Centamin Egypt - following the gold price ever upwards?

The gold price seems to be reaching new heights every day - but not all gold mining companies have followed suit. Some have seen production fall owing to local difficulties, while some of the explorers have disappointed.

Centamin Egypt, on the other hand, seems to be doing well and looks like an attractive proposition for any equity investor wanting exposure to the increasing gold price.

Centamin has a single large project, the Sukari project in Egypt's Eastern Desert. It has 12.9m ounces of resources (9.39m ounces measured and indicated plus 3.54m ounces inferred [ref] Company presentation, http://www.centamin.com/admin/uploads/Company%20Presentation%20-%20May%2009.pdf [/ref] , and is already in production, the first gold having been brought out in June 2009. Centamin management claims it is Egypt's first large scale modern gold mine - and while it is on a pretty large scale already, it could double production levels over the next couple of years.

What's the downside? Well the resources are pretty low grade, at only 1.53g of gold per tonne of ore. There are higher grade areas within the resource, at 4-7 g per tonne, and at places - particularly underground, where concentrations as high as 17 g per tonne have been found.

Still, the lower mineralisation near-surface deposits can be effectively open-pit mined. That's already ongoing, and the open pit operations could increase production to 325,000 oz/year by 2013 [ref] Investors Chronicle, May 2009: http://www.investorschronicle.co.uk/Tips/Buy/TipsOfTheWeek/article/20090521/025b4f28-4141-11de-98d0-0015171400aa/First-gold-glints-for-Centamin.jsp [/ref] . That's the bread and butter.

The jam on the cake will be the underground operations; construction of the access shaft is already in progress though full scale underground mining isn't expected to start till 2011. Underground mining will allow Centamin to access the much thicker mineralisation further down. 

The combination of underground and open pit production should ramp up to 500,000 ounces a year or more by 2012, on the existing resource base. That will involve a £60m investment in expansion and mining facilities - but the good news is that the company already has the money, so it's not a hostage to the fortunes of the bond markets or banks' appetite for risk [ref] Growth company Investor recommendation, http://www.growthcompany.co.uk/recommendations/1063572/its-no-mirage-for-centamin.thtml [/ref] .

And there's the tantalising hint of more to come, since drilling has shown that the mineralisation continues to the north of the existing production zone (and elsewhere: I particularly like the comment in the company presentation to investors that “Elephants don't travel on their own”).

What's more, this is going to be a nicely profitable mine. I'm not really a gold bug - to be honest I prefer good old boring commodities like copper and titanium dioxide and natural gas - and as I've been researching the gold miners recently one of the things I've found worrying is the number of small producers which expect to have costs above USD 800 an ounce. I remember how the gold price was stuck as USD 400 or thereabouts for years - if it heads back to that territory once the economy starts to recover, those high-cost mines could be in real trouble.

No such worries at Sukari, where management has indicated that likely operating costs are about USD 365 an ounce. That's already enough to qualify it as a bottom quartile cash cost producer [ref] Company presentation, p 3 [/ref] . Even better, once the underground part of the mine starts to contribute with its higher-grade ore and the company starts getting economies of scale through its processing operations, the cost could actually fall to USD 300.

Centamin gets to keep 50% of its profit, according to a profit share agreement with the Egyptian government. And that's a profit share not a royalty - Centamin gets to deduct its operating costs and a royalty before paying up. It won't get to pay income tax for 15 years, either. And since the company is debt-free, shareholders will get to see most of the profit from operations falling through to the bottom line.

While the company is moving from exploration to the production phase, it's continuing to drill, in order to increase its resources base. So far, most of the reserve that has been found is in one of its four licence zones, Amun. Management expects  resources to grow by around  500,000 ounces a quarter over the next couple of years [ref] Company presentation, p22 [/ref] . There is room for the resources to as much as double, according to a Bank of America Merrill Lynch analyst [ref] Daily Mail, 30 October 2009: http://www.dailymail.co.uk/money/article-1224205/INVESTMENT-EXTRA-Investors-strike-gold-Egypts-Centamin.html [/ref] .

Up to now, Centamin has been making losses. However, it should make a profit for the next financial year, now that it is producing - and the shares have been rising to reflect that fact. Formerlyly quoted on AIM (as well as in Australia and Toronto), the company has now moved up to the main list in order to widen its appeal to investors [ref] Growth Company Investor, 4 August 2009: http://www.growthcompany.co.uk/news/1064042/centamin-for-big-board.thtml [/ref] .

I like the corporate structure. Unlike many junior miners which have dominant management interests or large and sometimes troublesome minority shareholders, Centamin has a wide spread of shareholders. Management holds only 8.5%, with Paulson & Co at 11.16% the single largest shareholder, and I like the fact that the shareholder list includes names like JP Morgan Asset Management, Fidelity Investments, Henderson, and AEGON UK as significant holders [ref] Company presentation, p5 [/ref] .

I suppose though that you'd have to give a corporate governance score of minus ten for the fact that the executive chairman and MD are father and son. However, both have good industry credentials; Sami El-Raghy was involved in gold minute discovery and development for ASARCO and Chevron, while Josef El-Raghy has been a director at mining investment houses CIBC Wood Gundy and Paterson Ord Minnett. Trevor Schultz, executive director of operations, has built gold mines in Africa and the Americas, with work experience including BHP, RTZ, and Ashanti Goldfields.

Plenty of the gold mines I've looked at have been in very dodgy regimes indeed - civil war and coup d'etat seem to be occupational risks for some resource companies! Centamin is a bit different - Egypt has been in Mubarak's hands since 1981 and appears politically fairly stable. It is possible of course that things could go badly wrong - Egypt isn't a completely stable democracy - but it doesn't seem likely.

So far, so good. Exploration risk, nil - though there's some upside. Political risk, low. And it's worth noting that execution risk is also low; this is an easily mined large reserve, on a hillside which makes it easy to access. Removing the top of the hill could double the size of open pit mine, just like taking the top off an egg. The underground operations are a little trickier but the management in place is highly experienced and there are no particular difficulties in this location.

So it remains to be seen what the shares will be worth. Ambrian, which has a good record in resources sector analysis, estimates the company will make USD 141m turnover and USD 62.3m profit in 2010, with 6.3 cents earnings per share. It had a 73p price target earlier this year, and was expecting to increase that to 100p once production began, pointing out that a valuation of 1t .7x estimated present value of future cash flow would put the stock on close to the benchmark valuation for the sector. [ref] Investors Chronicle 1 May 2009:  http://www.investorschronicle.co.uk/Tips/Buy/TipsOfTheWeek/article/20090521/025b4f28-4141-11de-98d0-0015171400aa/First-gold-glints-for-Centamin.jsp [/ref]

The problem with that is that the stock is now trading at 145p. That probably reflects the rise in the gold price over the course of the year, but it does slightly worry me that the stock is sitting at its 52 week high. There may be value in the stock - but it certainly isn't hidden value!

Centamin is certainly an interesting stock, though. Its large scale, in particular, makes it quite a scarce resource - a new, independent, world class gold mine. Its targeted 500,000 ounce a year production levels would put it in the same league as the world's top producer, 650,000 oz/y Randgold. There aren't a lot of those around. That  makes it a potential bid target for the major mining companies - who would undoubtedly have to pay a premium if they wanted to get their hands on it.