How do you value a mining company?
How do you know whether a share price is a good buy and leaves you some room for value increase?
There are two main ways to value a company. Both end up at similar places and with similar values, but come from different angles. They are often used separately. Often people favor one over the other, and will dismiss the other method. This is unfortunate, as both have value..
Enterprise Value and Cost per Ounce
The first approach to valuing a company is by determining the Enterprise Value (EV) and dollar value you are paying per ounce of Resource held by that company. This is based on the quality and quantity of the reserves and resources held by the company. This page will deal with EV, and we will illustrate this with charts shortly, after a comment about net present value.
Net Present Value
The other method of valuing a company is to work out a companies Net Present Value. (NPV)
Here is what Paul Van Eaden is quoted as saying about NPV. It goes without saying that he prefers this approach.
“The only reasonable way to evaluate a mining company is to look at the net present value of the potential future cash flow, discounted at an appropriate discount rate. You have to take into account not just the cash flow that the mine(s) is generating, but also sustaining capital costs (including future exploration and development costs) associated with keeping the mine in production.”
We will illustrate this method with charts on the other page, (link above, or below). One thing that is worth keeping in mind is that mining stocks very often trade at a higher price than the NPV of their assets. This is because mining stocks also offer leverage to commodity prices. Paul Van Eaden again:
“…Take a gold mining company as an example. Assume we have a company that mines gold for a total cost of $400 an ounce, and let us pretend the gold price is $500 an ounce. The net present value of the mine would be calculated based on the $100 margin. If the gold price increases by 20% to $600 an ounce the net present value of the mine will double, since the margin would now be $200 an ounce. Thus the value of the company increased five times more than the increase in the gold price. Most people buy mining stocks because of this leverage.”
Net Present Value is covered on another page. Click Here
To work out the EV of a company follow these steps:
1. Determine the Market Cap of the company. (number of shares X share price
2. Subtract the value of Financial assets from that figure. (top left corner of diagram shows you what makes up these assets)
3 The value you are left with is the EV, as illustrated in the bottom right corner.
1. Take share price of the company you wish to evaluate.
2. Multiply the share price by the number of shares issued.
3. Deduct the “cash on hand”
And you are left with the enterprise value of the company set by the market.
Enterprise Value Per Ounce
This is the amount you are paying in dollars per ounce of resource when you buy shares in a company. Simply divide the EV by the total ounces resource held by the company, and you are left with EVO.
Use the company you used in your example above and Divide the EV by the resource ounces.
EG an EV of $22.6 million divided by 1,800,000 ounces = $12.55 Per EVO
Total Cost per ounce
This is a key part of your assessment. If your total cost per ounce is getting up to, or even above the price of gold, you may need to ask some serious questions.
There are a few simple steps to this:
1. Take the EVO
2. Add the average cost of producing an ounce of gold.
3. Add the development costs per ounce. To get this cost, add all the development costs together and then divide the answer by the total number of ounces resource in the project.
4. Add 1,2 & 3 together and you will have a total cost per ounce.
This diagram illustrates these steps:
Using an EVO $12.55. and 1000,000 oz.
1. Estimated Cost to produce an oz (not include taxes & royalties) $500.00
2. Development cost eg: $140 million divided by 1 million oz = $140 per oz
3. Total 1.2 & 3 = $652.55
4. $652.55 TCO
Is the EVO & TCO a good deal?
There is going to be wide differences in the Enterprise value per ounce of different companies. One of the key factors behind these differences is the certainty of the resources and reserves a company holds. The greater the percentage of their resource that is in the category of Reserve the better. Measured or Indicated also attract a higher EVO than inferred. Here’s an illustration:
Draw a line across this chart, from left to right, at the percentage of a companies resource that is in the Reserve category. The point where you intersect the diagonal line between the yellow and blue gives you an indication of the quality of each ounce of resource. The further to the right that intersect point, the higher the EVO you can expect to pay.
Of course, you need to balance this out with TCO. TCO will be impacted by grades, locations, and other factors. If a company has a large amount of their resource in the measured category, but has a very high cost of production, you should expect to pay less.
Take the Example of RAU on that chart: With a resource of, say, 1000,000 oz, allows us to draw a line across well over the 75% point. If you look at the chart below, I have placed a blue dot, as the position a resource of that size.
Putting this in perspective
The next chart will help you put this in perspective. There are a range of different companies listed across the bottom
The pink line illustrates the EVO, or Enterprise Value and cost per ounce for these companies. Notice they go down in value from left to right.
On the far right you will see Republic Gold illustrated. (RAU)
The center, red line, is the TCO. Here again on the far right you will see RAU. This is only an estimated TCO, based on the view that production costs would be in the lower quartile.
The blue line is the percentage of a companies resource in the measured and indicated categories. (note: not just reserves)
Notice that the higher EVO (pink bottom left of chart below) corresponds with the higher percentages of high category resource. (Blue, top left of the chart below)
Why is RAU’s “pink dot” (EVo) at the bottom right, while the “blue dot” (Percentage of higher category resource) is center or even far left?
This point alone, suggests RAU has been way oversold, and that it remains very undervalued.
Click on chart to enlarge.
As noted, it is obvious that RAU’s EVO (pink dot) is far right. Yet, the % of resource in the higher categories (blue dot) is left. This could suggest that the Enterprise Value per Ounce being paid is out of sync with the quality of the resource. More information and assessment of grades needs to be done to define this question
This is where being able to work out Net Present Value is useful. NPV is much more dependent on knowing grades, throughput, and gold prices. Hopefully you will have noticed by now that working out Enterprise Value, and Enterprise Value per Ounce does not require information about gold prices, or even grades. It focuses on Reserves, Resources and their category etc.
You are now in a position to turn your attention to how to work out Net Present Value. Click Here
To understand the background to the last chart check out this link:
Copyright: Chris Barrett, B.A.,Th.
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