Special Feature
Valuation opportunity So, with potential total mineral resources of just under 7m oz of the yellow metal across its various licences (adjusted for government shares and the downgrade at Inata), and recent cash costs to the company of mining the actual gold hovering around $950/oz, why is the market cap now a lowly £50m? After all, elementary maths will tell you that with the current gold price of $1600, that this equates to a $650/oz profit. If we assume that only 50% of the resources across its blocks will ultimately be mined, then the gross profit value of these 3.5m reserves is $2.275bn. Of course the market isn’t that stupid and what has gotten investors into a lather is the “hedge book” that was entered into with Macquarie Bank in relation primarily to its main producing mine — Inata. In a nutshell, Avocet has 173,250 ounces of gold to deliver at the hedged price of $950/oz under the agreement. At an anticipated cash cost of $1050-1100/oz, the company is actually losing money on these sales. In the near term, production is expected to be around 135k oz of gold p.a. and with delivery to Macquarie on the hedge around 33,000 p.a. this will result in a loss of $5m p.a. at the gross level. If the company went to delivery on the entire hedge then the total gross loss would be some $26m. Against cash reserves of around $60m and next to no debt, and profitability on the balance sales of 100k oz of gold of approx $500/oz at the current gold price ($50m of gross profit), you may be wondering what all the fuss is about?
TABLE - NET ASSETS
20 | www.financial-spread-betting.com | March 2013
The issue is that some $38m of the company’s $60m cash pile is sat as effective collateral against the hedge and so with these monies encumbered, and on an EBITDA rate of around $20m p.a, they will struggle to develop Souma and progress their prospects in Guinea. How to get out of this? Sell Souma or some of their licences, invite in partners, or bite the bullet on the hedge to take a one off hit and free up cash going forward to continue the mine’s development. It looks like they are going to take the option of biting the bullet on the hedge, and with a hedged price of $950 and a current gold price of $1600 (ironically the falling gold price actually helps them out here as it reduces the buy-back cost of the hedge) then on 173,250 oz’s, the cost of the entire buy back is around $112m. Of course, they currently have circa $60m in cash and so if they bought back pro rata the reduction in reserves on the hedge (50% of this – approx $56m) then the net cost would be pretty much covered entirely by the cash. This would, however, leave a relatively flimsy balance sheet and hence the speculation that a capital raising is imminent. The difference to the P&L profile going forward would be somewhat enhanced though as they would be able to sell their gold production at the prevailing market price. In effect, Avocet, should they buy back the hedge in part or whole, would be making a call that the gold price is actually going to go higher. Let’s look at the company another way: weighing up the Avocet’s asset base adjusted for both the hedge book loss and the Inata reserves reduction. The balance sheet lists the mine’s value at $270m; let’s be ultra conservative and cut this by one third. We also, in this exercise, write the intangibles down to zero and which is in the books at $50m. We are therefore reducing book value by $140m and which, pre the write down, is listed at $390M (see below).