Nevsun Resources Ltd. (NSU:TSX; NSU:NYSE.MKT, US$2.45), released its eagerly awaited Pre-Feasibility Study (PFS) for the Timok Upper Zone project in Serbia, a study we thought both positive and prospective. There were some changes from the Preliminary Economic Assessment (PEA), related in October, but even where the changes were apparently negative, there are reasons.
Shorter mine life?
The study calls for a 10-year mine life—lower than the 15 years in the PEA—due entirely to a lower reserve (27 million tonnes). This figure excludes 14 million tonnes of inferred resources, which cannot be included in a pre-feasibility study, although most of it is expected to be mined eventually. The company said it expected to extend the life of mine beyond the PFS's 10 years.
The total capex up to production increased from $630 million to $688 million, $114 million of which is to be spent before a production decision. This is still a very low number for such a large deposit, with payback of full capex expected in less than one-and-a-half years. In the PFS, the company split its pre-decision and post-decision capex, whereas it was combined in one capex line item in its PEA. It should be noted that the capital required does not include three payments (totalling $95 million) due to Freeport, in 2019, 2021 and 2022 (at current schedule).
Assumptions changed
Frankly, I think when the PFS is released only five months after the PEA, there should be similar parameters used, absent dramatic changes in commodity or currency prices, for a simple apples-to-apples comparison.
In like manner, the company used a copper price of $3.15 for its PFS compared with $3 for the PEA. Today's price is $3.06. The long-term assumptions on a 10-15 year mine starting in 2022 should not be changed in five months, especially when the copper price on the PFS release date was actually lower than when the PEA was released. Why increase the price assumption?
Although Nevsun did disclose these changes, the simple table was picked up by many so-called analysts who said the capital had been reduced and the payback (less than one year for the post-decision capex only) shortened. Headlines I read include "capex reduced," "smaller resource" and "payback time shortened."
This takes away somewhat from what was a very positive and exciting study, showing a robust project with lots of upside, both from this deposit and the potential for satellite deposits.
Timeline delayed
One negative is that initial production has been pushed back to 2022, with "in operation date" of 2023. However, CEO Peter Kukielski said he was confident that they can bring forward the start date, particularly given Serbian government support of both the project and the company. He stated that it was not a complex mine, one that would use conventional facilities, and that Nevsun had a team "eminently capable of building (it)."
Next steps are the start of construction of the decline, June this year; an initial resource for the Lower Zone (in joint venture with Freeport) in the second-half of this year; and a Full Feasibility Study in mid next year. All the while, ongoing exploration will seek additional deposits.
Does Bisha add value?
Nevsun has $148 million in cash, and with Bisha apparently improving its recoveries, the cash flow from that mine will add to the cash pile. The company believes it can raise the capital required without additional equity; bank financings (expected to be 50-60% of capital), plus strategic partnerships (for offtake agreements and so forth), and a stream on the gold are under consideration.
Kukielski was asked if he had considered selling Bisha in order to raise capital for Timok, with the questioner adding that such a sale would likely improve the market perception—and stock price—of the company. Kukielski replied that he thought it "highly unlikely" the company would receive full value and noted that Bisha provides strong cash flow.
Top project has potential to exceed expectations
It seems clear that Nevsun wanted to put out a conservative PFS, with numbers that would likely be improved, and also a mine plan to ensure a quick payback (with copper production front-loaded, with first full-year estimated to produce 180 kt, reducing to less than 140 kt in the second full year, and declining steadily after that). There's nothing wrong with either aim.
In short, we agree with Kukielski's opinion that Timok is one of the best, if not the best, undeveloped copper project in a relatively low-risk country and with low capital costs.
Separately, the company released ongoing drill results from the Lower Zone, which continue to enhance the potential for a large underground resource.
We believe—absent any unexpected negative development either in Eritrea or in Serbia—Nevsun stock will steadily trend upwards from here. It has already appreciated from $2.25 before the release of the PFS. We would not be surprised to find a larger company make an offer—perhaps Lundin (who tried to buy Timok before), or Freeport itself (but after the Indonesia saga is concluded). If you do not own, look for pullbacks to buy. Otherwise, hold on for the ride, trimming on strength if you own too much.
Stock market and tax query hurt Franco
Franco-Nevada Corp. (FNV:TSX; FNV:NYSE, US$67.87) has been weak on two factors. First, declines in the broad stock market affect Franco more than most gold companies, given that it is widely held by generalist funds, whose fund flows are more sensitive to the general market.
Second, Franco disclosed in its recent MD&A report that the Canadian Revenue Agency was conducting an audit of the company's 2012, 2013 and 2014 tax returns. This follows the very public dispute between CRA and Wheaton Precious Metals over the way it books revenue from its offshore subsidiary.
Booking revenues from offshore streams through offshore entities is very common, and both companies have said that they believe they are fully complying with the rules and regulations. Were Franco's structures to be disallowed, the back taxes owed would be relatively minor: approximately 9% of total revenues for 2012 and 2013 and 19% for 2014 (or a total 5% of total Net Asset Value), meaningfully less than for Wheaton. Going forward, however, the impact would be more meaningful, since Franco has invested in major streaming deals in recent years, mostly through the offshore units.
Franco remains a top company, with solid balance sheet, strong cash flow, and a deep pipeline. Notwithstanding the potential result of the tax examination, Franco is a strong buy here after the recent price decline.
Adrian Day, London-born and a graduate of the London School of Economics, heads the money management firm Adrian Day Asset Management, where he manages discretionary accounts in both global and resource areas. Day is also sub-adviser to the EuroPacific Gold Fund (EPGFX). His latest book is "Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks."
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Disclosure:
1) Adrian Day: I, or members of my immediate household or family, own shares of the following companies mentioned in this article: Nevsun Resources and Franco-Nevada. I personally am, or members of my immediate household or family are, paid by the following companies mentioned in this article: None. My company has a financial relationship with the following companies mentioned in this article: None. Funds controlled by Adrian Day Asset Management hold shares of the following companies mentioned in this article: Nevsun Resources and Franco-Nevada. I determined which companies would be included in this article based on my research and understanding of the sector.
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