Karora Resources: An Upgrade To The Investment Thesis (OTCMKTS:KRRGF)
It’s been a relatively quiet year for M&A in the gold space after a flurry of deals in 2021 that led to meaningful consolidation in a sector that desperately needs more of it, especially with inflationary pressures weighing on margins. However, this came to a halt with Karora’s (OTCQX:KRRGF) bold acquisition of a new mill in Australia, providing a more direct path for its Beta Hunt material, plus giving it an immediate ~60% boost in processing capacity and increasing its long-term production potential. Given Karora’s rare combination of growth and margin expansion, I would view sharp pullbacks as buying opportunities.
All figures are in United States Dollars and converted at an exchange rate of 0.80 to 1.0 Canadian Dollars to United States Dollars and 0.72 to 1.0 Australian Dollars to United States Dollars.
It’s been a relatively slow week for news in the gold sector, but Karora Resources (“Karora”) has had a busy week, reporting three major news items. The first was that its second decline at Beta Hunt is progressing ahead of schedule and on budget and that it had made the discovery of a new shear zone. The second was that it had entered an agreement to acquire the Lakewood Mill just west of Bulong, providing a more direct route for material from its Beta Hunt Mine. The final news was the announcement of a ~$40 million bought deal at ~US$3.85, with an option for a 15% overallotment.
While some investors might be less enthused with the final piece of news, and dilution from a producer is rarely ever welcome, the other two pieces of news could be game-changers. For starters, the Beta Hunt orebody is the gift that keeps on giving, and the potential for further reserve growth with a new shear zone (Sorrenson – which lies east and parallel to the A Zone and Western Flanks) suggests that this mine throughput expansion at Beta Hunt is long overdue. The second piece of news is even more exciting, though, which we’ll discuss in more detail below.
Karora Resources announced its agreement to acquire the fully permitted Lakewood Mill that lies 60 kilometers north of Beta Hunt for ~$58 million, with the majority paid in cash. This mill is fully permitted and has a processing capacity of 1.0 million tonnes per annum, potentially increasing capacity to 1.2 million tonnes per annum once commissioned. This is a huge deal for Karora, immediately boosting its processing capacity to 2.6 million tonnes per annum or 2.8 million tonnes per annum with the 20% expansion to the Lakewood Mill.
Looking at the map, we can see why this acquisition makes a lot of sense, especially in a rising fuel cost environment. As shown above, the Lakewood Mill lies a similar distance away from Higginsville (south of Beta Hunt), but Lakewood is a little closer. So, not only does this reduce bottlenecks at the Higginsville [HGO] Mill with two mines (and one that’s seeing increased throughput) all going to a single processing plant, but it could also provide some fuel savings.
Just as importantly, the acquisition of this mill significantly de-risks Karora’s previously planned expansion at HGO from 1.6 million tonnes per annum to 2.5 million tonnes per annum. This is a big deal from a potential capex standpoint and a labor standpoint, with skilled labor being very tight in many major mining jurisdictions (Ontario, Quebec, Nevada, Western Australia). While the updated capacity (post-deal closing) will be well above the current mine throughput, Karora will explore toll-milling opportunities to fill spare capacity until the Beta Hunt Expansion is complete in 2024.
As discussed previously, it’s understandable that some investors might not be elated with the news, given that there’s only been a 12% increase to the previously expected processing capacity (2.8 million tonnes per annum vs. 2.5 million tonnes per annum), but it’s costing 10% in share dilution. However, while Karora’s growth plan was very simple, as the famous saying by Mike Tyson goes, “everyone has a plan until they get punched in the mouth.”
At the time of the upgraded 3-year outlook, I would argue that Karora’s management might have thought that things might improve from a labor and supply chain standpoint and that inflationary pressures might remain elevated but not worsen. However, vaccination rules in Australia have contributed to an even tighter labor market, and supply chain headwinds have persisted longer than most expected. Finally, inflationary pressures have worsened, and rapidly increasing diesel prices were one area that few producers likely saw coming, at least to this degree. Hence, a very simple growth plan (increase mill throughput, add a second decline) suddenly got much more complicated.
Armed with a very strong balance sheet ($60+ million in cash), and a goal to continue to over-deliver on promises, this acquisition is a prudent way to place Karora in a better position to deliver on its growth plans of ~195,000 ounces per annum in 2024. This is because the company can now dedicate its focus to the second decline at Beta Hunt, exploration, and the nearly completed mill expansion at Higginsville (1.6 million tonnes per annum). In addition, it has more in its control, both from a labor and capex standpoint, given that it’s not having to do a major expansion at the HGO mill (+900,000 tonnes per annum), and make sure it can source the labor for both the second decline and the expansion.
To summarize, while the short-term increase in throughput may not be much different from the previous plans, the growth plans just went from a little ambitious and potentially over-budget (at least in the current labor/inflationary environment) to very achievable and possibly under budget. The reason is that to date, the second decline is tracking ahead of schedule and on budget, a testament to this team’s ability to deliver on its promises.
Long-Term Growth Potential
While the immediate increase in throughput and de-risked growth plan is great, it’s worth digging into the upside of this deal. As noted earlier, throughput will increase to 2.8 million tonnes per annum combined, which would support a ~190,000-ounce production profile at an average grade of 2.25 grams per tonne gold (blended head grade). However, suppose Karora can build on its reserves at Higginsville. In that case, it could look at completing its previously planned mill expansion (1.6 to 2.5 million tonnes per annum) once the current growth plan is executed.
With a massive land package south of Beta Hunt that includes HGO Greater, Lake Cowan, Spargos, and Mount Henry, these deposits could easily support mine production of 1.5+ million tonnes per annum long-term. So, assuming Karora was to add 900,000 tonnes per annum of capacity and expand the HGO Mill in line with previous plans, this could add an incremental ~50,000 ounces per annum to the production profile post-2025. Hence, the previous growth outlook of 195,000 ounces (mid-point) could become 240,000 to 250,000 ounces, dependent on head grades.
While it’s early to speculate on this potential, this would be a massive upgrade to the investment outlook, with a 250,000-ounce plus production profile potentially supported if Karora continues to make high-grade discoveries at Beta Hunt. Meanwhile, the nickel component should help immensely from a by-product standpoint, providing a clear path to sub $950/oz costs at a ~190,000-ounce production profile and the potential for sub ~$920/oz costs at a larger ~240,000-ounce production profile with HGO benefiting from economies of scale. Even at a gold price below spot prices, this could translate to industry-leading ~50% AISC margins post-2025.
Karora is currently in a population of few, being a dual-asset producer operating out of solely Tier-1 jurisdictions with all-in sustaining costs below the industry average ($1,150/oz). The only other comparable names within this group in the 125,000-ounce to 300,000-ounce production range are Wesdome Mines (OTCQX:WDOFF), Silver Lake Resources (OTCPK:SVLKF), and Ramelius Resources (OTCPK:RMLRF). Historically, these names have traded at a premium valuation, and the average enterprise value for these three companies currently is ~$1.10 billion, with Wesdome being valued the highest at ~$1.3 billion.
While Silver Lake and Ramelius beat Karora and Wesdome in terms of their production profiles, Wesdome and Karora are in a league of their own from a cost standpoint. This is because Wesdome and Karora’s 2024 costs are likely to come in below $925/oz despite inflationary pressures, more than $200/oz below the estimated FY2024 all-in sustaining costs for Silver Lake and Ramelius of ~$1,175/oz, and $1,150/oz, respectively. Therefore, I would argue that Karora should trade at a slight premium to Silver Lake and Ramelius and closer to Wesdome at $1.30 billion.
Having said that, Wesdome has Karora beat on grades with two of the highest-grade gold mines globally, and it’s also a larger producer, ramping up 210,000+ ounces by FY2024 with the help of Kiena. For this reason, I think it’s a stretch to assume that Karora would command a similar P/NAV multiple (1.20x or higher) and a similar market cap. Still, I think an enterprise value of $1.10 billion for Karora is attainable if it can deliver on its growth plans, which would be 190,000 ounces per annum in 2024 at all-in sustaining costs below $925/oz with the potential for further upside down the road from a mill expansion [HGO].
Based on an estimated 176 million fully diluted shares (over-allotment), this would translate to a fair value of US$6.25 for a 2-year target price. From a current share price of US$4.00, the updated price target would represent more than a 50% upside. This price target also assumes that Karora doesn’t get any help from the gold price, which could translate to a premium valuation for gold producers with higher cash flow multiples. So, while we could see some short-term pain from the share dilution, I think the long-term picture just became much brighter.
Previously, Karora Resources looked fully valued and even a little overvalued at its previous highs, given that while its growth plan was relatively simple, it looked like its upside was capped at 200,000 ounces per annum. However, this recent acquisition has not only de-risked its growth plan, but it’s also potentially pushed its long-term production potential to 250,000 ounces and could provide savings on haulage costs. Hence, investors should be very pleased with this recent move. Given Karora’s rare position as a solely Tier-1 producer with solid organic growth and industry-leading margins, I would view sharp pullbacks as buying opportunities.