|Shares Out. (in M):||199||P/E||14.9x||4.6x|
|Market Cap (in $M):||667||P/FCF||6.7x||2.8x|
|Net Debt (in $M):||-380||EBIT||133||338|
There are plenty of beaten down precious metals mining stocks in this much despised sector. Nevsun Resources (NSU) is unique in that its producing asset, the Bisha Mine in Eritrea, is transitioning from a gold producer to a low-cost copper and zinc concentrate producer. I believe that this critical transition is being overlooked (or overly discounted) by the market and the $660 million market cap NSU presents an attractive investment opportunity. Outside of the general carnage in the sector, an additional factor that has likely obscured or muddled the market’s discounting of the gold to base metal transition has been the selling pressure due the recent removal of the stock from the NYSE Arca Gold Miners Index, which is referenced by the sector’s bellwether index fund, the Market Vectors Gold Miners ETF (Ticker “GDX”).
Downside in the stock is mitigated by the fact that approximately half of NSU’s market cap is currently in cash, the vast majority of which is held outside of Africa, and there is no debt (thoguh there is a minority interest to account for in EV due to the 40% government ownership of Bisha). The stock also has a 4% dividend yield. As far as the upside, using the company’s current guidance for 2014 of 200 million pounds of copper concentrate, under $1 cost per pound, and the copper futures strip, NSU should generate $375 mm of EBITDA and $220 mm of free cash flow after maintenance CAPEX. This equates to an EV/EBITDA multiple of 1.2x and a free cash flow yield of over 30%. While the mine life indicates production through 2024, it is worth pointing out that this is a VMS deposit, which tend to occur in clusters and allows for relatively low cost reserve additions through near mine exploration. So while the free cash flow yield is by no means perpetual, it is also not as short lived as the stated reserve life would suggest.
Some may have stopped reading this write-up after the word “Eritrea”. Operating in Africa obviously poses certain risks, and Eritrea, located in the Horn of Africa has not been immune to the problems that have plagued it neighbors, particularly Sudan to the north. That being said, one key factor that I believe diminishes the sovereign risk is the fact that the government owns 40% of the project. Perhaps more importantly, there have been no material problems between Nevsun and the government thus far and the company has had a presence there since 1998. In 2012, NSU paid over $300 million in taxes (including payroll) and royalties to the government, representing over 10% of total GDP so this is a very meaningful partnership for Eritrea. In addition, the government’s economic deal with NSU (the combination of equity and royalties/taxes) is one of the highest for a producing mining project in the world.
NSU is still widely considered to be a gold company as it has produced gold from Bisha since 2011, with production of 313K ounces at a cash cost per ounce of $312 in 2012. As stated previously, the Bisha deposit is now transitioning from gold to copper and zinc production. NSU’s timing is excellent given the extremely bearish consensus views of gold and relatively neutral to positive views of copper and zinc. Nevsun’s expected production of 200 million pounds of copper in 2014 makes it a mid-tier copper producer but the 4% copper grade is one of the highest for open pit copper mines in the world (see RBC study that is summarized in NSU’s presentation). In addition, the base metals will utilize the same crushing and grinding circuits so this further reduces the likelihood of operational issues with the transition. The timing for the zinc production coming on stream is 2016 which may also represent good timing as several major zinc operations are shutting down and NSU’s expected zinc production at $0.20 per pound should put it very low on the global cost curve.
One key risk factor with mining companies generating free cash flow from stabilized projects, as I expect to be the case with NSU in 2014, is management’s use of cash. There are certainly no guarantees that management doesn’t do something destructive like embarking on an expensive foray into new exploration projects or acquisitions. However, I am comforted by the fact that management has shown a great deal of patience in this current industry down-cycle, reviewing many deals but not consummating any. Asset prices have only move lower and with many peers strapped for cash there are many more attractive opportunities then there were a mere six months ago. If they do not make an acquisition, I would expect management to increase the dividend and/or buy back stock as the copper concentrate free cash flow ramps up next year.