Kingsrose Mining Analysis: An Asymmetric Risk/Reward Situation

Kingsrose Mining currently has an enterprise value of around 8 million (at the time of writing), it used to trade at a negative enterprise value quite recently. At first glance one might think that company is this cheap for a reason - that the company is crappy, or the growth prospects are close to zero. This could be no further from the truth.

Kingsrose has a clean balance sheet, with roughly 31 million in Australian Dollars, and no debt obligations at all. The company is in possession of a 4^th generation Contract of Work (CoW) covering 100 square kilometres in the south of the Indonesian island of Sumatra - this single asset is known as the Way Linggo project. The land Kingsrose is licenced to explore and mine is located on the Trans-Sumatra Fault Line, which is located on the Ring of Fire, and there are many gold mines located to the north of their land package. One such mine is the Martabe mine which has around 8 million ounces in estimated gold resources, not to mention 73 million ounces of silver.

Quality of the Way Linggo Project

There is no doubt that the exploration potential at Kingsrose is huge, the recent drilling at Talang Santo showed significantly high grades (one intersection showed up to 31 g/t 490 metres deep). As well as this, Kingsrose has a busy aggressive exploration programme planned for 2021. There were many targets that Kingsrose identified years ago, but they did not conduct more drilling - as a result, they didn’t develop a proper pipeline of mining projects. At the time Kingsrose was focusing on their Talang Santo Underground Mine, which turned out to be a huge disaster as a result from poor engineering regarding water intake in the mine. The old management in the 2012/2015 period rushed the design of the mine and this resulted in many years of pain for shareholders. I must emphasise that the current management had nothing to do with this, and the turnaround story began a couple of years ago with favourable gold prices, and new open-cut mines being built on the old underground mines of the Way Linggo.

When looking at mining projects we need to gauge into their costs. Kingsrose has had a history of being in the low-cost quartile of gold miners. Up until the debacle in 2014, Kingsrose enjoyed all-in sustaining costs per ounce of around 250 to 650. At todays gold prices that is a huge operating margin. I am not stating that Kingsrose can achieve these kinds of costs per ounce again today, but I am emphasising that this is an impressive track record. We know as a fact that the gold grades are high, and this leads to lower costs, usually the market would pay a decent premium for projects of this quality. Instead, this gold company is still trading close to its net current asset value, albeit above it, but I have seen many gold explorers with no cash, heavy dilution, and a huge premium being paid by retail investors alike.

Asymmetric Risk/Reward Investment

We need to discuss the risks, as we would with any investment. The market has priced in the risks of the Indonesian government’s divestment requirements which stipulates that an Indonesian entity needs to control 51% of Kingsrose’s subsidiary PT Natarang at a certain point in the future. However, whoever this entity may be, they still must pay fair market value for the subsidiary. I have calculated that the gold and silver in the ground is worth 300 million dollars, possibly more when factoring in unexplored areas. I calculated this by multiplying Kingsrose's inferred and indicated resources of 140,000 ounces by the current gold price of 1800. Let us say it is a range between 300 to 500 million dollars’ worth of gold and silver. If Kingsrose were to sell 36 percent of the subsidiary (since an Indonesian entity already owns 85 percent of the subsidiary), they would get around 100 to 150 million in cash, if not more. What a terrific position to be in, Kingsrose still has 49% of the cash flows from the Contract of Work area, and 100 to 150 million in cash at least to pursue global acquisition opportunities. Talk about having your cake and eating it too!

I also want to discuss how Kingsrose presents us with an asymmetric risk/reward investment. We are paying 10 million in enterprise value for Kingsrose’s 300 to 500 million dollars’ worth of gold and silver in the ground. Let us say hypothetically the company went bust in the future for whatever reason (highly unlikely given that there is no debt, not mention favourable margins). If this were to happen, as shareholders we would still be able to get back more from the liquidation of the company (major gold players love to acquire smaller gold companies that are struggling). Even in the worst-case situation, we can make two to three times our money. Also, with recent monetary policy trends of monetary policy, we own a hedge in our portfolio in the form of a gold producer that can pay us dividends in the future.

Management

So, the downside is covered, and the upside takes care of itself from there. I also wanted to mention the management. The new board is full of geologists with huge experience. Dr. Michael Andrews is the Founder and Managing Director who owns 10 percent of the company. He has over 35 years of experience as a geologist. The new directors that have come in bring in immense experience. Tim Coughlin discovered the Amulsar gold deposit in Armenia, a five million plus gold resource. As CEO of Lydian International, he helped build its market capitalization to over 350 million. Darryl Corp worked with Newcrest and takes with him immense mine engineering experience to Kingsrose. John Carlile has co-authored numerous geological publications and was notably apart of Newcrest’s team when they discovered the Gosowong mine, which has six million ounces of gold in reserves and is one of the largest gold mines in the world. Fabian Baker, the new CEO of Kingsrose, is also a geologist, and at the young age of 33 has already a lot of experience under his belt. He founded and led Tethyan Resources, building it up to a market cap past 100 million, and led the company up until he sold it to Adriatic Metals last year. Baker understands the need to explore more targets in the Contract of Work area to build up a pipeline of projects and understands the need of consistent news flow and shareholder engagement. This is a new board that has a significant rapport, a dream team with a huge amount of combined experience, and a drive that is needed to succeed.

Analysis of Future Cash Flows and Asset Backing

A big part of my investing philosophy is to analyse the risks and the rewards, contrast the two, and see if I can get a high return for a low amount of risk. I have already analysed the assets (and hidden off-balance sheet assets), of the company. In December, I wrote a brief analysis analysing the future earnings/cash flows of the company:

Kingsrose Mining has a net current asset value per share of 0.053 cents, while the shares are trading at around 0.036 cents. The company’s bullion, cash, and receivables minus all liabilities equate to 39 million while the company’s market capitalization is 26 million. There is no doubt that there is a margin of safety between the market capitalization and the liquid assets minus all liabilities of the company. To make things even better, the company earnt 22 million in net income last year. Attaching a conservative valuation multiple of 8 to the company, the company should be valued close to 176 million dollars, which is 24 cents per share. The company is too small for institutions to meaningfully invest in, which provides an opportunity for us. We are hereby increasing our position in Kingsrose in the coming week.

We are emboldened to increase our position in Kingsrose tremendously because they have no debt, we are protected sufficiently in current assets minus all liabilities, which means we also get the gold mining business for free. The intrinsic value of 24 cents is based upon a conservative P/E multiple of 8. A P/E of 15, which is common in today's market (rightfully so due to historically low interest rates) will make the company worth 330 million dollars (45 cents). In the worst-case scenario, the intrinsic value of the company is 5 to 7 cents, a near double on our investment (NCAV and book value valuation). In the best-case scenario, the company should be valued on a conservative earnings basis (assuming 20 million in net profit per year) at 24 to 45 cents (not pricing in a further increase in gold prices, which we believe will happen due to uncertainty right now in the markets). Even if the company makes 5 million a year (very conservative scenario), a P/E of 8 to 15 will have the company valued at 5 to 10 cents a share. If they make 10 million a year the intrinsic value should be 10 to 20 cents per share

It will take a while for Kingsrose to reach its intrinsic value, but we don’t mind so we can continue to increase our position in the company as much as we can. A conservative valuation dictates to us an intrinsic valuation of 5 to 20 cents a share. A more exuberant optimistic target presents to us a valuation of 20 to 45 cents. We will refrain from pricing in those expectations; however it is quite possible that the company will become that valuable in the future. The margin of safety is there, and I have full confidence that the return will be satisfactory.

I also wrote the following analysis on Hot Copper (apologies if any of this is a repeat of the last analysis):

What intrigues me about the company is the huge discount to true value - they have 38 million in cash, no debt, and their market capitalization is around 30 million dollars. Net current assets per share equate to 5 cents a share while the price is 4 cents a share, so there is a clear fundamental floor, it is still very cheap. This means we are buying the operations, equipment, and reserves for nothing, imagine somebody trying to buy your business off you for less than its cash, and it is still a profitable enterprise - I would take that as an insult.

It is at a price to earnings ratio of 1, they made 17 million in free cash flow last year. I am not expecting this to continue forever, however they manage All In Sustaining Costs of up to 1000 dollars an ounce in a worst case scenario, they usually manage 700 an ounce, which many gold producers can't do. At current gold prices, they make 1300 an ounce from their gold, and a margin of safety in case gold prices were to drop significantly - I do not see that happening however, with money printing from the Federal Reserve, the ECB, and many central banks around the world. So, it's essentially a 'free hedge' in your portfolio, there is no leverage in the business.

The market seems to be discouraged because the Indonesian Government has the right to buy half of their Indonesian subsidiary for 'fair market value'. I spoke to the CEO/Chairman who told me that it is unattractive for purchase by Indonesian entities since they have to pay an extra 50 million dollars in obligations to the parent company. Also we calculated that the company should at least be worth 100 to 200 million dollars, well above the market capitalization of 30 million. I calculated that the gold in the ground is at least worth conservatively 100 million, and this does not include the gold in the 100 square kilometres that they have left to explore.

They also have new directors coming in, all who have significant geological experience. The board itself is geologist heavy, this gives me a great deal of trust in them. One of the directors discovered the Gosowong mine, one of the largest gold mines in Indonesia and in the world. I forgot to mention that the land Kingsrose has the rights to explore, it's located on the Ring on Fire.

Let us make a quick comparison with other gold miners - they usually issue a lot of shares, this renders the investment pointless. Meanwhile they are priced way above asset values and they have no cash flows. This company has enough cash to capitalize on overseas opportunities and to keep exploring it's land, without diluting share ownership or taking on debt. The Chairman told me that a share buyback is on the table, but only if they had nothing to do with the cash. They would rather find an opportunity in which an overseas company needs cash to pursue their project, and then Kingsrose can capitalize by providing capital and gain a stake in that mine. Not many gold producers/explorers in this market capitalization range can do this, a very enviable position to be in.

In short, the most conservative valuation of this company is 10 cents a share, a 76 million market capitalization, and that will still be very undervalued. A more accurate valuation would be in the 100-to-300-million-dollar range, and that can increase if gold prices were to rise. Kingsrose has the potential to become a mega gold producer one day, so the growth runaway is long. What makes this attractive is the hedging aspect of the investment, and the Disallowed (10x return) potential it has in the long term.

I used to believe that the intrinsic value was at least 10 cents, but 10 cents is still cheap. We have now revised our intrinsic value to a conservative 20 cents (circa. 140 million market capitalization), to 40 cents and even 70 cents (between 292 million and 511 million). I revised the estimate due to finding out about the gold and silver hidden in the ground, the potential of more gold and silver discoveries, and future growth and the management’s expertise and commitment to maximizing shareholder value. Even the Indonesian divestment catalyst would lead to significant growth opportunities, and the management would be quick to adapt by focusing on overseas acquisition opportunities right away (the market need not fear the Indonesian divestment obligation, it could be for the better)

Summary

It has been many years of frustration for the long-term shareholders of Kingsrose, to which is why the share price is so depressed. It is as if the market thinks that the Kingsrose of today is the Kingsrose of the 2013-2016 era. The market has completely ignored the company’s new drilling results. The market is too overly cautious at a time where the company has significant tailwinds pushing it to a new direction. As always, in my opinion, the best time to invest in a company is when the market is overly fearful despite the clear facts. I have tried to find anything wrong with the company and quite frankly I cannot. Even in the worst-case scenario we will be able to retain our principal, and more likely we will be able to make money. This investment has an incredible margin of safety. And in this market, it's the most attractive opportunity I have found.