Regis Resources is trading at a substantial discount due to problems that the company has well and truly overcome.
A series of recent announcements documents immense organic growth potential at the Duketon gold project.
Profitability has been restored, and we are expecting substantial free cash flow for the current financial year and well beyond, along with notable dividend yield.
The downside is well protected, first and foremost by a strong hedge book, but also by other measures.
Regis Resources is a high-conviction long idea, and we see near-term 80+% upside.
Regis Resources (OTCPK:RGRNF), the former darling of mid-tier gold mining in Australia, has taken a spectacular tumble from grace during the past 18 months driven by a trifecta of problems and compounded by the ongoing precious metals bear market. Shares of the company have been sold off brutally, losing 60% of their value since the start of 2014 and underperforming peers by a significant margin. The final washout came at the end of June; the end of the financial year for Australian investors, and tax-loss selling time down under. We submit that this washout represents a long-term bottom, and we are convinced that Regis Resources has since positioned itself for a rise back to former status.
A number of developments announced in July support our call for a dramatic turnaround for Regis Resources. The newly released data clearly shows that the mentioned trifecta of issues has been put to rest, once and for all; and the data also provides a highly attractive road map for organic growth for the company going forward. The results contained in the recent quarterly report have further reinforced our view documenting a financial performance well beyond our already high expectations.
With fundamentals resurrected, the dividend reinstated, and free cash flow generation protected by a hedge book that looks more attractive by the day, Regis Resources has suddenly turned into a high conviction BUY. The company itself agrees and has initiated a share buyback program; and directors Mr. Nick Giorgetta and Mr. Glyn Evans have bought shares worth almost A$5M on market in early August.
Investors are starting to re-discover Regis Resources but those who sold in June to realize a tax loss will have to wait a bit longer before they can join the party. We strongly believe that a window of opportunity still exists at the moment to buy Regis Resources near rock bottom prices, but the window is closing fast. The current article outlines our renewed bull case for this fine Australian gold miner. The Perfect Storm In A Nutshell
Market valuation reflects data from before recent announcement and quarterly report; compounded by Australian June tax loss selling. Summer doldrums are keeping the share price depressed for now.
Operational issues have been overcome and all mines are back to operating profitably at or above nameplate capacity.
Projected free cash flow upwards of A$120M for the financial year ending June 30, 2016.
An enviable hedge book is insulating cash flows from gold price volatility.
A share buyback program is commencing on August 25 providing additional downside protection.
A$0.05 to $0.07 dividend per share has been flagged for the December quarter (4% to 5% yield at current share price), an interim dividend is a distinct possibility in early 2016.
A$4.8M worth of insider buying during last week only.
Investors who sold in June will be allowed by the taxman to buy back in shortly.
BUY recommendations from analysts are increasing.
80+% upside, very little downside.
A Brief Summary
Regis Resources is operating three gold mines within its Duketon gold project in Western Australia producing roughly 300,000 ounces of gold annually: theMoolart Well mine, the Garden Well mine and the Rosemont mine. Two CIL plants process ore from these mines with ore slurry from the Rosemont mine pumped to the newly expanded Garden Wells facilities. Low costs at these low-grade bulk mining operations have enabled Regis Resources to remain profitable throughout most of the gold price correction, even supporting a maiden dividend in 2013.
We have written extensively about Regis Resources, and we would like to refer readers to past articles (here, here, and here) for details on the company, its history, and its assets. The most recent presentation is also a good starting point for further due diligence on the company.
At the time of writing, the company is trading close to resistance at A$1.40, some way up from its June lows of A$1.20, but a long way down from fair value as we will show a little later in the piece. Regis Resources has rejuvenated its balance sheet which boasts A$73M in cash and A$20M in debt (up from A$3M in net cash only six months earlier).
Management has a long history of success and a demonstrated track record of returning capital to shareholders. In fact, some of the most successful corporate stories in Australian gold mining were orchestrated by this management team which is held in very high esteem by investors and has attracted a valuation premium in the past. The size of the drop that happened over the past 18 months can be interpreted in part to a loss of this premium. Developments put in motion over the past few weeks clearly show the mettle of this management team, and we believe that the company will claw back its premium in due time.
N.B. Regis Resources has its primary listing on the Australian Stock Exchange where it is one of the most liquidly traded mining stocks, trading under the ticker ASX:RRL. Given the relatively low volumes on the company's OTC ticker we strongly recommend using the facilities of the ASX when dealing in the company's securities.
N.B. We are using Australian A$ values throughout this article to facilitate comparison with company reports. A$1 converts into US$0.73 at the time of writing. Trifecta of Issues
We mentioned a trifecta of issues that has affected the company in the recent past, and it's worth explaining how they have been put to rest by decisions reported in the July announcements.
The effects of the catastrophic 2013 pit flooding at Garden Well and Rosemont have taken some time to clean up, but operations are back to normal and measures have been implemented to prevent a recurrence. This was a one-off force majeure event that was managed well and decidedly. The company has moved on, repaired the balance sheet from the fallout of this event and has emerged arguably stronger from this misfortune.
Grade reconciliation issues at Garden Well and also to a lesser degree at Rosemont had been festering at the time of the flooding, and became a real problem in the aftermath. The company has identified certain portions of the two ore bodies as the culprits causing these issues and has excluded this ore portions from the mine plan until further notice. The person responsible for this problem, and its dragging on for too long, has been replaced. Operational data confirms that mined and recovered grades now match predictions at both affected operations.
The company's McPhillamys development project turned out to be profitable, but not robust enough to make a development decision in the market environment of late. The tough decision to shelve this project was the right one to make, but it has taken away the growth perspective for Regis Resources in addition to adding to mounting impairment charges. Regis Resources has since focused on restoring an organic growth story, and recent acquisitions are highly encouraging in this context.
Points #1 and #2 have been overcome as documented convincingly in the operational data reported for the past two quarters. Further improvements at the Garden Well plant are well under way, and we expect operations to operate at or above nameplate capacity again going forward, as has been the rule prior to the trifecta putting a spanner into the works of Regis Resources.
Point #3 deserves further scrutiny, and we will deliver just that in the following section. Organic Growth at Duketon
Shelving the McPhillamys project has left a hole in the company's growth profile, and it has left investors scratching their heads when trying to come up with reasons to invest in Regis Resources. It took over a year for the company to rekindle its growth perspective, and it went against the grain when it announced its plans in mid-July.
Several local peers, most notably Northern Star Resources (OTCPK:NESRF) andEvolution Mining (OTCPK:CAHPF), have been snapping up operating mines from struggling majors. Reportedly, Regis Resources had also participated in some of these negotiations but had found the asking price too rich for its liking. Regis Resources has put the focus on organic growth of its Duketon project instead, and has almost doubled prospective land holdings by earning into a neighboring cash-strapped junior explorer's interest, and by purchasing an existing resource close to the operating Moolart Well mine. Additionally, the company has stepped up its exploration efforts and has been on a tear lately reporting new discoveries and confirming discoveries at some of its known targets.
(Expanded Duketon gold project. Source Company Presentation)
This initiative to enhance the Duketon gold project rather than overpaying for aging assets was not only very inexpensive, it has also resulted in the following attractions along the growth road map.
The acquisition of the Gloster gold project (shown in green in the map above), located within trucking distance of Moolart Well, will most likely double the mine life of this operation (at the bare minimum) based on an existing resources of 332,000 oz in the indicated category. Moolart Well is the operation with the shortest reserve-based mine life in the portfolio, which is the reason we are especially happy with this deal. It comes at the cost of A$1.5M in cash plus a modest royalty of A$10/oz. That's less than A$14 per resource ounce (already including the royalty); and A$0 for the exploration potential of the surrounding lands.
The Duketon JV (shown in red in the map above) with neighboring junior explorer Duketon Mining Limited (ASX ticker DKM) has cost Regis Resources A$100,000 on signing, and requires the company to spend A$1M per year for two years to earn a 75% interest in 373 square kilometers of highly prospective lands. That's less than a song and a story, considering that much of these lands are located along strike from some of the company's existing reserves, including Moolart Well again, and in a region that Regis Resources understands like no one else geologically.
The two bullets above are important since they contain ample grounds for assuming a much-enhanced mine life, and expansion potential at Moolart Well. We are highly optimistic in this regard since the existing resource should almost immediately provide a boost to 7+ years, buying plenty of time to find more ore sources within the vast JV lands.
Regis Resources has proven that it understands the local geology and knows how to make discoveries in this particular part of Western Australia. CEO Mr. Clark was brimming with confidence at this year's Diggers and Dealers conferencein Kalgoorlie in his presentation as well as privately during breaks in the programme. Latest proof of concept for the company's local expertise was also promptly delivered in last week's quarterly report.
Results from drilling at the Banyego prospect are pointing to a new project which we believe might well turn into another operating mine in due time. This project is close enough to Garden Well to become another satellite operation along the lines of the existing Rosemont mine, leveraging existing infrastructure at Garden Well.
Confirmation of a significant discovery called Toohey's Well was reported; another deposit in close proximity to the Garden Well operation.
Potential for high-grade underground mining at Rosemont has firmed up sufficiently to warrant accelerated drilling, plus the initiation of further detailed studies to build on the conceptual study that has already provided highly encouraging results.
When Regis Resources decided to put the McPhillamys project on hold, it increased exploration and development activities at its core Duketon project. A year and a bit later, we conclude that these efforts are showing very satisfying results. The Duketon project is shaping up as a mining camp with world class potential, and Regis Resources is leveraging its intimate understanding of this camp. Given the size and the number of known prospects, we are very optimistic that Regis Resources will be mining gold at the Duketon project for many years to come, and expansions to the current 300,000 ounce per year are only a question of when, not if. M&A
Regis Resources has refrained from participating in local M&A activities so far, despite its fast-growing cash pile and solid foundation. Management has proven ability to find accretive opportunities, and we are looking forward to a meaningful addition to the company's portfolio. Over-paying has not been an option in the past, and we are not worried that it will be in the future. We are happy to wait with management for the right moment and expect the share price to react favorably when (not if) a strategic move is announced.
On the other hand, we cannot help but notice that the Duketon gold project is shaping up into a highly desirable asset. Major mining companies have certainly noticed the increase in size and attraction and we would not rule out Regis Resources becoming a target in its own right. This would most certainly require a hefty premium, given the company's solid position and outlook. Cash Flow and Valuation
Guidance for the financial year that has just started and will end on June 30, 2016 has been set at a range of 275,000 to 305,000 ounces at all-in sustaining costs (or AISC) of $970-$1,070 per ounce.
The gold price has been volatile of late to say the least, but has held up much better in A$-terms than it has in US$-denomination. Nevertheless, we commend the company for its foresight to build a hedge book that is the envy of many, not only in the Australian gold mining space. At the end of June, the Company had a total hedging position of 281,031 ounces, being 145,834 ounces of well spread out flat forward contracts and 135,197 ounces of spot deferred contracts, both with a price of A$1,437/oz. This hedging structure puts a floor under the sales price, but allows the company to take advantage of price spikes above this floor. During each of the last two quarters, this hedging strategy has resulted in a realized gold price in excess of A$1,550/oz, justifying an assumption of an A$500/oz margin on AISC for our valuation base case. Taking into account expansion capital of A$20M (the upper end of the guided range) results in expectations of free cash flow between A$117.5M and A$132.5M for the guided production range.
At a share price of A$1.40, Regis Resources has a market capitalization of A$700M, and an enterprise value of A$647M considering reported cash and debt positions at the end of June. Using the middle of the quoted range, we note that Regis Resources is trading at an EV/FCF multiple of 5.2. In times when free cash flow is elusive to most peers, such a multiple is virtually unheard of.
It doesn't end there, however. In reading between the lines, we believe that there is a lot of safety built into the company guidance, regarding production as well as cost. We see a high probability of Regis Resources outperforming on its guidance (as we have come to expect prior to the trifecta hitting the company), and in our upside valuation scenario, we use an assumption of free cash flow of A$150M, which would imply and even lower EV/FCF multiple of 4.2.
Changing angle, and setting up a DCF model for the company's three operating mines using reserve-based mine lives (plus the newly acquired Gloster resource, plus a very modest resource conversion assumption at the other mines), and middle-of-the-range production and cost guidance, as well as a realized gold price of A$1,500/oz, we compute individual NAVs (5%) as shown in the table below for our base case. We note a combined NAV estimate of A$751M using the described base case assumptions.
N.B. We used a 5% discount rate for our DCF model in line with industry practice for de-risked operations at steady state and about twice thelocal risk-free rate.
This base case model only accounts for the reported operational improvements, essentially resetting the three operating mines back to normal production as had been the case prior to being hit by the described trifecta, but it does not assign much value to the mentioned growth potential of the Duketon gold project.
We are therefore adding A$200M for the organic growth potential at the Duketon gold project, fully expecting various bolt-on ore sources to add significantly to mine lives (3 years of additional mine lives across the board has a present value of roughly A$150M), and fully expecting one more satellite mine the size of Rosemont to come into production within 5 years (we are assigning a modest A$50M to this assumption).
Additionally, we are adding a residual value of A$50M for the McPhillamys project, representing half of the project's carrying value.
Bringing these numbers together and assuming a valuation multiple of 1.2 on the NAV of the operating mines (Regis Resources used to attract a multiple of 1.5 in its heydays, and quite deservedly so) we arrive at a grand fair value total of A$1.15B, or almost 80% upside from the current enterprise value of A$647M. On a per-share basis, we estimate a slightly higher upside, fully expecting the share buyback program to be accretive for shareholders.
To reiterate, we have been very conservative in computing projected cash flows, and growth potential in these calculations and a case for a higher price target would be quite easy to present. As a base case, we feel very comfortable with this valuation, and we are very confident to see Regis Resources trade well above A$2 before too long. Downside Protection
There are several factors shielding our base case from to the downside. Here is a list:
The hedge book virtually guarantees cash flows at the assumed level well into the future. Continued A$ weakness should present ample opportunity to add to the hedge book when appropriate.
A share buyback program is due to commence on August 25, with a target to cancel 5% of outstanding shares. This initiative will provide support to the share price on dips going forward.
The dividend of A$0.05 to A$0.07 will be re-instated in the December quarter, yielding 4% to 5% based on the current share price. Regular dividend payments, quite probably including interim dividends in the first halves of calendar years as well, will re-entice investors, including income-seeking funds that have exited the register when the dividend was suspended.
Very recent insider buying worth almost A$5M @ A$1.30 per share has added confidence and further aligned key management with investors.
The soft Australian Dollar assists in keeping costs low, while the US$-denominated gold price remains stable in local currency terms - ensuring margins and ongoing profitability. We believe that foreign exchange advantages are here to stay for some time for Australian miners.
And there is one more argument to be taken into account. Having experienced serious operational trouble on several fronts, and having rectified these problems in the course of the past 18 months, the company has emerged stronger, and with additional measures and processes in place to protect its operations from a repeat of these tough times. We submit that Regis Resources today is much less likely to experience operational trouble than many of its peers. Why This Opportunity Exists
Gold-related investments have been out of flavor for several years now, and investors have become very picky when putting money into the gold-mining sector. Regis Resources has experienced the described trifecta of difficulties, and many investors have shifted their money to other, apparently more attractive players. The end of June is the end of the financial year for Australian taxpayers, and many investors have used the opportunity to book a tax loss on their holdings in Regis Resources. The additional drop on no news towards the end of June bears testimony to this assumption.
We would assume that many of these investors are itching to jump back in, given the spectacular turnaround story the company has presented since the start of the new financial year. Australian tax law does not provide an exact time frame before investors can do so without risking their tax loss credits, but tax advisors commonly recommend waiting for at least six weeks before re-initiating a tax-loss position. We, therefore, expect trading in Regis Resources securities to pick up very shortly.
Furthermore, all the mentioned announcements have been made in July and early August, smack in the middle of summer doldrums for investors in the Northern hemisphere. Regis Resources has a sizeable portion of US-based investors on its register, and interest will presumably pick up when trading desks are re-populated in a few weeks.
We strongly believe that the combination of tax-loss selling and summer doldrums has kept the window of opportunity open until now, but we believe that this window will be closing soon. Catalysts
Arguably the share price has already started to stir in recent sessions, and we expect this stirring to accelerate when investors who sold Regis Resources for tax loss reasons in June begin to re-enter, and US-based investors return from their vacations.
This timing will coincide nicely with the start of the share buyback program in a couple of weeks, plus the presentation of annual results and the confirmation of dividend payments in September.
We fully expect results from the ongoing exploration efforts, and the technical studies on Rosemont underground and the Gloster project to provide sufficient news flow to keep interest alive for the remainder of the year, coupled, of course, with solid results in quarterly reports. Takeaway & Investment Thesis
Regis Resources has morphed into a cash cow again, which comes at a greatly discounted price right now, thanks to the troubles of the past, tax loss selling and a bear market across the board for metal miners. Regis Resources has taken steps to resurrect the profitability of its existing operations, and has re-shaped its growth story - while putting in place measures to protect the downside. All said and done, Regis Resources has returned to being a highly profitable company with attractive growth opportunities, except the share price has yet to reflect this turnaround.
We see a minimum of 80% upside and we are targeting a share price of A$2+ by the end of 2015. Additionally, we are looking forward to pocketing a growing dividend in the future to boot. Regis Resources, at the present price, represents our highest conviction idea since this one in 2013 which has tripled our investment within a year, and has earned us an award from Seeking Alpha. We have already made Regis Resources our single largest position sincerecommending it to subscribers as a speculative tax-loss selling opportunity in early June, and we will be buying more on dips.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.
RRL Price at posting:
$1.35 Sentiment: Hold Disclosure: Held
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