A miner worth buying (at last)?

Armenian gold hopeful Lydian International (TSX:LYD), listed on TSX but having for some time promoted itself to UK investors via its Jersey registration (and ProActive Investors), is of interest for the funding package it has just announced for its Amulsar project, due to start construction in 2016. Any gold miner able to secure 100% funding at the present dire gold price, and in the current lending drought, deserves plaudits as well as a closer look. But in this case Lydian seems also to be achieving what looks like a good outcome for its shareholders, despite having to resort to a funding package containing one very expensive element. That element – gold and silver streaming – is relatively new to investors over here and deserves picking to pieces.

There are other contributors to Lydian’s achievement, including a low operating cost for its mine and, not least, a market cap that although drastically below its peak a few years ago, is still at a level (C$52m at 27 Canadian cents) that enables the required equity to be raised at a decent price without too much dilution.

Amulsar, according to an updated technical report in November 2015 is a > 5Moz gold resource of which 2.1Moz is planned to be extracted over a 10 year mine life for an initial $375m capital cost, and at a $1,150/oz gold price would achieve a 21.6% IRR and a ‘project’ NPV8 of $238m. After a two year build, first production in mid 2018 at some 210,000 oz per year should deliver operating margins of almost 60% over ten years.

By that ol’ Spanish broker method of NPV/current shares, a bogus share price ‘target’ would be touted as $US1.26 (at an 8% discount rate). But my ‘correct’ method after funding shows true ‘value’ as $US0.73, the relatively small decline demonstrating the benefits not only of gearing but also of a high ‘starting capitalisation’ – in that current shares only need to expand by 280% at the present price (or 214% at the likely price) in order to achieve the required equity contribution.

Even so, that outcome for the shares at their current price has been achieved by sacrificing much value to cost of financing, of which the ‘streaming’ element is by far the most expensive, even if kept to a small part of the whole.

The initial capex (with contingency costs added) over the two years before first revenue is $395m, and is practically all in place (except for the equity raising due in the next few weeks, which looks easily achievable) so that the total financing will look as follows (all in $US):

– shareholders and institutions new equity raise: $105m
– 5 year project loan at (9% – my long term assumption): $160m
– equipment leasing (we assume @10% interest): $70m
AND (the coping stone, locking all into place but at a price)
– a streaming deal for 6.75% of all gold and 100% of all silver produced: $60m

The streaming deal requires Lydian to deliver those proportions of production, in return for which (for the gold) it will only be paid $400/oz, regardless of the market price. (Silver is less than 1/2% of the mine’s production value). That means, of course, that Lydian loses more and more of its potential income if the gold price rises. But that, as I explain later, is not all.

I have run my usual detailed cash flow models to show the real cost of each type of finance and how much of the gross PV (i.e. the value of future cash inflows after capex has been made) which in this case is $569m, goes out to repay fund providers before leaving the remainder for shareholders. That way, a true picture of such a company’s risk profile, income and costs can be seen much more clearly.

For Lydian’s Amulsar project the picture is as follows:

Out of the $569m Gross Present Value, the PVs of each item of finance (repayments of principle and interest, and loss of revenue to streaming) will be (all at an 8% discount rate):

– For the $160m project loan: $144m (discount effect reduces repayments and interest)
– For the $70m equipment leases: $67m
– For the $60m streaming deal: $74m at $1,150/oz gold, but will increase steeply with price

As a % of the advance the NPVs of their repayments turn out to be:

– For the 9%, 5y project loan: 91%
– For equipment leasing: 96%
– For streaming at a $1,150/oz gold price: 124% (i.e. 36% more than for a typical project loan)

But, at a $1,500 gold price, the streaming cost NPV (if continued over the life of mine) would rocket to $109m – i.e. 182% of the advance. Recognising this, Lydian has an option to extract itself from the deal, but only at further onerous cost (which we have no space to describe – see the company website for all background).

One other, very important aspect of a streaming deal might however not be obvious. It is that the producer (Lydian) suffers the loss of revenue after its bottom line. It gets no credit against tax and royalties, which will remain payable as if it receives the full revenue before the streaming payment. So the real cost becomes excruciatingly more severe at higher and higher gold prices. Reflecting this, our models show the resulting earnings for shareholders remaining almost flat, at whatever gold price and even though streaming in Lydian’s case is a relatively small component of the funding.

No wonder that…

– Miners will try to avoid streaming deals (Lydian, presumably, has been forced to accept it as a ‘coping stone’ before the other fund providers will play ball).

And…

– The streaming companies have benefited immensely from the commodities slump. Their profits are the other side of the coin to the costs Lydian and others are bearing.

In a later article I will look at some of the best known streamers. (And also at Kefi Minerals, who has promised (‘threatened’) to include streaming in its funding package – no wonder its shares are weak).

Meanwhile, despite the cost of its streaming, Lydian looks one of the better mining bets. At my assumed $C0.27 ($US0.20) new issue price the ‘true’ NPV8 per share would be $US0.50 giving a ‘return’ in cash flow per share (i.e. before depreciation – so reported earnings will be lower) for an investor over the 10 year mine life of 31% p.a.

Lydian has said its issue price won’t be higher than $C35c ($US26c) at which the true NPV/share becomes $US0.60 and the cash flow return for an investor 29%. At a 10% lower gold price, due to the streaming factor working the other way, the true NPV/share would be almost the same.

Note re currency. Don’t confuse $Can in which the shares are priced with the $US used for project calculations, and against which $Can and Armenian Dram are down in 2015 by some 15%. My ‘value’ calculations are in $US. A 10% rise in AMD (which might be the next move) would reduce the $US NPVs by about 7.5%. (Space precludes showing all my calculations).