Milestone Reached – Countdown to Production Begins
Published: Wed, 09/16/15
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SUNRIDGE GOLD Sunridge Gold (SGC-V, SGCNF-OTCQX) was introduced to non-subscribers at the start of April. I expected the company to sign a mining agreement, then receive mining permits from the government of Eritrea in a matter of weeks. As seems to be the case with permitting worldwide the
government took longer than expected. The main hurdle has just been cleared however. The stock is up 20% since the first note I sent out. In this market that's a victory but I think there are more gains to come, and soon, now the countdown to production has begun.
• Sunridge Gold just signed a Mining Agreement with the government of Eritrea for its Asmara project, the key document that allows Sunridge to move forward towards production. • The staged mining process at Asmara begins with low capital cost high return Direct Shipping Ore ("DSO") mining that could generate cash flow of up to CAD $0.30/share by the end of 2016. • There is potential to increase the size of the DSO operation by 50% based on interest from smelters in lower grade material. • Sunridge had discussions with finance groups as permitting was ongoing. Management should be able to line up non-dilutive financing quickly, now that the Mining Agreement is in hand. • Sunridge continues to attract the interest of larger mining companies – particularly in Asia. The Mining Agreement/Licence approval may force the hand of potential company bidders that have been watching from the sidelines. That could happen fast and immediately re-price SGC. • Rapid issuance of Mining Licences and completion of financing arrangements should propel SGC higher – potentially much higher.
Sunridge announced late in the trading day on September 11 that it signed a Mining Agreement with the government of Eritrea. Not ideal timing for that sort of release but the news was too material to sit on once formal signing was done. Many Western traders are waiting for the mining permits but I consider those a formality now. While the permits are obviously important – that's the piece of paper that says "you can go dig your hole now" – it's actually the Mining Agreement that defines the commercial terms and relationship between Sunridge and Eritrea. Eritrean miner Nevsun (NSU-T, NYSE) received its mining licence for Bisha a month after the Mining Agreement. I think that is the longest SGC would have to wait for its permits and in any case timing should no longer impact project timelines. The mining licences cover three areas within the large Asmara project where Sunridge has made discoveries and advanced them to feasibility level. The feasibility numbers look great. Asmara has a Net Present Value of US$692 million pre-tax (US $428 million post-tax) and an IRR of 34% pre-tax (27% post-tax) using a 10% discount rate. Sunridge owns a 60% interest in the project. That equates to a post-tax NPV of US$257 million attributable to SGC shareholders against a current market valuation of US$27million and Enterprise Value (after partner ENAMCO's next required cash infusion) of US$20 million. Why the big difference between Enterprise Value and NPV? Two reasons; traders are just beginning to grasp that the important permit is already in hand and the perception that SGC needs to undertake enormous dilution in order to finance production. I think that perception is wrong due to a neat workaround management has devised to get into production quickly and cheaply.
Even junior miners that have successfully brought good projects to feasibility have been getting little or no love from the market recently. Why? In many cases the problem is trader's fear that the company will have to suffer large near term equity dilution to move its project forward. Asmara has very good economics. The problem is financing construction without massive dilution to shareholders. I think SGC will be able to do just that. The nature of the deposits at Asmara has given SGC a workaround that the market is not fully appreciating yet. I think that changes when the Phase I finance package is in place, which I don't think will take long. The actual mining plan for Asmara includes three stages starting with a low capex/high margin operation mining very high grade ore from the Debarwa deposit. This phased approach is similar to the very successful Bisha mine in Eritrea operated by Nevsun (NSU-T), another HRA list company. Nevsun moved from being a gold producer to a copper mine and will transition again to being mainly a zinc mine in about a year. The changes are based on the Bisha deposit which has different economic metals at different depths. Asmara shares this characteristic and Sunridge's management is using that to plan a mining operation that minimizes the capital outlay and maximizes early stage cash flow.
The key to the plan is the Debarwa Direct Shipping Ore ("DSO"). This is a small deposit but exceptionally high grade. The term "direct shipping" refers to the fact that Debarwa ore does not require upgrading in a concentrator before shipment to smelter. Simple crushing and screening will suffice. With its high copper and sulphur content and low impurities the ore is generating a lot of buyer interest from smelters and should attract a good price. At current metal prices Debarwa ore is worth almost $1,000/tonne. Mining it requires standard quarrying equipment that would be reusable for later mining phases. Because a mill is not required Debarwa has a capital cost that is a small fraction of a conventional mining operation. That's the key. A back of the envelope calculation shows this small DSO operation should generate $70-80 million in cash flow from 116,000 tonnes of DSO grading 15.6% copper. The cash cost after by-product credits is a very low $0.70-0.80 per pound of copper. It would take a few months to strip waste rock to expose the high grade ore after which the entire DSO deposit could be mined and shipped in 6-9 months. This operation needs about $30 million in capital, most of that for the mining fleet that would be retained and used for Phase II and III operations. When it's all said and done Asmara would have about $50-60 million left over and $15 million in bought and paid for mining equipment. It gets better. Because Debarwa DSO material is exceptionally "clean" with low impurities and penalty elements several smelters have expressed strong interest in receiving lower grade material with copper grades as low as 12%. The current pit shell includes 220,000 tonnes of material grading 12.8% copper with similar gold/silver credits if this lower cut off is used. Keep in mind that this is material that is in the mine plan anyway. The added 104,000 tonnes of material would be getting shipped rather than stockpiled but the mining costs are already accounted for. Remember too that SGC hasn't optimised production to account for this lower cut-off yet. When it does the available ore could increase again. Using the 12% cut-off (un-optimised) would add another 20 million pounds of copper production at the same low cash cost. This alone could add another $20 million in cash flow. The three stage plan envisages a small gold heap leach operation ($50 million capex) followed by full scale mining and milling of the main deposits. The main deposit mining would start by processing high grade copper "supergene" mineralization for the first 18 months which would generate high cash flow early followed by steadier copper then zinc production for the following 13 years. Management has had ongoing discussions with equipment suppliers and smelters about the DSO mine phase. The combination of extremely fast payback and a desirable DSO product has generated a lot of interest from suppliers. The market has been tough for big equipment suppliers and they are getting very aggressive about making sales. Based on negotiations to date, Sunridge management is confident they can secure attractive vendor financing for mining equipment and a loan to cover initial working capital for the DSO operation. In other words, Phase I could be financed without equity dilution. With a Mining Agreement in hand and permits on the way management will start final negotiations for the loan/finance package for Phase 1. These potential lenders have done most of their due diligence already so the package should come together quickly. Remember, I'm expecting NO significant equity dilution as part of this package. The DSO operation should net Sunridge US$50-60 million. Combined with cash on hand in the Asmara Mining Share Company and payments due from partner ENAMCO most of the equity component for the much larger Phase II/Phase III would be covered and there is room for further streaming or off-take agreements for the long life copper/zinc operation. Sunridge may be able to get to Phase II and III with minimal equity dilution. That leaves room for significant upside for current shareholders. Now that a Mining Agreement is in hand (remember, this Agreement and forthcoming permit is for the whole operation, not just the DSO) traders can start doing the math.
There have been rumors about a potential takeover offer for Sunridge for at least a couple of years. I know there is a factual basis for the rumour. Several Chinese base metal producers have been "kicking tires" since the original feasibility study was issued. Chinese miners and state owned enterprises are big investors in the Horn of Africa. The gold mine being developed in Eritrea was purchased and is being paid for by a Chinese company and the Chinese are substantial investors in Ethiopia. Sunridge management wants to build the Asmara mine but you can't ignore a significant, serious offer. Whether one of those materializes remains to be seen but with the current low valuation the potential for a suitor to offer two or three times the current market value is quite real. I don't see SGC management encouraging or going along with an offer that had a smaller premium than that. Even if it's not the preferred route for management I don't think traders buying the stock at current levels would say no to a short term double or triple. A serious offer would effectively take the decision out of management's hands. These potential suitors have been around for a while. With mining in a bear market, time was on their side. That is no longer the case. If a buyer wants Asmara and wants it to go ahead with ITS preferred suppliers and lenders, time is running out. While I can't give you odds about a takeover offer I think if it happens it could happen very soon now that the permitting hurdles are being cleared. At the current share price downside looks very limited indeed. Cash flow per share from the DSO operation should be more than twice the current share price and this revenue comes fast once the work starts. That cash flow plus milestone payments from SGC's local partner ENAMCO should allow the company to get to Phase II full production with limited dilution. On top of that is the very real chance that a larger company simply scoops up SGC now that permitting is done. That could happen even sooner. With Asmara on track again SGC a low risk high return bet with triple digit potential.
HRA looks for companies with potential to at least double over 1-2 years based on, exploration success, resource growth and development of metals deposits for production or take over by larger companies. HRA also uncovers high risk/high potential exploration plays, "swing for the fences" trades that can yield returns of hundreds or even thousands of percent. Now is the time to find opportunity in the resource sector. Companies with superior management and projects have never been cheaper. HRA specializes in finding just that kind of undervalued company. 22 early stage HRA picks have been taken over in the past eight years. |
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