SOUTHERNERA Should Seek Primary Listing In South Africa
February 12th, 1999, B-O-E Securities, Analyst: Hilton Ashton
SUF.TO Recommendation Strong Buy
Price C$7.05
· The Klipspringer Project is progressing exceptionally well mainly
as the result of the discovery of the Ml pipe. Ml lies within the
Marsfontein farm which the company is mining as a joint venture with
De Beers and a number of black interest groups. SouthernEra holds 40%
of the Marsfontein Joint Venture.
· While the Ml is being mined development on the Leopard Fissure
is taking place. The fissure extends over a distance of 6 km and is the
longest South African fissure system under the control of one company.
· SouthernEra still requires at least one more year to fully
define, through exploration, the extent of kimberlite mineralisation
on the Klipspnnger property. Numerous discoveries of indicator minerals
and diamond bearing fissure, blows and alluvial gravels make the blue
sky potential very exciting.
Recommendation: SouthernEra is cheap at C$7.05 per share therefore rates
a BUY. Our DCF valuation is C$ 14.93 per share with one- and three- year
price targets of C$20 and C$28 respectively. These targets are dependant
on favourable investor perception that the diamond industry is past its
worst.
We believe that SouthernEra should seek to move its primary listing to
Johannesburg. This will attract many South African investors both private
nd institutional and will enjoy a better rating than afforded it by the
Canadian investors. Offshore investors are just too far from the
Klipspringer Project to appreciate the good work, results and prospects.
MARSFONTEIN
BACKGROUND
When SouthernEra first started exploring the area where Marsfontein lies
(Marsfontein is the name of one the farms in the area) the company found
numerous diamondiferous anomalies including the now famous M 1 pipe. The
original focus had been on two fissure systems and small “blows”, which
formed part of the Klipspringer Project. Then the company discovered the
Ml pipe on the Marsfontein farm and announced exceptionally good values
on this small pipe. It attracted the attention of all sorts of
“entrepreneurs” including one particularly shady individual who
sported a grey area in the South African Minerals Act and alerted the
heirs of the original farm owners to the fact that Randgold had not
secured the mineral rights in the correct way.
SouthernEra's original plan was to mine the Leopard fissure plus the
small Sugarbird blow but the discovery of the rich Ml pipe changed all
previous plans. The Marsfontein joint venture then became part of the
Klipspringer Mine. Mining the Ml pipe has improved the company's position
by giving immediate ore reserves and cash flow while the mine establishes
ore reserves on the Leopard Fissure and does exploration on the
surrounding areas.
THE JOINT VENTURE
Following last year's battle between SouthernEra and Randgold on the
one hand and the heirs of the original mineral right owners on the
farm Marsfontein, De Beers bought up the heirs rights and negotiated
a 60% interest in the Marsfontein farm's minerals with the balance (40%)
going to SouthernEra. As part of the deal De Beers agreed to sell 49%
of its 60% share (29.4%) to various black interest groups as part of
a black economic empowerment deal. This deal does not, in any way,
impact on SouthernEra' s share of Marsfontein, which remains at 40%.
In terms of the joint venture agreement De Beers supplied the mineral
rights to the farm and SouthernEra supplied the treatment plant, which
it can purchase back from the joint venture at the end of the life of
the operations.
De Beers are the operators of the project and have the right to market
all the diamonds produced by the joint venture. The advantage to
SouthernEra is that the company gets paid within two days of the
valuation of the diamond production. SouthernEra has the right to
have their own independent valuation done on diamonds produced.
The joint venture has appointed a mining contractor to mine the
Ml pipe and to supply 2000 tonnes of minus 400 mm material to
the plant each day. The plant has a capacity of 43,000 tpm. The
pipe is yielding in excess of 418 cpht and a diamond parcel of
143,851 carats has been sold for US$168.70 per carat. Our financial
model conservatively assumes 400 cpht and 300 cpht in 1999 and 2000
respectively with a sales value of US$150 per carat.
MINE VISIT
We visited the mine last weekend (February 6) and were impressed by
the work that has been achieved during the past year. Since the Ml
pipe is fairly small (40m x 80m) it is being mined out fairly rapidly.
Mining commenced in August last year and the pit is already about
50 metres deep.
The contractors have stockpiled 225,000 tonnes of material stripped
from the top of the pipe, which grades at 30ct per 100 tonnes. as
well as 300 000 tonnes of material from a diabase intrusion running
on the extremity of the pipe, which has also been measured at
30ct/l00t. These stockpiles will eventually be treated when mining
on the pipe reaches the economic limit.
Exploration on the Marsfontein farm. which is also conducted as a
joint venture with De Beers represented by two geologists and
SouthernEra represented by two geologists, has revealed a number
of anomalies associated with diamond bearing ore:
1. Firstly, soil samples have revealed garnets and spinels
near the Ml pipe. These indicator minerals have been found on
two areas near Ml and have shown similar intensity as those originally
found over the Ml pipe. These could be the trace of pipes, blows or
they could be associated with the Leopard fissure system and further
exploration is required. Management believes that they are
definitely source anomalies.
2. Gamets and spinels in soil samples on a surface anomaly some
500 metres south of the Ml have also been found associated with
surface gravels. Gravels have been found over large areas near the
Ml pipe, which suggest that a separate alluvial deposit may occur
on Marsfontein. At one trench the top 4 metres of gravel tested an
exceptionally high grade of 137 cpht. These gravels will be treated
from March 1999 in a 50 tonne per hour plant, which is being
constructed specifically for exploration.
3. Another kimberlite pipe called M3 has been found on
Marsfontein. It has been drill tested to 100 metres with an
attractive grade of 30 cpht revealed. Management believes that
the test may understate the true grade.
These additional diamond bearing deposits have not yet been
accurately defined therefore cannot be classed as ore reserves.
However, management fells confident that the Marsfontein farm will
have adequate reserves to extend the life of the joint venture well
beyond the end-2000 when Ml pipe is exhausted. For valuation purposes
we conservatively assume that the Marsfontein JV will mine 500 000
tonnes yielding 50 cpht in 2001 and 300 000 tonnes yielding 30 cpht
in 2002.
OTHER KLIPSPRINGER OPERATIONS
LEOPARD FISSURE
The fissure system has been located along a strike length of 6 km.
The fissure has been drilled to a depth of 250 metres and has been
found to be extremely consistent in grade and chemistry. Three drill
holes have been completed and management believe that this to be
adequate given the consistency displayed by ore. In addition, the
mine is establishing 3 adits each on the east and west of the hill
closest to the treatment plant. The bottom adit is 400 metres in
length and has also given information on the resource. The fissure
has been bulk sampled on open cuts along the fissure and a 430
tonne sample gave a grade of 85 cpht with a value of US$120 per
carat. The country rock is competent dolomite therefore management
hopes to get less dilution during mining operations.
Based on a cost of R3,000 per metre and an advance of 500 metres
per month, it will cost R1.5 million a month on developing the
Sugarbird Fissure. It will require about 8 months and Rl0.5 million
to develop the approximate 3.5 km for the first adit system.
Management is experimenting on what mining method to use but the
conventional full shrinkage method usually used requires months
of development up front before any mining takes place. This is
the disadvantage whereas the advantage is that it is cheaper in
the long run.
This fissure system, unlike any of the others being mined in South
Africa, has the advantage of being controlled by one company,
which allows it to plan the best sequence of extraction.
The mining rate will be built up slowly, starting with 15,000 tpm
now and increasing to 20,000 tpm by year end. It will then
increase to 40,000 tpm when all the adits have been established
next year with a final target of 60,000 tpm planned towards the
end of 2000.
Management has a budget of R l 0 million to be spent on non
-Marsfontein development for 1999. This will virtually all be
spent on developing the Leopard Fissure adits.
SUGARBIRD BLOW
This blow was mined during the first half of 1998 while the
outcome of the Marsfontein legal battle was awaited. The blow
yielded 76 000 tonnes of kimberlite with a grade of 78 cpht and
diamonds valued at US$120 per carat, about the average of the
Leopard Fissure. The blow has reached its economic open pit limit
(some 55meters below surface) but the ore body continues below
the current pit floor where the pipe is 10 metres in diameter. It
is conceivable that mining will be continued below the existing
pit floor level using another mining method. This resource has not
been taken into account.
THE KLIPSPRINGER MINE
RESOURCES
The resource estimate consists of estimates of all sources
including SouthernEra's 40% share of Marsfontein diamonds. The total
estimated resource is summarised below:
Possible resource base of 5.5 million carats
BOE Securities Resource Estimate (SUE share only)
Source Tonnes ‘000 Grade (ct/l00t) Carats Comment
Ml pipe 518 400 2,072,000 T=40mx80mx150mdeepx2.7x0.4
Other Marstontein 400 150 600,000 M3, surface dump tonnes. some gravels
Leopard Fissure 2,700 85 2,295,000 Tonnes= 4000m x 1 m x 250m deep x2.7
Other non-Marsfontein 1,000 50 500,000 Possible
Total 4,618 118.4 5,467,000
We have a conservative estimate of the tonnage available from M3 pipe
and further bulk sample tests are required to firm up the numbers.
These resources are enough to sustain on-going operations until 2007,
which places the Klipspringer Project in the short life category.
Management is aware of this hence the strong emphasis on exploration
in order to extend the life beyond 8 years.
VALUATIONS
The Marsfontein Ml pipe is one of the richest known pipes in the world.
The problem is that it is small and will be worked out within 2 years.
In the meantime, it is providing substantial cash flow to the owners.
We estimate that the after-tax value of the pipe is US$300 million to
US$400 million, which will be earned over the next two years. This
includes 200 000 carats in stockpile and values all the diamonds at
US$150 per carat.
Ml is the highest grade kimberlite pipe in the world.
Comparative Analysis
Mine/Prolect Company Location Value Value
(US$/ct) (US$/t)
(M1) pipe SUF/De BeersSouth Africa 150 >350
Diavik (average) Aber/RTZ Canada 56 218
A-41 8 56 213
A-154S 63 289
A-154N 35 99
A-21 38 108
Ekati Panda Pipe BHP/Dia Met Canada 130 142
Tongo Fields Rex Mining Sierra Leone 175 140
Jwaneno De Beers Botswana 92 129
Ekati (average) BHP/Dia Met Canada 83 90
Venetia De Beers South Africa 60 77
Kimberley De Beers South Africa 110 110
Jericho JD/OD-1 Lytton Canada 60 56
Jubilee ALROSA Russia 100 53
Letlhakane De Beers Botswana 169 49
Catoca ALROSA/Endiama Angola 88 40
Argyle CRA/Ashton Australia 07 42
Premier De Beers South Africa 70 34
Orapa De Beers Botswana 44 32
Finsch De Beers South Africa 40 30
Camafuca SouthernEra/EndiamaAngola 100 17
Camatchia Diamond Works Angola 100 8
OPERATING COSTS
Operating costs are estimated, and used in our financial models, as
follows:
· open pit operations US$20 per tonne
· alluvial US$15 per tonne
· underground, fissure mining US$28 per ton
OTHER INTERESTS
ANGOLA
The company has withdrawn from its Luo and Cassanguidi concessions
and handed them back to its partners, Sphere Mining, but retained
a 10% interest. The political problems, which require vast sums of
money to secure the properties combined with operating difficulties
forced the withdrawal. Luo was losing money having mined out all
the best channels and Cassanguidi could only be mined 3 days per
week due to the strong river flow which continuously covered up
the river-bed gravels with sediment.
The company it still testing the Camafuca pipe and has collected
150,000 tonnes of ore that will be treated in a small plant being
constructed on site. Chris Jennings believes that the rim of the
pipe contains higher grade ore and that the pipe has been undervalued.
This will have to be proven. We understand that the Carnafuca pipe
lies near government forces stronghold and is not likely to be
attacked. However, Angola is in the throes of a civil war therefore
there can be no guarantee of security of tenure to any property in
the country.
We have a valuation for the Carnafuca pipe, which is valued at
C$0.70 per SouthernEra share using a 10% discount rate. However,
we do not include it in our evaluation due to the uncertainties
of Angola.
CANADA
Exploration on the company's has taken a back seat while it
concentrates on developing Klipspringer which holds the most
promise of future reserves.
POOR INVESTOR RECEPTION IN CANADA
SouthernEra's share price has had a tornd time on the Toronto
stock exchange. In the past year the share has oscillated from
a high of C$13.80 per share to a low of C$4.50 per share, rising
to C$9 per share just to fall back to the current C$7 per share
level. This after the company has done an excellent job in exploring
and developing the Klipspringer Project, and the Ml pipe in particular.
The Canadian investors are just too far from the company's primary
operation and lack the understanding of, and commitment to, the
company's operations. Apart from a few die-hard investors we believe
that the shares are held in weak hands. South African investors, on
the other hand, would love to invest in a Klipspringer Mine and would
certainly give the share a higher rating than their counterparts in
Canada. Our experience is that there is a high level of interest in
the Klipspringer Project amongst local investors. A dual listing is not
possible due to the South African Reserve Bank's exchange control
regulations thus we believe that management should seriously consider
seeking a primary listing in South Africa.
VALUATION
ABSOLUTE
VALUATION
Discount Rate %pa 5.0% 7.5% 10.0% 15.0% 3.5%
Klipspringer Project (C$ millions) 348 320 296 257 367
(pershare) 13.38 12.32 11.39 9.88 14.11
Cash (per share) 0.82 0.82 0.82 0.82 0.82
Mineral Properties (per share)
TOTAL (pershare) 14.20 13.14 12.21 10.70 14.93
The current share price of C$7.05 per share is well below the valuation of
C$14.93 per share.
RELATIVE VALUES
Canadian companies are discounted at a rate calculated by subtracting
from the rate applied to De Beers the differential in the long-term
(5 years) inflation rates of South Africa and Canada, which is 6.71%
per annum.
This means that, for calculating absolute and relative valuations,
the discount rate applied to Canadian shares is 10.2% minus 6.7% equals
3.5%.
The following table shows the valuation results of all major
developing/producing diamond-mining companies in South Africa and Canada.
Share Prices at February 11, 1999
Share Price Market Cap. Price/DCF 1-yr ret. 3-yr ret. Curr.PE PE Applied
(R) R'mill 1-yr 3-yr
Trans Hex 19.50 301.4 0.45 -19.3 36.5 4.2 6.0 8.0
ICH 19.95 210.9 0.64 -2.2 26.9 5.5 6.0 9.0
Gem 1.75 184.7 0.60 -33.7 42.9 n/a 6.0 8.0
Ocean Diam.2.95 131.5 0.65 -67.8 10.3 5.5 7.0 9.0
Benco 0.40 35.9 0.90 -64.8 -16.0 n/a 4.5 9.0
Wt. Average 0.58 -27.5 29.4
De Beers 96.20 33315.8 0.90 1.8 2.3 6.9 9.0 9.0
Anamint 88.40 8079.8 0.74 2.3 2.9 6.1 9.0 9.0
S.A. Wt. Av. 0.87 1.3 3.0
Canada (C$) C$'mill
Dia Met 17.50 574.7 0.65 85.7 29.4 n/a 20.0 20.0
Aber 10.15 464.6 0.21 54.4 35.2 n/a DMM ratio/applied
SouthernEra 7.05 202.5 0.47 183.9 59.1 n/a 10.0 20.0
Namco 3.70 138.9 0.21 -92.1 94.4 n/a 20.0 0.0
DMW 0.30 33.1 0.05 97.2 108.6 n/a 7.5 5.5
Wt. Average 0.42 72.3 43.8
Overall Wt. Average 0.79 13.28 9.87
The table illustrates that Canadian investors have downgraded their
diamond share investments. A year ago the Price/DCF ratios of Canadian
shares were about twice today's level.
In deriving the one- and three-year returns, we apply the PE ratios
shown to calculated earnings in those years to estimate share prices
in the same period, then we calculate the return from the capital gain
plus any dividends paid. The high return shown by SouthernEra on a
one-year view is due to the exceptional cash flow generated by the
rich Ml pipe.
CONCLUSION
SouthernEra will enjoy very high cash flow in the short term from
Ml pipe mining. However, management states that dividends will not
be paid for some years due to the need to develop the mine on the
Leopard Fissure, which is perceived as the mine's long term “bread
and butter” deposit.
Klipspringer Mine has the potential to become the largest and most
successful diamond operation outside of Venetia in South A.frica.
The lease area contains numerous discoveries of diamond significance
and these will be proven in the next 12 months. The company has
already made great strides in developing the project.
We believe that SouthernEra will be better served by South African
investors that are hungry for a listed, classy onshore diamond
mining company. We recommend, therefore that the company seriously
consider moving its primary listing to Johannesburg.
The share rates as a BUY at C$7.05 per share. |
