Wednesday, April 13, 2016

Endeavour Mining - Too Many Question Marks

It is an article written on request of one of my readers. 


  1. Endeavour Mining runs four mines, of which only one, Agbaou, is really impressive
  2. A new project, Hounde (located in Burkina Faso), should deliver substantial value to the company
  3. In my opinion, Endeavour is going to pay too much for the acquisition of True Gold, another African miner
  4. Due to the construction of a new mine and a probable acquisition of True Gold, I am not recommending Endeavour Mining shares


Endeavour Mining is a gold producer, currently running four mines in Africa:

  • Agbaou and Ity in the Ivory Coast
  • Tabakoto in Mali
  • Nzema in Ghana

Endeavour is a very dynamic company. In November 2015 it purchased the Ity Mine in the Ivory Coast and this year it sold its Youga mine, located in Mali. 
A few days ago the company announced that its  Hounde Project, located in Burkina Faso, entered the construction phase.
What is more, in a few days Endeavour is going to formally acquire another African mining company, True Gold (on April 21, 2016 two special shareholders meetings will be dealing with that issue).

Well, to make this analysis as simple as possible (there are many issues to discuss) the article is divided into four sections:

  1. Current operations
  2. Hounde project
  3. Acquisition of True Gold
  4. Valuation

Current operations

Let me start with presenting two charts:

The first chart shows the 2016 production forecast. It is clear that three mines, Agbaou, Tabakoto and Nzema, should deliver the highest output this year.

However, the second chart shows that in 2015 only the Agbaou mine was an operation that delivered substantial operating profit. I would even say that the company is fully dependent on this mine, with other operations having a marginal impact on the overall performance. 

What is interesting, this phenomenon was also visible in the previous years:

Operating profits by mine:

in thousands of US$

Nzema - laggard

It looks like the Nzema mine's performance had deteriorated since 2012. On the other hand, Tabakoto, in my opinion, should be consistently improving its results so this mine should, together with Agbaou, have a positive impact on the overall performance.

What is going on with Nzema? Well, it is quite a strange mine - apart from its own ore, it processes (mills) the ore bought from the third party. Let me cite the company (an excerpt from the Annual Form 2015, page 24):

"During 2015 the main plant feed came from Adamus, supplemented by ore from Aliva and third party sources. The third party material is blended with the ore from Adamus and Aliva to achieve the production targets for throughput and recoveries. A total of 47,383oz was produced for the year from third party sources"

Generally, it is nothing strange that a company is blending different ores. Such a technique is applied to improve recovery rates at the processing plant. However, mining companies typically blend their own ores, not the ores coming from the third parties. In the case of Nzema, in 2015 as much as 43% of all gold produced at this operation was extracted from the third party's ore (47,383 ounces: third party ore and 62,919 ounces: own production). The third party ore costs money so such a high content of this ore surely has a negative impact on production costs. 

The company does not report Nzema production costs per ton of ore milled basis but I have calculated these costs on my own. And it seems that I am right - these costs went up from $43.8 per ton of ore milled in 2012 to $78.72 per ton in 2015 (an increase of 79.7%). 

Now, according to my calculations, Nzema is going to break - even at the price of gold of $1,273 per ounce (assuming the same operating parameters as in 2015). 

Fortunately, there is the light at the end of the tunnel. Currently the company is mining the ore from the Adamus pit, the largest Nzema deposit (244 thousand ounces of gold, classified as mineral reserves). The ore from this deposit is of good quality - easy to process and of relatively high grade of 2.45 grams / ton.

According to the company, in 2015 the ore was mined from Adamus and Aliva deposits, but, looking at grades reported, I am quite confident that a majority of ore was from the lower grade Aliva deposit. If the company mines the ore coming mainly from Adamus, Nzema should deliver better results.

O.K. now let me discuss the best mine, Agbaou. 

Agbaou - the best mine

Agbaou started its operations in the third quarter of 2013 and should be operating till 2022. In my opinion, it is an excellent mine. It is a conventional open pit using the gravity / CIL recovery process. 
In 2015 Agbaou delivered 181.4 thousand ounces of gold (an increase of 23.6%, compared to 2014). With production cost of $29.9 per ton of ore milled (my calculations), each ton of ore milled / sold was delivering $49.0 in operating cash flow. Using another metric, cash cost of production (mining and milling) was standing at $462 per ounce of gold sold (a decrease of 7.8%, compared to 2014). 
If gold prices continue their march up, in the coming years this mine should be delivering excellent results.

Tabakoto - a chance for better performance

Tabakoto has been consistently improving its operating and financial results. Operating costs, calculated on a per ton of ore milled, went down from $124.9 in 2013 to $81.9 in 2015 (a decrease of 34.4%). In 2015 this mine delivered cash flow of $27.9 per ton of ore milled / sold. 

In my opinion, if the company is able to sustain the current operating performance at Tabakoto, it is highly probable that this mine will become another decent operation (together with Agbaou). 
However, there is one additional problem - the mine life is only 4.4 years so investors should closely study the exploration results delivered by the company in the coming future. 

Summarizing, today Endeavour strongly depends on the performance of the Agbaou mine. In my opinion, it is rather unlikely that the Nzema mine is going to improve its performance substantially. Therefore, until Tabakoto does not show much better results, the company is going to be the one - mine story. 
The fourth mine, Ity, was acquired at the end of 2015 so it is too early to present any reliable opinion on this operation. On the other hand, according to Endeavour estimates, this mine should deliver 65,000 - 75,000 ounces of gold in 2016, which means that Ity is going to be of minor importance to the company. 

Hounde Project (Burkina Faso)

Hounde will be an open pit mine, producing around 190 thousand ounces of gold a year, on average. According to the updated feasibility study, the basic project parameters are, as follows:

  • mine life: 10 years
  • mineral reserves: 30,601 thousand tons, grading 2.11 grams per ton (2.07 million ounces of gold)
  • gold price: $1,300 per ounce
  • Upfront capital costs: $328 million
  • NPV (5%, after tax): $415 million
  • IRR (after tax): 34.7%

The first pour of gold is expected in the fourth quarter of 2017. 
In my opinion, the economics of the project looks good. Assuming conservative, lower price of gold, for example $1,200 per ounce, the project should generate NPV of $302 million and IRR of 27.9%, which is a decent rate.

The company wants to finance the construction of Hounde from internal sources (no shares dilution is expected). Let me cite the company:

"The Project is fully-funded based on our expected pro-forma cash position following the completion of the True Gold acquisition, the mine equipment financing, and the undrawn portion of our revolving credit facility. However, rather than draw on our revolving facility, our objective is to fund the remaining capital needs from free cash flow"

Assuming that Endeavour will acquire True Gold, the company's share count should increase to 76,519 thousand (excluding La Mancha Holding anti-dilution rights). Therefore putting Hounde into operation should increase the intrinsic share value by $3.95. 

Acquisition of True Gold 

If the acquisition of True Gold by Endeavour is accepted by their shareholders, the transaction value should stand at around C$226 million (US$176 million). 
Let me analyze this project.

First of all, the acquisition of True Gold means the purchase of its flagship project, called Karma, located in Burkina Faso. Karma is quite a complicated mine, comprising of three types of ore: oxide, transition and sulphide. According to True Gold, Karma holds mineral reserves of 949 thousand ounces of gold.
True Gold plans to extract gold only from the oxide and transition ores, leaving the sulphide, refractory ore (hard to process) in the ground. 
Refractory ore accounts for 5.6% of total reserves only so leaving it in the earth has no material impact on the project's efficiency. 

Next, based on a gold price of US$1,250 per ounce, the project has a post-tax internal rate of return of 46.3% and a post-tax NPV of US$ 199 million (at a discount rate of 5%). 

Now, there is a question - what is Endeavour buying? 
Below I enclosed a simplified transition of the balance sheet of True Gold, as at the end of 2015.
All issues, related to Karma, are included in the line "Karma" (disclosed at its NPV value). The line "Equity" is a fair - value of True Gold. As the table shows, this value stands at $147.1 million so Endeavour is going to pay True Gold shareholders a premium of 19.6%.

What does it mean? In my opinion, it means that Endeavour is overpaying. If Karma is not going to deliver better operating and financial results than these presented in its feasibility study, this project is going to be unprofitable. 

When may such better results be delivered? For example, when the gold price goes substantially higher or Endeavour discovers new gold deposits at Karma. 

On the other hand, I understand that Endeavour management wants to acquire True Gold because Karma should be delivering free cash flow soon. And fresh cash is needed to construct Hounde.

Well, we will see but for the time being this deal does not look favorable for Endeavour.


The chart below presents enterprise value / EBITDA valuations, calculated for a few African miners (I excluded such big miners as, for example, Randgold):

As the chart shows, Endeavour is currently richly valued against its peers. 

Summing up - due to the issues discussed in this article, I am not recommending Endeavour shares. The company is quite richly valued and in the coming future it will face a few serious events: the construction of a new mine plus the consolidation of True Gold assets. In my opinion, such events are not supportive for the share price action. 

Disclosure: I do not own Endeavour Mining shares