The ugly duckling is becoming a swan

1 - Apologies, in advance, if this seems more like an essay than a post. You may want to get a cup of coffee so you are still with me at the end! Kindly note that I have used AUD amounts throughout.

2 - Having looked at the PowerPoint presentation to the recent AGM, I note that the Laverton triangle (see page 17 of the AGM presentation) has nothing in the top segment but the Coolgardie triangle (ditto, page 6) does. That suggests the resumption of production will be at Coolgardie first.

3 - The AGM presentations, both last year and this year, referred to Tindalls as the backbone of future, i.e. resumed, production. From the most recent table for reserves, Tindalls has 616,500 ounces at 2.2 grams/tonne in the surface area and a further 234,500 ounces at 3.9 grams/tonne underground. Obviously you have to do the surface first. So the good news is that the surface ore is easy to access but the bad news is that the grade is not as high as most of the other grades.

4 – Simply put, It appears that Tindalls has the reserves needed to create the five-year mine life which is one of their stated criteria for resumed processing.

5 - The Coolgardie plant is said to have a capacity of 1.2 millions tonnes pa. I would have assumed they would use all of that capacity but if they do not expect to use all that capacity then they may do a deal to process the ore of someone else nearby in return for them contributing to the recommissioning cost. It occurs to me that they might not only recommission but also expand the capacity of the plant. Anyway, since I want my analysis to be on the conservative side, I assume they only use half the 1.2 million tonnes per annum capacity of that plant.

6 - 600,000 tonnes pa at a grade of 2 grams per tonne gives 1.2 million grams of gold and that is, roughly, 40,000 ounces. I assume an all up cost of $1,000 per ounce. I pick that figure because FML stopped processing when the price of gold fell to $1,200 but (1) costs should have gone done since then after the mining boom finished, and (2) the Shandong expertise should help to lower costs. I assume a sale price of $1,500 per ounce, again being conservative, allowing for a drop in the price from current price which is close to $1,700 per ounce. Even if FML’s costs end up being $1,100 per ounce and the price drops to $1,600 per ounce, it seems to me they are still going to have a margin of $500 per ounce. So a conservative 40,000 ounces at a conservative $500 per ounce gives a conservative $20 million in the first year of resumed processing.

7 - From the most recent Annual Report, i.e. for the year ended 31 December 2016, FML has Accumulated Losses of $319 million. So the good news is that, for the first few years, there should be no company tax but the bad news is that any dividends will be unfranked.

8 - in the last year (i.e. 2016 calendar year) they spent $9 million on exploration so I assume $10 million of the $20 million profit for exploration which would leave $10 million and that is enough for a dividend of 5 cents per share as that would cost $9.1 million since there are 182 million issued shares.

9 - I note there are no share options on issue or proposed and that there is enough cash to both continue exploration and resume production. Obviously, there is no problem selling the gold because China will take it thanks to the Shandong connection.

10 - If they resume processing by the end of the 2017 calendar year then the first full year of production would be 2018 and the first dividend could be declared after the accounts for the company’s financial year ending 31 December 2018, i.e. in around March 2019, and paid around the time of the AGM in a May 2019, i.e. two years from now.

11 - If my assumption of 5 cents per share dividend is correct then, based on the current price of other ASX listed gold miners that pay dividends, i.e. share price expressed as a multiple of the dividend paid, the FML share price would be at least $1.50 (30 times the dividend) and the good future prospects for FML may reasonably be expected to push the share price higher than that.

12 – Or, in terms of earnings per share, if I stay with 40,000 ounces at a margin of $500 per ounce, giving a profit of $20 million, i.e. earnings of 11 cents per share. At the current share price of around 44 cents, that gives a price-earnings (PE) ratio of only 4 and that suggests a much higher share price. My bank-related stockbroking site suggests a PE for this sector of just over 12 so, on that basis, the shares should be 3 times the current share price of 44 cents (or 12 times earnings of 11 cents per share) which is $1.32, a 200% gain for those buying at 44 cents.

13 - If what appears above is correct then there could be as many as five significant share price increases:

(1) when they resume production in Coolgardie (which may become clearer after the PFS that is due to be received by FML in June),
(2) when they start paying dividends,
(3) when (or, for the pessimists, if) they discover more gold in Laverton,
(4) when they resume production in Laverton (in addition to Coolgardie),
(5) when they increase production levels (I have assumed a low level of initial, resumed production of 40,000 ounces in order to be conservative),
(6) when the price of gold goes up.

14 - With a market capitalisation of around $80 million (182 million shares at 44 cents per share) and cash on hand of around $45 million, shareholders get all those gold reserves and future prospects for $35 million which is just under 20 cents per share.

15 - Even if someone now pays 50 cents per share then, if my figures are correct the even if the share price two years from now is only $1.50 and if the dividend is 5 cents then investors get a capital gain of 200% in two years and then a return of 10% pa on their 50 cents/share investment from the (initially unfranked but later franked) dividends.

16 – For those who think my half the Coolgardie plant's capacity assumption of 600,000 tonnes pa is too low then, as an alternative, I assume 900,000 tonnes pa (being either operating plant with a 1.2 million tonnes pa capacity either (1) at 75% of capacity all the time or (2) at full capacity 75% of the time. Again, assume a measly 2 grams per tonne. That would give 1.8 million grams or about 60,000 ounces and, at a margin of $500 per ounce, the profit is $30 million. Ignoring company tax (due to tax losses of $319 million) and deducting $10 million for continued exploration leaves enough to pay a dividend of 10 cents per share and a likely share price in the region of $3 (30 times the 10 cents dividend) or at least $2 (a PE ratio of 12 and earnings of $30 million which is 16 cents per share). Of course, PE ratio devotees know that share prices tend to be based on forward earnings, i.e. next year’s earnings and not last year’s earnings. Either way, under the assumptions in this paragraph, the share price should be between $2 and $3.

17 - Shandong paid $2.50 for their shares (around 4.5 billion shares at 5 cents each gave the $225 million Shandong paid, then the 1 for 50 conversion means they got roughly 90 million shares for their $225 million which equals $2.50 per share). If the share price got back to $2.50 they would break even. At $3 they would have a 20% capital gain. A sustainable dividend of 5 cents per share dividend would provide a 2% return on their investment and they would have the prospect of further capital gains and dividend growth.

18 - Once dividends commence, the prospect of higher dividends would come from any or all of:

(1) a higher level of processing (I have assumed only 40,000 ounces but they were doing much more than that – I seem to recall, some time ago, seeing a figure of around 170,000 ounces - before they mothballed their plants),
(2) higher grades recovered (I have assumed only 2 grams/tonne and they have higher grades than that in a number of areas),
(3) a higher price for gold.

19 – If you want another basis of calculation then take 170,000 ounces, round it up to 180,000 ounces (to make the maths easier) and assume FML produces that much gold in a year. 180,000 ounces multiplied by an assume margin of $500 an ounce divided by 180 million shares (in round figures) gives 50 cents per share pa which, even allowing for $10 million of that money to be spent on further exploration, gives annual earnings before tax of around the current share price! If you think that figure is too high then I note that to get 180,000 ounces from the current plant capacities (1.2 mtpa at Coolgardie and 1.45 mtpa at Laverton) you would only need a gold grade of 2.7 grams/tonne: 2.65 million tonnes, with plants operating at around 75% capacity, would process 2 mtpa and assuming recovery of 2.7 grams per tonne gives 5.4 million grams or around 180,000 ounces pa.

20 – I note there is a “double whammy” of when processing better grades. For example, if it costs $1,000 an ounce to get 2 grams of gold out of a tonne of ore then if a tonne of ore yields 4 grams for the same outlay then the margin is higher because the same cost is spread over twice the gold. In other words, the better the grade not only provides more ounces of gold but also should result in a greater margin for each of those ounces.

21 - In the case of Tindalls, the underground resource is shown as having 3.9 grams per tonne. While there may be greater costs in extracting ore from what are referred to as the UG reserves than the surface reserves, I would doubt that any additional cost would double the cost per ounce so the progression from Tindalls surface ore to Tindalls UG should result in a greater margin.

22 - I also note that FML:

(1) has gold reserves so it is not one of those pure exploration companies, i.e. cross your fingers and hope they find gold at some time in the future,
(2) has reserves in Australia and not some country with significant sovereign risk,
(3) is not likely to require any capital raising,
(4) has experienced management and directors, and
(5) has links to China which clearly has a strategy for the future which favours gold as revealed by its appetite for gold in recent years, i.e. China would not be accumulating gold if it did not think the price of gold was going to go up.

23 - All that said, I find it hard to see a better investment on the ASX and FML appears to meet my favourite investment criteria of a stock for which it can be said that investment profit, from capital gain and /or dividends, is a question of "when, not if".

24 - I understand that many current shareholders have an average cost above the current spare price. It seems to me there is a need for patience, an often forgotten ingredient in stock exchange investment, which, in order to be successful, needs three ingredients:

(1) buying at the right time,
(2) selling at the right time, and
(3) patience in between those times.

25 - But I do not see FML as a purely speculative stock: it appears to be a good long term investment (i.e. a stock with good growth prospects), especially as a stock that will provide refuge from a financial crisis and as a way to profit from a gold price increase in a leveraged manner, meaning that if the price of gold goes from $1,600 to $2,000 then someone owning gold bars would achieve a 25% increase in value but if the price of gold goes from $1,600 to $2,000 per ounce then that $400 increase in the per ounce price of gold would mean that FML’s margin goes from $500 (assuming 1600-1100) to $900 (i.e. 2000-1100) and an FML shareholder should achieve an 80% increase in value. In other words, buying an FML share is the same as borrowing $1,100 for every ounce of gold you buy at $1,600.

26 – There are three kinds of gold companies:

(1) those who only explore: they risk running out of money;
(2) those who only mine: they risk running out of ore; and
(3) those who mine and explore: funding exploration from mining revenue thus extending mine life.

Happily, it appears it will not be too long before FML is a “category 3 company”.

27 – Further, bear in mind that there are only 182 million shares and, from the list of top twenty shareholders, it would appear that at least 2/3 and probably 3/4 of those shares are tightly held with the result that when FML is discovered by the market, the price may well rise more quickly than a stock with a lot of shares which are not tightly held.

28 – I wonder how long it will be before one of those investment subscription services “discovers” FML and creates a situation that resembles a herd of sheep trying to get through a narrow gate because of the comparatively small number of available shares.

29 – Finally, to give credit where credit is due, the Shandong people are carefully and sensibly turning an ugly duckling into a swan. I shudder to think where FML would be today without them. Over many years, I have noticed a strong correlation between good managers/directors and good performance and FML appears, to me, to support that view.

30 – It seems to me that HC users who follow FML do so for one of a number of reasons:

(1) Their average cost exceeds the current SP who wonder when/if they’ll get their money back,
(2) They are short-term investors who want to make money quickly,
(3) They are long-term investors who want to confirm they have made a good decision, or
(4) They are potential investors who don’t want to make a bad decision.

31 - Regardless of which of those descriptions fits you, the usual two rules apply:

Rule 1 – DYOR
Rule 2 – See Rule 1!

32 – I would welcome any constructive criticism of this analysis from the HC forum and I can only hope that any resulting discussion does not degenerate into comments that require moderation.