chatree costs, page-3

Management said there was poor equipment availability, and a shortage of skilled operators at Challenger in the quarter, and that is the reason for the production fall. Looking at the numbers though shows ore mined slighly above previous quarters, so either management have misstated the reason, or I have misunderstood. To me the reason is clear:, production was down 20% Q-o-Q and grade was also down 20% Q-o-Q, ie grade fell.

Direct Mining Expense was the problem at Challenger this quarter, rising 60% from $556/oz to $891/oz. Plus depreciation increased by $118/oz, which management said varies wildly between quarters.

Those two things increased Total Production Cost from a decent $1075/oz to a quite bad $1536/oz.

DEC'11 Direct Mining Expense: $556/oz * 27285oz = $15.2m total
MAR'12 Direct Mining Expense: $891/oz * 21893oz = $19.5m

So total mining costs increased by 28% while ore mined increased only 6%. That's another problem on top of the lower grade, that total mining costs increased. I don'tknow the reason for the increase, maybe they had to have more staff to cross the fault or something, or maybe the shortage of operators meant they had to bring in high cost contractors. Hopefully that rise in mining costs is temporary.

Grade this quarter was 4.32g/t versus the reserves of 5.67g/t. Even the December quarter of 5.43g/t was below the reserve average. So assuming grade will pick up from 4.32g/t to 5.67g/t over time, that will be a 31% improvement in grade from this quarter.

If total mining costs come down again, and grade improves in time, I guess Challenger would be running at $1000/oz total production cost. Total production cost includes depreciation of the acquisition, so $1000/oz would provide a good profit margin of $664/oz ON TOP of the acquisition costs. So at $1536/oz total production cost it is at risk of being a bad purchase but if they get it back down to $1000/oz, it's a pretty good one.

Challenger is harder to understand than Chatree though.

Challenger depreciation totaled $581/oz this quarter, with 21893oz produced. That is $13m in depreciation, $51m annualised. Was the purchase cost $376m? I don't know how much has been depreciated already, but the current rate of $51m per annum is depreciating over 7 years. They have around 5 years of reserves, so I guess they expect to convert more to reserves.

If they can get more reserves than the 5 years worth at current, the additional reserves would have little depreciation, am I right? So total production cost of those additional reserves could be up to $400/oz less than the current reserves (as low as $700/oz, potentially), since there's little depreciation.

Any current reserves have a good-case scenario of $1000/oz total production cost, and any additional reserves could be produced for as little as $700/oz (similar to Chatree!).

So it's looking ok, as long as the total mining costs come down again to where they were last quarter, or at least the ore mined increases to match the higher mining cost.

As for EBIT:
DEC'11: 27285oz at $1075/oz, margin of $589/oz and EBIT $16m
MAR'12: 21893oz at $1536/oz, margin of $128/oz and EBIT $2.8m

So a bad quater like this one has a small profit. A good quarter like December has EBIT $16m. I guess best case scenario for a quarter is EBIT $20-25m (at current gold prices).

As for Chatree, EBIT $34m looks like a pretty average quarter to me going forward.

Chatree+Challenger = EBIT $34m + $16m = EBIT $50m per quarter when they both have a decent quarter. Pretty good.

KCN $800m enterprise value, EBIT $200m PA if Chatree and Challenger both do decently, and not even including Nueva Esperanza or Bowdens.