cb's interview with "high grade"

Here is a direct extract from CB's interview with "High Grade - Drilling deeper for the news" 28th Nov.

It's long but good. I could've posted a link but you need to me a member to log in.

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Reserves and profits now the focus
Richard Roberts, 28 November 2012
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ON the eve of a shareholder vote that will give Western Australian-focused gold miner Focus Minerals a new controlling Chinese shareholder and a whopping $A220 million to “unlock” more of the wealth from its asset base, CEO Campbell Baird spoke to HighGrade about ‘the deal’ and what Focus could look like when all the dust settles.

Demonstrating the capacity to execute a longer term strategy that has Focus comfortably – and profitably – producing circa 200,000oz a year from a much bigger mine reserve base (as against resources) than today is where management’s attention is now, as it was at the start of 2012 when China’s Shandong Gold flagged its interest in making a substantial investment in Focus.

The means, then, to do it was the tricky part and the riddle wasn’t getting any easier to solve as the year unfolded.

Since the Shandong deal has crystallised, though, the plan hasn’t morphed into a more ambitious strategy to find 500,000ozpa to mine at any cost. That’s the first point worth noting.

Focus has already stretched in the past 2-3 years to reach its current output level, with Baird and the company’s board arguably pulling all the levers available to them – including the $A60 million Crescent Gold takeover – to diversify production, and geological, risk and add considerably to the amount of WA real estate available for serious exploration.

They had/have a less than optimum milling arrangement at Laverton that needs to be addressed, and they have a robust 1.2 million-tonne-per-annum milling operation at Coolgardie matched to district geology that hasn’t historically given up base-load tonnage of that order easily, and certainly not at a cost that makes the hub a world beater.

Baird, a mining engineer, has, as noted, pulled the levers available to capture a consistent head grade capable of delivering profits out of Coolgardie while the less glamorous (but expensive!) work of building inventory to support that production picture longer term is going on feverishly in the background and of course while resource depletion continues its brisk march.

And then there is Treasure Island, the evocatively named exploration project on the Lake Cowan salt lake, but more importantly on the southern extension of the Boulder-Lefroy Fault which has yielded so much gold to the north. It’s an area those working to the north would have deemed worthy of a whole-of-company focus, which it clearly hasn’t had – yet.

“Shandong understands what level of investment it is going to take to achieve our strategic plan for Coolgardie/Laverton and Treasure Island,” Baird told HighGrade.

“We have a plan … for a significant exploration investment at both Laverton and Coolgardie, in order to significantly build our reserve and resource position over the next three years. We also want to be well on the way to unlocking Treasure Island in 2013.

“500,000ozpa might be our [ultimate] goal, but we have learned some pretty tough lessons over the past 18 months, and one of those is don’t do growth for growth’s sake.

“Our first objective is to become a highly profitable and dividend paying miner. We will do that by having a big reserve, from making intelligent capital investments into Laverton and Coolgardie, continuing the consolidation of the Coolgardie area that was started seven years ago, commencing it in the Laverton area, opening up Treasure Island, taking opportunities as they may arise to make value accretive investments, but most of all to continue on with one of our core values to be excited by the joy of discovery and the satisfaction of making a mine out of it.

“We were fortunate enough at the end of last year for [ex Barrick Gold, Gold Fields, Placer Dome and WMC mining engineer and senior manager] Peter Ganza to join us as the manager of technical services. In the new year [2012], Peter built on seven years of previous work in the region to come up with a 10-year strategic plan for the company, looking at both the Laverton and Coolgardie resource bases. We have a resource base of 4.2 million ounces and we wanted to start working on not just the next 12 months, but we wanted to start looking out five years.

“The plan showed that in a global sense if we assumed only a 40% conversion of resources to mining inventory, we could produce at plus-200,000oz for the next 10 years – 235,000oz by 2015 – but we just couldn’t see a way to really capture this significant opportunity with our current cash flow from operations. We were undercapitalised as a business.”

That all looks set to change on Friday when Focus shareholders meet to approve, presumably, the $A225 million share placement at 5c (compared with the current 3.4c trading level) to Shandong which gives the leading Chinese gold producer 51% of its new Australian gold business partner.

Initially given a “thanks for your interest, we’ll be in touch” from Focus’ board when they approached it at the start of the year, Shandong did some more homework on the company and that ultimately included site visits, and apart from anything else would have been under no illusions about the options Focus had available to it to fund its proposed growth as well as the potential of its assets.

Baird is typically candid on this point.

“Internally we were starting to have conversations that if we were going to be able to achieve the vision that we were coming up with, we may well need external investment to achieve it,” he said.

“At the time we certainly did consider debt funding but one of the great weaknesses that Focus has always suffered from, due to its rapid growth, has been that we have very much consumed our reserves as fast as we have created them, thus debt funding has always been difficult for us, as a bank looks for a significant tail of reserves in order to cover itself. Thus we had a fantastic vision for the company, a company that was getting on its feet, but not the strong cash flow in the immediate term to start building a reserve base in order to give the market what it was now looking for which was a big reserve and low cash costs.

“There are not too many shareholders of Focus Minerals who wouldn’t argue that one of the quickest ways to get a re-rating for Focus will be to give it a more solid and robust [ore] reserve base from which to produce from.”

Baird said Shandong had “displayed good faith and professionalism” through the investment process and had “expressed no desire to run or control the company, and in fact they have multiple times expressed their desire for the existing management team to be the team that drives their investment for all shareholders”.

While he steered away from directly addressing the political and cultural issues around Chinese investment in Australian resources, he did indicate that a fear of the unknown (known unknown?) could be driving perceptions of Chinese investment specifically. And then there is the wider question of why an ostensibly state-controlled entity would sensibly invest in an under-appreciated Australian gold equity at a time when returns from such investments are being more studiously compared with those available from other gold instruments, such as ETFs and the like.

As highlighted recently by regular HighGrade columnist and investment fund manager John Robertson (Gold miners must discover new value proposition, November 14-20), gold equities have been serially and significantly trailing returns from physical gold, reflected in prevailing gold prices, and industry leaders such as AngloGold Ashanti’s Australian-born CEO Mark Cutifani have highlighted the threat to the attractiveness of gold equities posed by exchange traded funds – funds sponsored by the gold industry itself!

On Chinese investment, Baird said people need look no further than the historical context.

“Australia’s capital needs for the development of the mining industry are vast [and] we have found all the easy deposits and are now into our phase two projects,” he said.

“You can name on one hand all the no-brainer projects that have been found in the past decade that would have been developed regardless of price. In fact I can truly only name one and that is Sandfire’s Degrussa project and even they were ultimately developed with the assistance of a big Korean shareholder.

“It has been this way however for a long time; in the 70s we developed the Pilbara with the assistance of the Japanese, then through the 80s and 90s the Japanese investment into our country built the tourist industry of Queensland and also much of our property and other iron and coal and copper mines around the country.

“Then in the 90s as the industry was collapsing in on itself as the prices fell, we had the influx of Placer, Homestake, Barrick [Canadian and American] and the South Africans who bought up all our gold assets.

“The one constant through all of this, has been that the mines have been built in Australia and they have employed Australians and we have created for ourselves one of the most vibrant and dynamic industries and workforces in the world. This dynamism has only been able to thrive with the assistance of overseas capital investment into the industry.

“If anything this investment will only add long-term to the number of Australian employees that we are able to employ. The requirement to start work on unlocking the reserves and resources of the company is going to require us to hire people, employee the services of more local drilling contractors, and expand our mining operations into the future, so again a clear demonstration of the upside of such an investment into Focus Minerals and Western Australia.”

Focus itself was owned about 15% from Germany, 15% the US, and a further 5-10% from across the UK and Asia, with the balance Australian.

“We have always been internationally owned. If you look at the register of most if not all Australian mining companies they would have a similar register makeup,” Baird said.

“The next wave of investment that we are benefiting from is the investment by Chinese companies who are looking to benefit from this dynamic industry that we in Australia have developed.

“It is not often that you can have a conversation and the other party is able to agree to an investment for just 51% of your company, paying a 33% premium for the privilege and ends up investing into the company more than your market capitalisation at the time.

“So yes there might have been others [potential investors] but who else would be prepared to partner with you to this level?”

On the subject of the broader gold investment question and lagging returns that were costing gold company executive jobs, Baird not surprisingly said there wasn’t an easy answer.

“There are so many variables – the market is a complex animal, and who can say that they truly understand it, let alone are able to give it what it wants?” he said.

“I really feel for Mark Cutifani; I have watched his progress with interest over the past couple of years [and] he really set out to make AngloGold successful and different from the other majors, and I believe that where many others have failed he has very much succeeded on so many fronts. Safety, culture, production and costs, he has ticked all the boxes, yet like us, he has not been rewarded for that significant success.

“At Focus Minerals one of our core values is that ‘we are excited by the joy of discovery and then satisfaction of making a mine out of it’, however a company the size of AngloGold is really up against it. They may make discoveries every day but generally it is not enough to move the dial for the average investor. They have become almost an industrial stock [and] you can’t see inside them to the level that you can see inside a company like Focus Minerals.

“As a gold company, we obviously have the challenge that a gold ETF does not. Our reserve/resource depletes with time. In fact buying a gold ETF means that we are now down one ounce. The Gold ETF has gained value and we now have lost value. We need to replenish that value. But again we have upside there. Historically our discovery cost has worked out at about $30 a resource ounce. It takes just one drill hole to discover the next monster.

“I don’t know what the answer is … but I don’t think that ETFs are a major threat to gold equities. If anything I believe that they are a great marketing tool for the wider market of gold exploration and mining equities. They do cannibalise our market to a small degree, in particular for the ‘beginner’ investor, but soon they start to learn about the wider world that is the exploration and mining world and they soon start to understand the upside that can be achieved from investing in exploration and mining companies. A case in point is the recent rise of Sirius Resources. You can’t get that sort of return from investing in a nickel or gold ETF – and many would argue that nickel is a dead metal; or Northern Star – you wouldn’t have got that sort of return, with a dividend, from investing in a gold ETF.

“So while the insitu value of a gold equity may devalue over time, while producing, it just takes one drill hole and you blow past the rate of return for a gold ETF.

“I can’t speak for [Shandong] but as I said, we should treat the gold ETFs as the easy way into investing for the new investor, they get a stable investment from the gold ETF, but then that introduces them to the world of mining equities.

“And remember, someone has to mine the gold that is purchased by the ETF fund every time an investor purchases an ETF.”

Baird said he expected Shandong, at least initially, to be “a patient investor”.

“But there will also be an immediate demand for a demonstration of putting their investment to work,” he said.

“We tried to grow very aggressively in 2010-2011 – if you remember the mantra ‘aggressively expanding into a rising gold price’, we lived that at the beginning of 2011 and it was the catalyst for us starting our openpits in Coolgardie and bringing on the Mount. We were then presented with the value opportunity that was Crescent Gold. Many people questioned our sanity at the time, but it was an area that I knew well and had always thought at the right price it was a project worth taking on. We were able to acquire it for $60 million in Focus paper and we have been able to produce about 110,000oz from it since July last year. It has certainly not been without sacrifice; we invested over $17 million of Focus’s money into the business, in particular to kick start the Apollo pit, from which we have been able to produce 65,000oz.

“Shandong … could see what we were trying to achieve [and] could see the challenges that we faced in bringing it to fruition at Laverton and Coolgardie and Treasure Island simultaneously.

“They gave us a tick for the Crescent integration and want to back the Australian management to implement the strategy we’ve outlined.

“But like any investor, they will want to see a pretty quick demonstration that they will be getting a return on their investment. So it will be important for us to quickly build reserves at both Laverton and Coolgardie.

“We will get [bang for our investment buck under the new regime] from hitting Dreadnought and the Tindals area at Coolgardie and from Burtville in Laverton. Then we need to start working our way through the ranked targets at both operations and bringing them to reserve status as quickly as is practicable.”

The next significant jump in Focus’ annual production was “not something that can be achieved at Coolgardie and Laverton alone”, Baird said.

“It may well be achieved from a major discovery at Treasure Island.

“But you, like me, will have to wait and see.”

Hawk