Stepping back from general market comment this week, we have released a detailed research note on Lucapa (LOM). We have frequently commented on Lucapa in previous Weeklies but this time we have sought to come to grips with the fundamental value based on projected earnings from its two diamond mines. We have extracted some of the more salient points from the research. The full report is also attached.
Selling at 68% discount to projected Net Profit stream We have estimated that the projects will generate A$140m in net profits for Lucapa over the next 10 years. With the market capitalisation at $45m, this is a 68% discount to estimated earnings.
Selling at 79% discount to projected Cash Receipts We have estimated that the projects will return cash of A$217m to Lucapa over the next 10 years. Again, the market capitalisation is selling at a very large discount, being 79%. Thus, at current levels, the shares are fundamentally very cheap with nothing in the share price for blue sky appeal from kimberlite exploration or mine life extensions.
Lucapa Diamond Company Research Note
Stepping back from general market comment this week, we have released a detailed research note on Lucapa (LOM). We have frequently commented on Lucapa in previous Weeklies but this time we have sought to come to grips with the fundamental value based on projected earnings from its two diamond mines. We have extracted some of the more salient points from the research, discussing them below.
Focusing on the meaningful numbers
Rather than provide pages of earnings estimate tables we have presented the key bottom lines;
• equity accounted net profits, and
• cash receipts to Lucapa.
Note that the cash receipts are much greater than the net profits due to the repayment of A$83m of loans to Lucapa, which were used to finance the development of the projects.
We have presented estimates for the next three years but we have also included a column for the aggregated 10 year assumed life figures to give a better feel for the big picture. Note that the assumptions for diamond prices are lower than what we would have used a year ago, owing to continuing uncertainty cause by the virus.
Selling at 68% discount to projected Net Profit stream
We have estimated that the projects will generate A$140m in net profits for Lucapa over the next 10 years. With the market capitalisation at $45m, this is a 68% discount to estimated earnings.
Selling at 79% discount to projected Cash Receipts We have estimated that the projects will return cash of A$217m to Lucapa over the next 10 years. Again, the market capitalisation is selling at a very large discount, being 79%.
Thus, at current levels, the shares are fundamentally very cheap with nothing in the share price for blue sky appeal from kimberlite exploration or mine life extensions.
What about the kimberlite exploration program?
Previously, before there was a track record of diamond production, the driver for the share price was the allure of a very valuable kimberlite pipe at Lulo. The logic used was that the source pipe for the high value diamonds being recovered in the alluvial mine could be many times more valuable than what investors would place on an alluvial mine.
Lucapa has been searching for the source pipe(s) for five ears now, spending in the order of US$3m p.a. It is difficult to hold speculators attention for this period of time, so the story has gone quiet. Occasionally there is some news that rekindles speculative interest, such as the program to bulk sample the L071 and L072 pipes, but last week’s news of a negative result for L072 has dampened the enthusiasm just now. We will know the results for the second pipe within a few weeks.
It should be noted that the first two pipes being tested in the Canguige catchment were selected for ease of access at the end of the wet season, not because they were the best prospects. More pipes remain to be tested.
While we are quietly confident that the source pipe will eventually be found, it is too difficult to give an exact time frame. We would rather say that success is lurking in the background and concentrate our investment decision on the back of the lower risk, operating mines. That is the focus of the research note. Hopefully, one day, we will come to work and see a release that the pipe has been found, which could give us spectacular share price performance.
Company debt is 3x covered by project debt
Investors have queried Lucapa’s ability to service the debt position in the light of the disruptions caused by the virus. In this regard it should be noted;
• the repayments schedule has been renegotiated, providing a moratorium that takes the pressure off the Company for 2020 and 2021, and
• of the three financiers, two of them are sizeable equity holders in the Company. It is unlikely that they would threaten their equity positions by being too aggressive on repayment schedules.
Notably, while Lucapa owes approximately A$26m to three lenders, the money owed by the two projects to Lucapa is more than three times as much, at approximately A$83m.
Cash flow from the operating mines and the repayment of loans to Lucapa should be sufficient to enable timely repayments of debt.
Mine lives will be much more than 10 years
Our model assumes a 10 year life for each mine. This is more aggressive than what can be calculated on the Lulo JORC resource, because of the rules, but it doesn’t take much imagination to see that the the available gravels will be much more than what has been announced to the ASX.
It would not be surprising to see a mine life well in excess of 10 years.
The Mothae life of 10 years is verifiable on the released JORC resource. There is no speculation here. However, there is additional material not yet reflected in the JORC statement that could support mining for an extended period beyond 10 years. In particular, the resources have been calculated to a vertical depth of 300m, yet the pipe has been modelled to a depth of 500m. In due course this zone will be drilled and brought into the resource statement, but it is not necessary to do this in the near term.
Impact of coronavirus on operations
The Lulo mining operation suspended production for about three months but it is back at near full capacity now.
Mothae has been placed on care and maintenance, likely until the end of the year. At this point Lucapa would like to use this downtime to increase the capacity of Mothae from 1.1 Mtpa to 1.8 Mtpa by spending an estimated US$6m on the front end of the plant. We have assumed that this happens as the number look compelling; payback on capex is less than 12 months.
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