Just the start

Now that the cashflow is finally here and the stock has started moving, it is time to revisit some of the views I expressed a year ago.

Despite being quite frustrated with the combination of management conservatism and heavy costs associated with the pit stripping, I have remained heavily invested in RED - indeed even bought some more.

Last quarter the open pit delivered 14m of free cash and there are another 6 quarters to come. If the 14m is representative, the open pit will deliver another $84m. But in reality with the strip ratio falling by more than half and grades rising strongly toward the end of the mine life, the $14m is likely to be exceeded materially. Note the reserve grade of 3.5g/t and the fact the reserve grade continues to be exceeded by circa 10% which implies a true reserve grade closer to 3.8g/t. Processed grades since the reserve was announced are only around 3.2g/t, so the last 18mths will see material pretty close to 4g/t in my view.

Also last quarter saw US$1250 gold price versus current price of $1330.

Factoring all this implies that $100m+ of further free cash flow is quite realistic from the open pit. Of course this is on top of the $18m starting cash position.

So what about the underground? I have previously referred to the 2011 annual report reserve as being a better model than the new lower grade model. This has clearly been the case with the recent open pit reserve grades being exceeded so significantly. The 2011 model had an underground reserve grade of 5.82g/t (open pit was 3.4g/t which was probably spot on for the true pit performance as an aside).

The new model has an underground reserve of 4.3g/t and mine plan grade of 4.7g/t.

And the metrics for the underground still look good. But if the 2011 model was right (as it has been for the open pit), then the true delivered grade will be 24% higher than the mine plan grade (and 3.5% higher than the new reserve).

We simply won't know until they actually start mining, but given the historical record on grade I would argue the new modelling is simply too conservative (remember also the old timers mined at 12g/t with more selective methods).

So my view here is the underground will be a real bonaza of a project - and yes despite all the arguments, it appears it will be fully funded easily from open pit cash flows.

I also note the US$55m capex is a "peak draw" rather than actual capex spend. This is important because peak draw factors early operating losses and if the model is conservative (as Red 5 always appear to be) then the true performance will be better. This financial year capex (to first underground production ramping) is only circa A$40m, so the total US$55m looks conservative on that front too.

And the big unknown (and big upside potential) will be exploration performance. Other the the work at Mapawa 5-6 years ago, virtually no other work has been undertaken in modern times. The strike between Mapawa and Siana is incredibly prospective - particularly the area of faulting responsible for the pit wall slump which caused us so much grief. This area was never drilled properly because of difficult ground conditions - yet the faulting there makes for a perfect mineralised target zone. I'd be very surprised if the near mine area does not deliver a significant new discovery.

If exploration delivers or Red 5 can do an exploration deal to source further open pit mill feed, then we are looking at a 100kozpa+ long life operation.

This would be worth a considerable multiple of the current market capitalisation, even at present gold prices.

The new government is wanting to hold mining to Western Standards - Red 5 is meeting this and delivering already. Most operations are not, these are the mines that should be concerned.