West Africa—Still Early Days with Lots of Potential: Dan Hrushewsky


AfricaJennings Capital Analyst Dan Hrushewsky sees investors' understanding of risk as directly related to the unknown. West Africa is unknown to many investors but it has a long history of mining, good infrastructure, favorable geography, many active producers and huge potential. In this interview with The Gold Report, Hrushewsky details three gold mining business models and specific companies active in West Africa that provide investors with asymmetric possibilities of limited downside and strong upside in a world-class mining jurisdiction.

The Gold Report: When many mining investors hear West Africa, the first thing they think of is risk, especially political risk. Is that a baseless concern? West Africa sounds exotic, but does that mean that it's high risk?

Dan Hrushewsky: I think risk often times has to do with the unknown. The less we know about something, the more risky we think it is, although one doesn't mean the other. Exotic does not have to mean higher risk from an investor standpoint. The lack of general investor awareness of West Africa provides outsize return opportunities for those who are aware.

West Africa Map

TGR: Some gold investors will be familiar with Ghana because several majors have been active there for many years. What other countries stand out in West Africa as being mining friendly and prospective?

DH: Burkina Faso is a real standout for several reasons. First, it's had relative stability for the last 20–25 years. Second, the potential for exploration is huge because it was fairly late to the exploration game, especially compared to Ghana. Burkina Faso's adoption of a world-class mining code in the mid-1990s kick-started modern mining exploration, which has paid dividends in the form of six new mines starting up in the country in the last five years. On the other hand, Ghana has seen at least 60 years of modern mining exploration. Other areas in West Africa are highly prospective for gold as well, including Mali, Liberia, Senegal and Côte d'Ivoire.

TGR: The two most interesting countries for mining from your point of view are Burkina Faso and Ghana?

DH: I like those two a lot, but that doesn't mean that the others don't have a lot of potential. Both Ghana and Burkina Faso are interesting for the combination of exploration potential, stable operating environments and stable political situations.

TGR: What's the infrastructure situation like?

DH: The highways in Burkina Faso are top quality, almost at the level of North American single lane highways. The construction quality and level of maintenance is very high. Burkina Faso is a very flat country, so accessibility is not a problem. If your destination is not on a road, you can generally just drive there anyway by going off-road because of the flat, savannah-type topography and dry climate. The power infrastructure varies with the location. Some parts of the country have access to hydroelectricity that comes in through Ghana, through the Lake Volta Power Authority. Most of the country is outside that system and companies have to produce their own power, but that's largely the situation in most of Africa, and in many mining jurisdictions in the world.

TGR: Are the best projects in this part of West Africa financeable? Are they moving forward?

DH: Financing a mining project is currently a challenge worldwide. The risk trade is still generally off. While some of the major stock indices are hitting new highs, junior and senior mining equities are very undervalued due to investors' lack of appetite for mining company risk, and the turbulent gold price environment. This makes financing the equity component of an overall financing package a very dilutive exercise. It doesn't matter whether the mining project is in Ontario or in West Africa, it is still a tough go. That's the general landscape.

"The lack of general investor awareness of West Africa provides outsize return opportunities for those who are aware."

Having said that, selected high quality mining projects are finding equity financing regardless of location. In West Africa, I can cite a couple of projects that have been successful in raising equity recently. These have tended to be higher quality projects with a critical mass of several million ounces plus an above-average grade.

TGR: Do you have any examples of projects that are advancing with funding in this environment?

DH: One example is PMI Gold Corp. (PMV:TSX.V; PVM:ASX; PN3N:FSE), which had a successful financing approximately six months ago. Another example is Aureus Mining Inc. (AUE:TSX; AUE:LSE), which did a successful financing, given its market cap. It raised its own market cap in financing, which is always a tall order. Roxgold Inc. (ROG:TSX.V) also did a successful financing very recently, at market, with no warrants. What all these projects have in common is above-average grades.

TGR: What is an above-average grade in West Africa?

DH: Generally for an open-pit mine, an above-average grade is 2 grams per ton (2 g/t) and up. Roxgold has a grade that is probably one of the best in the world at 19 g/t for its Indicated resource category.

TGR: At 19 g/t, that must be for an underground mine?

DH: It is underground, but just because it's an underground mine doesn't mean it must be high grade. Many producing underground mines in West Africa have grades in the 4–10 g/t range.

TGR: A few companies have been able to get financing for some projects. What is the nature and structure of those financings? Who's contributing the capital to move things forward?

DH: With the equity markets in a risk-off holding pattern, there has been a global vacuum in project financing. Stepping into the void have been numerous "non-traditional" financing players. Two sources of non-traditional financing are the royalty and streaming companies. Over the last 18 months, they have been getting more traction than normal. Another increasing source of funding has been sovereign wealth funds from the Middle East and Asia. We saw a group invest in Inmet Mining Corp.'s (IMN:TSX) Cobre Panama project. As an analyst, I hear about lots of private money, especially from the Middle East, actively chasing projects in the space. When oil prices are high, you see a lot of petro dollars sloshing around the Red Sea basin, looking for a place to go. With the currencies being questionable, these funds often go into gold-related investments.

"Both Ghana and Burkina Faso are interesting for the combination of exploration potential, stable operating environments and stable political situations."

What I've also been noticing is a surge in private equity activity. Recently, several private equity funds have been created that plan on entering the gold and base metal sectors.

Another interesting trend we are seeing is traditional project debt financiers becoming more risk-on. We saw a recent debt financing for Aureus' New Liberty project in Liberia where two banks, Rand Merchant Bank and Nedbank, did a financing on very good terms with no hedging and a low interest rate. A political risk insurer out of South Africa made that deal possible. One caveat of the political risk insurance was that 50% or more of the project's costs must be sourced from South African suppliers.

TGR: What was the approximate dollar value on that?

DH: About $100 million ($100M). The interest rate was 5% all-in, including the political risk insurance. There was no gold hedging. Overall, the terms were very favorable.

TGR: What specifically do you look at when you're evaluating particular projects? Are deposit size and grade at the top of the list? Do you have any example companies that describe your investment model?

DH: I don't look for particular geology or a particular deposit type or a particular region. I look for a good business model. Gold mining is a business just like any other business. The projects that I analyze can be classified into three main business models.

The first model is the high-grade deposit. Roxgold is an excellent example. It has one of the highest-grade deposits in the world. And that deposit is growing. Why are high-grade deposits attractive? Upfront capital expenditures (capex) will be low as will operating costs. Low operating costs mean high margins. High margins are good because the project's debt capacity is higher and because the project can make money in high and low gold price environments. It's almost a vaccination against a potential drop in gold prices.

A second business model that I like is exemplified by another company I follow, True Gold Mining Inc. (TGM:TSX.V). True Gold is a lower-grade deposit, but it's a heap-leachable deposit. In the world of heap-leachable deposits, it's one of the higher-grade deposits. A heap-leach business model is a low capex, low operating cost one. That is important because with the lower capex it is easier to finance and the low operating costs mean higher margins, which mean resilience to lower gold prices.

"Investors love the story of their companies getting taken over by a major. It is almost a Cinderella story, but there's a reason Cinderella is a fairy tale. Big takeovers at high premiums are rare."

There's also a third business model that I have in my portfolio of West African projects and that is the low-grade but very large deposits. Such projects have a higher cost structure. Even so, such a project can be very appealing to investors because it has a high leverage to the price of gold. For a given change in the gold price, the value of the project goes up the most. The prime example in my gold coverage universe is Volta Resources Inc. (VTR:TSX). It's a very large deposit, the largest single undeveloped gold project in West Africa at almost 5 million ounces of Measured and Indicated, and all those ounces are located in a single pit. As an investor, if you believe the price of gold is going up, this is a project that will, on a percentage level, give you the most leverage to gold price increases. Normally, a higher-cost project is sensitive to gold prices going up, but the flip side is that the same project is sensitive to gold prices going down. In Volta's case, there is a cushion against a fall in the value of the company due to its non-core asset portfolio, which we value at a level that exceeds its current market capitalization. Another way to look at it is investors get the flagship property, Kiaka, for free.

TGR: How far along is Kiaka?

DH: It has a prefeasibility study and Volta is working on a bankable feasibility study. The company recently came out with a revised resource estimate based on a staged capex and a selective mining scenario in which it demonstrated that it can produce gold from a smaller plant initially and use the project's free cash flow to fund expansion. This decreases upfront capex to about $400M from the $610M that was estimated in the prefeasibility study. The $400M is still very high compared to Volta's market capitalization. The company is being quite creative in its investigations as to how to finance that. With the abundance of alternative financiers around, I think that it will be able to cobble together something that works.

TGR: You describe your three favorite business models for producers. How would investors choose the appropriate model for themselves?

DH: Each model offers something for investors. It just depends on risk tolerance and one's view on future gold price direction.

TGR: I am glad you brought up the price of gold. Gold has been going sideways for a year and a half. But investor expectations for continuously rising gold prices make the sideways price action feel like an eternity.

DH: The price has been sideways, but at very high levels. We have trained ourselves to expect constant increases in prices. That is not realistic for anything. No trend goes on forever. Although gold prices are at very high levels, many investors stand there disappointed at $1,600/ounce. It is a little ironic.

TGR: In a way, things have never been better, but people are disappointed.

DH: For the price of gold, things are very good. Pricing is not at its recent peak, but so what? It's still a very high price and if you're producing gold, you're making a ton of money.

TGR: Let's discuss exit strategy. Some of the majors, such as Kinross Gold Corp. (K:TSX; KGC:NYSE), had major write-offs with big merger and acquisition (M&A) activity in West Africa. It appears that the M&A window is closed for now. What does that mean for the growing miners that you cover? Is regional aggregation similar to a success story like Randgold Resources Ltd. (GOLD:NASDAQ; RRS:LSE) an option? What are the various exit strategies?

DH: Investors love the story of their companies getting taken over by a major. It is almost a Cinderella story, but there's a reason Cinderella is a fairy tale. Big takeovers at high premiums are rare. It happens so rarely that it doesn't impact anybody in a normal course of events. In this market, the big buyout is so rare, nobody will miss it if that activity pulls back.

I see a lot of good management teams. A lot of them are pretty smart. It's not a stretch of the imagination to have a team build one project and then look around and try to do it again with its pipeline of projects, and/or with other companies' projects via mergers/acquisitions. I think that will happen to some extent. Although consolidation in West Africa has been a story that was on the verge of being told for at least five years and hasn't really happened, times change and the next five years should be different. Companies will be doing deals and consolidating on their own, without the majors. The class will organize itself as opposed to the teacher coming in and telling everybody what to do.

We have already witnessed some of this behavior. Two of the companies I cover almost merged recently, PMI and Asanko Gold Inc. (formerly Keegan Resources) (AKG:TSX; AKG:NYSE.MKT). Those projects were less than 30 kilometers from each other and had some powerful synergies. PMI's shareholders voted against it. But there will definitely be some consolidations in the future. I'm seeing people out there that are smart enough to do these sorts of things.

TGR: Can you sum up the reasons why investors should be interested in West Africa and why they should take a look at some of these projects?

DH: One reason is that it offers huge potential for discoveries. Relatively speaking, it is still early days with regards to modern exploration, and many deposits remain to be found. Also, being early days, most exploration has been for shallow deposits, and for the most part, depth extensions have not been investigated. One example of what is possible is the Obuasi mine in Ghana, which has been mined for over 100 years and goes as deep as 1,500 meters.

Another reason is that the region is generally very open to gold mining. Gold mining constitutes a large part of the West African countries' GDP and foreign currency earnings. Growth of the industry has been the focus of most of the governments in West Africa, as evidenced by supportive mining codes. Burkina Faso is a good example. The incredible growth in its mining industry over the last five years—six new mine start-ups—reflects the very welcoming environment for gold mining in that country.

Finally, West Africa is a region ripe for consolidation, and we will see more of that occur in the future, especially if financing remains difficult to obtain.

TGR: Thanks for your insights. I look forward to following up in the future.

Dan Hrushewsky, senior precious metals analyst at Jennings Capital, is primarily responsible for African precious metals. He joined Jennings Capital in Toronto from NCP Northland Capital Partners, and was previously senior vice president, corporate development with Chalice Gold Mines and vice president of High River Gold. Hrushewsky has nearly 30 years of experience within the mining sector. He holds an engineering degree from the University of Toronto, a Master of Business Administration degree from McMaster University and is a CFA.

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1) Alex Gimurtu conducted this interview for The Gold Report and provides services to The Gold Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
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3) Dan Hrushewsky: I or my family own shares of the following companies mentioned in this interview: None. I personally or my family am paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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