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Morgans CIMB Research – ADD (29 Aug 2016)
Evolution Mining

After Ernest Henry

■ EVN has paid A$880m for a 30% economic interest in copper and silver production from Glencore’s Ernest Henry mine Reserves, and a 100% interest in the gold credits, for which it will pay 30% of mine production costs.

■ After the Ernest Henry “gold streaming” deal, EVN has upgraded FY2017 guidance to 800-860koz at an AISC of A$900-960/oz, with the acquisition to be funded by A$500m in debt, and a 2-for-15 issue at A$2.05 per share.

■ After the FY2016 result, the sale of Pajingo and the EH deal including the equity issue, our valuation on a 0.0% discount rate at the spot gold price and current AUD/USD exchange rate is A$2.82, which is our price target.

A strong FY16 year

EVN reported production of 803.5koz of gold at an All-In-Sustaining Cost (AISC) of A$1,014/oz. The received gold price was A$1,597/oz, a margin of 57%. Net mine cashflow was A$428.2m, with EVN’s underlying profit A$226.9m. After an impairment on the sale of Pajingo, and expensing one-off costs for the acquisitions of Cowal and Mungari, EVN reported a net loss of A$24.3m. A final dividend of 2cps was declared. Ernest Henry has added 1.0Moz to EVN’s December 2015 Reserves of 5.7Moz, and 1.8Moz to Resources of 13.0Moz.

The Ernest Henry deal

Evolution will pay A$880m to Glencore and contribute 30% of the production costs for the Life-of-Mine (LoM) area, expected to support production for 11 years. EVN will be entitled to 30% of the value of the copper and silver in the copper concentrate produced, and 100% of the gold. The concentrate is trucked to Glencore’s Mount Isa smelter, and subsequently railed to Townsville for refining at Glencore’s copper refinery. EVN has agreed to pay 49% of costs of exploration and production outside the LoM area for 49% of the product value. Glencore will continue to own and operate Ernest Henry, with the agreement incorporating a number of protections for Evolution. The acquisition is to be funded in part with a 2-for-15 rights issue at A$2.05 per share.

Revised valuation and price target

Our conventional SOTP valuation is A$2.13 per EVN share, and our conventional target a 10% premium to that at A$2.34. Our preferred methodology is to use the spot gold price and the current AUD/USD FX and a zero discount rate. Under this model the operational risk is covered by the gold price contango, and we believe it is suitable for a company with a portfolio of producing mines. Using this method we generate an SOTP valuation of A$2.82 per EVN share, including A32 cents for exploration upside, which is our target. Risks to achieving our target include fiscal and regulatory changes, operational risks, declines in the spot gold price, and a rise in the AUD/USD exchange rate.