By Seeking Alpha,
NEVSUN Resources (NYSEMKT:NSU) is the operator and 60% owner of the Bisha mine, which is one of the highest grade open pit copper mines in the world with copper equivalent grades higher than 4%.
With $380 million cash in the bank, zero debt, and operating cash flow estimated between $280+ million for 2015 with a copper price of $2.90-$3.0 per pound, I think Nevsun is one of the cheapest stocks in the resource sector, and I’ve ranked it as my top pick for 2015 as a result.
As mentioned, Nevsun owns 60% of the Bisha copper mine in Eritrea, East Africa, with the state of Eritrea owning a 10% free carried interest in the mine, plus an additional 30% paid participating interest. The mine contains 7.4 million tonnes of high-grade copper at grades of 3.57%, plus high grade zinc at grades of 5.54%, which will be mined beginning in 2016.
For 2014, Nevsun will produce between 180 to 200 million pounds of copper at all-in costs just above $1 per pound. This means with copper currently priced around $2.90 – $3, Nevsun’s margins are approximately $1.90 to $2 per pound of copper produced. These large margins have resulted in solid free cash flow and earnings, with Nevsun reporting earnings per share of $.36 for the first nine months of 2014. During that time, the company’s working capital position increase from $462 million to $519 million.
The one “catch” here is that copper production is expected to drop over the next few years, as the company transitions to mine high-grade zinc ore, with over 1.7 billion pounds of total zinc production expected starting in 2016.
However, the company should still produce around 200 million pounds of copper equivalent production in 2015, just a small drop off from 2014. While copper equivalent production is expected to drop off to 120 million pounds by 2016, it’s very possible that recent exploration results will lead to a larger copper resource base, which could increase the company’s 2016-2020 copper output.
In addition, the company expects a major zinc supply gap beginning in 2016, as closure of several large zinc mines and a lack of new projects should result in a shortage, as you can see in the chart above. By 2025, the zinc supply gap could be as high as 5-10 million pounds of zinc. So an increase in the price of zinc would have a very positive impact on Nevsun.
THE STOCK REMAINS UNDERVALUED
Nevsun’s balance sheet is rock-solid – the company has $380 million cash and zero debt at the end of the last quarter, with $515 million in working capital. In addition, Nevsun trades at an EV/EBITDA of less than 2, a Forward Price/Cash Flow of less than 4, a Forward P/E of less than 8, and the stock has a forward yield of 4.36%, after the company recently increased the dividend by 14%.
On the TSX exchange, analysts have a consensus price target of $5.43 per share for Nevsun with five buy recommendations, two strong buy and five holds, according to Yahoo Finance. Between the 12 analysts, they are expecting an average 2015 earnings per share of $.55 on revenue of $586 million.
EXPLORATION RESULTS HINT TOWARDS A LONGER MINE LIFE
Recent drilling results at the Harena deposit, located 10 kilometres south of the Bisha mine, were quite encouraging and demonstrate the potential for further growth.
Some of the best drill results intersected zinc grades higher than 8% and copper grades higher than 4%. In addition, high grade gold between 5 g/t – 8 g/t was intersected at the Footwall Gold Zone. All of these drill results are not included in the current resource.
Other drilling results have been just as impressive. For example, on Nov. 13, the company reported 2.66% copper and 1.05 g/t gold over 38 metres, 1.82% copper and 2.66% zinc over 36.8 metres, and 146 g/t silver over 14 metres, and 8.5 g/t gold over 14 metres.
The company completed 27,300 metres of diamond drilling in 2014, and the exploration work will be included in an updated mineral reserve and resource statement, which is expected to be released in February 2015.
Life of mine payable metals production currently calls for 891 million pounds of copper, 1.7 billion pounds of zinc, and 414,000 ounces of gold, but because of these outstanding drilling results, I’m expecting the life of mine production estimates to be increased.
IS ERITREA RISKY?
I think one huge reason the stock is not being fairly valued is investors perception of country risk in Eritrea.
As previously mentioned, the company’s Bisha mine is located in Eritrea, East Africa. This is considered to be a higher risk mining jurisdiction. According to the Fraser Institutes’ Survey of Mining Companies in 2013, Eritrea scored a 50 rating out of 100, which puts the country in the middle of the pack on the list, and below regions like Ghana, Mexico, Chile, Ontario, Quebec, Nevada, and Turkey.
However, the country also scored higher than several other African regions, including Zambia, South Africa, Zimbabwe, Ethiopia, and several South American regions like Brazil, Guyana, Panama, and Argentina. In addition, the government of Eritrea already owns a 40% total interest in the Bisha mine, so it has a huge stake in the mine.
In addition, Nevsun has been operated in the country for 16 years now, without any major issues from the government. The company says on its corporate presentation that it has strong government support from Eritrea, with stable taxation and mining regulation for over 20 years.
ACQUISITION/MERGER OPPORTUNITIES FOR GROWTH
Another risk factor with Nevsun: they are a single mine producing company, so the company’s earnings will be affected if anything were to ever happen at the mine, whether it’s an explosion or accident at the mine, a natural disaster, equipment failure, a labor strike, etc.
However, Nevsun is actively looking to put its $500+ million working capital to good use with an acquisition or a merger. In fact, the company recently responded to media speculation that it had received a $1 billion+ offer from a company called QKR Group. The company confirmed that it has received interest on a potential corporate transaction from various parties, but it could not disclose any more details.
I think there are more than a few growth opportunities for Nevsun, so I hope the company doesn’t get bought out. The first acquisition target is Sunridge Gold, a company that owns the Asmara project in Eritrea. This project is expected to produce 65 million pounds of copper, 42,000 ounces of gold, 184 million pounds of zinc, and 1 million ounces of silver on average annually for at least 8 years. Like the Bisha mine, this project is owned 60% by Sunridge and 40% by the government of Eritrea, with the government paying Sunridge $18.33 million for their interest.
The project only requires $30 million in initial capital costs to reach initial copper production in 2015. In the first two years (2015-16), the project will produce high-grade copper, gold and silver ore from the Debarwa project, which should provide a nice capital infusion to help fund phase II of production, where 3 million tonnes of high-grade copper, gold and silver will be produced. Full production would be reached by mid-year 3.
Nevsun clearly has the working capital to acquire Sunridge, which carries just a $30 million market cap, plus fund the initial capital requirements at Asmara. Since it already operates successfully in Eritrea, I see this previous relationship as a huge benefit to Nevsun. An acquisition or even a joint venture makes perfect sense for Nevsun in my opinion.
The next potential suitor for Nevsun is an Australian copper mining company called Sandfire Resources, which carries a market cap of $733 million on the ASX.
This company is already producing high-grade copper and gold at its DeGrussa copper-gold Australian mine – last quarter, the company produced 9,288 ounces of gold and 17,654 tonnes of copper, at cash costs of just $1.18 per pound, which is just above Nevsun’s costs. Full year production is expected to reach 65,000 to 70,000 tonnes of copper and 35,000 to 40,000 ounces of gold at cash costs between $1.15 to $1.25 per pound. DeGrussa contains total gold resources of 795,000 ounces, plus 634,000 tonnes of copper, so the mine should be producing high-grade ore for years to come.
Like Nevsun Sandfire also looks undervalued, with an EV/EBITDA of 3.32, a forward P/E of 6.04, and $68 million of yearly free cash flow, according to Yahoo Finance.
Since Nevsun and Sandfire carry roughly the same market cap, I think a merger of the two companies would make a whole lot of sense. The new company would have 355 million shares outstanding, carry a market cap of $1.4 – $1.5 billion, but also have an outstanding balance sheet with $430+ million in cash and just $160 million in debt (from Sandfire), plus potentially produce well over $80-100 million in annual free cash flow. A re-rating could follow the merger, since the new company would be a multi-mine copper producer – instead of two separate, sole-operating mine company’s.
To recap, Nevsun is undervalued, has a rock-solid balance sheet, pays a healthy dividend, has numerous growth opportunities, and has operated successfully in the country of Eritrea for more than 10 years now. I will continue to add shares in 2015.