Royal Oak feels pinch of debt, high costs
Kemess seen as crucial to gold miner's health
Monday, September 28, 1998
PETER KENNEDY
British Columbia Bureau
Vancouver -- In spite of stronger gold prices and some encouraging words from a key creditor, Royal Oak Mines Inc. is expected to continue to be squeezed by onerous debt payments and the cost of running its aging mines.
While Royal Oak is trying to shed its high-cost image by developing the $480-million Kemess gold and copper mine in British Columbia, the Kirkland, Wash., company remains one of North America's highest-cost gold producers.
And without a more substantial increase in gold prices, analysts expect the company to remain under severe pressure until it can prove that Kemess is capable of being the low-cost operation that Royal Oak chief executive officer Margaret Witte has said it will be.
Royal Oak officials did not return phone calls last week. But the company signalled that it is feeling the pinch, by disclosing plans to take a pretax writedown of $81-million in its third-quarter results.
News of the writedown -- which reflects the impact of weak bullion prices on the value of reserves at Royal Oak's mines in Ontario and the Northwest Territories -- has provided ammunition for those who worry about the company's future.
"Royal Oak has no room to manoeuvre from a financial standpoint," said John Ing, president of Maison Placements Canada Inc. in Toronto. "Kemess is over budget, gold prices are low, and the company is stretched to the limit. . . . It's not a very desirable position to be in."
In addition to a $120-million (U.S.) loan from Trilon Financial Corp. and an affiliate, Royal Oak has $175-million in senior subordinated notes outstanding.
The company made a $10.4-million interest payment on those bonds on Aug. 15, and faces an $11-million payment Feb. 12.
Michael Jalonen, an analyst with Merrill Lynch Canada Inc. in Toronto., said Royal Oak is now more dependent then ever on its ability to get the new Kemess mine up and running as designed.
At full speed, Kemess is designed to produce 250,000 ounces of gold at a low cash cost of $79 an ounce. If it was running at capacity, it would account for 73 per cent of the 340,000 ounces of gold that Royal Oak expects to produce this year.
The costs are expected to be so low because the company plans to count revenue from future copper production at Kemess against the cost of mining the gold.
However, Kemess is not slated to reach commercial production until the end of this month, and Mr. Jalonen said investors won't know how the mine is doing until operating results are released for the third quarter, which ends Sept. 30. "We need to see the production numbers and recovery rates to get an idea about the health of the mine."
Meanwhile, investors appeared to regard the writedown as a non-event. Since it was announced late Tuesday, the company's share price has fallen only slightly. The stock closed Friday at $1.14 (Canadian) on the Toronto Stock Exchange, up 3 cents on the day and down from $1.17 when the writedown was announced.
"This news wasn't unexpected," said Dorothy Atkinson, a mining analyst with IPO Capital Corp. in Vancouver.
Others point out that there may be some reason for optimism, after seeing gold recover to $293.90 (U.S.) an ounce on Friday from a 19-year low of $274.60 in late August.
"Their financial picture can change if [they] get a shot in the arm with the price of gold," said Larry Pezim, a broker with Goepel McDermid Inc. in Vancouver. "Basically, these guys have to pray for a better gold price."
Last week, Royal Oak said covenants on its loans have put limitations on its ability to protect itself from fluctuating commodity prices by selling gold on the forward markets at a premium above the current rates. As a result, the company says it is now selling its entire production on the spot market.
That marks a big change for a company which realized an average of $481 an ounce for the 389,203 ounces of gold it produced in 1996. That year Royal Oak achieved the highest realized price of any gold producer in North America.
By contrast, Royal Oak realized an average of $343 an ounce for the 91,289 ounces of gold it produced in the six months ended June 30. While its cash cost for gold production averaged $268 an ounce during that time, the company still reported a loss of $32.7-million (Canadian) or 24 cents a share, on revenue of $45-million. That's because the cash cost doesn't include costs such as interest payments.
Royal Oak's cash costs are well above those of rivals Placer Dome Inc. and Barrick Gold Corp., which are under $170 (U.S.).
Royal Oak attributed the first-half loss to lower gold prices and production as well as a writeoff of deferred financing costs relating to the retirement of debt.
In the first six months of 1997, Royal Oak also reported a loss, of $60.2-million (Canadian) or 43 cents a share, on revenue of $106-million.
Mr. Pezim doubts that creditors such as Trilon and its affiliate, Northgate Exploration Ltd., will let Royal Oak falter, after providing the company with the $120-million (U.S.) loan to pay contractors involved in construction at the Kemess mine. The loan carries an interest rate of 11 per cent, as well as fees, and a royalty interest in Kemess gold reserves.
"These guys have deep pockets and I tend to think that they aren't going to let this company go under no matter how many writedowns it takes," Mr. Pezim said.
Northgate Exploration's chief executive officer, Terry Lyons, said he visited the Kemess property last week and is pleased with Royal Oak's progress.
"I think they will make commercial production within the parameters set out in the loan agreement," he said. "They are not at commercial production yet, but they are getting there."
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