Description

Description

Aurico Metals (TSX:AMI) is not only the most recent royalty company to emerge in the precious metals mining space (created in July 2015), it is also the only one with a significant portion of its asset base tied to a traditional mining operation: in this case the advanced gold/copper development project, Kemess, in British Columbia.  The beauty of this structure is that we get the benefit of royalties (reduced exposure to operating and construction cost overruns, diversification across different mines, asset light model all while maintaining exploration upside) with a development kicker that gives us more leverage to rising commodity prices, as well as a direct call option on the development success of the project itself.  The royalty business, detailed below, kicks off EBITDA of C$8M to $14M in a gold price environment of C$1,000/oz to C$1,600/oz.  Kemess, when fully ramped up, could easily be generating $160M in EBITDA per year just from the underground operations at spot prices.  What intriguing about Kemess is that it is already quite de-risked, with the South mine having already been in production from 1998 to 2011 and C$1B in infrastructure already in place.  It is already one of the lowest-risk development projects with the best economics in the world.  The best part is that you can buy this stock at a discount to its royalty peers and get the Kemess project for free (vs an after-tax NPV of C$420M).  We think despite roughly doubling from its listing in July 2015, there is still material upside, with another doubling quite attainable (target price C$2.50 per share). 

Background

Aurico Metals (TSX: AMI) was created as a SpinCo of the July 2015 merger between Aurico Gold (TSX: AUQ) and Alamos Gold (TSX: AGI).  The SpinCo was originally comprised of the 100%-owned Kemess Underground (KUG) project in British Columbia, a newly created 1.5% net smelter return (NSR) royalty on Alamos’ Young-Davidson mine in Ontario,  the existing 2% and 1% NSR royalties on the Fosterville and Stawell mines in Australia; and US $20M in cash.  Since listing, Aurico Metals bought out a private company called Mineral Stream, adding several more royalties to the portfolio: a 0.25% NSR royalty on Barrick Gold’s (TSX: ABX) Williams mine, a 1.5% NSR Royalty on Barrick’s David Bell mine and a 0.5% NSR royalty on Wesdome Gold Mine’s (TSX: WDO) Eagle River mine.  All 3 of these mines are in Ontario.  As of the most recent quarter ended 9/30/16, Aurico Metals has 156M fully diluted shares outstanding, cash of C$20M, no debt, and an undrawn credit facility with availability of US$15M for an enterprise value of C$164M.  Top shareholders include Alamos Gold (10%), Van Eck Associates (9%), Donald Smith &Co (8%), Tocqueville Asset Management (6%) and AMI insiders (4%).

Producing Royalty Portfolio

Young-Davidson (Ontario, Canada):

Young-Davidson is one of Canada’s largest underground gold mines with P&P reserves of 3.8M oz, M&I resources of 1.5M oz, and inferred resources of 0.3M oz, using an assumed gold price of US$1,250/oz.  Per 100% owner and operator Alamos Gold’s October 2016 corporate presentation, gold production is expected to be 170-180K oz in 2016 with total cash costs of US$600/oz, all-in sustaining costs of US$825/oz and total capital of US$85M-$95M.  95% of costs are in Canadian dollars.  Throughput is ramping nicely, on track to hit full capacity in 2018 with production of about 220K oz per year post 2018. Mine life is at least 17 years per management.  Using Aurico Metals’ $1,300/oz price deck, the 1.5% NSR royalty revenues are forecast at $3.3-$3.4M for 2016.  At full production, this revenue should ramp to about C$6M with no improvement in cost or price realizations. 

Fosterville (Victoria, Australia):

Fosterville is Newmarket Gold’s (TSX: NMI) crown jewel, representing roughly 60% of its annual run-rate gold production.  P&P reserves are 0.4M oz, M&I resources are 1.9M oz and inferred resources are 0.7M oz.  The company has consistently exceeded production targets (3 years in a row) and due to its tremendous exploration success, it continues to expand the resource base and convert resources to reserves (mine life based on reserves of just 5 years really underplays the resource potential).  Per Newmarket Gold’s most recent earnings report just a few days ago, gold production is expected to be 130-140K oz in 2016 with total cash costs of $450-525/oz and sustaining capital of $42-$45M.  All-in sustaining costs are not broken out at the mine level but across the whole complex (Fosterville, Cosmo and Stawell) they are forecast at $900-975/oz.  Aurico Metals forecasts the 2% NSR royalty revenue at $3.4-$3.5M in 2016.  Mill capacity is 850K tons per year (vs 700K current run-rate).  With production and cash cost both moving consistently in a favorable direction, revenue from this royalty could well exceed C$4M in the next couple of years.    

Other Royalties (Hemlo-Williams, Eagle River, Stawell):

Collectively, the remaining 3 producing royalties have P&P reserves of 1.4M oz, M&I resources of 1.5M oz and inferred resources of 0.6M oz.  Production for 2016 is forecast at 290-310K oz.  There is significant upside potential from exploration, particularly in Eagle River and Stawell.  Aurico Metals forecasts total NSR royalty revenue of $1.0-1.2M in 2016. 

Kemess Project

Kemess is located in north-central British Columbia, and hosts 3 known mineral deposits: 1) the Kemess South orebody, which was mined by Northgate Minerals (TSX: NGX, acquired by Aurico Gold in 2011) via an open pit between 1998 and 2011, 2) the Kemess Underground (KUG) deposit, which lies 6 km north of the South open pit, and 3) the Kemess East deposit.  Aurico Metals has 100% ownership of mineral title to the claims for the KUG project, and surface rights are predominantly public lands owned by the province of British Columbia.  None of the property-wide resources are subject to any royalties.  Over its life, the South mine produced about 3.0M oz gold and 750M lbs copper.  Aurico Metals released results of an updated feasibility study (FS) for the KUG project in March 2016.  The results indicate that the KUG project is a robust, low-risk project benefiting from extensive existing infrastructure (processing plants, crushed ore stockpile and reclaim facilities, access and service roads, airstrip, electrical sub-station, power lines, 300-person accommodation camp footprint, etc. 

Using US $1,250/oz gold and US$3.00/lb copper prices, the study arrives at an after-tax NPV (5%) of C$421M with total life-of-mine production of 1.4M oz gold, 4.5M oz silver, 570M lbs copper.  After-tax IRR is a bit over 15% in this base case.  Annual production is targeted at about 130K oz gold, 50M lb copper over the first 5 years.  Co-product all-in sustaining cost over the first 5 years is expected to be roughly US$680/oz gold and US$1.35/lb copper.  Pre-commercial production capital costs of C$450M expected.  Sustaining capex is modeled at approximately C$260M.  85% of operating costs will be C$ denominated.   Material upside potential to the 12 year mine life has been identified including adding a secondary crusher to increase mill throughput capacity.  The study was based on only 43% of the indicated resource base.  Further potential at Kemess East represents significant upside opportunity.

Final Environmental Assessment (EA) approval is expected in February 2017, followed by the signing of an Impact Benefits Arrangement (IBA) with local First Nations groups.  The final construction decision is expected in 1Q17 with project financing in 4Q17-1Q18 and first commercial production in 2020.

Valuation

If we take an apples-to-apples comparison P/NAV approach vs the royalty peer group, which is pretty well defined, and apply only the NAV of Aurico Metals’ royalties + cash on the balance sheet, it becomes pretty clear that the market is ascribing little to no value for the Kemess project.  AMI CN just on royalties and cash trades at a 17% discount to the peer group average on a P/NAV basis.  What’s unique about AMI CN is that it is the only one in the royalty peer group with an advanced gold development project.  Yes, it may deserve a discount to the pure royalty peers on P/NAV if we compare true apples to apples, but to give zero credit to the development project that is this low risk seems pretty Draconian. 

Note: AMI CN NAV only includes royalties + cash and is estimated based on Aurico Metals’ corporate update from October 2016.  NAV for peers is taken from Bloomberg consensus. 

With any development company, as you de-risk the project, the discount to NAV on that project will shrink, but we already have 2/3rds of the infrastructure in place, the approvals are progressing nicely and are very nearly at a rubber stamp stage, and this is a mine complex that already has a deep history (production from 1998 to 2011) – we are simply moving underground.  The value ascribed to Kemess per Aurico Metal’s corporate update in October 2016 is C$421M (C$2.81 per share), which is simply the after-tax NPV per the feasibility study on the KUG project, giving no value for Kemess East.  Most of the assumptions of this study do not look aggressive to us, but certainly a 5% discount rate does given that we still await some key permits.   The Street, with their average price target of C$1.60 per share, is giving just C$0.60 to C$1.00 per share of value to Kemess depending on how much they discount the royalty business.  A 65%-80% discount to the NPV of KUG is the other extreme to us – given the upside potential of the resource base, we'd go with at most a 40% discount.  This still gets us to a C$2.50 per share price target. 

Risks

·         Lower commodity prices: royalty assets mitigate this risk, but Kemess project clearly would suffer under a depressed commodity price environment

·         Project development risk: permitting, financing and construction risks are clearly a factor for the Kemess project.  While low risk, lots can still go wrong.

·         Competition for new royalty assets: the more senior royalty/stream peers have billions of dollars of available capital ready to deploy on new transactions, and the sector is becoming more crowded with new entrants like Osisko and Sandstorm.  Deal economics may suffer in the future.

Catalyst

• Kemess Environmental Assessment (EA) approval expected in February 2017
• First Nations Impact Benefits Arrangement (IBA) expected 1Q17
• Kemess construction decision to follow in 1Q17
• Kemess project financing in 4Q17 to 1Q18
• Additional drill results at Kemess Underground (KUG) and Kemess East in 4Q16, 1H17
• Future royalty deals, partner deals with 100%-owned Kemess