Description

Company Overview:

Centerra Gold (TSX:CG) is a Canadian based intermediate gold producer. The company operates 3 primary assets:  the Kumtor gold mine in the Kyrgyz Republic, the Mt. Milligan copper-gold mine in British Colombia and the recently completed Öksüt heap-leach gold mine in Turkey.

In addition to their 3 operating assets, Centerra owns the rights to 2 development projects in Canada, Kemess and Hardrock, that they are progressing toward production. The company also owns a portfolio of non-core molybdenum assets, including a metallurgical facility, which offsets costs associated with the its two molybdenum mines on care & maintenance.

Background: Company has underperformed peers over the last few years due to on-going Kyrgyz government risk, poor operating results at Mt. Milligan and uncertainty surrounding the development of Oksut.

Kumtor (Operating - Kyrgyzstan): Despite Kumtor being a world class resource (high grade (~3 g/t), high volume conventional open pit mine) with significant exploration potential, de minimus investment was made in the asset between 2012 and 2018 as the result of a consistently strained relationship with the Kyrgyz government. Prior to 2012 the asset had consistently added to reserves and extended its mine life at consistent grades (see below). However, given the lack of certainty in the outcome of their negotiations, Centerra elected to allocate their financial resources elsewhere. As a result of its chronic under investment, Kumtor’s high grade reserves are currently nearing completion - latest mine plan (March 2015) has mining concluding in 2023 (the mill will process low grade stockpiles through 2026). We believe the street is predominantly using this mine plan when calculating their NPV.

Source: Company filings.

However, after a tenuous 3-year negotiation, Centerra and the Kyrgyz government signed a new long-term agreement in mid-2019 signaling the end to the dispute. Once signed, Centerra’s messaging and strategy changed dramatically and overdue exploration resources allocated to the asset were immediately realized. An updated resource estimate at the end of 2019 increased M&I by 6Moz at over 3 g/t or 112% (see below). 

Source: Company filings.

Centerra has announced that it will provide an updated reserve estimate along with an updated mine plan in the second half of 2020 – given the history of the asset, we expect most of the M&I to be converted into minable reserves. Given that higher grade ore would be brought forward this mine plan is likely to dramatically increase the NPV of the asset. To put this into context, Kumtor 2020 guidance has Kumtor producing 540Koz of gold at an AISC (all-in sustaining costs) of $775/oz (higher than average), which at current Gold Prices equates to ~$550mm of AIS Free Cash Flow. As discussed above, on the current mine plan (see below), beginning in 2023, production is expected to drop off and costs are expected to ramp as the pit depletes and low-grade stockpiled ore is processed. A simple NPV on those estimates derives an NPV on those cash flows of ~$2bn. If we assume that the mine life gets extended through to 2030 (~75% of M&I are converted to reserves) at L3Y average production and costs levels (costs could be lower given higher M&I vs. reserve grade) the NPV doubles to ~$4.5bn (~US$3.3bn Market Cap). To keep it simple the below math does not include an expansion in growth capex, however, given that the majority of the resource is from within the pit (Hockey Stick Zone - see below) we expect that capex/pre-stripping would remain relatively consistent and is unlikely to change the narrative.

Source: Kumtor 2015 Technical Report and Company Filings.

Centerra has doubled this year’s exploration budget at Kumtor to $20mm – given that none of the results from this program will be included in the current mine plan we would argue it’s likely that there is further upside from here.

Oksut (Operating - Turkey): Centerra’s low cost development asset, Oksut, reached commercial production earlier this year on time and on budget. As the asset ramps it should materially contribute free cash flow to the group towards the second half of 2020. Investors are unlikely to give Centerra credit until it reaches name plate, however, given its relatively simple profile (low strip open pit with heap leach processing) we view ramp up risk as relatively low. The addition of another high quality, low-cost asset will not only improve the free cash flow profile of the company but will also help diversify the geopolitical risk in the name.

Source: Company filings.

Mt. Milligan (Operating - Canada): Since first production in 2013, Mt. Milligan has consistently struggled to deliver clean results. However, after a thorough re-assessment of the asset, the Company released a new technical report earlier this year which appears to have reset expectation to more achievable levels. This includes higher costs, lower recoveries and a reduced reserve life. In addition to the revised report, the company received an environmental permit amendment which seemingly addressed its intermittent water issues.

Mt. Milligan remains complimentary to Centerra’s portfolio given its ability to generate cash, attractive copper/gold mix and much lower geopolitical risk jurisdiction. While missing numbers remains a possibility, we believe this risk likely already priced into the stock. Therefore, delivering on now achievable numbers will improve investor confidence in the asset and the company, likely leading to further share price appreciation.

Hardrock (Project - Canada): The Hardrock Mine is a joint venture (50% Centerra, 50% Premier Gold) open pit development project located in Ontario, Canada. Despite being the likely near-term development candidate at Centerra, we view the project as unlikely to be commissioned until its economics are refined - latest feasibility study (see below) does not meet Centerra’s stated return threshold (>15% IRR at $1,250/oz gold). Unfortunately, Centerra and Premier have made public differing views on how to proceed with the project – Premier would like to quickly progress the project while Centerra would prefer to wait, harvest cash and slowly improve the economics of the project. We believe Centerra’s strategy to be prudent. The disagreement began with Premier’s 2019 press release of an updated resource estimate and the publishing of an unreleased revised technical report. Since the disagreement began, Centerra has rejected a $205mm offer for its stake and litigation on the validity of the resource update and technical report began. While we do not expect the project to be commissioned until Centerra and Premier jointly agree on the technical report and economics, the revised resource points to potentially materially improved economics (21% uplift in grade for the open pit resource). On a LoM average basis this would increase AIS FCF by 40% at $1,250/oz and 32% at spot. With respect to NPV, changing nothing else but increasing the grade in the 2016 Feasibility Study by 21% would increase the after-tax NPV of Hardrock by 80% to (~US$550mm to ~US$1bn) and would also meet Centerra’s investment hurdle at $1,250/oz gold. 

Source: Company filings.

Kemess (Project - Canada): We view Kemess as a potential longer-term option for Centerra. Despite its potential to create value, Kemess currently does not meet the Company’s return threshold. While further work will likely improve the economics, current copper prices, longer development timeline and significant capex (large scale block cave mine) likely push this project out.  

Investment Case: Improving investor sentiment as the result of an inflection in free cash flow generation should drive a re-rating of the Company’s valuation, which in combination with a materially higher corporate NAV due to Kumtor’s updated mine plan should result in significant share price appreciation over the next 24 months. Further, Centerra’s clean balance sheet (net cash) and lack of near-term production cliff should allow the Company to advance and improve their large but currently marginal development projects.

Upside: Lower than expected costs due to their significant fx and oil exposure and an improved capital allocation program (increased dividend and/or buybacks).

Target Price (Spot Gold - $1,800/oz): Kumtor’s mine life is extended meaningfully while the company trades up to a comparable P/NAV and implied free cash flow yield to the comp sheet as near-term catalysts are met. 

Source: Company filings, Street Consensus and Internal Estimates. 

Appendix

Source: Company filings. 

Catalyst

Catalysts/Risks:

• Centerra is able to convert a significant percentage of Kumtor’s M&I into reserves and extend the high grade mine life of the asset

• Oksut reaches name plate by the second half of 2020 without significant operational issues

• Mt. Milligan’s operations remain in line with company expectation

• Centerra remains prudent when evaluating capital allocation

• Centerra returns capital to shareholders

• Centerra is able to realize significantly lower costs over the next 12 months as they benefit from their exposure to exchange rates and oil prices

• Gold prices remain elevated