Little beauty this stock. Hit my 100% 'up' on this little...

Little beauty this stock. Hit my 100% 'up' on this little beauty.

Thought some of you might the piece below from Charlie Aitken on AVO interesting.

Avoca Resources: the golden avocado

I love recommending resource companies that are about to enter production. There tends to be a predictable period of re-rating as the cash flow starts to arrive and the risk profile diminishes. In this context, I believe Avoca is at this inflection point.

On the May 12, Avoca management announced that the commissioning of the one million tonnes per annum (1mtpa) Higginsville treatment plant has commenced. Commissioning is expected to be complete by the end of June, at which point the mill will be ready to start accepting high-grade ore from the company's Trident orebody.

My strong view on Fortescue Metals Group (FMG) is based on the same approach. Similarly, the investment case for Avoca is a simple story.

Avoca is the Western Areas (WSA) or Jubilee Mines (JBM) of the gold sector. It is my view that the following factors define the strong investment case: High-grade, simple processing route, exploration upside; quality management and operating team.

Elephant country

Avoca has a market capitalisation of $500 million and an unhedged gold exposure, with 62% of the register being institutional. It has exploration control of the belt between the 15 million ounce St Ives and the 6 million ounce Norseman gold fields. This is elephant country.

Management are developing and bringing into production the high grade Trident discovery. The average grade is in the order of 6 grams per tonne and approximately half of the gold is recovered as free gold via the gravity circuit. However, the region has a history of overcall in the order of 20%, which essentially means that 20% more gold is recovered than the reserve grade estimates and cash costs are lowered as you treat the same amount of material. In addition, the treatment process is a simple CIP circuit.


Low cost, rising production

As a result Avoca is expected to be one of the lowest-cost producers in Western Australia, with cash costs of about $360 an ounce. In addition, it has a strong rising production profile with 2008-09 output expected to be about 170,000 ounces. However, with significant exploration upside, we expect the potential upside is for 190,000 ounces in 2009-10 and 2010-11.

At this stage the company has outlined a five-year mine life, but with the obvious prospectivity of the location I we expect this to increase to 10 years with good expected results from an aggressive exploration program over the next two years.

From 2008-09 onwards, I expect the company to deliver a sustainable net profits after tax in the order of $45–50 million, equating to approximately 10 times earnings. Considering the major domestic gold companies are trading on 25–30 times, this represents an unsustainably low price/earnings multiple for a quality gold play, with exploration upside. I have a buy recommendation and a $2.80 target over the next 12 months, but clearly as production growth and profitability growth kicks in over the next few years it is easy to see Avoca as a $5 stock. Avoca is a good little story that is going to become a good mid-sized story. Buy them before production growth and before the gold price makes new highs. Buy them before the global investment banks "discover" the stock