reported very strong drill results near infrastructure with the best whole grading 56 g/t over 15m (already reported in Q2 2020). At that time the market got excited but now everybody seems to have forgotten, what an increase of grade can do to their costs. Once you model a stope grade of 4 g/t and the open pits AISC falls below US$ 1300 per ounce. This stope grade might sound aggressive, however bear in mind that not only have their drill holes in the Western mining front been very strong with several significant intervals grading above 10 g/t, compare page 24 & 25 of their presentation, their overall reserve grade as of 31.12.2019, which does not include these new holes, is also 4 g/t. Thus, there is in our view a visible path to lowering AISC to a very competitive level, which should be a strong trigger for a re-rating. We would expect them to achieve this lower cost some time in H2 2022. In their August 17 release they confirmed that the new mining front will be part of 2022 mine plan:
“The expansion into new mining fronts is a key component of our current strategy to extend Plutonic's mine life and increase production by further improving our mining grades and efficiencies. Our ongoing drill program, utilizing our dedicated exploration drill rig, will continue to infill the Western Mining Front with the aim of including parts of this area in the 2022 mine plan."
Furthermore, the new 3D modelling of the resource will improve mine planning and should drive the improvement of stope grade.
Exploration story: Resources are growing
Superior is also a very attractive exploration story, as its resources have grown steadily over the last couple of years. Superior’s total mineral inventory, i.e. M&I resources + Inferred Resources was 4.96 Moz at year end 2019. Despite the strong resource base, reserves are however only 330koz which is often seen as cause for concern. We would however expect reserves to grow significantly, as the Dec 2019 figures do not yet include the strong drill results seen over the last 18months. Furthermore, Plutonic’s reserve statement is based on a gold price of A$ 1925, which is more than 20% below the current gold price of around A$ 2400.
The next Resources & Reserves Statement is planned for early H2 2022 and should particularly reveal an increase of reserves. Since late Q4 2020 they have a third underground drill rig, which is dedicated to exploration in operation and we should thus get more regular exploration updates.
Main Pit Pushback:
With the increase of the gold price it made a lot of sense to revisit their past producing pits and they released a PEA for the main pit pushback in December last year. Based on a gold price of US$ 1505 they derive a NPV5 after tax of US$ 84m requiring initial capital of US$ 82m. AISC are projected at US$ 863 per oz, thus we expect them to be able to finance a significant portion of the development with debt. Furthermore, we expect significant FCF from Plutonic until the pushback.
They have another 1.2 Mtpa mill on care and maintenance which could be restarted with little capex.
Their H1 operating cash flow was burdened by US$ 4.4m gold loan repayment, US-$ 1.8m loss on the gold calls the sold in conjunction with the loan and a US$ 0.8m “golden handshake” for the departure of their interim CEO Tamara Brown. Thus, the underlying FCF in H1, excluding the (positive) working capital change, was US-$ 6.8m. This cash-flow was realized at a gold price of US$ 1791 which equaled A$ 2320 during H1. As most of their costs are in A$ the latter figure is even more important. Thus, the H1 gold price was even a touch below the current level.
Although we expect a reduction in AISC and obviously ultimately also higher gold prices, we base our valuation on the H1 gold price and AISC level, to illustrate the strength of the valuation case.
Based on H1 underlying FCF we estimate a FCF per ounce of US$ 185, we have assume a life of mine production of 665koz for the underground operations, while this is higher than the underground reserves of 330koz it is still just 50% of the M&I underground resource base, given the very low price assumption in the reserve base, we consider it much more reasonable to base the valuation on the M&I resource base. Due to the rather low execution risk, we included 50% of the NPV of the main pit pushback in our valuation. Of the outstanding the 23.6m warrants and options, 80% will expire February 23 2022 (14.6m strike price C$1.52, 4.8m strike price C$ 0.8). We therefore base our valuation on only 126m diluted shares (currently 122m outstanding). This approach leaves upside to C$ 1.50, i.e. more than 180% upside at current price level.
There is strong leverage to both a reduction of AISC or rise of the gold price. E.g. should they manage the reduction of AISC to sub US$ 1300 which we expect, that leads to US$ 200 more in FCF per ounce or US$ 133m additional pre-tax FCF over the life of mine (after tax NPV5 US$74m higher, i.e. fair value per share C$ 2.24).
Appendix: AISC model:
Substantial Free Cash flow as of Q3
Sequential and yoy growth in production in Q3 & Q4
Continued AISC improvement in H2 and particularly in 2022
Resources update in summer 2022
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