Review of operating costs showed the 2017 plan to be too optimistic, and the company has guided that overall LoM total site costs are likely to increase 8–14%, to $810–$850/oz. …the mining cost has hovered around C$3.00/tonne, even as the mining rate increased from 210Ktpd to 300Ktpd over the last few years. The economies of scale have not materialized, and despite spreading the fixed costs over more tones, the variable cost increases negated that decrease.
This is paradigm capital’s note:
Cost Pressures Overshadow Near-Term Production Increases in LoM Plan Review
Investment Thesis. Detour Gold is an Intermediate gold producer with the flagship Detour Lake mine in northern Ontario. We view the mine as a world-class asset with annual gold production expected to be in the 550–700Koz range for 20+ years. Due to the nature of the orebody there are some years of lower profitability in the near-term, and we believe the long-term value of the world-class asset and years of stronger profitability longer-term is not fully recognized.
Detour released its Q1/18 financials and the preliminary results of a review of an updated life-of-mine (LoM) plan for the Detour Lake operations on Thursday and held an Analyst Workshop on Friday. While Detour was successful in identifying opportunities to increase production in 2019–2020, this was overshadowed by a review of operating costs suggesting permanent increases to the estimates provided in last year’s LoM plan.
Q1 Results Buoyed by Grade, but 2018 Guidance Downgraded
Detour’s Q1 financial results were good, with 157.1Koz of gold produced at an AISC of $1,072/oz. However, operationally, the quarter was weak with the average total mining rate (ore & waste) running at ~250Ktpd versus the expected ~300Ktpd rate due to equipment issues (major shovel failure). The better-than-expected grade (1.17 g/t) from mining the area of the Campbell pit crown pillar helped offset the operational difficulties to deliver the good financial results for Q1. Detour has downgraded its 2018 guidance to 595–635Koz and an AISC of $1,200–$1,280/oz (previously 600–650Koz @ $1,050–$1,150/oz).
Updated LoM Plan Improves 2019–2020 Production, But Costs Are Higher
Detour had been reviewing its 2017 LoM plan to assess if it was possible to increase production in 2019 and 2020, as the production had been forecast to dip to ~550Koz and the lower grades and higher strip ratio in those years, significantly reduced cash flow. While the review did demonstrate that it will be possible to increase the production to ~600Koz in those years, the review of operating costs showed the 2017 plan to be too optimistic, and the company has guided that overall LoM total site costs are likely to increase 8–14%, to $810–$850/oz. This cost review was based on the experiences to date, which have been “lack of cost reductions” rather than increases; for example, the mining cost has hovered around C$3.00/tonne, even as the mining rate increased from 210Ktpd to 300Ktpd over the last few years. The economies of scale have not materialized, and despite spreading the fixed costs over more tones, the variable cost increases negated that decrease. Detour did provide the “big-picture” guidance of the new LoM plan, although the review is not yet finalized, and the official new plan is expected to be released in June.
No Near-term Strain on the Balance Sheet Envisioned
As at the end of Q1/18, Detour has $152.5M in cash and long-term debt of $258.5M, maturing in 2020–2021. The concern of the 2017 LoM plan was the low cash flow in 2019–2020; this has partially been addressed by the increase in anticipated gold production in those years. We do not yet know how much of the improved cash flow from increased production will be offset by higher operating costs, but we anticipate it should be a net improvement in cash flow for 2019–2020 — to be confirmed when the LoM plan is released in June. With net debt of only ~$108M and a cash-flowing asset producing over 500Koz of gold annually (with a ~20-year mine life), we see no immediate financial stress, and do not foresee the necessity to raise money through an equity issue, particularly after the 32% decline in the share price following the release of this news.
Valuation & Conclusion
We have made preliminary adjustments to our forecasts for Detour. Based on the broad guidance, we have increased our gold production by ~50Koz for both 2019 and 2020. As a first pass, we have simplistically applied an 11% increase to our prior operating cost assumptions (the mid-point of the LoM increase suggested in the guidance). Based on this, our NAV (5% DCF, priced at spot gold $1,323/oz) declines from C$20.30 to C$17.34/sh, or about 16%. We apply a 0.9x P/NAV multiple to the NAV calculated at our target $1,450/oz gold price to arrive at a new target price of C$19.85 (was C$25.50). While there are some challenging years ahead, there are also some of the mine’s best years still ahead. We believe the 32% share price decline on Friday was an overreaction to a market loathe for negative surprises from gold producers. The share price decline was double that of our preliminary estimate of the decline in NAV, and we expect some of this to be recovered in the next few trading days, but not all, as some uncertainty remains until the full new LoM plan details are released in June, and the company will be in the investor penalty box for such a significant change in LoM guidance over the plan released just one year ago. Nevertheless, in our opinion, if the share price remains at these depressed levels, it is possible that Detour could become a takeover candidate for a senior gold producer looking to add a world-class asset to its portfolio. We maintain our Buy rating.
Gold & Precious Metals
- Detour Gold Corp: Cost Pressures Overshadow Near-Term Production Increases in LoM Plan Review
[NAV: $17.34<img src="https://www.paradigmcap.com/images/default-source/default-album/down_arrow.png?Status=Temp&sfvrsn=da0d0b0f_2" alt="Down" width="9" height="9" hsp,="" $19.85="" tp<img="" buy]
Event: Detour released its Q1/18 financials and the preliminary results of a review of an updated life-of-mine
(LoM) plan for the Detour Lake operations on Thursday and held an Analyst Workshop on Friday. While
Detour was successful in identifying opportunities to increase production in 2019-2020, this was
overshadowed by a review of operating costs suggesting permanent increases to the estimates provided in
last year ‘s LoM plan.
Analyst: Don Blyth
Previously published research notes available at www.paradigmcap.com/research or
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from MasterMetals http://bit.ly/2vX879Z on April 30, 2018 at 04:32PM