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  • Elena Lam

CNMC Goldmine | Initiation

Updated: Jun 23

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Key Points

  • Strong execution and effective cost management has allowed CNMC to remain profitable since 2012


  • Spot gold is at its seven-year highs driven by a host of uncertainties such as the U.S. China trade war, a slowing global economy and the COVID-19 pandemic


  • We believe that the prolonged low interest rate environment, economic uncertainty, as well as geopolitical tensions between the U.S. and China will continue to drive safe-haven demand for precious metals like gold


  • While CNMC has been left behind in the 2020 gold miners rally due to a spate of unfortunate events such as the Malaysian Movement Control Order, we believe that the worst is over. As such, we expect gold production in 4Q2020 to be boosted by the commencement of underground mining and higher heap leach recovery rates


  • CNMC’s strong cash position, low liabilities and superior liquidity ratios will allow it to tide through its misfortunes


  • We expect CNMC’s margins to be boosted by lower oil prices, a key mining consumable contributing an estimated 15-20% of CNMC’s all-in sustaining costs


  • CNMC has significant exploration upside supported by its strong track record of active exploration and its Kelgold and Pulai projects hold promising potential


  • Applying a WACC of 12.11% and an EV/EBITDA exit multiple of 4.0x, we arrived at an estimated fair value of SGD0.33 using the Exit Multiple Method, representing an upside of 59.3%. Our fair value is also supported by the Gordon Growth Method, which yielded a fair value per share of SGD0.33

Company Overview

CNMC Goldmine Holdings Limited (CNMC) together with its subsidiaries are principally engaged in the business of exploration, mining of gold and the processing of mined ore into gold dores. The Group commenced operations in 2007 and is the first Catalist-listed gold producer on SGX-ST. The group currently has 3 projects in the State of Kelantan, Malaysia.

The Sokor Project, which achieved its first gold pour in 2010, is the group’s flagship project covering an area of 10sqkm with 5 identified gold deposits. As of 31 December 2019, estimated total gold resources at Sokor are 16.32 Mt at 1.7 g/t gold grade, which translates into 900,000oz of contained gold. In 2017, the group had also completed the acquisition of a 100% stake in Kelgold Mining Sdn. Bhd., which owns a 15.5sqkm greenfield project that can potentially increase the group’s gold production, as well as a 51% stake in Pulai Mining Sdn. Bhd., which owns a 38.4sqkm brownfield project that can potentially yield gold, iron ore and feldspar.

CNMC uses a combination of heap and vat leaching and CIL processing to process ore that has been mined.


Key Milestones since IPO

2011

  • 28 October: CNMC’s shares commenced trading on Catalist, with placement of 41,100,000 placement shares (23,900,000 new shares and 17,200,000 vendor shares) at SGD0.40 each

2012

  • 30 December: Commissioned 70kt Heap Leach Facility at Sokor

  • First-year of net profitability since the commencement of exploration operation in 2007

2013

  • 3 January: Heap leach operation enters production and achieves first gold pour

  • 20 September: Commencement of production at CNMC’s second leach yard

  • 18 November: Commissioning of second gold de-absorption plant, tripling total de-absorption capacity. The Group will be able to handle the gold loaded carbon generated from the Group’s estimated heap leaching capacity of 1Mt of ores when the third leaching pad, which is currently under construction, starts operation

2014

  • 20 May: Commencement of production at CNMC’s third leach yard with leaching capacity of up to 600kt, bringing combined leaching capacity to 1Mt

2015

  • Produced record 31koz of gold in FY2015 up 19% year-on-year

2016

  • 23 August: Approval of application for large scale operation status for Sokor. CNMC is now allowed to mine unlimited amounts of ore at Sokor

  • 22 September: Output at Sokor exceeds 100koz, surpassing initial ore reserves estimate

  • Restarted a vat leach facility at Sokor that increased the group’s leaching capacity by approximately 200kt of ore. The Group’s total estimated processing capacity increased to 1.2Mt

2017

  • 20 January: Mining lease extended to 31 December 2034

  • 24 February: Completion of subscription of new shares representing 51% of the enlarged share capital of Pulai Mining Sdn. Bhd

  • 16 May: Completion of the acquisition of the entire issued share capital of Kelgold Mining Sdn. Bhd.

  • 6 November: CIL plant began trial operation. The CIL plant has the capacity to process 500t of ore daily

2018

  • 2 May: Official opening of CIL plant

  • Completed construction of the first of two new heap leach pads in FY2018 to replace three older ones

  • Sokor achieves highest monthly gold production record of 5,892.32oz in August

2019

  • Second new permanent heap leach pad which will be ready by 4Q2019, will bring heap leaching capacity to 6Mt from 2.8 Mt

2020

  • Expected completion of flotation facility


Over the years, the group has managed to grow its overall ore processing capacity by over a hundred times from just 60kt in 2011 to 6,255kt in 2019. Active exploration over the years has also increased gold resources three-fold from 327,700oz in 2011 to 900,000oz in 2019.

The group’s gold production volume has been largely stable since FY2014, with the exception of FY2017, averaging 28.9koz per annum. In FY2014, the group recorded a 106.5% year-on-year increase in gold production as the completion of a third leach yard and full-scale operation of the Group’s second gold de-absorption plant tripled the group’s processing capacity. However, gold production fell significantly in FY2017 due to low ore grades. Construction of the CIL plant which processes higher-grade ore was delayed till 2Q2017 and could not contribute to the Group’s production in time in FY2017. Subsequently, the official commencement of the CIL plant in FY2018 boosted the Group’s gold production to an all-time high in FY2018. FY2019 saw a 10.6% decline in gold production from 2018 as weak rock masses and water underground in 3Q2019 forced the group to push back the schedule for underground mining, affecting overall production.

Strong execution and effective cost management have allowed CNMC to be profitable each year since FY2012. The group’s revenue has been largely driven by gold production volumes with the exception of FY2013. In FY2013, even though gold production increased by almost two-fold, a 20.4% decline in average realised gold price per pound from USD1,651 to USD1,314 caused revenue growth to be flat. In FY2014, the group was able to achieve a 346.2% surge in net profit due to economies of scale as well as a five-year income tax exemption. The surge in gold production that year allowed the group to improve its all-in-costs per ounce to USD725 from USD1,073 in FY2013. However, net profits fell back down in FY2017 due to lower production volumes as well as costs for the construction of the new CIL plant and increase in royalty fees from 5% to 10% of revenue. Profits remained low in FY2018 mainly due to expenses incurred for the Proposed Dual Listing on Stock Exchange of Hong Kong and the grant of performance shares to deserving employees. Subsequently, higher capital expenditure for non-sustaining operations resulting from the construction of the underground mining facility and expansion of production infrastructure in FY2019 continued to place pressure on net profits.

CNMC’s current share price of SGD0.205 as of 21 June 2020, is 66.4% down from its peak in July 2016 and 48.8% down from its IPO price of SGD0.40.

Thesis 1: Bullish sentiment for gold continues to build

In August 2019, gold prices breached the $1,500 ceiling for the first time in over six years as investors rushed to safe havens, spooked by a host of uncertainties including the U.S.-China trade war and a slowing global economy. Since then, global growth has been decimated by the COVID-19 pandemic, further fuelling gold’s run. As of June 21, 2020, gold prices have surged 24.6% in the past year.

Ever since they were launched in 2003, gold ETFs have amassed 3,355t of gold worth USD184bn. Gold ETFs have contributed to rising investor interest in ETFs over the years by making gold investing much more accessible. April 2020 saw a sixth straight month of inflows into gold ETFs, lifting global holdings to a record high. Investment demand for gold has far outweighed marked weakness in consumer-focused sectors of the market.


Room for more gains

Even with prices at seven-year highs, we believe that there is still more room for gains. Prolonged low interest rate environment, economic uncertainty as well as rising geopolitical tensions between the U.S. and China are expected to continue driving safe-haven demand for the precious metal.

The current low interest rate environment plays to gold’s advantage. Years of easy monetary policy from the world’s central banks have resulted in a shortage of safe assets. Negative yielding debt signals that demand for safe assets is greater than the supply for them. With negative-yielding debt mounting, hard assets like gold are becoming increasingly attractive.

Since the start of 2020, global central banks have been aggressively slashing rates and leaning heavily on quantitative easing to cushion the COVID-19 blow. With many central banks around the world emphasising on the uncertain outlook for growth and concerns about deflationary pressures as justification for their ultra-accommodative policy, we opine that low rates are here to stay.


In the recent Federal Open Market Committee (FOMC) meeting, the Fed indicated that it expects to maintain interest rates near zero until the end of 2022. The ECB also took a similar stance, stressing that it was ready to increase its coronavirus stimulus program if needed, as the eurozone faces a deep economic crisis.

Safe-haven demand aside, central bank gold purchase is also expected to continue driving demand for gold. According to the 2020 Central Bank Gold Reserves (CBGR) survey, 20% of central banks intend to increase their gold reserves over the next 12 months, compared to just 8% of respondents in the 2019 survey.

As evidenced by the survey responses, even central banks are wary that low interest rates are to persist.


Setting the stage for gold miners to reap outsized profits


Gold miners, which are a levered play on gold prices, have rallied strongly. As evident from the relative price movements of GDX, GDXJ and Gold, percentage changes in GDX and GDXJ are amplified whenever there is a shift in gold prices.

Thesis 2: Sound fundamentals untainted

Unfairly punished

Since the start of 2020, CNMC’s stock price has been unfairly punished as a result of various short-term idiosyncratic factors. It began with CNMC’s announcement on 31 January 2020 that more than half of its underground mining crew, many of whom had flown back to Hubei for the Chinese New Year celebrations, are unable to return to Kelantan as scheduled on 3 February 2020 due to the Malaysian Movement Control Order (MCO) and China’s travel ban as a result of the COVID-19 pandemic. This announcement sent its share price down 11% in a day. Following which, disappointing FY2019 results along with the halting of mining activities between 18 March 2020 and 6 May 2020 kept CNMC’s share price depressed.

As gold miners rallied across the board and CNMC got left behind, valuation spreads between CNMC and other gold miners widened. CNMC is now trading at an attractive valuation.


Strong balance sheet to tide through crisis

As of 31 December 2019, CNMC has a net cash balance of USD4.7mm. Based on our understanding with the CNMC investor relations team, the group has no plans at this point in time to raise any funds to tide over the COVID-19 outbreak. Additionally, the group has never turned to the capital market to raise any equity since their IPO in 2011.

Its total current assets less inventory of USD17.5mm would be able to more than cover its current liabilities of USD8.5mm. Other key liabilities such as CNMC’s convertible loan and its rehabilitation obligation would only be due in 2022 and when CNMC’s mines cease to produce at an economical rate respectively.

CNMC’s liquidity ratios stood out when compared to both large and small cap peers. CNMC outperformed the 75th percentile of its small cap peers in all 4 matrices we used and large cap peers in 3 of the matrices. Given CNMC’s robust balance sheet, we are confident in CNMC’s ability to tide through downturns.


Recovery is round the corner

We believe that the current situation is short lived and that recovery is round the corner. As of 6 May 2020, CNMC has restarted open-pit mining operations. Tentatively, we expect underground mining activities will resume in 4Q2020. Hubei has lifted its lockdown and Malaysia’s RMCO is expected to be lifted come 31 August 2020. The earliest these Hubei mine workers can return to Kelantan is 15 September 2020, after a 14 days mandatory self-quarantine. By these assumptions, CNMC’s underground mining operations would be delayed by 8 months. That said, CNMC's solid fundamentals puts it in good stead to capitalise on elevated gold prices when the full potential of CNMC’s underground mining activities is finally unleashed.


While we expect FY2020’s gold production figure to be a modest 22kt, we forecast that FY2021’s gold production figure will increase by an impressive 30% year-on-year. It is also important to keep in mind that the disruption in underground mining operations does not deplete or reduce CNMC’s underground gold resources. Therefore, while an 8 months shutdown of underground mining would affect CNMC’s production figures and earnings between 1Q2020 and 3Q2020, CNMC will be able to regain investors’ confidence and recapture its deserved value when it reports astronomical growth in production figures in 4Q2020.

Thesis 3: Lower oil prices to boost margins

Severe inventory overhang to keep oil prices under pressure

Collapsing oil demand with lockdowns in many countries and suspension of air travel has pushed oil prices to all-time lows. Even though OPEC+ had agreed to reduce output by 9.7mm barrels per day (bpd) from May to July to stem the slump in prices, the deal is insufficient to prevent sharp inventory builds.


The current inventory overhang means that there will be a lag in the recovery of oil prices compared to economic recovery. With global oil storage near full capacity, the U.S. Energy Information Administration (EIA) expects inventory levels to only normalize towards the end of 2021. Hence, a sharp bounce back in oil prices appears unlikely in the near term.


Diesel, a main mining consumable

This spells good news for CNMC as the collapse in crude oil prices saw Malaysian diesel prices fall 20.6% from RM2.18 to RM1.73 per liter since the start of 2020. As CNMC does not have a grid power line currently, all the machinery at CNMC’s concessions are powered by diesel. CNMC’s management has also previously guided that diesel is one of their main mining consumables.

As CNMC does not disclose their operating cost breakdown, we will use data supplied by S&P Global Market Intelligence to guide our analysis. Across the board, energy costs typically make up about 15% to 20% of gold miners’ AISC. Since power from diesel generators typically cost more than energy supplied by a network, we expect CNMC’s energy cost as a percentage of AISC to be in the higher end of the range.

We expect the fall in diesel prices to bring about cost savings of an estimated USD1mm per annum in FY2020 and FY2021. While higher gold prices will boost CNMC’s top-line performance, lower oil prices will aid their margins.

Thesis 4: Significant Exploration Upside

Strong track record of active exploration

CNMC actively engages in exploration to extend mine life and discover fresh targets for production. As a result, the group has been able to grow its gold resources even after depletion for on-going mining activities year-on-year.


Even though exploration for gold did not yield enough resources to replenish the resources depleted through mining in FY2019, the Group yielded noteworthy results for silver, lead and zinc resources, which increased by 74%, 58% and 84% respectively in FY2019 compared to the previous year.


Upcoming exploration activities in the Sokor Field Project will be focused in four known orebodies (namely, Amang area, Rixen Central, Ketubong and New Found lode) and two prospects (Sejana area and Tiger area). In 2Q2020, the group will conduct diamond drilling as soon as practical, with some trenching to verify anomaly found on the surface.


CNMC is also considering underground mining for Rixen but these remain plans at a preliminary stage. This has the potential to increase ore reserves at Rixen in the future.


Kelgold and Pulai hold promising potential

In the long-term, there is potential for exploration works at Kelgold and Pulai to increase the group’s reserves and resources.


Kelgold has significant potential based on the geological information available and offers a strategic synergy due to the proximity to the Group’s existing Sokor Project. Exploration work thus far has been prospective as soil sampling and trenching verified gold anomalies. However, further exploration will be needed in order to estimate a Mineral Resource in accordance with JORC 2012 guidelines. Nevertheless, the odds of reporting resource estimates appear promising.


Feldspar has been mined at Pulai prior to CNMC’s involvement. Feldspar mining is subcontracted to a local producer who supplies ceramics manufacturers in Malaysia. CNMC plans to continue working with the existing subcontractor to further develop the Malaysian market and explore for marketing opportunities outside Malaysia. Additionally, geological data collected supports the potential for gold mineralisation similar to that discovered at the Sokor Project. Work to date has been encouraging and warrants further follow-up work before gold mineralisation can be defined.

Valuation

Based on our financial model, which you can [download here], we derived a fair value/share of SGD0.33 for CNMC using a Discounted Cash Flow Model (DCF) with the Exit Multiple Method as our primary valuation method. This represents an upside of 59.3% from the last closing price of SGD0.205. We also supported our valuation with a DCF using the Gordon Growth Method, which yielded a fair value/share of SGD0.30. We will adjust the model accordingly as the ongoing narrative develops.

We utilized a WACC of 12.11%, derived using CAPM and an EV/EBITDA exit multiple of 4.0x, which is a conservative figure given that the median EV/EBITDA multiple of CNMC’s small cap peers is 8.6x. For the Gordon Growth Method, we assumed a terminal growth rate of 2.0% given that CNMC still has significant exploration upside.

We further sensitized the target price with the key assumptions of WACC, exit multiple and terminal growth rate. We obtained a fair value range of SGD0.26 to SGD0.45.

Key revenue assumptions:

  1. 200t of ore mined per day from underground mining in FY2021 and FY2022 and 300t/day thereafter

  2. Commencement of underground mining in 4Q2020

  3. 3.0g/t average grade of ore from underground mining - guided by the 3.96g/t grade reported in CNMC’s ore reserve

  4. Doubling of CIL plant capacity to 1,000t/day in FY2023

  5. 5% increase in heap leaching recovery rate due to continuous leaching

  6. Average realised gold price of USD1,600 from FY2020 to FY2022 - a conservative estimate given that gold price is USD1,727 as of 18 June 2020. Thereafter, we project an average realised gold price of USD1,500 as the Fed begins to pull back support.


In summary, for FY2020, we expect gold production to dip further due to the temporary mine closure between 18 March 2020 and 3 May 2020 as well as the delay in commencement of underground mining caused by the COVID-19. However, we opine that CNMC will experience a strong recovery starting 4Q2020 when underground mining is in full force, allowing the group to yield higher ore grades. The timely increase in heap leaching capacity will also boost the group’s overall gold production going forward, allowing the group to take advantage of the high gold prices.


We did not account for the anticipated commencement of the new flotation facility in FY2021 in our projections due to various uncertainties surrounding this operating segment. We will adjust the model accordingly to reflect the expected revenue that can be derived from the sale of other metals as more information becomes available.

Key cost assumptions:

  1. 5% decrease in mining and processing costs in FY2020 and FY2021 due to lower diesel prices

  2. Additional 5% decrease in heap leaching processing cost due to logistical cost savings brought about by the permanent heap leach pads


Going forward, when CNMC eventually transitions to a power grid, we can anticipate AISC to be lower than the figures reflected in our model above.

Risks


1. Execution risk

Like all mining companies, CNMC will continue to face execution risks for all its projects ranging from collapse of underground mines to inclement weather which could halt CNMC’s mining and production of gold.


The Kelantan state is exposed to the seasonal North-East monsoon period which typically runs between December and February each year. However, Sokor remains relatively protected due to its topography. At the same time, CNMC has contingency plans for re-organising process workflows and reallocating its resources to ensure continuous production during the annual monsoon period.


Other execution risks include the delay in commencement of new production and mining facilities. In 2017, CNMC experienced a delay in the commencement of its CIL-plant. This has come as a huge detriment to CNMC’s gold production figure as they have intended for the utilisation of the CIL-plant to provide a huge boost in gold production. In 2019, CNMC also experienced delays in the commencement of its underground mining operations due to weak rock masses and water underground which has affected gold production.


Such execution risks continue to be present and come at a great cost for CNMC as they could significantly lower CNMC’s gold production figures.


2. Fall in gold price

CNMC does not hedge its commodity price risk. Hence, a sharp fall in gold prices will have an adverse impact on CNMC’s share price. Every USD100 fall in gold price is expected to translate into a SGD0.05 fall in CNMC’s share price.


3. Strong recovery in oil prices

Larger-than-expected cuts in oil production or stronger-than-expected recovery in demand for oil in the months going forward can cause oil prices to recover quicker than we anticipated. Given that CNMC has yet to transition to a power grid, this will drive up their operating costs.


In thesis 3, we established that the fall in diesel prices is expected to bring about cost savings of an estimated USD1mm per annum in FY2020 and FY2021. Hence, if oil prices were to recover strongly, causing EBIT to decline by USD1mm in FY2020 and FY2021, our target price will decrease to SGD0.32.

Historically, CNMC’s share price has also not exhibited a strong correlation with oil prices. Hence, we do not anticipate any recovery in oil prices to cause a sell down of CNMC.


4. Lower-than-expected grade of ore from underground mining

CNMC’s gold resources and reserves estimates are based on certain estimation methodology and procedures, various assumptions and professional engineering judgment. There is a possibility that the actual grade of ore derived from underground mining might be lower than that reflected by reserves estimates. In such an event, the group will not be able to realise the increase in gold production that underground mining is expected to bring about.


5. Foreign exchange risks

CNMC’s revenue is denominated in USD while operating costs, exploration and evaluation expenditure and/or purchases are denominated in SGD, MYR, RMB and USD. The Group has not entered into any agreements or purchased any instruments to hedge possible currency risks. Hence, any significant fluctuations in the exchange rates of USD against SGD, MYR and RMB could adversely affect the financial position and results of the Group.

A 10% strengthening of USD against the SGD, HKD and MYR at the respective reporting dates would increase/ (decrease) profit before tax and increase/(decrease) retained earnings by the amounts shown above.

Catalysts

In the near term, we expect 3 catalysts to drive CNMC’s share price.

1. Completion of second permanent heap leach pad

In 2018, CNMC had completed the construction of the first of two new permanent heap leach pads to replace three older leach pads, which had a total annual leaching capacity of about 2.8Mt of ore. Since the completion of the second permanent leach pad in 4Q2019, the upgraded heap leach plant has the capacity to process 6Mt of ore annually.


The new leach pads are designed to hold the mined ore for continuous leaching to enhance gold recovery as well as reap logistical cost savings. The existing practice of having to remove the ore from leach pads after processing and moving it to mine tailing ponds for storage will be eliminated.


Every percentage increase in the heap leach recovery rate will directly translate into a percentage increase in gold produced via heap leaching.

As illustrated above, a small 5% increase in recovery rate from 35.0% to 36.8% can reap an estimated USD0.6mm in additional revenue. Hence, we expect the increased production brought about by the new leach pads to partially offset the decline caused by the mine closure.


2. Commencement of underground mining


Tentatively, we foresee that underground mining at Ketubong will resume in mid-September upon the return of the Hubei miners. The commencement of underground mining will bring about 2 key benefits: extending CNMC’s mine life and improving CNMC’s margins.

New Discovery which has the highest ore grade out of all the other deposits and which uses CIL extraction, is a rather small deposit with a mine life of 5 years. With underground mining at Ketubong, the group will be able to continue extracting higher grade ore, with higher profit margins, for an additional 7 years.

Even though the margins at Ketubong is lower than New Discovery due to the higher cost associated with underground mining, it is almost double of that at Rixen. This is due to the fact that gold from New Discovery and Ketubong can be extracted via CIL extraction, a method which yields much higher recovery rates than heap leaching. With underground mining, CNMC will be able to continue to keep the CIL plant running at full capacity in the years forward, improving the group’s overall gold production and margins.


3. 4Q2020 earnings release

We project that the following key events will lead to an impressive year-on-year increase in earnings in 4Q2020:


Revenue drivers:

  • Full force commencement of underground mining leading to higher gold production figures

  • Higher gold prices

  • Higher heap leaching recovery rates

Cost drivers:

  • Lower diesel prices

  • Logistical cost savings from new permanent heap leach pads

Conclusion


The combination of high gold prices and depressed oil prices create the perfect storm for gold miners. Even though CNMC faced some short term pains due to the COVID-19, the worst is over and CNMC is well-set to capitalize on the current conditions with the timely boost in heap leaching capacity and its heavy reliance on diesel-powered generators. With sound fundamentals and a strong balance sheet, it will take a lot of beating for CNMC to suffer collateral damage. We believe that it is only a matter of time before the market realizes that CNMC has been unfairly punished and the inflection point occurs.


Thanks for reading,

Elena and Shawn


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: Jonny Caspari

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