Caledonia Mining — Doing everything you want a gold miner to do

Caledonia Mining — Doing everything you want a gold miner to do

Caledonia Mining (CMCL) beat its FY16 production target of 50kozpa by recording 50.4koz Au produced, with AISC costs down 12% y-o-y to US$912/oz, while C1 costs dropped 9% due to a commensurate annual increase of 18% in gold ounces produced. Investment continues at Blanket to raise production towards 80kozpa by 2021, with US$36m spent in the past two years alone, and another US$18m due in 2017 before capex drops off markedly. The central shaft is on track and on budget for completion in mid-2018 and is two thirds-complete. While this investment takes place, CMCL carries a sound cash balance of US$14.3m at end December 2016. The dividend yield is a high 3.8% and the stock is trading on a very low P/E of c 4x vs the FTSE miners index at 2.1% and 40x respectively.

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Caledonia Mining

Doing everything you want a gold miner to do

Q4 and FY16 financial results

Metals & mining

12 April 2017

Price

115.50p

Market cap

£61m

US$/£:1.25

Net cash (US$m) 31 December 2016

14.3

Shares in issue

52.8m

Free float

97.7%

Code

CMCL

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

3.1

(0.9)

87.8

Rel (local)

2.5

(2.6)

58.9

52-week high/low

143.0p

63.5p

Business description

Caledonia Mining mines gold at, and maintains management control over, its main operating asset, the 49%-owned Blanket gold mine in southern Zimbabwe. It is also progressing its understanding of a number of promising satellite projects close to Blanket.

Next events

Q217 results

August 2017

Analysts

Tom Hayes

+44 (0)20 3077 5725

Charles Gibson

+44 (0)20 3077 5724

Caledonia Mining is a research client of Edison Investment Research Limited

Caledonia Mining (CMCL) beat its FY16 production target of 50kozpa by recording 50.4koz Au produced, with AISC costs down 12% y-o-y to US$912/oz, while C1 costs dropped 9% due to a commensurate annual increase of 18% in gold ounces produced. Investment continues at Blanket to raise production towards 80kozpa by 2021, with US$36m spent in the past two years alone, and another US$18m due in 2017 before capex drops off markedly. The central shaft is on track and on budget for completion in mid-2018 and is two thirds-complete. While this investment takes place, CMCL carries a sound cash balance of US$14.3m at end December 2016. The dividend yield is a high 3.8% and the stock is trading on a very low P/E of c 4x vs the FTSE miners index at 2.1% and 40x respectively.

Year
end

Revenue (US$m)

PBT*
(US$m)

EPS*
(c)

DPS
(c)

P/E
(x)

Yield
(%)

12/15

49.0

5.1

8.1

4.8

17.8

3.3

12/16

62.0

19.6

21.4

5.5

6.7

3.8

12/17e

76.2

26.0

35.6

5.5

4.1

3.8

12/18e

81.9

26.8

29.8

5.5

4.8

3.8

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Costs driven down by ramp-up

Caledonia’s on-mine and all-in sustaining costs (AISC) continue to fall with 2016 recording a y-o-y decline in mine costs of 9.3% from US$701/oz to US$636/oz as production increased 18% in line with the Investment Plan (IP) roll-out. AISC decreased 12% from US$1,037/oz to US$912/oz. The AISC decrease in part reflects CMCL’s accounting of the Zimbabwean government’s 2016 launch of an export incentive credit rebate in H216 (see page 4).

Exploratory drilling replenishing gold stocks

Caledonia ramped up its underground drill programme in 2016, completing 22.2km of exploratory and resource definition drilling. This has resulted in a marked increase in resource confidence and the addition of new inferred material (page 3).

Valuation: Adjusted for FY16 results, forecasts intact

As a result of adjusting our model for FY16 results, royalty and rebate adjustments and using our gold price assumptions and maintaining our US$/£ forex rate at 1.25, our combined dividend discount flow (of Blanket’s free cash flow of production post-IP implementation) and DCF of vendor facilitation loan repayments increases slightly from 146p to 149p share. We also expect a 124% increase in headline EPS to 35.6c in 2017 (cf 15.9c reported in 2016). Our valuation uses a 10% discount rate to reflect general equity risk. Forcing our model’s valuation of Caledonia’s shares to its current share price (113p as of 12 April 2017) requires using a discount rate of 15.6% (in our Q317 note this was 16.3%). In our view this relatively low, and decreasing, hurdle rate represents a marked reduction in the country risk factor applied by the market to Caledonia’s shares, and an increasingly positive view on CMCL’s ability to deliver its IP successfully.

2016 and 2017: Production up and costs down

Caledonia’s FY16 results show the company continues to run a tight ship at its 49%-owned Blanket gold mine in Zimbabwe. Effective control of its mining practices and increased underground mining flexibility are evident on the bottom line, with y-o-y EPS growth of 79%, simultaneously driven by the marked y-o-y increase in gold production to 50.4koz – a slight beat on Caledonia’s guidance of 50koz for 2016.

The year ahead should continue the positive trend of 2016, with production up, costs down and positive cash generation comfortably covering capital outflow. Management targets 2017 production of 60koz, which in our view puts it well on track for its targeted 80koz in 2021.

Cash costs down: FY17 should see a further incremental drop

C1 equivalent on-mine cash operating costs fell for the second consecutive year, supporting the company’s ability to implement significant capital expansion plans at Blanket. Cash operating costs were 9.3% lower y-o-y in 2016 and a further 3% drop is expected in 2017 as production ramps up to 60koz.

Exhibit 1: Cash cost profile, showing 2015 and 2016 reported numbers and 2017-25e

Source: Caledonia Mining and Edison Investment Research. Note: Solid line denotes reported numbers, dashed are forecast.

We note from the company’s MD&A that in Q416, on-mine costs were actually at our forecast for FY17 at US$614/oz. Although quarterly production is relatively variable (as with all mines), this early sign that costs are coming down as planned is further support to management’s ability to implement the Investment Plan.

Expansion plans: Central shaft key for 2017

With two elements of Caledonia’s Investment Plan completed on schedule during 2016 (ie the No. 6 Winze and Tramming Loop), the company’s main development focus is the sinking of the 1,080m planned Central Shaft. So far, this shaft has been excavated to a depth of 633m and is therefore roughly two thirds complete. The main phase of capital investment has now passed, with US$36m expended over the course of 2015 and 2016, and the last major capital investment of US$18m due over 2017. Most of this will be used to finish excavation and fit-out the Central Shaft ready for operation in mid-2018, as planned. Pre-development works underground, using the newly completed No. 6 Winze, have been completed and will ensure that once the Central Shaft is completed, first gold production can occur shortly thereafter.

Caledonia stated in its FY16 MD&A that the main impediment to the central shaft’s development has been some intermittent loss of electricity to its shaft sinking equipment as a result of electricity supply difficulties from the Zimbabwean national grid. As a result, extra diesel-powered generators were installed in 2016 to provide additional power to the Central Shaft development as and when required.

Additional works to add flexibility at minimal cost

Caledonia has decided to tweak the internal structure to Blanket’s haulage ways, beyond those originally provided by the Investment Plan. This is only a slight modification to the Investment Plan, incurring minor incremental costs, but should result in even greater flexibility as the mine establishes itself for long-term growth below the 750m Level.

These other projects are:

The AR South Decline, completed in early 2016 to a depth of 780m, is now being extended to 870m or the 26 Level and will allow for more rapid access to deeper level gold resources.

A second decline at AR Main will also be completed to a depth of 780m. Again, this will provide additional mining flexibility to access gold resources below the 750m Level.

A further extension to the Tramming Loop is also being completed. This extension will de-congest the Level 22 haulage way, and include a loop around all the grizzlies used on 22 Level. Grizzlies are parts of the mine where ore is screened for oversized pieces prior to haulage to surface.

Exploration drilling significantly raising resource confidence

To address the issue of lower-confidence resource ounces being present below the 750m Level, Caledonia materially stepped up resource delineation and exploration drilling over 2016. The company drilled 22,172m of drilling over 2016, 55% up on the year. This, backed by information generated from digitising historical production and exploration data has resulted in an increase in resources and reserves. Highlights of these programmes are:

Addition of 1.2Mt of new mineralised inferred category material equating to 200koz grading 5.00g/t Au.

Upgrading 343,000 tonnes grading 5.19g/t Au for 47,700oz Au from inferred to indicated category.

5% increase in code-compliant resources and a 13% increase in Proven and Probable reserves.

A note on geological digitising of old mine plans

As Caledonia formalises its digital models using old paper mine plans, we expect it to markedly increase its geological understanding of Blanket’s numerous orebodies. Although orebodies can be relatively easily followed by miners underground, understanding the subtleties of orebody shapes and the nuanced interactions they can have with each other and various geological structures around them, can yield surprisingly positive results. We expect the company to continue to develop its own internal geological systems and for the results of these improvements to be borne out in a net positive gain for resources and reserves at year-end. New resource to reserve estimates are currently being compiled and will replace the old published ones released in 2014.

There is also the potential, however uncertain at present, that the digitising process could open up fresh lines of thought into Blanket’s orebody genesis and provide new drill targeting techniques with the obvious potential positive impact it could have on gold resource and reserve levels.

Additionally, increased knowledge of the orebodies underground will allow tighter mine planning by engineers to take place, and potentially small improvements to grade control practices through optimised orebody wireframe modelling, in particular around production headings.

FY16 results and valuation adjustments

The following paragraphs highlight the key changes and main assumptions we use to value Caledonia’s shares. For an extensive overview of the company’s Investment Plan please read our January 2015 outlook note, Future-proofing Blanket.

Edison’s gold price deck – in line with current levels long term

The model we use to forecast the gold price implicitly assumes a relationship between the total US monetary base, inflation and the gold price. In 2015 there was a (extremely rare) decline in the total US monetary base and (arguably conservative) absence of inflationary pressures. These combined to reduce the base for our longer-term analysis and, therefore, our longer-term numbers.

For further detail on the above method, please refer to page 48 of our October 2016 sector report: Mining overview: Gold and other metals.

We base our valuation of Caledonia’s shares using the following gold price deck and apply it to our production forecasts which include the targeted 60koz in 2017.

Exhibit 2: Edison’s gold price forecasts

Year

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

US$/oz

1,275

1,220

1,284

1,362

1,344

1,281

1,274

1,257

1,245

1,264

Source: Edison Investment Research

Zimbabwean gold industry incentives

The Zimbabwean government reduced the royalty rate paid on incremental gold production in 2016 from 5% to 3%. For Caledonia, this meant that for the additional 7,196ozs of gold it produced in 2016 compared to 2015, it saved a modest US$181k which will be offset against royalty payments due in 2017. We assume this continues into 2017 and 2018, which covers off the main phase of development at Blanket, but resist applying this royalty reduction longer term due to potential changes in its structure.

Using our gold price assumptions (see Exhibit 2) and the estimated annual gold production amounts as outlined in the IP for 2017 and 2018 results in the following small royalty savings:

Exhibit 3: Revised royalty payment amounts 2017 and 2018

(US$m)

Old royalty charge

New royalty charge

Change (%)

2017

3.8

3.6

-6%

2018

4.1

3.9

-4%

Source: Edison Investment Research

Export incentive credit (EIC) introduced to promote gold mining

In May 2016, the Zimbabwean government announced an export incentive scheme designed to promote increased gold mining and therefore increase the amount of gold the country can export. The export incentive provided to Blanket was 2.5% of the sale proceeds from the gold sold to the Fidelity refinery in Harare. Caledonia recorded the majority of this incentive in Q417, which was the reason all-in sustaining costs were much lower than in previous periods. The total amount under the export incentive scheme received by Caledonia was US$1.1m.

We note from management that the scheme has recently increased the rebate on sales from 2.5% to 3.5%. In terms of adjusting our forecasts for this rebate, we increase our gold revenues by 3.5% of total sales across our valuation period 2017 to 2026 as shown in Exhibit 4.

Exhibit 4: Edison forecast for export incentive credit rebate over valuation period

Unit

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

Gross gold revenue

US$ 000s

76,223

81,856

94,671

105,818

108,137

105,410

104,834

103,435

102,448

104,01

Rebate at 3.5% of total sales

US$ 000s

2,668

2,865

3,313

3,704

3,785

3,689

3,669

3,620

3,586

3,640

Source: Edison Investment Research. Note: Our estimates of the rebate on total gold sales before refining or royalty costs are applied

Cash build expected to accelerate post 2017

Caledonia invested US$19m over 2016 and after all mine and head office costs, finished the year with a net cash position of US$14.3m, a 33% y-o-y increase. Note that with production expected to reach 60koz for 2017 and costs expected to decrease as fixed costs (which at Blanket account for approximately 60% of total mine costs) are spread over more ounces, we expect a further 6% increase in cash to US$15.3m. This assumes US$18m in capex spent in 2017, as well as a gold price of US$1,275/oz.

2018 should see a doubling in cash

Looking further ahead, as capex drops off markedly in 2018 (only US$8.2m is forecast for 2018) and production increases from 60koz to 67koz, cash build should accelerate considerably with a doubling of cash to US$29.4m at end 2018, we estimate.

Dividend increased and policy looks sustainable

Caledonia guides that its recently increased 5.5c annual dividend paid in 1.375 cent amounts, will be maintained and is covered three times by cash. For reference, the FTSE Mining Index average cash cover is only 1.1x, making Caledonia appear a far lower risk investment in terms of dividend sustainability. We include this dividend in our model for both 2017 and 2018.

Valuation: Export incentive drives moderate increase

As a result of adjusting our model for FY16 results, royalty and rebate adjustments and using our gold price assumptions and maintaining our US$/£ forex rate at 1.25, our combined dividend discount flow (of Blanket’s free cash flow of production post-IP implementation) and DCF of vendor facilitation loan repayments increases by 2.0% from 146p to 149p per share. This is at a 10% discount rate to reflect general equity risk. Forcing our model’s valuation of Caledonia’s shares to its current share price (113p as of 12 April 2017) requires using a discount rate of 15.6% (in our Q317 note this was 16.3%). This relatively low hurdle rate represents, in our view, a marked reduction in the country-risk factor applied to Caledonia’s shares, as well as a significantly more positive view on the company’s ability to deliver its IP on time and on budget, which is now two years completed.

Exhibit 5: Financial summary

US$'000s

2015

2016

2017e

2018e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

48,977

61,992

76,225

81,858

Cost of Sales

(35,796)

(38,500)

(44,181)

(47,847)

Gross Profit

13,181

23,492

32,045

34,012

EBITDA

 

 

8,967

23,257

29,556

31,665

Operating Profit (before amort. and except.)

5,645

19,766

25,745

26,465

Intangible Amortisation

0

0

0

0

Exceptionals

2,850

(788)

0

0

Operating Profit

8,495

18,978

25,745

26,465

Net Interest

(535)

(176)

287

370

Other financial items

0

Profit Before Tax (norm)

 

 

5,110

19,590

26,031

26,835

Profit Before Tax (FRS 3)

 

 

7,960

18,802

26,031

26,835

Tax

(2,370)

(7,717)

(3,750)

(7,345)

Profit After Tax (norm)

2,740

11,873

22,281

19,490

Profit After Tax (FRS 3)

5,590

11,085

22,281

19,490

Minority interests

(811)

(2,797)

(3,502)

(3,765)

Net income (norm)

 

 

4,220

11,276

18,779

15,725

Net income (FRS3)

 

 

4,779

8,288

18,779

15,725

Average Number of Shares Outstanding (m)

52.1

52.8

52.8

52.8

EPS - normalised (c)

 

 

8.1

21.4

35.6

29.8

EPS - normalised and fully diluted (c)

 

8.1

21.4

35.6

29.8

EPS - (IFRS) (c)

 

 

8.9

15.9

35.6

29.8

Dividend per share (c)

4.8

5.5

5.5

5.5

Gross Margin (%)

26.9

37.9

42.0

41.5

EBITDA Margin (%)

18.3

37.5

38.8

38.7

Operating Margin (before GW and except.) (%)

11.5

31.9

33.8

32.3

BALANCE SHEET

Fixed Assets

 

 

49,276

64,917

79,106

82,106

Intangible Assets

0

0

0

0

Tangible Assets

49,276

64,917

79,106

82,106

Investments

0

0

0

0

Indigenisation receivable

0

0

0

0

Current Assets

 

 

23,562

25,792

26,867

41,573

Stocks

6,091

7,222

4,444

4,623

Debtors

4,236

3,425

3,133

6,728

Cash

12,568

14,335

18,480

29,412

Other

667

810

810

810

Current Liabilities

 

 

(8,397)

(9,832)

(7,753)

(10,730)

Creditors

(6,709)

(9,832)

(7,753)

(10,730)

Short term borrowings

`

(1,688)

0

0

0

Long Term Liabilities

 

 

(14,080)

(19,365)

(19,365)

(19,365)

Long term borrowings

0

0

0

0

Other long term liabilities

(14,080)

(19,365)

(19,365)

(19,365)

Net Assets

 

 

50,361

61,512

78,855

93,584

Minority interests

 

 

(1,504)

(3,708)

(6,739)

(10,034)

Shareholder equity

 

 

48,857

57,804

72,116

83,550

CASH FLOW

Operating Cash Flow

 

 

8,331

25,631

28,512

29,010

Net Interest

0

(194)

287

370

Tax

(1,462)

(2,466)

(3,750)

(7,345)

Capex

(16,567)

(19,885)

(18,000)

(8,200)

Acquisitions/disposals

0

3

0

0

Term loan facility and equity issuance

0

3,360

0

0

Dividends

(2,504)

(2,994)

(2,903)

(2,903)

Net Cash Flow

(12,202)

3,455

4,145

10,932

Opening net debt/(cash)

 

 

(23,082)

(10,880)

(14,335)

(18,480)

HP finance leases initiated

0

0

0

0

Other

0

0

(0)

(0)

Closing net debt/(cash)

 

 

(10,880)

(14,335)

(18,480)

(29,412)

Source: Company accounts, Edison investment Research

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

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Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Caledonia Mining and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
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Frankfurt +49 (0)69 78 8076 960

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Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

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Level 12, Office 1205

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NSW 2000, Australia

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Probiodrug — Early PQ912 data for Huntington’s; AD data soon

Probiodrug’s new preclinical data showed that PQ912 demonstrated efficacy in Huntington’s disease (HD) in an animal model. Subject to further preclinical work, PQ912 could be fast-tracked to the clinic, which would diversify Probiodrug’s R&D pipeline with a new indication. Much will depend on the outcome of the company’s milestone clinical Phase IIa SAPHIR trial with PQ912 for Alzheimer’s disease (AD) with the data readout shortly. PQ912 is a first-in-class small molecule glutaminyl cyclase (QC) inhibitor and represents a differentiated approach in the AD field. We value Probiodrug at €345m or €42.1/share.

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