Description

Gold One is a South African gold producer traded on the Australian stock exchange (Bloomberg Ticker: GDO AU). The company's primary asset is a shallow underground mine in South Africa. With its first mine online, the company is transitioning from a gold explorer/developer to a producer. I expect multiple expansion to accompany this conversion.

Using annualized September figures, 2011E and 2012E guidance and applying current spot gold prices, I calculate that the company is trading at 4.6x, 3.6x and 2.7x EBITDA and 8.0x, 9.1x* and 3.7x FCF. For reference, intermediate gold companies trade at ~5.5x and ~5.0x 2011E and 2012E EBITDA. At a multiple of 5.5x 2011E EBITDA, I calculate the stock is over 45% undervalued. Using 5x 2012E, the shares are over 70% undervalued. Other non-earning assets provide enough value for a potential double.

Gold One's main mine, Modder East is located 30 km east of Johannesburg in the East Rand Basin. This basin forms part of the northeast quadrant of the Witwatersrand Basin, a large gold-producing province. The Modder East mine is an uncomplicated geologic structure with low dips (300-500m). A shallow decline leads to lower costs. The resource depth of 450m compares to a South African average of 3,250m. The current reserve report cites blended reserves at 4.00g/t (grams per ton). Using 150,000 ounces of production (2012 guidance), I calculate a reserve life of 10 years* before assuming any resource to reserve conversion, which could add another 2-3 years.

*In actuality reserve life is longer since production is expected to drop off in later years. New production from another mine should help offset.

 See website for latest company presentation. The company also posts analysts reports (on delay).

http://www.gold1.co.za/index.php

Production guidance for 2011 and 2012 is 120,000 and 150,000 ounces, respectively. Costs for 2011 are expected to be US$417/ounce. No guidance was given for 2012, but better fixed cost absorption from higher production should more than offset expected inflation.  To be conservative, I assume a slight increase.

Cost breakdown*:

Consumables                        26%

Labor                                    24%

Equipment                            12%

Processing costs                   16%

Electricity                              11%

Water                                    1%

Management                         4%

Other                                    6%

*Modder East mine plan

GDO's other mines include Ventersburg (#2 asset), Sub Nigel (training mine), New Kleinfontein and Turnbridge, Holfontein and certain properties termed "Goliath." The Goliath entity will be merged with White Water Resources and ring-fenced (maybe spun-off) in 2011.

The other promising mine, Ventersburg is located in the Free State province in South Africa. A pre-feasibility study should be completed in 1Q 2011. Adjusting for a stronger South African Rand, capital costs are projected to be US$275 MM with cash costs of US$475/ounce. The first gold pour for this asset is expected in 2015.

 Capital Structure

8.5% Converts                                      $63 MM

Other Debt                                            $9

Total Debt                                             $72 MM

Cash                                                     $9

Net Debt                                               $61 MM

Options                                                 $2

Equity (807.1 @ A$0.325)                     $262       

Enterprise value                                   $327 MM

My projections below use current spot gold prices to derive 2011 and 2012 numbers. For 2011 and 2012, I assume production of 120,000 and 150,000 oz. This is in-line with management's guidance. The technical report assumed higher production estimates, but management is focused on hitting its guidance (and beating). Therefore, I believe some cushion was baked in.

 *Per South African law, 26% of Modder East was sold to BEE (Black Economic Empowerment). My numbers exclude 26% of operating profits, but include the value of GDO's loan used to fund the BEE purchase from GDO. That loan will be paid down with cash flow from the mine.

**Run-rate FCF assumes full cash taxes.                                                                               

*Per South African law, 26% of Modder East was sold to BEE (Black Economic Empowerment). My numbers exclude 26% of operating profits, but include the value of GDO's loan used to fund the BEE purchase from GDO. That loan will be paid down with cash flow from the mine.

**Run-rate FCF assumes full cash taxes.

Valuation

I look at valuation* using several different metrics - NPV, EBITDA, FCF and $/oz reserves. Using my assumptions for production, current gold prices and a 10% discount rate**, I calculate an NPV of A$0.47 per share. At a 5% discount rate**, the NPV is A$0.56 per share.  As such, GDO is trading at 69% and 58% of NAV, respectively.

*All valuations assume dilution from convertible notes.

On an EBITDA basis, GDO trades at 4.6x annualized September production, 3.6x 2011E and 2.7x 2011E. Small/Intermediate gold companies trade around ~5.5x and ~5.0x 2011E and 2012E EBITDA. At a multiple of 5.5x 2011E EBITDA, the shares are worth A$0.47, or A$0.56 using 5x 2012E.

As I mentioned above, other non-earning assets provide enough value for a potential double. Ventersburg is a free option and Goliath can be valued using the current trading price of White Water Resources. If I include Goliath and my estimates for Ventersburg, there is another A$0.10 of value.

Assuming fully-taxed FCF, I calculate the shares trade at 9.1x 2011E (high capex year) and 3.7x 2012E as capital expenditures dip. The benefit of the NOLs* will obviously result in higher cash generation. For example, my estimates for actual cash generation for 2012E amount to ~38% of the current market cap.

*No taxes should be paid for 3-4 years. 

Looking at the business on an EV/Reserve basis, I calculate the stock is being created for A$226/oz, or A$133/oz and A$32 if Goliath and Ventersburg are stripped out. Comparables trade for over A$300/oz.  

Other

The board of directors also seem to believe the shares are cheap. GDO directors recently purchased shares (Davison 200K @ ZAR 2.40, Winters 100K @ A$0.335, Wheatley 120K @ A$0.335, Dicks 75K @ ZAR 2.39, Harris 200K @ A$0.328). The total (A$700K @ A$0.34) is not huge, but this is clearly a good sign for a business like this. Note that the largest holder, Navada Trading is controlled by Mvelaphanda, Och-Ziff, and Palladino

Conclusion

As discussed above, GDO is a cheap vehicle to create gold. The business is inexpensive both on a standalone basis and versus comparables. And unlike owning the actual commodity, I believe you can "win" on GDO even if gold prices stay here.

Risks

1. Lower gold prices
2. Strengthening in the South African Rand
3. Use of free cash flow. The company indicated that it wants to finance Ventersburg separately, but some cash from Modder East will inevitably fund capital requirements at Ventersburg.
4. Operational difficulties (i.e. progress on mine development, lower grams/ton per ton than mining plan, higher costs, etc.)
5. Inability to extend reserve life
6. Issues related to South African operations
   1. Higher costs - royalties, labor, electricity
   2. Nationalization concerns

Catalyst

Reserve updates

Cash generation

M&A