Shanta Gold - relatively cheap? Gary Newman reviews...

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Gold is all the rage at the moment and looks set to remain strong, even if we do see some pullbacks or it not advancing to the price levels that some are predicting. So, it is no surprise that there is so much focus at the moment on any company operating in the gold sector, either producing or even just early stage explorers. With such a big recent rise in the gold price, many miners have followed it upwards, so if you are only just getting into gold now the trick is to try and find value, and if something does look cheap, to understand why it might be trading at a lower market cap than you would expect. One ShareProphets reader has recently asked me to take a look at Tanzanian gold producer Shanta Gold (SHG), as to him it seemed relatively cheap and he wondered if there was a good reason for it being so...

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Production comes from its New Luika mine in Tanzania, and with elections coming up this autumn you could argue that adds some political risk, especially as Tundu Lissu, who has been in exile after being shot 16 times in 2017, has returned to run against current president John Magufuli. But there are also similar levels of political risk in many of the other gold-producing African countries and I wouldn’t expect a large discount being applied here based on that alone. Looking specifically at Shanta itself, its latest production and operational update showed production of 22,216oz for the second quarter, up around 10% as compared to Q1, and with averaged realised gold price of $1,663/oz it achieved free cash flow of $15.5 million and for the first time in its history moved into a position of net cash. Full year guidance is for 80,000oz to 85,000oz, at an AISC of $830-880/oz. During the period it reduced debt by $17.2 million, down to just $13.4 million in total now outstanding, and at the end of the period it had cash of $21.6 million. Currently it forwards sells some of its gold, but is in the process to moving to a completely unhedged position – a strategy adopted by many of the big gold producers in order to offer a leveraged position on spot price movements.

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Given how far gold has risen in the past couple of months, and given an all-in sustaining cost of just $771/oz, the company should be generating significantly more net free cash flow – at current spot prices and assuming costs and production are similar to last quarter, by my calculations net cash flow for a three month period would be in the region of $6.5 million higher than reported in Q2 (maybe closer to $4.5 million if annual AISC comes in at the top of the predicted range). The shares are currently trading at around 16p and a market cap of £127 million, so given the likely forward cash generation here - even if you used the much lower average from Q2 - it is easy to argue that at first glance the shares do indeed look cheap to me compared to many of its peers. But as is often the case with these smaller producers, cash flow generation alone doesn’t tell the full story, and although these figures always look impressive on paper, the longevity of the project plays a massive part as well and isn’t always as immediately obvious from the financial results and similar.

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So it came as no real surprise to me to see that the New Luika mine only has current booked reserves of 515,000oz, and at the current rate of production that gives a mine life of less than six years, and explains why the cash flow generation looks high in relation to the market cap – it all comes down to how long a period that cash flow can be maintained for. The good news is that most of those reserves are in the higher grade parts of the mine (Bauhinia Creek, Luika and Illunga), but it does mean that the company is going to need to add further reserves if it is going to keep generating similar levels of cash flow longer term. There is some potential to do so at New Luika, as it also has a further 824,000 ounces in the resources category, again with the bulk of that being at the three parts of the mine previously mentioned. It isn’t a one trick pony either, as also in Tanzania it has the Singida licence, which already has permits in place and financing discussions are well advanced. Capex to get this project to production is estimated at around $83 million, with $43 million of that for the underground part of the mine, and expected cash costs of $699/oz, so the economics look good and it isn’t a huge amount of money to find either to get it off the ground. Assuming that Singida does go ahead and reach the production stage, Shanta would be targeting annual production of 43,000 ounces over a nine year period, as per the pre-feasibility study. There is also future potential from the acquisition of the West Kenya Project from Acacia Exploration, a subsidiary of mining giant Barrick Gold, which is due to complete for a payment of $7 million plus $7.5 million worth of Shanta shares, and a 2% smelter royalty. The inferred mineral resource for the project is 1.182 million ounces of gold and with very high grades at 12.6g/t. Further in-fill drilling will be required before a decision on financing the project through to production, but to date over $55 million has been spent on exploration, and historically the licence did produce nearly 260,000oz from the Rosterman mine. Assuming that the drilling shows the desired results, then longer term this also has the potential to add significant production for many years to come.

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So, overall, although you can’t argue that Shanta looks particularly cheap based purely on current production and the lifespan of that, I think there is enough potential to add to those reserves, from resources, and to significantly extend its mining life across several projects, whilst also diversifying its geographical risk with a move into Kenya. Ultimately the success here from this share price level will solely come down to the price of gold and the ability of the company to bring at least one of its non-producing projects into production in the next few years. In the meantime though it is hard to see the share price going much lower, although it will continue to fluctuate as gold does, and I suspect the next few sets of financial results, with gold prices this high, will ultimately drive the share price higher – barring a really negative outcome to the elections in Tanzania. On that basis, I would view this as a speculative buy, and given the performance of gold at the moment, I’d expect there to be chances to bank a healthy profit here from these levels in the short to medium-term, even if ultimately everything doesn’t go to plan over the coming years.

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