By Seeking Alpha,
When we last reported on Nevsun Resources (NSU) it was under the pre-text of Nevsun being a gold miner outperforming all other companies included in the Market Vectors Gold Miners ETF (GDX).
Since then Nevsun has finished mining the top gold-bearing oxide zone and has transitioned to mining the supergene layer at its Bisha mine in Eritrea which contains predominantly copper (accompanied by gold and silver by-products). And in its new incarnation as a copper miner the company has just filed its financial statements for the fourth quarter and full year 2013. A concise summary of these statements can be found here.
In a year that was characterized by the transition from gold miner to copper miner, including several months of down-time at the processing plant, Nevsun Resources recorded a profit for the year. Not surprisingly, and evidenced by the chart below, Nevsun has continued to outperform peers in the gold as well as the copper mining space.
- Transformation from gold to copper miner has been completed successfully.
- The Bisha mine has a substantial zinc component and will eventually turn into a primary zinc asset.
- Considering the financial position an acquisition is becoming more and more likely.
Going forward, Nevsun will be a copper producer with costs in the lowest quartile, presumably for many years to come.
Additionally, and perhaps much less noticed, a pleasant surprise was hiding in the resource and reserve update released in February and the title of this article already alludes to this item.
In the present article we would like to summarize the company’s current state and look at what might be in store for Nevsun Resources in the near-to-mid-term future. The article concludes with our current investment thesis for this company.
THE BISHA MINE
The Bisha mine is Nevsun’s single producing asset. It is located in Eritrea and operated by a JV company of which Nevsun is a 60% shareholder. The remaining 40% interest is held by the Eritrean National Mining Corporation, or ENAMCO.
The mineralisation at the Bisha mine is of an exceptionally high grade which has enabled the company to produce at industry-leading low cost so far. Since declaring commercial gold production early in 2011 the company has amassed an impressive cash position while paying dividends at sector-leading yield rates.
The transfer to mining the supergene layer was accomplished in 2013. Instead of producing silver gold dore bars the mine now ships copper concentrate. Nevsun continues to use the front- and back-end of the original gold processing plant, and inserted a new concentrator for supergene copper production. This change-over necessitated several months of non-productive down-time. The company has managed the logistical challenge of this change-over admirably and has declared commercial copper production at the start of December 2013.
During the transformation the company discovered gold-bearing pyrite sands which were processed through the new concentrator as part of ramping up the new plant configuration. Remnants of pyrite sands are still stockpiled and will be processed in due time.
The picture below is taken from the company presentation and illustrates the layered structure of the mineralisation at the Bisha main pit. The top oxide layer has been mined out and the company has successfully transferred to mining the supergene layer underneath. This supergene layer contains high-grade copper with some precious metals by-products.
Once the supergene layer has been exploited the company will start mining the fresh rock colored in blue in the illustration. This ore contains copper and zinc, with precious metal by-products. And it is the zinc component that we have become especially interested in.
While we believe that copper prices will be see-sawing in the foreseeable future, we are very bullish on zinc over the next few years. Production costs at the Bisha mine are very low and will ensure healthy profits on the copper production regardless of the copper price. However, we have great expectations for even higher profits once the company adds the zinc-circuit to the plant and starts mining the fresh ore.
For the current year the company has issued guidance for production of 180M lbs – 200M lbs of copper at “cash costs in industry lowest quartile“. We have been unable to quantify this cost guidance with the company and will be eagerly awaiting the next quarterly report with data for the first full quarter of copper production.
Valuation of the Bisha mine is guess work at this point in time due to the lack of a concrete cost guidance and no past data for copper production. We will therefore abstain from putting forth our assumptions. However, we take note of analyst price targets in the $4 to $5 range, comparing favorably with the current share price of $3.40.
RESOURCE AND RESERVE UPDATE
As mentioned in the introduction, Nevsun has released its 2013 resource update without much fanfare in February. And while we noted the expected results for the main pit and the satellite Harena pit, we were pleasantly surprised to see maiden open pit resources for two more satellite zones: the Northwest and the Hambok zones.
The attached map is copied from the company presentation and illustrates the layout of the deposits currently considered in the company’s resource and reserve statement.
Supergene depletion through mining in the Bisha Main pit was successfully replaced, presumably pushing out mining of the underlying fresh ore by a year. The reserve-based mine life remains at 11 years “demonstrating the robust nature of the high grade Bisha Main ore body“, as CEO Cliff Dacis rightly stated.
Contained copper in the total indicated resource increased by 22% due to the addition of the two maiden resources to the inventory.
The NW zone is situated close to the main pit and close to infrastructure and contains supergene and primary ore for a total indicated resource of 91M lbs of copper, 60M lbs of zinc plus precious metals by-products. The grades at the NW zone are respectable, but noticeably lower than the grades recorded for the operating Main and Harena pits. Since the NW deposit is situated very close to the operating pits and within the mining concession we would assume that this deposit can be developed relatively quickly. Presumably ore from the NW deposit will be blended with high-grade material from the two currently operating pits.
The Hambok deposit is situated at a distance from existing operations, and within a vast area for which Nevsun holds the exploration rights. The recorded grades for this deposit are similar to the NW zone; however, we note that this deposit is also showing the top gold-rich oxide layer which was depleted in the main pit last year. The stated gold grades of this oxide layer range between 5oz/t and 6oz/t for the indicated and inferred resource categories. It is still early days and the oxide resource is still small, but the deposit is open and exploration continues.
We believe that the exploration results from the Hambok deposit give rise to two expectations:
1./ If the gold-rich oxide inventory can be further expanded the company might consider switching the gold circuit back on and produce precious metals again in addition to copper. This would require expansion of the crushing and grinding circuit and probably also an additional thickener. To justify such an expansion would require a substantial oxide resource. It is important to remember the 100,000 tonnes of stockpiled oxide material at the Bisha plant in this context.
2./ The definition of a maiden resource in the exploration area might be a harbinger of further discoveries. There is a distinct possibility of this area turning into a veritable long-lived VMS mining camp. The 2014 exploration program is targeted at expanding the existing Hambok resource and at testing several other targets in this exploration area.
All four deposits currently included in the company’s resource inventory are open with extensions that still require definition.
The demand-supply dynamics for zinc are pointing towards a supply shortage in coming years. The growing zinc resource that is part of the fresh rock zone has caught our imagination in this respect. The company has stated that it is currently developing a plan to implement a zinc circuit with a view to start producing a zinc concentrate in H1 2016.
The growing zinc resource and the occurrence of zinc in all four deposits included in the inventory so far is good news in this context. Mining the fresh ore will probably add costs due to higher energy consumption for crushing and grinding among other factors.
Copper grades are significantly lower for the fresh ore compared to the currently mined supergene ore. Zinc grades are 5+ times higher than copper grades in the fresh ore zone in the main pit which will essentially turn Nevsun into a primary zinc producer as soon as mining of this zone starts. Grade ratios vary across the other deposits, but ore from the satellite pits will probably be blended with ore from the main pit and will not materially change the picture.
We therefore view Nevsun as a low-cost copper producer for the time being; but looking ahead a couple of years we expect Nevsun to morph again into a primary zinc producer, at least as far as production from the Bisha mine is concerned. And that will quite probably constitute perfect timing in the light of the mentioned supply-demand situation for zinc.
WHAT TO DO WITH ALL THAT CASH?
After having paid for the copper expansion in cash the company’s balance sheet still shows a cash position of $303M and $419M in working capital. The current ratio on Nevsun’s balance sheet is close to 10. Consider this cash position in the light of a market capitalisation of $686M at the time of writing.
This company sure has a lot of cash and needs to put this money to work. Nevsun is already paying a dividend of $0.14 per annum which translates into a dividend yield of 4%. No wonder, that rumors about imminent acquisitions by Nevsun prosper, but that has been the case for almost two years now. It appears that Nevsun has been hunting for potential acquisitions, but has not found a target that has lived up to this company’s standard.
Presumably an acquisition for Nevsun would have to entail an asset to rival the Bisha mine, would need to leverage in-house expertise in open pit mining and would have to diversify country risk.
The fact that Nevsun is operating one single mine, and the fact that the company is doing so in Eritrea has been the main detractor for many investors. Exposure to the associated risk factors has certainly helped to put a damper on the share price.
So far the host country of Eritrea has been a very reliable partner, quite probably helped by the fact that the government owns a 40% share of the Bisha mine. Nevsun has been reiterating the virtues of this partnership, and indeed investors have no reason to complain so far. However, UN sanctions in combination with little information on Eritrea other than news about this country’s conflicts with its neighbor Ethiopia has kept some potential investors at bay.
Consistent performance should help alleviate doubts, and diversification into another, presumably safer jurisdiction would probably reduce the discount placed on Nevsun’s valuation by the market.
THE THESIS AND WRAP
Nevsun has successfully turned from a highly profitable gold producer into a highly profitable copper producer. And will morph again in a couple of years, this time into a zinc producer. We especially like this zinc outlook and are considering initiating a position for this very reason. We believe that the market has yet to catch on to the zinc-twist in Nevsun’s story.
Potential investors ready to pull the trigger now should do so before March 31 in order to be eligible for the first quarterly dividend in 2014.
We expect Nevsun to make an acquisition in the near future, but have been expecting just that for some time. The ubiquitous drop in share price following such an acquisition might just be the catalyst for your humble scribe to initiate a position.
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