Anglo Asian Mining Plc (LON:AAZ) is the topic of conversation when Hardman and Co’s Analyst Paul Mylchreest caught up with DirectorsTalk for an exclusive interview.
Q1: Can you give us an overview of Anglo Asian Mining?
A1: The company produces gold, mainly, silver and copper from 4 mines in Lesser Caucasus region of western Azerbaijan. Three of the mines are located at its flagship 300 square kilometre Gedabek complex and a fourth is located 50km to the north west.
The company has also invested heavily in downstream processing facilities which include a heap leaching operation, an agitation leaching plant, which cost $45m, and a flotation plant, which allow the company to produce gold dore bars and copper concentrate.
We should emphasise that Azerbaijan is a friendly jurisdiction for the resources sector, although predominantly in oil and gas up to now. The production sharing agreement that AAZ has negotiated with the Government of Azerbaijan is essentially the same as the one BP negotiated for oil and gas.
Senior management is a mixture of Azeri and British nationals and the former have close ties to the Azeri government. The President of Azerbaijan conducted the opening ceremony for the first mine at Gedabek in 2009.
In 2018, the company produced 83,376 gold equivalent ounces, of which about 73,500 oz. was actual gold, paid its maiden dividend and ended the year with net cash on its balance sheet. The production guidance for 2019 is 82,000-86,000 gold equivalent ounces.
Q2: What sets the apart from the average junior mining company?
A2: The vast majority of junior mining company are exploration plays and don’t have any production, whereas AAZ is, obviously, considerably more advanced. Nor does the company need to raise additional capital, certainly for the foreseeable future, if at all.
In terms of financial metrics, the outstanding aspect of the company is its cash generation, which is primarily due to its low-cost production. The company’s all-in sustaining cost, or AISC, per ounce of gold production for FY 2018 was $541, which puts it comfortably in the lowest quartile for the gold mining industry cost curve globally. In terms of the SandP Global Market Intelligence’s projected 2019 cost curve, the company is bordering on the lowest decile.
The main reasons for the low-cost structure are: i) it’s Azerbaijani jurisdiction; ii) predominance of open pit mining; iii) access to the national power grid; iv) modest levels of reinvestment (despite bringing o new mine production, e.g. Ugur); and v) investment in efficient downstream processing facilities.
To give you an indication of their underlying cash generation, the company began 2018 with net debt of $18.1m and ended with year with net cash of $6.1 million.
Q3: Can you outline some of the key investment criteria relating to the company?
A3: I’d make three points in terms of investment criteria:
Firstly, we have calculated a fair value based on a DCF valuation, using a discount rate of 8% and an average gold price of $1,350/oz, of 156 pence per share.
This valuation also includes significant stockpiles of copper and gold in ore and in the tailings dam, which amount to 87,000 oz. of gold and 10,900 tonnes of copper. While the company cautions that it’s got more work to do on establishing the route to extract this metal, we are assuming fairly modest recovery levels of 46% for gold and 60% for copper.
Secondly, we mentioned the company’s cash generation, which is prodigious. We estimate that during the seven years from 2019-25, the annual free cash flow, defined as net income + depreciation and amortisation – capital expenditure, will average $27.7 million. The average free cash flow yield, i.e. dividing that figure by the market cap., is 16.2%.
We also estimate that the aggregate free cash flow generation during this period will be in excess of the stock’s current market capitalisation. Obviously, if AAZ doesn’t find some attractive new mines to invest in, the company will need to significantly increase its pay-out ratio, which is currently set at 25%.
Lastly, the company paid a dividend of $0.07/share in 2018 and we expect a similar payment in 2019 which implies a dividend yield of 4.7%.
Q4: Your financial model for the company doesn’t currently look beyond 2025, can you explain why?
A4: We are currently assuming that they produce between 80-90,000 gold equivalent ounces in each of the next seven years to 2025.
We have been very conservative in our estimates at this point. Our 2019-25 production estimates are confined to the 482,000 oz. of remaining Proved and Probable gold reserves, and related silver and copper, for the Gedabek open pit mine and the three other mines at Gadir, Ugur and Gosha.
This excludes an additional 553,000 oz. of Measured and Indicated gold resources and additional silver and copper. While the confidence level of Measured and Indicated resources is slightly lower than reserves, we would emphasise that Measured and Indicated resources are typically enough on which junior mining companies will base a mine plan.
Secondly, we are also not assuming anything either before or after 2025 for the potential for mining at the Gedabek open pit to transition to an underground mining operation in the next few years. Nor are we assuming any upward revisions to reserves and resources from ongoing exploration work at the three other mine sites.
Q5: At this stage, how do you assess Anglo Asian Mining’s prospects beyond 2025?
A5: We think that it is highly likely that the company’s production will continue well beyond our current 2025 forecast horizon. There is the potential for an underground mine at Gedabek and the exploration work during 2017-18 has already identified a down dip in the ore body from below the Gedabek open pit towards the nearby Gadir underground mine.
Secondly, we believe that the Gedabek- Gadir area could be part of a much bigger porphyry-epithermal system of copper-gold mineralisation.
A bit of geology. AAZ classifies the Gedabek open pit as a high-sulphidation epithermal system and Gadir as a low-sulphidation epithermal system. The largest copper-gold mines in the world are porphyry systems formed from hydrothermal fluids that originate in large magma chambers in ancient volcanoes. High and low-sulphidation epithermal mineralisation often occurs as the upper portion of a larger system which is linked at depth with porphyry mineralisation.
The company’s drilling programme and a recent airborne geo-physical survey have discovered evidence of porphyry mineralisation. The company is ramping up its exploration programme and there is a possibility that the current mines in the Gedabek area are sitting above a larger “system” of copper-gold mineralisation which could be exploited in due course.
If we look at the location of Gedabek from a bigger picture perspective. It lies on the Tethyan Tectonic Belt which stretches from Corsica and Italy in western Europe across two continents to south east Asia. It contains more than 400 significant mineral deposits. Since 1965, more than 80% of discoveries have been copper and/or gold and 19 of them would be classified at ‘Giant’, over six million ounces of gold or five million tonnes of copper.
There’s a lot of exploration work to do in the company years, but there is considerable upside potential.