Introduction
In this article I'll discuss Luna Gold (LGCUF.PK), a gold producer owning the Aurizona mine in Brazil where it expects to produce approximately 100,000 ounces of gold this year. Luna Gold seems to offer an attractive risk/reward ratio, despite the current price of gold and its streaming agreement with Sandstorm Gold.
I'll first give a brief general overview, moving over to the company's production profile and its expected growth, which will result in my investment thesis at the end of this article. This article won't contain a lot of links, there are no hyperlinks available for Luna's press releases, but you can find the link to all press releases here.
I think Luna Gold is a decent investment to have exposure to the gold price as the company is already in production and is currently installing upgrades to move to an annual output of 135,000 ounces per year (112,000 net to Luna). This will generate a cash flow of approximately $60M per annum which should be sufficient for Luna Gold to continue to increase its output even further. This cash flow will obviously also be used to fund further exploration work on its land package containing 220,000 hectares immediately surrounding the Aurizona mine.
General overview
Luna's Aurizona project is located on the north shore of the Brazilian coast, relatively close to Belem, which is a relatively large city.
The company has been in commercial production since Q1 2011 and the management is trying hard to boost the output at Aurizona to bring the company into the category of mid-tier producers as the company is targeting an eventual output of 450,000 ounces of gold per year (including expected production from underground production at Aurizona as well as being able to produce gold from its greenfields exploration projects surrounding the mine).
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At this point, Luna is only producing from the Piaba deposit which hosts a reserve base of 2.3 million ounces. The company is currently busy with an expansion program which will allow the company to reach an average output of 135,000 ounces of gold per annum. Luna Gold expects to have this expansion program completed by Q4 2013.
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Besides the Piaba reserves of 2.3 million ounces, the company has an additional 2.3 million ounces of gold in the resource categories at Piaba and nearby satellite deposits. This will allow the company to move forward with its expansion plans, as at the current expected production rate of 135,000 ounces per year, the life of mine at this moment is approximately 30 years.
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Luna Gold's guidance for this year was announced in January, outlining an expected production of between 95,000 and 105,000 ounces of gold at a cash cost of approximately $710/oz. In the next subtitle I will provide a cash flow simulation using different gold prices.
Let's also not forget the company has to sell 17% of its output to Sandstorm Gold (SAND) as consideration for the up-front payment it received in 2009. This means Luna Gold will have to sell approximately 17,000 ounces this year and 23,000 ounces next year at a fixed price of $400/oz. As Luna is selling this 17% at a loss (as the production cost is $700 vs. the received price of $400), this will cause Luna's cash cost for their 112,000 ounces per year to increase by $60/oz, to $750/oz.
Sandstorm also has the right to purchase 17% of the gold production of a potential Aurizona underground mine if they pay 17% of the capital expenditures for this underground mine. Sandstorm agreed to pay $500/oz! of gold ! produced from underground operations.
Cash Flow simulation
In this simulation I'll use an output of 110,000 ounces of gold (approximately 83% of the total output, allowing for the 17% of the production to be delivered to Sandstorm Gold) at a cash cost of $750/oz (allowing for the losses on the gold sold to Sandstorm, the lower expected cash costs per ounce because of economies of scale and a slight cost inflation). Keep in mind cash costs do not include sustaining capital expenditures, exploration expenditures and G&A expenses.
Gold Price | Cash Flow |
1000 | 27.5M |
1100 | 38.5M |
1200 | 49.5M |
1300 | 60.5M |
1400 | 71.5M |
1500 | 82.5M |
1750 | 110M |
2000 | 137.5M |
As you can see, Luna Gold is trading relatively cheap at just 3X the operational cash flow using a gold price of $1200/oz. Luna Gold spent only $3.5M on exploration and G&A expenses, which is very low compared to other companies.
The Balance Sheet
Luna Gold's balance sheet seems to be relatively healthy with a working capital of approximately $20.7M as at the end of Q1 2013. As the company has almost no long-term debt, Luna Gold should be! able to ! use debt financing to further expand its production profile in Brazil.
The current long-term debt mainly consists of a revolving facility issued by Société Générale and Mizuho Corporate bank at a current value of $28.7M. This facility matures in 2016, and from Q3 2014 on, the company will have to pay $3M per quarter as repayment of the principal amount. This is followed by a balloon payment of a maximum of $12M at the maturity date of this facility.
This facility required Luna Gold to hedge 23,000 ounces of gold over three years at an average price of $1567/oz. In hindsight, this was an excellent move and shows why hedging isn't always a bad thing.
As Luna Gold makes considerable cash flow - even at the current price of gold- the company should obviously have no problem repaying its current debt.
Investment Thesis
Luna Gold offers excellent fundamentals to get exposure to the price of gold, as the company currently has 4.6 million ounces of gold on their land package with considerable upside potential on their 220,000 hectares of land holdings surrounding the Aurizona Mine. As the company has outlined no less than 9 exploration targets, I'm convinced there's much more gold to be found around the Aurizona Mine.
Aurizona is expected to produce approximately 100,000 ounces of gold this year and 135,000 ounces next year (112,000 ounces net to Aurizona) at a cash cost of approximately $700-750/oz. The only negative thing is the gold streaming agreement with Sandstorm Gold whereby Sandstorm can buy 17% of Aurizona's gold production at $400/oz, which is considerably lower than the current production cost.
As Luna's balance sheet looks good and as the company is cash flow positive, I'm waiting for a pullback before initiating a potential position. I am convinced the management team will continue to tick boxes at Aurizona and will be able to bring the project into Phase II of production within 3 years which should increase the total output of ! the mine ! to 250,000 ounces per year.
Luna Gold is a good way to increase your exposure to gold as the company is already producing and has a minelife of approximately 30 years. This operating cash flow will enable Luna Gold to fund its autonomous growth path towards its planned 450,000 ounces of gold per annum, as the surrounding greenfields area offers a lot of potential to considerably increase the current resource estimate.
Another possibility to get exposure to Aurizona's increasing production profile is through buying Sandstorm Gold, but the valuation of the latter company is much higher than what Luna is currently trading at.
As the trading in Luna shares on the pink sheets is very limited, I would recommend to trade in Luna on the Toronto Stock Exchange where the company is listed on the main board under the ticker symbol LGC.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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