Monday, 31 March 2014

Mawson West (TSX:MWE) - Cheap but not 'Stupid Cheap'

While some companies don't screen well (hidden assets, unprofitable divisions, bloated pension liab.), others with limited-life assets (miners, O&G, airlines, equipment rental, shipping) can often screen far too well relative to their intrinsic value. Mawson West ("Mawson") unfortunately falls into the latter category. 

I first came across Mawson after it popped up on a few 'stupidly cheap' screens and from reading a couple of writeups on the name. Based on trailing numbers, Mawson trades at 0.5x EV/EBITDA and 1.0x P/CF, while having half of its C$93 mln market cap sitting in cash. That looks stupid cheap. And there are a number of possible reasons for this valuation: i) small-cap < $100 mln market cap company; ii) mining stock (I know, why even bother); iii) operations in Africa, Democratic Republic of Congo to be more precise; iv) and no dividend or buyback (quite the shocker for a mining company). Now while the Congo risk is difficult to discount due to political instability, possibility of nationalization, and ongoing tax and royalty hike discussions, Mawson appears cheap enough to warrant a further look. 

The bad
Low hanging fruit has been picked - Mawson currently has one operating asset, the open-pit Dikulushi mine. The company acquired the mine from Anvil and had been processing low-grade stockpilled material on site, as well as deepening the pit to extract high-grade material at the bottom - both of which are now depleted. This has been a great asset operating at $1.35/lb cash costs ($0.80/lb Cu incld. silver credits) with simple open-pit operations, and a well functioning processing plant. It has also been a great investment as the 83 mln shares issued (now worth ~C$46 mln) have generated C$108 mln in EBITDA and C$95 mln in CFO over the last twelve months. With the open-pit depleted, the main ball has come to an end, but investors do have a free ticket to the after-party (...continued later, in the good part). 
Congo risk should not be overlooked - the Congolese government continues to have on and off discussions regarding imposing a royalty, hiking mining taxes, or banning concentrate exports (forcing miners to build processing facilities). Something will likely be done, as aside from the threat of terrorism/nationalism, Congo is probably one of the best places to start a mine in the world. There is no royalty, mines are exempt from taxes for the first five years of operations, and taxed at a very reasonable 16% thereafter (eventually rising to 40% after 15 years). 
Valuation not quite 'Stupid Cheap' - here's a summary of Mawson's assets:
Dikulushi underground - following depletion of the open-pit reserve, Mawson will continue mining the high-grade  deposit via underground operations. The rate of production will slow to half of the prior 21,000 ton per year pace, at $2.10/lb cash costs ($1.50/lb Cu with silver credits). The current resource only supports 9 months of operations, and management wants to extend the mine-life to 5-years. At the current 9 month life, the project is worth C$9 mln ($0.05/sh).
Kapulo open-pit - Mawson's core asset has always been the Kapulo mine located roughly 150km NE from Dikulushi. The open-pit project is set to start operations in the second half of the year with the plant ~70% complete. The remaining ~US$60mln of development costs will be funded through cash on hand (US$48mln), continuing cashflow from Dikulushi, and a refinanced debt facility. Kapulo hosts a large >7MT reserve at 3.2% copper that can support a 10-year mine life, producing ~16kT/year at $1.90/lb Cu cash costs. At $3/lb Cu and a 10% discount rate, the project is worth C$116 mln or $0.67/sh.
Sum of Parts - corporate adjustments: +$0.33/sh in cash and options, -$0.31/sh for debt and SG&A. Adding these to the mines, Mawson is worth around $0.74/sh for +34% upside. Which is not bad considering the valuation is at the spot Copper price, company is fully funded, and a large chunk of the value is in the simple open-pit project.

The Good
Grade and Longevity - From working in the mining industry, if I learned anything, it would have to be: i) grade is king - be as close to the toe of the boot as possible in terms of operating costs; and ii) invest in long-life reserves to provide upside during periods of commodity price volatility. The high grade is observable with world class cash costs at Dikulushi, even after the deposit shifts to underground mining. While Kapulo offers great longevity with a 10-year mine life based on current reserves, with competitive cash costs. 
Free Options after initially valuing the mines, I was pretty disappointed. Here's a company trading at 1x CF, with half its market cap in cash, yet only worth a measly 34% premium based on intrinsic value. But there's still something here. The biggest upside for Mawson is through adding reserves. Now before I indulge in this discussion, I'm not a geologist and possess virtually no knowledge of the Congo Copper belt, and yes, I do understand that every resource company is always promising additional resources. But even a layman like myself can build some educated scenarios. With Mawsons' infrastructure already in place, the threshold for additional resources to be accretive is very low. I have built three simple scenarios for potential upside:
i) Dikulushi Underground extended - if Mawson is able to extend the underground resource life by an additional 2 years (management feels they can get 5 years total out of the deposit), additional value to shareholders would be ~C$52 mln or +$0.30/sh - total NAV $
ii) Dikulushi Satellite deposit - if Mawson is able to build a reserve 1/5th the size of 3.6MT mined ore at Dikulushi from nearby deposits, additional value to shareholders would be ~C$54 mln or $0.31/sh - total NAV $1.30/sh. Two nearby deposits will be reporting initial reserves in the coming months. The resource size, grade, and further prosperity of these deposits can yield significant value.
iii) A rise in copper prices - combining the above two scenarios with $3.50/lb Cu prices into the future would add another $0.70/sh, bringing our NAV to $2.03.

I'm not a fan of 'leap-of-faith investing' (prophesying expansion and margin improvements out of thin air). And though the three scenarios above have yet to materialize, the likelihood of one or more of these options ending in-the-money is high. When valuing upside options, like anything else in investing, price is the key determinant of your risk and reward, and the price to be paid for Mawson's options is currently zero.

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