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Drew Clark: Adding Value Through Growth
Source: Brian Sylvester of The Gold Report (9/22/10)
Drew Clark is a relatively new analyst with Byron Capital Markets, but that doesn't mean he doesn't espouse his fair share of wisdom. In this exclusive interview with The Gold Report, Drew provides an in-depth look at gold companies in all categories that he believes are respectable investment opportunities.
Drew Clark: I am one of the two analysts covering the mining space at Byron Capital Markets. My counterpart, Jeff Wu, is located in our Vancouver office.
My coverage universe breaks down into two groups: producers and developers. All of the companies in those spaces have growth prospects, either through production growth or the development of new operations. Our goal is to provide a universe of companies that present investors with proven management teams, economic projects in their pipelines and ultimately, favorable value propositions.
Why precious metals? I believe we're in the middle of an historic run in the price of gold, which is highly favorable for all participants in the industry. As a result, in this environment I view both the prospects and investors' appetites in the gold sector as being much more favorable than other sectors.
TGR: You said in a recent research report that "gold companies that are several years away from achieving commercial production track the movements in the price of bullion almost as closely as producers. It's almost as if the market is attributing value based on cash flows as if their profile is a function of current, not future, commodity prices." When do you think that started, and what is it a function of?
DC: Primarily over-exuberance. People aren't looking at the big picture and what drives the value of these development stories. As I said, one would assume these movements are the result of the market attributing spot prices to their cash flow profile. But if you calculated the implied price based on these current market prices, they're consistently lower than prevailing spot prices. It's a curious relationship where the share price movement is tracking the spot prices, but the actual valuation is being calculated by lower, more realistic, long-term prices.
Market participants are simply not properly identifying the intrinsic value of a company, which is more a function of these more realistic prices. Let's say there's a company with a resource evaluating the economic viability of a potential development. We don't know with any certainty if that company's project will be developed or when it could potentially enter commercial production or even what its output may be. What we do know with certainty is they're not going to be selling their output at today's prices.
Now, in terms of production companies with profitable operations, such relationships make perfect sense because market participants primarily evaluate them on their ability to generate cash flows and less so on their intrinsic or net asset value.
TGR: We recently saw the gold price trade at an all-time high of $1,282 last week. Gold typically climbs higher in the fall with the Indian wedding season and Christmas jewelry buying. Do you expect gold to eclipse that mark again before the end of the year?
DC: Long answer and short answer—yes. But accurately predicting the future price of bullion is very difficult. However, we believe gold prices will move in a clearly higher direction over the long term.
One thing I would point out is that although jewelry has historically been a key source of demand, investment demand is quickly overshadowing it. It is becoming more of the key component from the demand side of the equation.
TGR: Are the ETFs driving that?
DC: Yes, the SPDR Gold Trust (ETF) (NYSE:GLD) and other ETFs are now holding well over half of the worldwide production in vaults, a source of demand that is a newcomer to the gold party.
TGR: Going back to your research for a moment, you recently compiled something you call the "Lucky 21," which is a fairly comprehensive list of precious metals companies including producers, developers and explorers, all of which are poised for growth. We know how you spent your summer. What are some of the criteria needed for a company to make the "Lucky 21"?
DC: The Lucky 21 list was inspired by taking a step back and looking at what enables a company to add value without relying on rising bullion prices. What are the principal characteristics of these companies? The ability to accomplish resource expansion, exploration success (making a discovery), production growth and the ability to generate returns with positive cash flow growth.
However, the bias in our "Lucky 21" companies are those with an above-average ability to grow their resource base in a meaningful way. These companies have added value through the drill bit by either growing their assets or extending the mine life of their current operations.
We've also highlighted companies that are expanding production or are commissioning projects that are relatively easy to expand, in addition to companies that have a high likelihood of discovering or delineating a new ore body.
TGR: But geological promise is one thing. How much importance do you put on things like management? Cash costs?
DC: Obviously, the first thing we look at is the deposit and its geology when considering an exploration or development play. Once we have determined that there's a high probability of success, we look at the management team, in addition to the potential economic viability of the project. Have they found big projects in the past? Have they been able to raise the money? And have they been able to develop projects into mines? At the same time, there are sometimes very high impediments to development like a lack of infrastructure or political problems in the country where they're operating. Just because it's an economic deposit doesn't mean it will be put into production.
TGR: Heading back to the "Lucky 21," explorers and developers have the most potential for gains given their already low share prices. Let's start with the explorers and tell us about a handful of those companies that you like.
DC: I tend to like the exploration plays that are conducting programs to test areas similar to those that have been successfully drilled before or of a similar geological model. We tend to shy away from programs drilling the first or second holes on projects and more towards drilling step-out holes to test mineralization along trends for example.
As I mentioned before, although we evaluate exploration companies based on their growth of resource potential, we are always highly cognizant of infrastructure and other crucial impediments to developing a mine that could render such an economic deposit worthless because of factors that have nothing to do with what's in the ground.
Take Geologix Explorations Inc. (TSX:GIX), for example, which is currently conducting a promising exploration program in Mexico. Their Tepal Gold-Copper Porphyry Project is located close to key infrastructure. To date it has successfully delineated a resource of over 1.15 million ounces (Moz.) of gold and over 400 million pounds (Mlbs.) of copper, which equates to about 2.4 Moz. of gold equivalent ounces. The company's current drilling targets are geophysical anomalies that are geologically similar to the two pits drilled to date, which still remain open in multiple directions at depth.
A high likelihood of adding nearby ore bodies in addition to more ounces will have a favorable impact on the potential economics of the project, which the company is currently evaluating through a preliminary economic assessment (PEA). Favorable access and potential for significant resource expansion is one of the reasons it's one of our growth companies.
Another property the company holds in Mexico is the Libertad Project, which we feel they get little or no value for. It's seen limited drilling to date, but is currently undergoing a 2,000-meter program. The two most recent holes intersected 2.03 grams gold per ton (g/t) and 1 g/t of gold equivalent over intervals of 26 meters and 51 meters, respectively. Although early stage, we feel the Libertad provides a real kicker to the story.
Like most of our companies in the report, Geologix is very cheap, trading at enterprise value per gold ounce in the ground of under $15, based only on the mineralization defined to date.
Another company with similar attributes but with monster potential is Kiska Metals Corp. (TSX.V:KSK). The company holds the Whistler project in a large continuous land package in Alaska, which I just returned from last week. It's part of what we believe is an emerging porphyry district. Of the 20 targets delineated to date, only Whistler has been drilled enough to establish a resource estimate, which stands at 5.75 million gold-equivalent ounces in all categories. The company boasts a very low discovery cost of $4 per gold-equivalent ounce and Kiska is finding all of this in Alaska, which makes it even more impressive.
In addition to Whistler, Raintree East and West, Rainmaker and Island Mountain are four porphyry centers that have been identified but have yet to be significantly drilled. As these targets are tested, I expect to see even more potential resource growth through successfully identifying new ore bodies.
Relative to their other Alaskan projects, Kiska has favorable infrastructure in a relatively flat area, which could allow numerous deposits to be mined simultaneously. With potential for enormous size and a gold/copper weighting of 65/35, we view the Whistler Project as one that will be highly enticing to the majors as the company continues to successfully grow its resource base.
TGR: In both of those cases, you're effectively saying that the companies have projects in addition to their main projects that are not really seeing a lot of value from the Street. Are there any short-term catalysts with those companies? For instance, are we going to see some drill results in the near future from either Geologix or Kiska?
DC: Absolutely. Geologix is conducting two 5,000-meter drill programs that are going after new geophysical anomalies. What I find encouraging about Geologix is that they're going after absolute growth. They're not drilling around their existing pits for smaller incremental growth. They're trying to show that this thing has some serious size.
TGR: So there could be other pits in addition to the main pits?
DC: Correct. Right now they have a north and a south zone, and they're drilling other ones that have a similar geophysical signature. They will also conduct a preliminary economic assessment in early Q4.
TGR: When will we see those drill results from Geologix?
DC: By year-end.
TGR: And when will we see Kiska's drill results?
DC: Kiska is drilling right now and we can expect drill results within the next four weeks from follow-up testing of previously drilled targets, in addition to preliminary metallurgical results for Island Mountain. Although the company is drilling the Whistler Deposit, which should result in some resource growth, Kiska is testing new nearby targets that will not be spaced tight enough to enable a resource to be estimated on them after this round of drilling. An updated resource estimate on Whistler is coming in November.
TGR: We'll look for that. You told us about a couple of explorers and now we're on to some developers. Last week Sandspring Resources Ltd. (TSX.V:SSP) was one of the big movers on the TSX. It went from $1.30 to over $2 at one point and there was no news other than the rising gold price. You have a 12-month target on Sandspring of $3.15. Tell us about that one.
DC: Sandspring is an emerging Guyana gold play; it's had tremendous success with the drill bit. The company owns the Toroparu Project located in the upper Puruni River region, which encompasses a land package of 100,000 hectares. Unknown to most people, Guyana has a significant amount of artisanal mining. While flying to the site, I was shocked at how many pits I could see littering the jungle, with some of significant size.
Toroparu was once mined through sluicing, and it wasn't until a proper drill campaign testing the bedrock beneath the saprolite that the potential for size at Toroparu was demonstrated to the market. The competency of the Sandspring's exploration team and prospectivity of the property is best demonstrated by the fact that for every meter drilled they have discovered 100 ounces of gold-equivalent ounces in the measured category.
TGR: Is there a catalyst on the way that could push the share higher?
DC: Another part of the story that's just emerging is the potential for a new trend. Drilling is underway on one of the many off-trends identified with geophysics. That has the potential to demonstrate new areas of mineralization. The prospect of delineating new resource ore bodies at Toroparu would expand the size and scope of the project considerably. Furthermore, the in-fill drilling on the resource extension 400 meters northwest of the current pit has the potential to significantly increase the pit shell size or even add a second pit to the pipeline.
Sandspring will conduct a PEA in October. I believe the market will finally begin to recognize the robust economics of Toroparu. I conservatively valued it at $3.15, which was based on applying a 1x multiple on our net asset value estimate for the company.
TGR: What about some other developers?
DC: I've just returned from Northern Peru where I visited Sulliden Gold Corp.'s (TSX:SUE; OTCQX:SDDDF) Shahuindo Gold Project, located in the Cajabamba Province, along the same trend and hosted within a similar geologic model as Barrick Gold Corporation's (NYSE:ABX; TSX:ABX) Laguna Norte and Newmont's Yanacocha mine. Shahuindo has the potential to be a large and highly economic mine in as little as two years. The operation currently envisioned is for a simple, open-pit, heap-leach operation that will require a relatively low capital expenditure (capex) of what we estimate will be around $120 million in an expanded scenario.
Prior to this year's drilling, only 45,000 meters have been drilled on the project. With six rigs on the property by October, the company will drill an additional 30,000m by the end of the year. Currently, there's four there. I estimate that the company is very close to meeting its publicly stated short-term goal of delineating 2 million oxide ounces. The PEA released earlier on Shahuindo reported cash costs of $403/oz. on average. The proposed mine would produce an internal rate of return of 55% using a $975 gold price and with a capex of $90 million. Annual production would reach a minimum of 105,000 ounces of gold under this dated scenario. We believe that the company will be pushing production and all of these metrics in a favorable direction in the upcoming feasibility update in Q1 of 2011.
TGR: Any others?
DC: Another development with a similar simple heap-leach operation is Grayd Resource Corporation (TSX.V:GYD) in Mexico. At the La India Gold Project, the company has delineated over 1.25 Moz. of gold, and it has enjoyed very encouraging exploration success as of late. Tarachi, north of La India's main ore body, had great intersections of mineralization in all seven holes, which all started from the surface, that they drilled on the property. The last assay released on the property was 88 meters of 1.5 g/t of gold. Grayd could be on the verge of delineating another economic ore body on the property.
Grayd is in the process of finalizing a PEA that will consider the project to be built for around $65 million and generate strong recoveries by conventional heap leaching. Gold recoveries are estimated at 83%, which yields an average annual production rate of 100,000 ounces at a cash cost in the $450/oz. range.
The property has excellent infrastructure and is located next door to Alamos Gold Inc.'s (TSX:AGI) Mulatos mine. Both La India and Mulatos share the same geological system, meaning that La India is sure to have some larger players watching its progression toward development. In terms of upcoming catalysts, there is the PEA and ongoing drilling at Tarachi, but the PEA is the big one coming up.
TGR: And finally onto the Lucky 21's precious metals producers. These companies are probably the least risky of the bunch. What are your favorite names in that space?
DC: Our favorite name has been Yukon-Nevada Gold Corp. (TSX:YNG). Yukon Nevada just commissioned the Jerritt Canyon Mine in Nevada and it has the Ketza River Project in the Yukon. Yukon Nevada is producing at Jerritt Canyon and is on the verge of commercial production. So it's emerging from an obscure turnaround story into a cash flow generating miner.
The company has already surpassed my estimated output rates for 2010 and has positioned itself to post strong production numbers for the remainder of 2010 and 2011. We are extremely encouraged by the progress made at Jerritt Canyon.
In the Yukon, Ketza is a high-grade, past-producing project surrounded by infrastructure. It is currently undergoing a promising and fully funded exploration program. We estimate that the open-pit operation would require a relatively small capital outlay of around $25 million and would produce at a minimum of 62,000 ounces annually for 7.5 years at a cash costs around $365.
Why we like Yukon Nevada is not only for its production growth and its development project in the pipeline, but also because of the fact that it's still got a table-pounding value proposition. Our 2011 production forecast, 237,000 ounces, produces a cash flow estimate of $0.16 a share. That puts the forward price multiple of our estimated cash flow at a little over three times, a level normally not seen by anyone generating such significant profitable gold production.
With the profile for 2011, we see the likelihood of YNG being re-rated as an intermediate producer as inevitable.
TGR: Any other producers you like?
DC: We like Avion Gold Corp. (TSX.V:AVR; OTCQX:AVGCF) as well. Avion holds interests in numerous projects in Mali, principally the Segala and Tabakoto Projects, in addition to the Houndé concessions located in Burkina Faso. It is currently producing between 75,000 and 85,000 ounces in Mali, and Avion is poised to grow their output rate to 200,000 ounces by 2012, according to management.
Production aside, I see the real source of Avion's growth being the exploration upside through both the drill bit and potentially more strategic acquisitions similar to those they've conducted in the region to date. Avion is already conducting a $10 million, 60,000-meter drill program in 2010 on its land package. I believe it will continue to yield strong drill results.
Recently they tied up a property that is just south of Semafo Inc.'s (TSX:SMF) Mana Mine, called Houndé, in Burkina Faso. The package is hosted in the same greenstone belt as Mana, which trends directly onto the property. They are conducting a program for 5,000 meters this year along with a geophysical program. With the resource estimate by year-end, we feel the market is attributing no value to potential resource at Houndé.
TGR: Given its proximity to the Semafo property, is Avion a potential takeover target?
DC: I would see Avion as a potential takeover target based on their continued resource expansion. They've had some struggles related to ramping up production, but from a resource standpoint, it's a terrific story. Semafo has a huge chunk of that trend, so, one would assume they've got enough to work with in the area.
TGR: Do you have any parting thoughts on the precious metal sector in general and what's happening there right now?
DC: Yes, for the most part what we're trying to tell investors is that you need not rely on a rising gold price to find value in these companies. Think about American Barrick when they bought Gold Strike or Osisko Mining Corp. (TSX:OSK) that bought Canadian Malartic for $80,088.88 (8s are lucky for Chinese) and turned that into an absolutely breakneck growth story.
We are not trying to imply that we're onto the next Osisko, but looking for similar traits—good management, good resource upside and obviously, people who are going to be able to develop a proper mine at the end of the day.
TGR: Drew, thanks so much for your time.
Drew Clark joined Byron Capital Markets research team as a mining analyst in November 2009, focusing on small- to medium-capitalization precious metals companies with strong growth profiles. Drew has several years of research experience and most recently, he worked for two years in the Institutional Equity Research division at CIBC World Markets. Drew holds a Bachelor of Commerce with a Major in finance from McGill University and is currently a Level III candidate in the Chartered Financial Analyst (CFA) program.
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1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Sulliden, Avion, Grayd, Sandspring and Kiska.
3) Drew Clark: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None.