This one courtesy of "The Constant Investor"
Very interesting reading. Particularly bullish on HGO in near future (if Cu price holds up).
Unfortunate misunderstanding of Kanmantoo's location in relation to wine regions though! (never mind).
This article found via internet search on HGO tonight - freely accessible, though I suspect from subscriber content.
Acknowledgements to Mitch Taylor , Alan Kohler. Hillgrove Resources
HILLGROVE RESOURCES LIMITED IS AN AUSTRALIAN MINING COMPANY LISTED ON THE AUSTRALIAN SECURITIES EXCHANGE FOCUSED ON DEVELOPING ITS FLAGSHIP KANMANTOO COPPER MINE AND ASSOCIATED REGIONAL EXPLORATION TARGETS, LOCATED LESS THAN 55KM FROM ADELAIDE IN SOUTH AUSTRALIA.
17 JULY 2017
MITCH TAYLOR SPOKE TO ALAN KOHLER
You want to change one – which one do you want to change?
Bell Financial Group. Yes.
Reason being still good. We still own it. Still like it. The thesis hasn’t changed at all; we’ve just got a new one that I think is pretty exceptional. Thought you might be interested in hearing about that one. I would be. What is it?
The company’s called Hillgrove Resources (ASX: HGO). It’s a pure-play copper miner. The sole operating asset is located just 55 km south east of Adelaide. The project’s been a monumental failure. Over the last seven years, the market cap has declined from 230 million to 48 million despite raising new equity of 150 million along the way. About $400 million of shareholder value has been destroyed. Although some of this value destruction has resulted from a declining Aussie dollar copper price, the bulk of the losses were actually owing to lower than anticipated feed grade, a misalignment of employee and contractor incentive, and of course significantly higher capex than originally forecast. We think that’s all behind the company and we think the outlook from here for shareholders entering around these levels, at eight cents, is good.
In the last two years, management have been replaced and efficiencies have improved. The debt’s been reduced and the mine plan, which has been a monumental failure, has been independently reviewed by two external, highly credible, independent expert reports, and we think the new management team have earned their stripes. Over the last 18 months, the company’s invested more than $70 million in a giant cutback to access an ore body that was previously mined in 2012. These costs are now sunk, and that $70 million investment exceeds the current enterprise value. It must’ve been touch and go – the company would’ve gone broke.
It almost did. When we entered the stock nine months ago now, the way we entered was via sub-underwriting a convertible note with attaching option issue. That convertible note was for $5 million dollars of capital. At that time, they’d spent $65 million on this cutback, and they just needed $5 million more in order to access this previously-mined ore. It’s all happening right now. They’ll actually be mining this higher-grade ore in the next three or four weeks. Once they get there, the strip ratio will reduce by more than 50%. As a result of this, Hillgrove will go from being a very marginal producer to a copper miner operating in the bottom quartile of the global copper cost curve.
From December 2017 to June 2020, over this time period, if the copper price remains where it is today, we expect Hillgrove will generate net cash more than double its market cap. Beyond 2020, there are significant mine life extensions. We don’t value them at this stage; however, their significance is actually in extending the mine life and thus extending the time to mine closure. 30% of the company’s now owned by antagonistic shareholders, and they want this cash that’s going to be generated over the next three or four years to be returned to shareholders. Hillgrove actually has about half of its market cap backed by franking credits. We like the cash return aspect to this one. What is its market cap?
It’s a complicated one. Because of the existence of the convertible notes and the options, the market cap that you’ll see quoted on Bloomberg and other data providers is only about $17 million. Because those convertible notes and options are in the money, we treat them as equity. If you adjust for them, the market cap is about $48 million today. You’re saying that over the next 18 months, they’ll generate, what, $100 million in cash.
Over the next two and a half years. My number’s actually 125 million in cash. To put that in perspective, that’s about 130 million pounds of copper. A lot of people will look at this company and say, that’s very well, forecasting the mine plan, but this thing’s been a monumental disaster. They’ve never been able to do what they’ve said over the last seven years. Up until recently, I would say. When they did change the mine plan and they changed the independent expert assessing the amount of copper that’s in the ground about 11 months ago, he drastically cut the reserve. My numbers are based on his mine plan, and for the last 11 months, the company has actually operated slightly better than his proposed mine plan. Of course, it’s a copper producer, so there is copper price risk in this one.
The company’s unhedged at this stage. It’s difficult for them to hedge until they start getting through this ore body because of the restrictive covenants contained within the convertible note. However, from December, we think that they’ll be in a position to hedge the copper price. We expect they’ll hedge about half their copper price exposure over that key two and a half years. We’re sitting on our hands with it, with the copper price for the next five months, but if it holds where it is, we really think this is a good one and could do very well. Could you tell us what your average entry price was?
Our average entry price is about four cents. You’ve doubled your money already.
We have. When we invested, we invested with the copper price approximately 20% lower than where it is today. I think most of the uplift to date has been on the back of the copper price going up rather than the operational improvements. I think there is still plenty more upside. Basically, given the fact that stock trades at eight cents, I think net cash per share will be at least 18 cents or 17 cents by mid-2020 at the latest. What does that imply, do you think, for the share price at that point?
If the thing’s got net cash of 18 cents and you’ve got antagonistic shareholders who want the company to distribute that cash, I think that the market will be excited about the prospect of receiving half of their investment in cash, i.e., more than approximately the current market cutback in cash. Then they’d be happy to let the rest sit and back the continuation of the ore body, assuming management succeeds. Are you saying that they value the cash return as a yield?
No, because I think the cash will all be returned at once. I think if this thing does work as we think it will and the mine life continues to be extended by way of underground drilling, they’ve got a little tiny exploration programme that should be sufficient to extend the mine life, I think this could be actually priced on an earning to multiple. If it were to be priced on an earning to multiple, say, I don’t know, even 10 times or eight times average earnings, it could be even more than 20 cents per share. I’m not speculating about it. What I like about it is the net cash per share that we think it’s going to generate is double the current share price. With that margin of safety, we’re pretty comfortable to take the copper price risk, and we think everything else will look after itself. You said it’s southeast of Adelaide. That must be, what, near the Coorong or perhaps even the McLaren Vale wine region. Where is it?
That’s correct. It’s in a place called Kanmantoo, and it is near the premier wine region down there. The permitting is sufficient, so there’s no issues there. To their credit, despite the real difficulty in operating and the lack of performance over the last few years, management has really managed the environmental and local engagement very well. They have exceeded the requirements of their rehabilitation to date. What’s so important about that is that enables or increases the chances of securing significant increases in mine operating life. The numbers that I’ve quoted today out to mid-2020 are all based on the current approved mine life. Any mining beyond that date, which is largely expected to be underground mining on the same ore body that continues at depth: that will have to be subjected to another environmental review. There could be a bit of argy-bargy with the local wineries there. To their credit, they’ve preemptively managed this and are in good stead. Well, nice find, Mitch.
Well, let’s hope it keeps going.
(20min delay)
