Ever Wondered How Do The Analysts, Analyse? Part 2

WHAT ANALYSTS SAY: Breakaway Research continues its insight into the minds of Resource Industry Analysts.

The next case to discuss is comparing companies with defined resources.

Exploration and Development Companies with Defined Resources

Here we will look at two recent notes – Anova Metals (ASX: AWV), a pure gold play, and Avalon Minerals (ASX: AVI), a copper/iron developer.

The main method used here is the enterprise value per unit of metal in the relevant company’s resources.

Here again there are uncertainties, and figures need to be treated with care. These include (and yet again are not limited to):

Do you use the diluted, partially diluted or undiluted enterprise value, either total resources, measured and indicated resources or reserves can be used; or
Do you include resources over all the companies’ projects, or just their key project in the comparison?

Tending to use total resources over the whole of a company’s portfolio on a fully diluted basis.

An example of this below is Chesser Resources (ASX: CHZ), which had 100 per cent of the Kestanalik project (12.47 million tonnes at 1.86g/t gold) and 50 per cent of Sisorta (14.55 million tonnes at 0.67g/t gold).

Also equity ownership of a project needs to be taken into account in the comparatives.

Below is the example used for Anova Metals. This includes ASX and TSX-listed companies at various stages of devel-opment – please be aware of the notes at the end of the table.

Anova Metals Peer Comparison

Source: IRESS, Company reports
* Papillon merged with B2Gold,
with the shares suspended from trading on September 23, 2014 – The EV
represents that as of the time of suspension Chesser is in the process
of selling the 746,000oz Kestanelik deposit for US$40 million, or
US$53/oz
*Gascoyne has entered into a HoA with Monument Mining
(TSX.V: MMY) to form a 50:50 exploration and development JV – this is
yet to be finalised

The key things that will effect valuations here include grade, size and metallurgy of resources (e.g. quality and hence economic potential of the resource) and project stage.

In the current market funding is also critical – companies that are funded towards development will trade at a significant premium over those that are seeking funding.

Location can also play a part here, with more remote locations commonly adding to capital and operating costs, and hence adversely affecting project economics.

The above table shows a broad trend of increasing EV per ounce with project stage, grade and resource size, but does show anomalies, however which can be explained.

One clear anomaly is Victoria Gold – it has a similar resource to Midway Gold’s Pan project, however on an EV/ounce value is only at around 3 per cent of that of Midway.

Is this due to the project stage (permitting vs construction), location (Nevada vs the Yukon), some other factors, or most likely a combination of all?

This is something potential investors would need to look at.

Another point raised in the above table is one of companies trading at below cash backing, as shown by Chalice Gold (ASX: CHN), with a market capitalization of $37 million and cash of $44 million.

In the current market we have seen a number of examples of companies with large cash reserves being valued at or below cash, with no value ascribed to projects, even if the projects have merit.

The same may apply partially to Victoria Gold, with cash of C$32 million and a market capitalisation of C$40 million.

The next case is where a company has polymetallic resources, and below is the peer comparison table as used in our recent note on Avalon Minerals.

All points raised above are still valid here – this case throws up a few more factors to be considered.

Avalon Minerals Peer Comparison

Source: IRESS, Company reports

You will note in the above table quoted grades as ‘CuEq%’. This reflects the in-ground value (IGV) of the mineralisation expressed as an equivalent copper grade.

This is calculated by summing the values of each potentially economic metal in the mineralisation to get the in-ground value per tonne of resource, and then calculating the copper grade that would give this value.

In carrying out calculations, for the purposes of an indicative comparison, potential metallurgical recoveries are not taken into account.

This contrasts to the requirements of public releases by listed companies, where metallurgical recoveries do need to be taken into account when reporting equivalent grades.

Here we have used copper as the comparison metal, given that the potential majority of each company’s cash flow (with the exception of Northern Iron) will be from copper.

Another key metric in the above table is ‘EV/IGV’. This reflects the proportion of the in-ground value of mineralisation reflected in the share price.

It is important to remember that the in-ground value is significantly higher than the expected cash flows from a project.

A starting point rule of thumb is that the NPV of a project (which may or may not be similar to a company’s EV) will be around 10 per cent of the in-ground value.

This allows for recoveries, operating and capital costs.

Operating and capital costs will also be dependent upon the resource type. For example, bulk commodities will generally have higher operating and capital costs per unit of in-ground value, and hence a lower NPV.

This is particularly relevant to the peers for Avalon, where magnetite is thrown into the mix in a few of the peers.

As can be seen in the above table there is general trend in increasing EV/IGV with project stage and in-ground value per tonne of mineralisation, however again the table does throw up anomalies.

Conclusions
I hope we have explained the rationale and processes behind the peer comparisons and relative valuations between generally non-producing companies in notes that we write.

Some clear points arise from the discussion:

There are general trends in comparative valuations, with increase in value driven with project stage and potential economics of a project;
Such trends and comparisons are indicative only – these need to be treated with care, and there are usually reasons for the discrepancies and anomalies from the general expected trends in values;
No two companies are identical, again reinforcing the indicative nature of comparative valuations; and
These methods however are a valuable tool in company and market analysis.

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