Gold’s rally in 2019 is not showing any signs of abating, with prices climbing to fresh highs amid uncertainty in global markets. I’ve decided to take a look at CNMC Goldmine to see if there are any investing opportunities.
Company Background
CNMC Goldmine Holdings Limited is a Singapore-based investment holding and management company. The Company is a gold producer and its main segment is Gold mining, which is engaged in exploration, development, mining and marketing of gold. CNMC is principally engaged in the business of exploration, mining of gold and the processing of mined ore into gold dores.
Projects / Assets
It currently has 3 projects in Malaysia.
- Flagship project in Sokor
- Greenfield Asset in KelGold Mining
- Brownfield Asset in Pulai Mining
The Company is focused on the development of its Sokor Gold Field Project. The other 2 assets are in various stages of exploration phase so there’s not much interest there unless they struck gold. Let’s take a closer look at the Sokor Gold Field Project.
3 Types of Processing Facilities in Sokor
I think it is quite important to know about the gold extraction processes because in their reports, terms such as ‘heap leaching pad’ and ‘CIL plant’ keeps coming up and you have to know if these are important features/equipment in a gold mining company or just some words they use to confuse the shareholders.
Carbon-in-leach – Method of extracting gold from higher grade ore. Uses cyanide solution to melt the gold in tanks and then uses activated carbon to retrieve it. It provides economies of scale as it has a gold recovery rate of more than 90%.
Heap Leaching – A simple low cost facility that is applicable to low-grade ores. Gold recovery of about 60-70%
Vat Leaching – A compromise between heap and CIL, the irrigation process uses improved flow rates of cyanide solution and with its sloped design, there is no need to agitate or transfer the heaps. Thus, it is quite efficient in gold recovery at about 80%.
Gold Production
In FY2018, CNMC produced 31,473 ounces of find gold, which is their highest production so far.
Their glory years were in FY14 to FY16 before they hit a speed bump in FY2017. In that year, they were hit with triple whammy of ;
- temporary stop work order by the Kelantan state authorities
- delay in commencement of new facility operations to extract gold from high grade ore.
- lower grade ores which reduced find gold production
These factors caused a slide in revenue, profit and increase in all-in production costs. To mitigate the decline in revenue and profit, the management announced a series of initiatives to further boost production, reduce operating expenses and diversify to mine other minerals.
Expansion Plans
Gold Production
Firstly, the management announced that they will be building an additional gold de-absorption and smelting facility next to the existing CIL plant to scale up operations and boost production efficiency.
Secondly, they embarked on underground mining concurrently with the existing open pit to increase supply of high grade ore. This will increase mining cost but profitability might increase as high grade ore will yield more fine gold.
Lastly, they also have plans to increase the capacity of their carbon-in-leach plant but is subject to their resources and performance from the current plant.
Reduce Operating Expenses
Their heap leaching pads will be replaced by 2 new pads with higher capacity, from 2.8 mil tonnes of ore to 6 mil tonnes. These will reduce the time and resources required to remove the ores from the pads after being processed as they are able to handle larger loads.
Currently, they are spending about 20% of their total expenses on diesel. Diesel consumption is one of mining’s main consumables and as they continue to expand their operations, the amount of diesel used will increase. To reduce diesel consumption especially for electricity from their generators, they are talking with authorities to set up a national power grid line at Sokor.
Diversify Mining Portfolio
Besides Gold, the Sokor mine has deposits of lead, zinc and silver. They have commenced installation works to construct a new facility to produce lead and zinc. The plant is expected to start operations before end 2019, subject to permits being obtained for commercial operations from relevant authorities in Malaysia.
Financials
Past Results
From their 1Q results and commentary, it is quite clear that management is optimistic that they have turned the corner. Production and revenue will also be better than previous year’s.
But this is only one side of the story. Since 2014, their profit has been declining due various reasons such as higher cost, lower gold prices and increase in expenses due to expansion. 1Q19 has shown signs of recovery, with EBITA coming in at $3.5m, about 65% of FY18’s EBITA.
For mining operations, it is useful to look at their production cost such as operating cost (labour, consumables, transport, administrative etc), capex (replacement of equipment) and royalties/taxes. This is usually calculated in per ounce of fine gold.
As you can see, the all-in cost are on a rising trend but the price of gold seems stagnant. I don’t foresee all-in cost to go back to 2014 levels as their operating cost have increased since then due to the addition of several new plants. To have profit growth, they must be able to produce a much larger volume of gold to enjoy economies of scale. Whether they are able to do that remains to be seen.
Cashflow
Their FCF generation is quite strong since 2014, enabling to build up a huge cash hoard. The dip in 2017/18 is due to the poor performance as well as the installation of new CIL and heap leach plants. I’m impressed that they are able to fund their expansion plans using their own internal resources.
Valuation
Since the Sokor project is already in production, it is fair to use DCF analysis to determine the intrinsic value.
Some of my assumptions are:
- Discount Rate = 10%
- FCF per share = $0.03 with 4% annual growth
- No terminal value, up to 2034 (16 years to lease expiry)
From these assumptions, we get a fair value of $0.31. With net cash of $0.044 per share, we have a margin of safety of 21% from current price of $0.28.
I place a pretty high discount rate of 10% as I considered their business high risk. The mining and metals industry is highly cyclical and just because the price of gold is high doesn’t mean it will stay that way. CNMC is a price taker and can’t determine their own prices. Because of this, their earnings and cash flow will be highly volatile.
The FCF of $0.03 is an average of FCF CNMC has generated since the Sokor mine is operational. Their current permit to mine is up to 2034, subject to any extensions in the future but I guess for now it is fair to assume up to 2034.
Business Risk
Cyclical Industry
Normally, I would avoid companies working in cyclical industry such as this. Commodity companies are, mostly, price takers with exception of Nickel and Iron producers. Such companies as Norilsk Nickel, BHP Billiton and Vale can determine the price of commodity by changing amount of their production. Because of big changes in the prices of mining company’s products, they are characterized by highly volatile earnings and cash flows over a number of years which they have little control.
High Fixed Cost
Commodity companies may have to keep mines operating even during low points in price cycles. The reasons for this are prohibitive costs of shutting down and reopening operations, which we have seen in 2017 when they were forced to stop work.
It is also important to mention that for metals and mining firms to get started, large infrastructure investments are needed. This pose a risk when CNMC seek opportunities to extend its existence beyond the Sokor Mine.
As for metallurgy, we have seen in 2016 and 2017 that low grade ores have caused their revenue to dip. As such, they had to install a new CIL plant to process higher grade ores to increase production. The type and grade of the ores also determine how it can be economically mined.
Permitting Risk
I’m assuming that they had to bend over backwards to get the extension of the permit. In the process, they had to pay a high processing fee and increase their due royalties. This will probably be the same process when they start their other 2 projects. Some other risk include their permit to commercialize their zinc and lead reserves.
Finite Resources
Any mine has finite quantity of natural resources; therefore metals and mining is a finite business. Mineral deposits contain a certain amount of ore and when that ore is mined out the deposit is depleted, no matter what one does or wishes. The longevity of a commodity company depends consequently on astute acquisitions, successful exploration, and/or a range of non-mining or downstream businesses. All these has to be taken into consideration when valuing commodity companies like CNMC.
Conclusion
No doubt the near term outlook looks bright for CNMC as they reap the rewards of their expansion plans. Production will increase due to their new CIL and heap leaching plants. I’m guessing about 40,000 ounces will be produced for FY19. Revenue will also be boosted by the higher gold prices and assuming all-in cost stays around US$1000 per ounce, profit should also increase tremendously compared to the previous 2 years.
However, one has to include the risks involved in their business nature in their valuations before deciding to invest in them. As they continue to mine, they have to constantly upgrade their facilities and this will affect their profitability.
There should not be any risk in debt financing as their balance sheet and FCF generation is strong enough fund their expansion.
Given the circumstances, the Moss Piglet would not be investing in them for now. The main reason is that we are unable to clearly gauge their spending and are quite concern over their ever increasing operating costs. Over the years, they are constantly introducing new facilities and mining methods to sustain production growth. We are also not confident that their earnings will reach the 2014-15 highs.
Perhaps the next few quarters might shed a little more light on the results of their investments and hopefully, it would be good. Catalyst that might change our views are the outcome of the tax waiver (currently 24%), feasibility of the other minerals and implementation of the national grid line.
Cheers.
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