This article is about Centamin PLC (CELTF.PK). Centamin has a market capitalization of $600 million. It currently operates the Sukari gold project, of which it owns 50%. It also has some minor exploration properties in Ethiopia, as well as roughly $130 million in cash and equivalents, and $220 million in current assets.
Centamin has managed the Sukari gold project exceptionally well, given that it has seen rising production and a reduction in costs. It has been in production since June, 2009. In 2010, the mine's first full year of production, it produced 150,000 ounces. It is slated to produce 320,000 ounces of gold in 2013, with 160,000 ounces belonging to Centamin, and the company hopes to ramp up production over the next couple of years to as much as 500,000 ounces per year. Furthermore, the company's cash costs have dropped from over $700/ounce to less than $600/ounce since the beginning of 2012.
Despite these positive developments Centamin faces a pressing issue that could destroy most of the company's value. On October 30th, 2012 a court ruling came down in Egypt claiming that Centamin had violated its mining concession agreement, and it subsequently rescinded the company's right to mine at Sukari.
The company continued to mine at Sukari alongside its partner: the Egyptian Mineral Resource Authority, which is a government agency entrusted to oversee and regulate mining activities (you can read more about them here). While the company is appealing the ruling, it came out on May 10th with a press release saying that the Egyptian State Commissioner's office produced a report that was against Centamin's interests, and the stock fell from $0.708 to $0.578 in just one day. The issue remains unresolved at the present time.
Despite the situation the company has continued to operate, and has done so profitably throughout. It has continued on the path to increasing its production while lowering costs, and it only saw the mine actually shut down for a week in December due ! to an unrelated lack of fuel.
Ultimately Centamin faces serious political risk with its primary property being located in Egypt. However investors have not seemed to discount it. Given its costs and production estimates its shares are valued at 14 times its future cash flow at the current gold price of around $1,315 per ounce (I base this claim on cash flow estimates provided below). Further, when Centamin's price action is compared to that of the junior gold miners ETF (GDXJ), there is little overall difference, and the only noticeable differences are the spikes in price in Centamin's shares when the aforementioned pieces of bad news came out on October 30, 2012, December 13, 2012, and May 10, 2013.
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Given that Centamin has performed in line with other junior gold miners, and given that it has not made a new bottom since the December mine stoppage, there is evidence that some investors see value in the company's shares, and that they believe that the risk that Centamin will lose its right to mine at Sukari is not so high. There is plausibility to this viewpoint: given that the company is partnered with the Egyptian Mineral Resource Authority--an Egyptian government agency--it would seem that the company's interests are aligned with the Egyptian government's.
But despite this optimism there is a material risk that Sukari will be shut down, and that Centamin will be worth little more than its current assets and its Ethiopian exploration properties, which is less than half of the current valuation. This risk does not appear to be sufficiently priced into the stock at the current valuation. Consequently, I would avoid the stock at its current valuation relative to the gold price. However I would not short the stock either, given the possibility that a ruling can be announced in Centamin's favor that causes t! he share ! price to spike.
1: About Sukari
Sukari is a gold mine located in Egypt.
Sukari is owned by Sukari Gold Mines, which is a corporation that is 50% owned by Centamin through its wholly owned subsidiary Pharaoh Gold Mines, and 50% by the Egyptian Mineral Resource Authority. The following diagram illustrates this ownership structure.
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A: Sukari's Resources
Sukari has roughly 23 million ounces of gold (10 million ounces of reserves at 1.13 grams per ton, and 13 million ounces of resources at 1.4 grams per ton) assuming a cutoff grade of 0.5 grams of gold per ton (meaning that this figure is based on the assumption that the company will only mine ore that it believes contains at least 0.5 grams of gold per ton). The following charts detail this data.
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Given that Centamin owns only half of Sukari its share of the resource is 11.5 million ounces of gold, with 5 million ounces of reserves.
B: Production at Sukari
Production at Sukari has been steadily rising. In the mine's first full year of production it produced roughly 150,000 ounces of gold (75,000 attributable to Centamin). In 2013 the company estimates that Sukari will produce 320,000 ounces of gold (160,000 attributable to Centamin), and it hopes to peak at in 2015 or 2016 at 450,000 - 500,000 o! unces (22! 5,000 - 250,000 attributable to Centamin). The following chart displays the historical data along with future estimates.
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The company has clearly set high growth standards for itself, and potential investors will be pleased to learn that the company has been exceeding its expectations. The company recently announced preliminary production results for the second quarter of 2013. Thus far this year the company has produced 180,000 ounces of gold, which equates to 360,000 ounces annualized, or 112.5% of the company's estimated production.
In the first quarter of 2013 the company produced roughly 86,000 ounces of gold at $1,112 per ounce ($556 cash costs plus other expenses). This speaks to the fact that the company has done an excellent job at containing costs, which have been rapidly declining.
If we assume that the company will continue to lower costs, so that conservatively it will cost them $1,100/ounce to mine an ounce of gold, and that it will have a conservative 200,000 ounces of production attributable to it (assuming 400,000 ounces of production annually from 2014 onwards), then the following table estimates the company's cash flow at various gold prices.
| Gold Price (US Dollars Per Ounce) | Centamin's Cash Flow |
| $1,000 | ($20 million) |
| $1,250 | $30 million ($43 million at $1,315 gold) |
| $1,500 | $80 million |
| $1,750 | $130 million |
| $2,000 | $180 million |
| $2,500 | $280 million |
Given the company's roughly $220 million in c! ash, equi! valents, gold bullion, and other liquid assets, the company appears to be relatively inexpensive given its growth potential, as it trades at just 9 times its estimated cash flow with these assets backed out. Given the aforementioned issues it is having with the Egyptian government this apparent undervaluation seems to be appropriate. However, the company will need roughly $275 million in order to ramp up production to the higher level. Without backing out the cash the company trades at roughly 14 times its estimated 2014 cash flow, which seems to be somewhat expensive given Sukari's tenuous legal status.
C: Exploration
Sukari has some exploration potential. The company claims that there are seven areas that it believes to be promising, with two in particular--Quartz Ridge and V-Shear--that have shown promising preliminary drill results. Some highlights from Quartz Ridge include:
22m @ 1.11 g/t from surface
11m @1.08 g/t from 58m
5m @ 2.04 g/t from 31m
4m @ 26.27 g/t from 156m
Some highlights from V-Shear include:
10m @ 4.71 g/t from 151m
28m @ 2.98 g/t from 11m
4m @ 100.7 g/t from 30m
The high grade ore at V-Shear appears to be especially promising, however 100+ grams of gold per ton of ore should always be viewed as anomalous, and more generally three or four drill holes should not be extrapolated so that a mine is assumed. However given that these two regions are near Centamin's NI 43-101 compliant resources, there is a good chance that these drill holes will anticipate additional gold resources.
2: Centamin's Exploration Properties In Ethiopia
Centamin also has some exploration targets in Ethiopia, which are shown on the following map.
The company is not reporting any drill results or resource estimates on any of its Ethiopian properties. I should not tha! t the wes! tern-most property--Nyota's Tulu Kapi project--is owned by Nyota Minerals, which is 19.4% owned by Centamin. The Tulu Kapi project has about one million ounces of probable gold reserves at 1.82 grams per ton, 1.1 million ounces of indicated resources at 1.86 grams per ton, and 760,000 ounces of inferred resources at 1.83 grams per ton. Unfortunately the market is giving these resources virtually no value. Nyota Minerals has a market capitalization of just $6.7 million, making Centamin's stake worth just $1.3 million. Given that these are the only mineral resources that Centamin has in Ethiopia, I don't think that the company's other Ethiopian properties are of any significant value relative to its market capitalization.
3: Risks
A: The Price of Gold
Centamin's share price will be correlated to the price of gold providing it has no more issues regarding its mining rights. The price of gold has plummeted as of late as is evidenced in the following chart. However it seems to have found support at $1,200 per ounce.
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The price increase above $1,300 appears to be bullish, which suggests that the downtrend in gold may come to an end. Still, the downtrend is intact, and lower gold prices will be reflected in Centamin's share price.
B: Mining in Egypt
I have already discussed the specific problems facing Centamin. But more generally Egypt is a risky place to mine given the drastic political changes that have taken place over the past couple of years. As I already mentioned above Centamin had to stop mining for a week in December due to a lack of fuel. This lack was due to the Egyptian General Petroleum Corporation falsely accusing the company of owing it for fuel used over the past several years. This wasn't the only time in 2012 that operations at Sukari ceased. In June the company reported that! it stopp! ed mining at Sukari for a week because of unrest in some of its labor force. Ultimately no matter how the company's licensing issue is resolved with the Egyptian government, Egypt is simply a risky place to mine. As a result Centamin shares should trade at a discount to mining companies that operate in lower risk jurisdictions.
Conclusion
There are two powerful opposing forces effecting Centamin's valuation. On the one hand the company has done an extraordinary job managing the Sukari Project, which has seen production rise and costs come down. On the other hand there is the risk that the company will lose its right to mine at Sukari. Furthermore, more generally, Egypt is a risky place to mine.
Ultimately, given that Centamin has political issues that are specific to its own property I think the latter force should outweigh the former, and the stock should be avoided. Furthermore, given that the company is so well managed, and given the potential that it will win its appeal against the Egyptian government, shorting the stock is a dangerous proposition. Nevertheless, because Sukari is such a well managed mine, gold bulls should consider adding Centamin shares at 8 - 10 times cash flow if the company's licensing issues are fully resolved.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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