Australia | Mar 28 2017
Brokers have returned from a tour of copper-gold mine Ernest Henry buoyed by Evolution Mining's purchase of a stake in a well-run asset with long-term opportunities.
-Forecasts based on the 11-year reserve at Ernest Henry may be underestimating the potential
-Buying the gold stream adds production without paying a control premium
-Evolution Mining could be net cash by end FY18
By Eva Brocklehurst
Gold miner Evolution Mining ((EVN)) has impressed the brokers that toured the company's Ernest Henry copper-gold operation in north Queensland. The company has taken an economic interest in the mine, which provides a base load of gold/copper production and cash flow that along with the company's other major asset, Cowal, sets a firm foundation for the portfolio.
Evolution Mining has bought into a well-run asset with top-tier infrastructure amid opportunities to lift production and gold recoveries, in Deutsche Bank's view, and valuing the stake in Ernest Henry simply on a 11-year reserve underestimates the potential to extend the mine life. The broker increases mine life assumptions to 15 years and lifts its valuation on the stock by 5%.
Canaccord Genuity also finds no obvious shortcomings in the current mine that would affect near-medium term expectations, while in the longer term there is the opportunity to increase production and extend mine life. The broker, not one of the eight monitored daily on the FNArena database, upgrades to Buy from Hold in the wake of the tour, with a target of $2.45.
Brokers observe Ernest Henry is a well capitalised asset that underpins the copper operations of Glencore, which hosted the site visit. Evolution Mining has paid for 100% of gold output over the 11-year reserve and 30% of the copper produced by the mine over its current life. This economic interest comes with 30% of the associated operating and capital expenditure.
The ore body is open at depth and the company participates in any extensions to mine life, with its share of production moving to 49% of all metal output from 2027 onwards. The company recently reported production for the year to date from Ernest Henry of 13,000 ounces, which puts it on track to meet the March quarter estimates of 21,000 ozs.
At the outset Morgan Stanley believed buying the gold stream from a copper-gold mine was a novel way to add production without paying a control premium. Yet, unlike the prior acquisitions of Mungari and Cowal, the company does not operate this mine. In the broker's opinion this limits its ability to add value through asset optimisation. Morgan Stanley adds some value to its base case after the visit but maintains other elements as upside scenarios.
The real prize, UBS believes, is exploration below the reserves that are largely untested and provide genuine upside to the mine life, but acknowledges these improvements are not going to make a large difference any time soon.
Macquarie is also under the impression that there is little motivation for major increases to the size of the mine at the current point in time, other than low capital expenditure on de-bottlenecking. Harvesting cash appears to be the main near-term goal. Nevertheless, the broker still expects Ernest Henry to be a leading contributor of cash flow to the Evolution Mining portfolio.
The reserve life exceeds the anticipated operating life of the Mount Isa mines and smelting operations of Glencore, where 2023 is the focus of the current closure plan. At that point, Deutsche Bank believes Evolution Mining could look to acquire Glencore's remaining stake in Ernest Henry, as it switches to selling to export markets, with Glencore retaining offtake of concentrate. Evolution Mining has acquired first right of refusal on any further divestment.
Deutsche Bank believes Evolution's string of acquisitions over the last two years has progressively improved the company's portfolio. Both Cowal and Ernest Henry have at least 15 years of remaining operations and, given the strong free cash flow, Evolution Mining's balance sheet should be net cash by the end of FY18.
Morgan Stanley learnt that the company has limited ability to directly influence the production plan but Glencore could take mine production to 6.8mtpa from 6.4mtpa for almost no capital expenditure. Canaccord Genuity also believes there are few hurdles to achieve this target. Beyond that, the valuation benefits are less obvious.
Glencore has suggested any increase to above 7mtpa would require a further $60m in capital expenditure. In this case, such an investment would need to add at least another 400,000tpa, in Morgan Stanley's opinion. Yet, Evolution Mining could capture gold from the tailings with leaching and each 1% increase adds $16m in revenue at spot gold prices.
Macquarie believes the main catalyst for the company is likely to come from further portfolio optimisation in the form of divestments. Edna May, Western Australia, continues to be a drag on the company's performance and the broker is not convinced the underground opportunity provides a compelling reason to retain the asset. UBS agrees that upgrading the portfolio through divesting short life/marginal assets and acquiring higher quality assets is likely to be the major source of creating value.
The full seven from seven Buy recommendations on FNArena's database are an indicator of the consistency of broker views. The consensus target is $2.55, which signals 17.9% upside to the last share price. Targets range from $2.30 (Credit Suisse) to $2.80 (Citi).
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