Ariana Resources — Update 29 November 2015

With the critical-path forestry permit secured, Ariana’s JV partner Proccea Construction has now commenced Kiziltepe’s eight-month development phase. With long-lead items easily sourced in the current subdued mining services sector, we consider that the eight month construction period is manageable and first production in H216 a realistic timeframe. With construction soon to be underway, Ariana will also continue to build on its geological knowledge of its licence areas. Ariana and its consultants have developed a geological model that indicates the presence of a significant sub-volcanic porphyry. This may be responsible, in part, for the development of the low-sulphidation gold-silver veins in the area. Associated with this porphyritic intrusion are arrays of low-sulphidation epithermal veins, of which the Kiziltepe project envisages mining at least five during an initial nine-year mine life.

Our valuation for Ariana’s eventual 50% interest in Kiziltepe is 1.73p (1.71p in our last note) using our revised gold and silver price forecasts and mining costs contained in the June 2013 DFS. We have not changed the mining schedule from our previous valuation (see page 9).

Our start date for mining at Kiziltepe is H216. On this basis, our valuation is now 1.73p per share. This valuation is for Ariana’s eventual 50% share of the Red Rabbit project and uses a discount rate of 10% to reflect general equity risk. Our model takes into account Ariana’s debt funding arrangements with Turkish bank Turkiye Finans Katilim Bankasi. Our de-risked valuation stands at 3.14p, which we believe better reflects the continuing success of Ariana’s exploration activities on licences close to the Kiziltepe project, potentially extending LOM. Furthermore, our valuation remains a robust 0.74p at gold and silver prices of US$1,050/oz and c US$14.8/oz respectively.

Ariana had current cash burn rate of c £65k per month, low in terms of mining juniors, reflecting the result of a series of cost-cutting exercises as Ariana awaited its final forestry permit approval. Ariana considers its current cash balance and receivables due will support its operations until mining commences in H216.

We consider the following risks, which largely revolve around the current gold price environment, are specific to Ariana’s investment case:

With its critical path forestry permit received, the only permits remaining pertain to local government (mayor’s and governor’s office) and are being sourced during the construction phase. With the US$33.2m in capex sourced via bank debt and due for drawdown, Ariana and its JV partner Proccea Construction have commenced construction of the Kiziltepe gold-silver mine. With a small modular plant design, only an eight-month construction period is envisaged; at this late stage we hinge the production start-up at Kiziltepe to management’s current guidance of H216 for mine-start up and first gold-silver production. Ariana considers that Kiziltepe will operate in excess of 10 years, which we consider is realistic considering the considerable number of very similar geological targets along the Sindirgi gold corridor (the overarching domain in which Kiziltepe sits). Ariana and Proccea have designed the tailings storage facility for 15 years of operation at a c 20koz AuE production rate.

Ariana’s strategy of low-cost exploration is achieved through the use of its owner-operated drill rig, as well as (non-exclusive) access to a Newmont exploration database containing two decades of information.

As we commented in our outlook note in December 2012, “it is only a matter of time, cost and drilling” before new gold veins, and by extension, mineral resources are established across Ariana’s licences. In the past year, Ariana has again identified a number of prospective gold/silver-bearing zones, these are in addition to its numerous other discoveries including on the Kepez and Karakavak licences located less than 10km to the north-east of Kiziltepe.

Exploration highlights for the Sindirgi gold corridor include:

On 17 November 2014, Ariana announced ‘’the confirmation of a significant volcanic complex containing mineralised sub-volcanic porphyry’’. This is significant in that the company has taken a major step forward in terms of understanding the geology covering its licence areas, not only at a regional scale, but also at the local and mine scales. This is particularly important for the understanding of orebody formation processes that underpin the emplacement and formation of economic, mineralised, gold-silver and base-metal occurrences in the region. The porphyritic intrusion identified in the area is not so much to generate potential investment relating to these large, bulk-tonnage and potentially low cost orebodies, but instead to drive targeted exploration and to discover, drill-out and create value from greenfield exploration targets. The overarching view of Ariana’s geology, is that an intrusive system has been identified, which also links the geology of the intrusion with that of associated smaller but potentially higher grade narrow gold-silver veins, which the future mine at Kiziltepe will extract.

The Kepez porphyry is located only 6km from the future Kiziltepe mine, and has been mapped over an area spanning 1,600m by 900m. It is made up of quartz feldspar phenocrysts set within a rock of rhyolitic composition. Magnetic surveying of the porphyry has shown it to exhibit intrusive characteristics and that it is likely to represent a sub-volcanic stock. The porphyry is located on a 5km ring-structure occurring within a volcanic caldera.

Economic porphyry systems are a much sought-after deposit type due to their capacity to yield high tonnages (and therefore revenues), are lower-cost and have long-life mines. Turkey hosts a number of economically viable porphyry hosted exploration and production-stage mining projects. The most notable deposits and mines closest to Ariana’s projects are:

However, we also note from this cursory review of advanced-stage mineral deposit evaluation in Turkey that the majority of precious metal mining occurs from epithermal vein-type deposits, such as:

Ariana has gold resources and reserves relating to its near-term development project Kiziltepe, a JORC exploration target for the ‘blind’ Arzu Central deposit situated under cover between the future Arzu South and North pits; it also has a maiden resource covering its Salinbas/Ardala JV with Eldorado Gold in north-east Turkey. These resources globally contain over 1.4 Moz of gold and gold-equivalent ounces (silver is converted to equivalent gold ounces on a 71:1 basis) and are contained in the following exhibits.

Exhibit 4 summarises the part of the Kiziltepe resource that has been converted into mineable reserves.

On 29 October 2013, Ariana announced an initial resource estimate for the Kizilcukur and Ivrindi projects. The resources use a 1/gt cut-off grade, which Ariana deems appropriate to allow for any future mining to be trucked to the future processing plant at Kiziltepe. Note that further metallurgical and resource definition drilling will be required to de-risk these projects for extraction. The current JORC resource is shown below. Ariana has started to factor the below resources into its mine schedule for Kiziltepe, however they currently remain outside our valuation.

Ariana also has a lower-confidence JORC exploration target for the area between the Arzu North and Arzu South pits which it is currently drilling. This area, named Arzu Central, is overlaid by volcanic deposits making open-pit mining of this potential resource unlikely due to a prohibitively high strip ratio (underground mining will cost more and will have a marked [decreasing] effect on any mineable reserves calculated). The current exploration target is given in the following exhibit.

Salinbas, like Ariana’s other gold-silver projects, is characterised by an epithermal style of mineralisation, but this time hosted by a breccia unit occurring at or near the contact between volcanic rocks and limestone. This deposit is geologically related to the nearby Ardala copper-gold-molybdenum porphyry, which is also under licence to the Eldorado-Ariana JV. Drilling undertaken in 1999 by Anglo American and from 2009 as part of the JV has been used to produce a 3D computer model of the mineralisation. This model indicates gold-silver mineralisation at Salinbas over an extent of 750m by 500m, controlled by one dominant gently dipping fault zone with much of the gold and silver occurring in the footwall position (ie the lowest position on the fault plane). The mineralisation is also open down-dip on the fault plane from an east-south-east to southerly direction. The maiden resource for this JV is given in Exhibit 7 below.

Our previous Salinbas valuation was based on an illustrative approach, whereby certain data inputs were sourced from Ariana, and others taken from the Kiziltepe DFS or assumed based on industry knowledge. The gold prices used were based on Edison’s own gold price assumptions as given in our sector report Gold – US$2,070 by 2020, with the silver price calculated from the gold price using a gold-silver conversion ratio of 71:1. Our previous Salinbas valuation was based on the assumption that mining and processing were based around a heap leach operation with costs and gold/silver recoveries reflecting this method. However, Ariana and its consultants have revised the method to include a conventional carbon-in-leach (CIL) plant, and while this pushes up processing costs, the economic results of the new CIL mine method are markedly improved.

A comparison of the data inputs used in our previous January valuation versus those used in our current (May 2015) valuation are given in Exhibit 8 below.

We value Ariana’s 49% interest in the Salinbas-Ardala JV based on the 2015 scoping study RNS announced on 1 April 2015. We note that code-compliant reserves have not been calculated and the scoping study used code-compliant mineral resources only, with inferred material mined alongside higher confidence indicated and measured resources. This is a key risk to our valuation and calculation of reserves will likely negatively affect the outcome of future feasibility through potential loss of resources during conversion to reserves studies.

We also note that our use of a flat 10:1 waste-to-ore stripping ratio (as detail was over life of mine) will not likely reflect the actual mine plan based on the eventual use of a code-compliant reserve estimate. The topography of the Salinbas area is that of steep-sided hills and mountains. This will have a variable effect on the stripping ratio as mining of the Salinbas deposit occurs over a mine life of ten years. For example, raising the 10:1 strip ratio to 15:1 has a marked effect on our valuation, reducing it by 69% from 3.04p to 0.95p.

Ariana will be able to sell resource ounces from its other projects into the Red Rabbit JV (of which it will eventually own 50%) for three times the cost of discovery. In our January 2010 report, Gold – Valuation benchmarks are obsolete, we calculated global discovery costs of US$7.16 for inferred ounces, US$10.50 for indicated ounces and US$36.82 for measured ounces. The arithmetic mean of all three is US$19.16. So, hypothetically, if Ariana sold a resource ounce at US$19.16 into the Red Rabbit JV it would effectively achieve a 50% profit over its original cost of discovery per ounce, equating to US$9.58 (US$19.16 x 3 = US$57.48 / 2 = US$28.74 - US$19.16 [Ariana’s original cost of discovery]). These attributable profits are in addition to Ariana still owning 50% of the resource by virtue of the JV and the attributable profits it achieves from potentially mining these ounces within the JV. Scaled up, 100koz of resource ounces could be worth US$958,000 to Ariana in cash terms.

Total cash cost – estimated break even at US$722/oz

Exhibit 10 gives the total operating costs breakdown (ie C1 cash costs plus central costs and depreciation). This was achieved by averaging the yearly amounts over the eight-year life of mine of Kiziltepe. The total average cost per gold-equivalent ounce is therefore US$722. A conversion factor of 71 has been used to convert silver ounces into gold ounces to provide gold-equivalent (AuE) production ounces. Depreciation is based on Ariana’s estimated total US$33.2m capex requirement straight-lined to end of mine (2023). Note that sustaining capex is low, estimated by Ariana’s consultants at US$50,000 per year, which we forecast will start to be spent from 2016 to 2023. If Ariana is to extend the life of operations at the Kiziltepe-based processing plant, we would then expect sustaining capital to increase. The magnitude of any increase in sustaining capex will be dependent on a number of factors; including the number of additional years of operation envisaged and any expansion to processing capacity required to lift throughput above the current scheduled 150ktpa.

Exhibit 10 details assumptions used in our base case valuation using the DFS announced on 24 June 2013. The changes refer to operating and capital costs, with the mine schedule used for mining the pits at Arzu South, Kepez, Arzu North, Banu and Derya remaining unchanged apart from the start of mining, which we now forecast to occur in H216 rather than 2014. The current life of mine is therefore H216 to 2025,

Our gold and silver price forecasts, which should be viewed alongside analysis within our February 2015 sector report Gold: The value of gold and other metals, given in Exhibit 9. Our 2016 gold price is adjusted for a hardening of expectations of a US rate hike by end 2015.

Our valuation factors in 100% debt funding of Red Rabbit, based on Ariana and Proccea’s arrangement with Turkish bank Turkiye Finans Katilim Bankasi. Also, we now forecast the capex required to develop Red Rabbit will be spent during the latter half of 2015 and during 2016. Previously, we assumed all of the required capex of US$24.8m, (ie total capex required of US$31.1m net of Proccea’s remaining investment of US$6.3m of the total US$8m it is required to invest under the terms of its JV with Ariana), would have been spent during 2014, but due to the delays in permitting the project we have adjusted this assumption. We also include a working capital requirement as stated in the DFS of US$3.2m or £2.1m in 2016. On the basis of the above revisions, we now value Ariana’s eventual 50% share of the Red Rabbit project at 1.73p. This reduces to 0.74p using gold and silver prices of US$1,050/oz and US$14.8/oz respectively.

Ariana announced on 31 July 2014 that it had secured 100% of the financing required for its eventual 50% interest in the Kiziltepe Mine. Financing is 100% debt and was secured with Turkish bank Turkiye Finans Katilim Bankasi. It is structured using participatory banking principles and carries no requirement for hedging. We have adjusted our valuation for the credit facility, which will be repaid monthly during the period mid-2016 to mid-2019. We assume repayment will be at an annualised interest rate of c 7.39%.

We consider the following risks, which largely revolve around the issue of project permitting and the current gold price environment, are specific to Ariana’s investment case:

We also provide the following qualitative sensitivities specific to Ariana resources:

Ariana has raised via the issue of new shares, a total of £818k during 2014 and £1,343k year to date in 2015 at a share price of 0.9p. This money has been used to further the geological understanding of Ariana’s licence areas, pursue and complete its environmental impact assessment (now approved by the government) and complete a trial mining exercise as per the conditions of its mining licence. Ariana has a current cash burn rate of c £65k per month, low in terms of mining juniors, reflecting the result of a series of cost-cutting exercises. Ariana considers its current cash balance will support its operations until mining commences in H216. We currently forecast the £17.2m in capital expenditure required to construct the Kiziltepe mine being spent over H215 and H116. Proccea will manage the construction phase, at which point it will take its full 50% interest in the Red Rabbit joint venture.