Company: Red 5 Limited
Share Price: $0.105
Market Cap: $69.23m
Recommendation: ‘Spec Buy’

With gold staging a break to new all-time highs, the ‘yellow metal’ has come increasingly into focus for the investment community. Most companies – big and small – with any sort of exposure to gold have seen their share prices rally in anticipation of further potential appreciation.

Both producing and exploration companies have equally benefited. However, caution should be had, particularly at the speculative end of the gold sector, where there is a big difference between the hopeful drillers and those goldies with a ‘real’ blue sky story.

Standing out from the crowd, Red 5 Limited (RED) is a company on a clear path to first production and momentum in the stock may just be building.

Red 5’s company-making asset is a 90% interest in the Siana Gold Project in the Phillipines. A bankable feasibility study (BFS) – on an initial open pit operation followed by an underground mine using a modern gravity and carbon-in-leach treatment plant – is complete and work continues to receive the final ‘green light’. Current activities include stgelopment of a detailed underground mine plan, Environmental Impact Statement Submission and Environmental Compliance Certificate approval, which are Board and bank funding syndicate conditions to the project proceeding. Considering the handsome economics of the project there is little reason why Siana won’t get off the ground. These near term announcements provide significant share price drivers and provides shareholders with that all important newsflow.

The Red5 share price plummeted during the worst of the financial crisis as credit markets froze and non-producing miners were particularly hit. With initial US$73m capex costs for Siana, the funding proposition seemed almost impossible at the time.

However, with the global economy on the mend and the worst of the ‘GFC’ behind us, higher risk appetite has returned and credit markets have begun to loosen. The BFS has demonstrated a net present value (NPV – which takes into account funding requirements) for Siana of approximately US$250m at current gold prices – providing a 47% internal rate of return. Even assuming a 20% fall in the gold price to US$800/oz, the BFS indicates an NPV of US$150m, equating to a 38% internal rate of return on investment. With Red 5’s current market cap hovering around A$70m, the differential between the value locked in the Siana deposit and that reflected in the company’s share price is substantial.

As part of the long term mine plan, it is possible that additional underground drilling may see the resource base increase. As it stands, Siana is expected to produce 849,000 ounces of gold over a ten year operating life, with an average cash cost of production of US$351/oz – low by any standards. The deposit remains open at strike and management has flagged the potential upgrade to approximately 975,000 ounces over time. Currently holding cash of $22.7m, the company has sufficient funding to continue stgelopment at Siana in anticipation of first construction by the last quarter of 2009.

Capital costs including sustaining capital for the life of the project total US$104m (including escalation in underground stgelopment costs and US$10m in contingencies) and assuming owner purchase of underground plant and equipment from the operating cash flows. The capex estimate is based on supply of new equipment, as normally required in the BFS, with the exception of the SAG mill that is already purchased and to be refurbished. Opportunities exist to reduce the capital costs via prudent purchase of selected used equipment and heavy earth moving machinery, thereby increasing the underlying NPV of the project.

Volatility in the share price may be encountered in the medium term with funding expected to be obtained through equity or debt markets, although likely a combination of both. However, the real risk is a decline in the gold price which would reduce Siana’s NPV. Nevertheless, as previously mentioned, gold may retrace some 20% and the project remains handsomely profitable. Trading on a current market cap of A$70m, the differential between the NPV of Siana and Red 5’s market value is considerable, particularly if gold holds its current levels. We are recommending Red 5 to our clients as a ‘spec buy’.

Joshua Terlich is an analyst at All views in this article are those of, not of and do not constitute advice.  


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