Description

Orezone, is a Canadian company that holds a 90% stake in the Bomboré Gold Mine in Burkina Faso, a very interesting project due to its low AISC, reserves, exploration upside, and specially, because it is already in production and generating cash. The mine, located 85 km east of Ouagadougou, benefits from excellent infrastructure, including access via a paved international highway, ensuring straightforward logistics.

In 2023, the mine encountered significant challenges, including downward revisions in guidance, increased AISC, resource depletion from informal mining, contractor delays, heightened security costs, currency appreciation, higher royalties, and surging energy costs, resulting in a decline in the stock price. However, despite these obstacles, preliminary FY 2023 results suggest an inflection. Q4 witnessed notable enhancements in ore processing, grade, plant recovery, and gold production compared to previous quarters. The timely completion of the Bomboré powerline project signifies a significant achievement in cost reduction, yet market recognition of this progress remains muted, presenting an appealing entry opportunity into the stock.

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Bomboré is part of the growing gold sector in West Africa, close to Ouagadougou. The region has seen increased activity with the arrival of several gold companies exploring, developing, and producing. Notable players include Endeavour Mining, Semafo, IAMGOLD, Roxgold, Teranga Gold, Sarama Resources, B2Gold, and West African Resources. Despite its long history, Bomboré faced challenges, notably a resource reduction announcement in August 2016, delaying its development cycle. As a result, a new management team took control and revitalized the project, uncovering new reserves as they progressed. The initial plan involved constructing separate circuits to extract gold from oxides and sulfide-containing hard rock. The strategy aimed to finance oxide gold extraction, using the cash flow from the oxides (Phase I) to fund mine expansion and extract gold from sulfides (Phase II). Orezone executed the project on budget and on time, commencing Phase I production in December 2022.

This was not by chance, projects in West Africa are renowned for their efficiency in completion, often ahead of schedule and under budget. This is largely due to the to the involvement of engineering, procurement, and construction management (EPCM) contractor Lycopodium Minerals, with a portfolio of over 12 mines in West Africa. Lycopodium took care of Bombore´s Phase I and will take care of Phase II.

For 2023, the company provided guidance of 140k to 150k ounces of gold. In the first part of the year, it produced 76k ounces of gold with an AISC of US$1006. With gold priced at US$2000 per ounce, Orezone was poised to generate US$125M annually. Meanwhile, exploration results yielded positive outcomes, discovering new zones of high mineralization.

Bomboré's Phase I oxide plant commenced commercial production ahead of schedule and under budget on December 1, 2022, exceeding its planned processing capacity of 5.9Mtpa. In October 2023, Orezone unveiled findings from an expansion study proposing the integration of a 4.4Mtpa hard rock plant with the existing oxide plant, elevating total processing capacity to 10.3Mtpa. This expansion is Phase II and promises a notable rise in gold output at a minimal additional capital outlay. The construction of the new 4.4Mtpa hard rock processing facility will position Bomboré to produce an average of 209,000 ounces per year, achieving an all-in sustaining cost (AISC) of $1,121 per ounce. First gold output from the hard rock plant is slated for Q3-2025, marking a significant milestone in the mine's operational expansion.

A feasibility study, conducted last year at a base case gold price of $1,750/oz reported on a 100% project basis, reveals significant insights. The study demonstrates an after-tax NPV5% of US$635.9 million, offering rapid payback, along with an impressive mine-life spanning 11.3 years. During this period, the projected gold production totals 2.11 million ounces. Employing conventional open pit mining techniques, the operation maintains a low strip ratio of less than 2:1, enhancing efficiency and cost-effectiveness. The implementation of Phase II involves establishing a hard rock plant, requiring a capital investment of $167.5 million. This strategic expansion aims to bolster the operation's capacity and output. Following expansion, the operation anticipates an average annual gold production of 231,000 ounces during the initial three years, with an AISC of $1,081 per ounce.

When everything looked rosy, challenges emerged. In Q2 2023 Orezone revised its guidance downward, raising AISC to US$1100-US$1180. Informal gold mining had depleted resources, reducing grade and second-half output, as initial stockpiles were depleted. Delays from contractors necessitated additional hires and increased security costs. Local currency appreciation increased OPEX, and higher gold prices raised royalties. Further, energy costs surged. In 2021, Orezone had signed a PPA with Genser Energy Burkina SA to use gas to reduce electricity costs. Wit the war in Ukraine, gas prices spiked, and Genser redirected supply, breaching contracts. Orezone had to resort to diesel generators, which increased AISC by over US$100. In parallel, the company initiated works to connect to the national grid, in order to lower AISC again by US$100. However, the combination of higher royalties and increased costs reduced free cash flow from US$31M in Q1 to US$8M in Q2 2023, leading to a sharp decline in the stock price.

While some would point out at political instability in the region as an explanation for the share price decline, the chart below shows to which extent Orezone has underperformed a basked of West Africa gold miners over the last year:

Orezone recently disclosed its preliminary FY 2023 results, indicating a production recovery trend. Ore tonnes processed in Q4 totaled 1,449,769 (compared to Q3: 1,453,541 and Q2: 1,400,160), with an ore grade of 0.82 Au g/t in Q4 (Q3: 0.74, Q2: 0.87). Plant recovery for Q4 stood at 88.9% (Q3: 88.8%, Q2: 91.1%), resulting in 33,916 Au oz of gold produced in Q4 (Q3: 30,726 Au oz, Q2: 35,482 Au oz). Additionally, Orezone announced the completion of the Bomboré powerline construction in late December, with commissioning and acceptance by SONABEL, the state power provider, finalized in early January. Process plant energization is underway and slated for completion by January 21, 2024. The powerline's installation replaces onsite diesel gensets, offering significant reductions in operating costs. In fact, in Q1 2023, the cost per kilowatt hour amounted to $0.63, covering expenses such as diesel, equipment rental, and operational costs. With the implementation of grid power, this figure is expected to reduce to approximately $0.20 per kilowatt hour.

Further, Management claims that artisanal depletion is superficial. With artisanal methods, it was not possible to reach the bottom of the deposit. Therefore, as excavation continues, there will be less depletion.

In the current scenario, if Angold ends the year with average costs of US$1200 AISC while gold stands at US$1800, we could generate an annual free cash flow of $50 million, resulting in a 15% FCF yield on the enterprise value, which seems a fair valuation for a project in Burkina Faso, in my opinion. However, if AISC decrease by US$100 due to the electrical grid connection and another US$50 due to reduced depletion, the free cash flow could rise to US$80 million per year.

If, on top, they increase production to 100,000 ounces in 2026, we could potentially reach US$137 million of annualized cash flow. This compares to an Enterprise value of US$281 million.

As the improvement becomes more visible, my bet is that Orezone should re-rate somewhere close to 0.6x NAV for a 50% upside in the medium term. Of course, a higher multiple to NAV and a potential sulphide expansion and reserve extension brings the target price further up, with the Analysts´ consensus having an average target price of C$1.96, which I would not underwrite for the moment.

Catalyst

Quarterly results throughout 2024.