Australia | Nov 27 2019
Evolution Mining has embarked on its riskiest acquisition to date, the Red Lake gold mine in Canada.
-Substantial investment required to turn around production rates
-Challenging and complex gold mine will require expertise
-Exploration required to replace lost ounces
By Eva Brocklehurst
Evolution Mining ((EVN)) is pinning hopes on discovery success at Red Lake in Canada, acquiring the gold mine from Newmont Goldcorp. The acquisition is expected to add value in the medium term but requires investment to turn around the current operations and, in doing so, increases operating risk.
Ord Minnett points out the company may have an impressive record but the complexities of Red Lake mean this is its riskiest proposition to date, while Credit Suisse assesses Evolution Mining is paying for what is expects, not the current performance, and this is a small risk to acquire a potentially more material opportunity.
Red Lake will be acquired from Newmont for US$375m cash, funded via a debt program, plus a contingent consideration of up to US$100m that involves US$20m per 1m ounces of gold discovered over 15 years. A US$150m capital expenditure and exploration program will take place for the first three years at Red Lake and the majority of the expenditure will go towards mine development.
The asset requires significant investment to rejuvenate its performance, UBS asserts, suspecting it will take 2-3 years to judge the merits of the acquisition. Evolution expects to eventually obtain around 200,000 ounces per annum at an all-in sustainable cost (AISC) of US$1000/oz or less.
While not altogether clear, UBS assesses the acquisition represents around 10% of the company's market capitalisation and would lift resources and production by around 20%, extending the group's mine life beyond 10 years.
The deal is accretive on reserves, resources and production but a little less so after factoring in the required capital expenditure and exploration commitment as well as a -30-40% downgrade to reserves, on Evolution's assessment, in January 2020.
Low efficiency and productivity as well as a high cost structure provide an opportunity, Canaccord Genuity believes, as does potential for additional high-grade. The broker, not one of the seven monitored daily on the FNArena database, has a Hold rating and $4.30 target.
Macquarie anticipates a progressive ramp up of tonnage from the first half of FY21 to a 900,000tpa run rate by the end of FY23. The operations produced 276,000 ounces at an all-in sustainable cost of US$988/oz in 2018. 2019 production forecasts, however, are just 150-160,000 ounces at US$1600/oz, affected by water ingress which shut down the mine in July for three months. This implies the mine is currently making a loss.
Citi also points out the mine workings require innovative mining methods, ventilation expertise and an understanding of the challenges around dilution. Evolution has emphasised its experience with high-stress mines and the fact the operations team at Red Lake will remain intact.
The mineral endowment is very high-grade, UBS notes, with historical production of over 20g/t compared with current underground reserves of 9.4g/t. However, because of under-investment in development, exploration mining rates and grades have declined over time.
Were the mine to get back to a notional 1.1mtpa throughput at a higher assumed grade of 10.0g/t, with AISC of US$900/oz, UBS estimates it may be able to deliver US$202m in annual cash flow.
Why Red Lake?
The broker highlights Evolution Mining has been very successful at Cowal since the acquisition from Barrick in 2015, by investing in exploration, and this bodes well for success with Red Lake but models a negligible contribution to earnings until FY23.
Citi considers the acquisition screens well from a risk perspective but suspects investors will be concerned about the geographic dispersion and the complexities involved. If there is a chance to turn around the asset then there will be sufficient reward, and the deal gives Evolution a foothold in the region.
The project should be accretive to production and reserve/resource metrics, Macquarie assesses, and the AISC target of US$1000/oz is an indication that the company will give up some margin in return for increased production.
The broker also suspects there may be opportunities to regain lost margin by shedding higher cost ounces at short mine-life assets such as Cracow and Mungari. Ord Minnett, too, wonders whether Mungari and Cracow are worth more to someone else, and whether Evolution Mining still has aspirations for the Kalgoorlie Super Pit.
Credit Suisse presumes that the company has favoured acquiring the cash-consuming Red Lake over the cash-generating 50% of Super Pit because of the superior exploration upside and the 100% operating control. There is also exposure to North America.
However, with no guidance for 2020-22, other than restoring production potential, the broker suspects investors will have to be patient and trust in the due diligence and the company's ability.
Evolution created significant value when it acquired Cowal, supported by the gold price, and was also astute in buying Ernest Henry, the broker adds. Meanwhile, Citi upgrades to Buy, given the -15% pullback in the share price over the past eight weeks.
FNArena's database has two Buy ratings, three Hold and two Sell. The consensus target is $4.52, suggesting 12.6% upside to the last share price. Targets range from $4.00 (Morgan Stanley, Ord Minnett) to $5.60 (Macquarie).
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