Alkane Resources — Update 26 July 2016

The TGO has been operating steadily since Q214, and has mined a total of 2.6Mt of ore grading 2.09g/t Au to produce 158koz of gold for gross revenues totalling A$234m, at a total cost of A$203m for a gross margin (on average) of 16%. However, with gold prices clearly higher since start CY16, driven primarily by global economic and political uncertainties, gross margins have improved significantly, averaging 28% over H2 FY16. Surface mining is currently taking place over two deposits, primarily from Wyoming One, but also at Caloma with another pit, Caloma Two, due to start towards the end of H117. Alkane provided a positive investment decision during H216 to extend the TGO’s mine life by taking mining underground at Wyoming One, and released a reserve of 62koz in June 2015. Alkane estimates a total capital cost of A$20m to develop the UG mining phase, although this value will be refined as Alkane completes its own feasibility study into the project during H117.

At June 2015 Alkane stated open-pit ore reserves of c 235koz; net of FY16 production of 67.8koz this becomes 167koz, or roughly a further three years of production at a rate of 60kozpa. This however does not account for the TGO’s net (of reserves and FY16 production) open pittable and underground gold resources totalling c 1.0Moz.

The following sections detail the operational performance of the TGO and discuss the exploration activities being planned to extend the mine’s life.

The main factors affecting the TGO’s operational and financial performance during Q416 were:

The following exhibit provides quarterly operational data for the TGO since mining commenced in Q214.

The following exhibit shows a comparison of actual reported FY16 operational data versus our last estimate of the past financial year’s performance at the TGO. Although Alkane continues to extract greater amounts of waste from the Wyoming One pit, we had overestimated the volume of waste removed by 10%. Our grade assumptions were within 1% of the actual reported gold grade from ore mined, while our forecast for the level of tonnages milled was higher by 6.5%. We consider this is due to Alkane making run-of-mine decisions relating to waste mining requirements, the prevailing gold price and ore grades delivered to the ROM pad over H116 when gold prices (in US dollar terms) were still low and trading in a range of US$1,070-1,181/oz. These factors would therefore have guided Alkane as to how much mined ore is stockpiled rather than treated during any one quarter.

Reflecting the 24% q-o-q improvement in TGO gold production through Q416, gold revenues at end FY16 exceeded our forecast by 6%.

We have adjusted our production model for management’s guidance on gold production during FY17 and over LOM, with a large increase over our previous assumption for gold production occurring in FY18. The following exhibit compares our old and new production schedules. The increased production is due to the Caloma Two pit coming on line during FY18, at which point all three pits will be producing ore (Wyoming One, Caloma and Caloma Two). Production is then estimated to reduce in the following years as production at the TGO transitions from solely open pit production to a mixture of open pit and underground (on a roughly 3:1 split). Also, production from the largest pit, Wyoming One, will start to tail off as it reaches the natural end to its planned mine life in mid-FY19.

With the TGO now firmly established as an operating gold mine and two and half years into its now 10-year mine schedule, Alkane is looking to bolster its resource base. Alkane has a portfolio of prospective exploration tenements and projects in the Dubbo region of New South Wales. Certain projects will now have increased exploration work undertaken on them. This will need to focus on deposits that can yield ore amenable to processing at the TGO gold processing plant.

Alkane is also investigating the potential for reinitiating some form of mining activity at the old Peak Hill mine site located in same area as the TGO. Alkane previously operated this project from 1996, until the end of the planned mine life in 2005. With the vast majority of oxide gold material mined out during this initial mining period, the material left is refractory.

Alkane is due to update the market on details of a new exploration programme by the start of Q217.

The Bodangora and Kaiser projects are vastly different in terms of geology than Elsienora (see following section), being porphyritic in nature, similar in geological style to the large gold mines collectively called the Cadia Valley Operations (CVO) owned by Newcrest located c 100km to the south. The CVO has produced 8Moz of gold since production started in 1999, and produced 667koz and 74kt of copper in FY15. Bodangora and Kaiser are potentially very large gold-copper systems, and are therefore generally more capital intensive to develop than epithermal vein-style deposits, such as Elsienora. For example, the Ridgeway underground operation, which is one mine within the CVO, cost A$345m to develop in 2002, and the Cadia East mine A$1.9bn.

Significant drill intercepts (announced 6 May 2016) are 111m at 0.61g/t Au (KSRC0013), 176m at 0.20g/t Au (KSRC016) and 311m at 0.28g/t Au (KSRC018). While the latter two intercepts are low-grade, Alkane has suggested that similar widths and gold grades were discovered at the Ridgeway deposit prior to its development and were later found to be just 200m from the higher grade system core (eg 296m at 4.41g/t Au and 1.02% Cu). Obviously, it will be Alkane’s intention to replicate the success of exploration at Ridgeway at Bodangora and Kaiser.

Although existing mines in the area are relatively high cost to develop, at this stage the potential size of mineral resource and the overall structure of any ore-body defined at the Bodangora and Kaiser Project areas is unclear. As such, it is not possible to accurately comment on the cost of development that would be required to exploit any economic fraction of these large porphyry style systems. Such development could either be standalone (from the TGO) or involve concentration of gold grades on site for further treatment at the existing TGO plant.

The Elsienora gold project is subject to a farm-in agreement between Alkane Resources and private company Balamara Resources. The terms of this agreement required Alkane to spend A$500k over three years from September 2013 for 80% of the project. Alkane has now satisfied this farm-in requirement and as such now owns 80% of the Elsienora gold project.

The Elsienora project is located approximately 200km to the south-east (as the crow flies) from the TGO, and so any mining at this project may require beneficiation on-site to reduce the volumes of ore transported. Or, if the deposit is appropriate for heap leaching, more autonomous operations could be developed, potentially utilising surface mining equipment from the TGO as mining at this site focuses more on underground mining activity. However, the establishment of a sizeable gold resource is required first and is the subject of Alkane’s current activity over Elsienora. The Elsienora project comprises two exploration licence areas (EL 6082 and EL6767). Within these licence areas, six named prospects exist: the Hit or Miss, Junction Point, Nobbs Reef, Pickers, Cuddyong and Stockyard Creek.

In our opinion Elsienora presents a good opportunity for Alkane to delineate a gold resource that would be amenable to processing at the current TGO plant and small enough to potentially fund at a modest cost. Drilling at Elsienora has so far consisted of 29 reverse circulation drill holes spread over a stated strike length of approximately 700m. Elsienora has had both historical mining activity (in the 19th century) and exploration via drilling (by a company called Planet Metals Ltd, 1969-74) undertaken on it. Planet Metals’ exploration intersected narrow zones of polymetallic mineralisation in an apparent volcanogenic massive sulphide (VMS) setting. Assays from this era of exploration show promising signs of potentially economic metal grades, with intersections of 1.78m at 7.54% Zn and 3.48% Pb (from diamond drill hole DDH001) and 2.6m at 8.54% Zn, 3.16% Pb, 0.66g/t Au and 74g/t Ag (DDH004).

The geology of Elsienora comprises a package of variably pyritic, intermediate to felsic volcaniclastics. Gold mineralisation occurs in two different styles, the first being typically small low sulphide quartz veins of orogenic origin (ie a mountain-forming event resulting from tectonic activity). The second style comprises sulphide rich disseminated mineralisation, though this style is found to be less common.

The 29 drill holes completed to date have produced grades ranging 0.44g/t to 5.25g/t over intercepts of 1m to 29m. Excluding outlier intercepts of 29m at 1.53g/t (ELRC 001), 11m at 1.47g/t (ELRC002) and 18m at 0.44g/t ELRC008, the average intercept and gold grade reduce to 3.3m at 1.51g/t. This gold grade is comparable to the 1.5-1.7g/t gold grade range of the current TGO measured and indicated resource categories and therefore supports further exploration to contribute information for future a JORC-2012 compliant resource estimation.

Aside from its grass root exploration plans, Alkane has an existing resource of similar scale to its current TGO gold resource, albeit with sulphide and by extension refractory, characteristics. This resource was defined prior to the Peak Hill (oxide) Gold Mine closing in 2005. The currently defined sulphidic Peak Hill mineral resource will need updating for JORC-2012 guidelines. Updating to current JORC guidelines will require Alkane having a greater understanding on the costs of mining this resource, even before a mining engineer makes an assessment for what portion can be economically mined (which then becomes an Ore Reserve under JORC guidelines). With this resource situated beneath the old open pit, it is likely that an underground operation will need to be contemplated to exploit it.

Alkane continues to progress the DZP’s development on a number of fronts. Alkane has now completed all the land purchases required to build the DZP site. These land purchases total 3,500 hectares of which 500 hectares are for the actual mine and processing operations. The remaining land will be reserved for continuation of farming activities and a management company has been established to facilitate this.

There are now no permits, land purchases or major engineering or geological components requiring completion and the DZP is now ready for development. Ongoing processing refinements continue at the ANSTO research facility near Sydney where Alkane has been operating a pilot processing plant facility. However, these refinements do not affect the front-end design of the DZP or any element of the mine’s construction. Refinements and improvements to DZP products made at ANSTO can be translated to the mine-scale via minor changes to the back end of the process flow sheet and do not require material changes to the overall engineering design.

Alkane’s share price has not tracked the increases seen in the wider gold market. This is not due to operational problems or material misses on guidance, which have not occurred during FY16. We view Alkane’s flat share performance as an indication of the market’s continuing anticipation of a number of DZP catalysts coming through. In our opinion this is due to certain material agreements over the future sale of DZP products not yet being converted into commercial off-take agreements, which once finalised would also trigger financing. We expect Alkane to start announcing these agreements to the market over the coming months. We consider that these agreements will need to be announced before end CY16 for the project development timetable to be maintained (first production at the DZP is slated for CY18). We maintain our view that the DZP provides the most de-risked exposure to a range of high-quality technology metal products outside of China.

A summary of our base case valuation and a comparison with our previous valuation is given in the following exhibit. This is a fully diluted valuation including all DZP financing assumptions (see our October 2015 update note). We also provide a value for Alkane’s shares based only on the value of the TGO, and excluding any value for the DZP. This TGO-only valuation is considerably higher than its value assuming the DZP is successfully financing and developed.

Our previous April 2016 base case valuation of A$0.90 per Alkane share reduces 17% to A$0.75 reflecting the impact of dilution resulting from the placement of a total of 82.6m shares (see following section). The value of the TGO reduces slightly due to a revised mine schedule (Exhibit 3).

We have also included a per share value for the amount of bullion-on-hand available for immediate milling (at end FY16: A$4.9m). This value, effectively work-in-progress, equates to A$0.01 per Alkane share.

The following is based on Alkane’s Appendix 5B quarterly report and not full audited accounts (due August 2016). As such certain assumptions are stated that will differ from the as yet unpublished statutory accounts. Alkane reported A$109m in gold revenues generated by the TGO and cost of sales of A$81.5m, production (A$18.4m) and development (A$63.1m) costs as per its Appendix 5B cash-flow report. After deductions for depreciation of A$27.4m (Edison assumption) and net interest of A$0.2m, our estimate of a loss before tax for FY16 is A$6.4m.

Alkane finished FY16 with cash of A$24.5m, a 64% increase y-o-y (FY15 cash: A$14.9m), driven mainly by the issue of shares, raising gross proceeds of A$12.4m. Post-balance sheet date, Alkane finalised its equity offering, raising a further A$4.1m.

The company expects expenditures as per its quarterly cash flow report to be A$30.4m in Q117.. This comprises A$4m on exploration and evaluation, A$3m of which is allotted to DZP product development with the remainder allocated to exploration activities at the TGO. The remaining A$26.4m in cash outflows comprise A$8.3m on development of the TGO (extension of tailings facilities and other site and plant work), A$16.5m in TGO production costs and A$1.6m in G&A.

The following items have been factored into our financial model since our April 2016 note: