CNMC Goldmine | 1H20 Update
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CNMC recorded a headline loss of US$1.1M in 1H2020 as revenue fell by 48.6% yoy due to a significant drop in gold production resulting from MCO restrictions and lower grade ore
Excluding unrealised FX losses due to MYR depreciating against the dollar, headline net loss would have been lower at US$0.4M. MYR has since seen a steady recovery against the USD
Gold has continued to rally and surpassed its 2011 peak of US$1,921/oz. Our outlook for gold for 2H2020 remains positive
Open-pit mining has fully resumed since 6 May 2020 and processing capacity beginning June 2020 is comparable to pre-COVID levels
Underground miners are expected to return to Kelantan in September and the processing of higher grade ore from underground mining is expected to occur in 4Q2020
CNMC has largely performed in line with our expectations and we remain optimistic of a strong showing in the 2H2020 print. We raise our fair value estimate to S$0.40 to account for higher expected gold prices.
CNMC published their 1H2020 financial results on 14th Aug 2020 and we participated in the virtual results briefing to gather more insights on the current business environment. The teleconference helped bolster our belief that while 1H2020 results had been hurt by COVID-19, CNMC is on the road to recovery. This post summarises the key events that led to its 1H2020 performance as well as our outlook on the group going forward.
Revenue fell by 48.6% yoy to $10.5M largely due to two factors: (1) significant drop in gold production as a result of the COVID-19 fallout and (2) lower grade ore.
Gold sold declined by 60.2% yoy to 6,222oz. Due to Malaysia's Movement Control Order (MCO), CNMC had to halt all mining activities for seven weeks between 18 March 2020 to 5 May 2020, denting gold production. Management also mentioned that time was taken to service the machines post-shutdown before processing activities can fully resume, further delaying gold production. However, CNMC was allowed to fully resume open-pit mining beginning 6 May 2020. Management also indicated that processing capacity beginning June was comparable to pre-COVID levels, signifying that the worst is over for CNMC in our view.
Apart from the disruption caused by COVID-19, lower ore grades also contributed to the decline in gold sold. However, management noted that a new zone at Sokor that contains better grade gold ore near the surface has recently been discovered. The open-pit mining crew will be focusing on this zone in the near term. Coupled with the resumption of underground mining in 4Q2020, we can reasonably expect improved ore grades in 2H2020.
Lower gold production was offset by a 29.0% yoy increase in averaged realised gold price to US$1,683/oz, allowing revenue to fall by a smaller extent.
Operating profit swung to a US$1.2M loss from a US$4.0M profit a year earlier. On the cost front, the group managed to reap cost-savings in the form of lower site and factory expenses (-30.9%) and rental and other lease expenses (-30.9%) from the production halt. Key management remuneration also more than halved to US$0.79M in 1H2020 as executives took pay cuts. However, a large part of its costs remain fixed and the cost savings were insufficient to offset the decline in revenues.
Accordingly, CNMC ended 1H2020 with a headline net loss of US$1.1M, down from a $2.9M profit a year earlier. Excluding the impact of unrealised FX losses due to the depreciation of the MYR against the dollar, headline net loss would have been US$0.4M.
Despite these short-term headwinds, CNMC's balance sheet remains sound with net cash of US$10.3M as at 30 June 2020. Management also affirmed that they have no plans to raise debt and that the group has enough cash to tide through the crisis and carry out planned expansions.
1. Higher grade ore from underground mining expected to be processed in 4Q2020
In our [previous article], we mentioned that we expect the underground mining team to only return to Kelantan in mid-September which is largely in line with recent management guidance. Management mentioned that they have since been able to obtain the official green light for some of the Chinese expatriates to fly back to Malaysia, with the first batch expected back in Malaysia by end-August. Upon arrival in Malaysia, all workers have to be quarantined for 14 days before they can travel to Kelantan. Hence, barring any unforeseen circumstances, the underground mining crew is expected to be back in Kelantan by September.
Following the return of the underground mining crew to Kelantan, management also indicated that 2-3 weeks of infrastructural works will be required before the miners are able to reach the high grade ore zone underground. Therefore, the processing of higher grade ore is expected to occur only in 4Q2020, which is once again in line with our expectations as mentioned in our previous article.
2. Gold prices remain supported by safe-haven demand
Since our previous article, gold has continued to rally and surpassed its 2011 peak of US$1,921/oz. Our outlook for gold for 2H2020 remains positive due to a confluence of factors. We stand by our view that prolonged low interest rates, economic uncertainty as well as rising geopolitical tensions between the US and China are expected to continue driving safe-haven demand for the precious metal. Gold-backed ETFs recorded their eighth consecutive month of positive flows, 177t or US$9.7B of AUM in July (Source: Gold.org). In addition, Goldman Sachs expects gold to continue trading in the range between US$1,800/oz to US$2,000/oz in the months ahead (Source: MarketWatch).
3. Recent USD weakness is highly supportive of CNMC
Included in the US$1.1M headline net loss recorded in 1H2020 was an unrealized US$0.67M foreign-exchange hit stemming from the MYR’s depreciation against the USD in 1H2020. However, we do not see USD strength persisting in 2H2020.
The USD has been on a downtrend since March as factors that once supported the USD are now waning. USD interest rates are converging to other developed economies’ interest rates. The 10-year US Treasury yield fell from 1.9% in January 2020 to 0.71% at time of writing. The narrowing of interest rate spreads makes the USD less appealing to investors relative to other currencies. Additionally, as more and more countries start to reopen and business sentiments improve, improved risk sentiments also helped push the dollar weaker.
The above illustrates the impact of a 10% strengthening of USD against the SGD, HKD and MYR on FY2019 retained earnings. Hence, USD weakness is expected to benefit CNMC since its revenue is denominated in USD while costs are mainly denominated in MYR. As of writing, the MYR/USD pair has already retraced ~6% from its March highs of 4.44.
As of writing, CNMC’s share price is S$0.305, 8.2% shy of our previous fair value estimate of S$0.33. In light of the higher gold prices and the updates provided by management during the 1H2020 earnings release, we have made several changes to our model, which you can download in our [Telegram Channel]:
1. Increased average realised gold price
In light of the fact that gold prices at time of writing was US$1,949/oz and that average realised gold price in 1H2020 was US$1,638/oz, we have revised our average realised gold price upwards.
2. Reduced ore produced via underground mining
Management guided that the initial goal for underground mining would be to mine 50t to 100t of ore per day, before ramping up production to 300t to 350t per day. Hence, we have revised our projections accordingly.
We derived an updated fair value/share of S$0.40 for CNMC using a Discounted Cash Flow Model (DCF) with the Gordon Growth Method as our primary valuation method. This is 31.1% above the last closing price of S$0.305. We also supported our valuation with a DCF using the Exit Multiple Method, which yielded a fair value/share of S$0.38. We will adjust the model accordingly as the ongoing narrative develops.
1. Fall in gold prices
While we are bullish on gold, we do not rule out the possibility of a sharp downward correction in the months ahead. Events like the discovery of a safe and effective vaccine for COVID-19 earlier than anticipated have the potential to reverse gold’s safe-haven flows.
Given that CNMC does not hedge its commodity price risk, a sharp fall in gold prices will have an adverse impact on CNMC’s earnings. According to our sensitivity analysis, every US$100 fall in gold price translates into a S$0.07 fall in CNMC’s fair value estimate.
Compared to our previous article, our new fair value estimate is more sensitive to changes in gold prices (up from a S$0.05 fall for every US$100 fall in gold price) since we revised gold prices upwards and gold production downwards in our updated model.
2. Escalation of COVID-19
CNMC’s underground mining crew to is set to return to Kelantan in September, barring any unforeseen circumstances. Should there be a second or third wave in Malaysia or China, the commencement of underground mining might be delayed to 2021.
Since our initiation on 23 June 2020, CNMC has risen 38.6% from S$0.22 to S$0.305 at the time of writing. It reached an intraday peak of S$0.39 on 28 July after gold prices rallied above US$1,900/oz on 27 July, surpassing its 2011 record. While we raised our fair value estimate to S$0.40 to account for the higher gold prices, our outlook for CNMC remains largely unchanged.
During the recent EGM held on 26 June 2020, shareholders have also approved the adoption of a share buyback mandate. Hence, we can expect to see value-accretive buybacks if the market severely underprices CNMC going forward.
Judging by CNMC's large intra-week price swings over the past few months leading up to the earnings release, market participants betting on gold price movements seem to be engaged in a speculative tug-of-war. However, we note that gold price in 2H2020 has thus far been materially higher than the ~US$1,500/oz levels seen in 2H2019. Furthermore, given management's upbeat outlook for the rest of the year, we remain optimistic that there will be a fundamental reason for re-rating come 2H2020 as gold production normalizes and CNMC successfully capitalizes on the higher gold prices.
Thanks for reading,
Disclaimer: We are long CNMC at an average price of $0.21. This is not a buy recommendation, this is only for educational and discussion purposes.
Cover photo source: Vladimir Patkachakov on Unsplash
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