On January 24th /08 CIBC World Markets analyst Barry Cooper initiated coverage on Aurelian Resources.
Company Profile
Aurelian Resources Inc. (TSX: ARU) focused on their wholly-owned Condor Project, consisting of approximately 95,000 hectares in south-eastern Ecuador. Fruta del Norte (FDN), their flagship epithermal gold-silver deposit, was discovered in April 2006 and has a NI 43-101 compliant initial inferred resource of 13.7 million ounces of gold (58.9 million tonnes grading 7.23 g/t gold.
Event
In a note entitled “Scarcity Has A Price And It’s Higher Than Here” Cooper explains the reasons behind his Sector Outperform – Speculative rating and $20.00 target.
Takeaways From The Event
Cooper’s investment thesis is as follows “Aurelian holds the rights to a very large
profitable gold deposit in an era where there are few similarities. We think that there will be the potential for multiple bidders for the company as gold producers have outgrown Mother Nature's supply capabilities.”
Cooper believes that one of the main characteristics of the Fruta Del Norte (FDN) deposit is its high grades. He estimates that 35% of the ounces grade more than one-half ounce per ton. With initial underground costs for the operations in its first years estimated to be less than $150/oz, discounted cash flow analysis (11%if considering only an underground operation) or 13% for a more valuable underground/open pit combination) indicate that the company trades at 1x NPV using $800/oz gold (valuation includes royalties of 4%).
With Ecuador currently in the midst of assessing new mining laws which will be incorporated into constitutional reform, mining laws are scheduled to be determined before mid year thereby removing much of the political uncertainty (regarding royalties and profit sharing between Aurelian and the Ecuador government) overhanging the stock.
Cooper expects that initial mining at FDN is going to be based on a method known as long hole mining, which is similar to the extraction method used at the Hemlo camp in Canada. He estimates a mining rate of approximately 4,000 tonnes/day initially rising to 12,000 tonnes/day if the operation remains an underground mine.
Since there is no commercial power supply in the surrounding area of FDN, Aurelian has proposed using a nearby river to support power generation. This could possibly keep electricity costs “well below world averages and more importantly build goodwill if extra capacity were made available to local users.”
Cooper estimates $500 million in capital expenditures to build the mine.
Lastly, Cooper writes “with average production growth of major gold producers rising about 70% in the period 1996-02 versus flat to declining since then, the need for more deposits has never been more critical. [He] think[s] that Newmont’s announcement of its inability to replace reserves in 2007 is an omen of things to come for the industry. Companies have exceeded the production capacity that can be provided by both Mother Nature and social obstacles that exist in today’s environment.” With that as a backdrop, he believes the odds are high for Aurelian to be acquired. Furthermore, “Regardless of the probability of unfavorable political events, [Cooper is] convinced the market will apply some discount to Ecuadorian assets. Evidence of the discount is in the current Aurelian share price. But quantifying the right discount is difficult and [he] also knows that political discounts will ebb and flow with general market sentiment. What [he is] more convinced of is that the longer the bull market for gold continues, the more the discount will shrink due to the scarcity factor of the deposit.”
Upcoming Catalysts
1. Drill results will continue to be released and Cooper expects a combination of in-fill information and newly found ounces should corroborate the prior high-grade data.
2. Resolution of mining law is scheduled to be addressed by mid-year which should remove much of the uncertainty about economic participation by Aurelian and the government.
3. A resource update incorporating new drill data is expected to be released in the first half of the year. It is possible that some of the mineralization will move up a category in certainty and there could also be additions to the total ounces contained in the deposit.
4. Scoping studies on the deposit are being worked on with completion later in the year. Cooper thinks he has built in reasonably conservative estimates for mine construction in the present environment of rising costs.
5. He also thinks that clarity is likely to breed corporate interest in Aurelian and suspects that a bid for the shares will come within the 12-18 month investment timeframe.
Valuation and Price Target
On an Enterprise value (EV) per ounce in the ground basis (which is one of the most common valuations methods utilized for early stage development projects but also ignores capital costs, operating costs and recovery costs from ounces in nature to ounces for sale), Aurelian’s “shares sit near the median of simplistic EV/ounce calculations although at almost 50% below the average. When additional economic parameters are considered however, (as ounces are not created equally) [Cooper] believe[s] that FDN is not deserving of a discount that is this high.”
On a Total Acquisition Cost (TAC) basis, Cooper’s evaluation implies “that a takeover bid could be supported by paying a price of $184/oz. for the recovered resources at Aurelian with no value for upside.” This would equate to $17.83/share but the difficulty with this approach is that “for every $50/oz. move in the gold price there is an implied change in the ARU share price of $3.” The suitability of the TAC method lies in its ability to account for recoveries, capex and operating costs and then interweaving
the enterprise value to give a more comparable number on a per ounce basis.
On a discounted (10%) cash flow basis, “Aurelian is trading at a P/NAV of 0.7x compared to peers trading at 0.8x using the lower discount rate (of 5%).”
Cooper has envisaged a number of different valuations methods for Aurelian and he believes that “in the absence of political discounts [he] see[s] the share price being supported at prices above $15/sh.”
Investment Risks
Without limitation, some of the risks associated with Aurelian include, Cooper’s assumption for the gold price to average $1,000/oz in 2009, the expectation that Aurelian is acquired in the next 12-18 months, reserve and resource risks, development risk, country risk (including changes in mining law and government regulations) and economic risk, etc.
