Orosur Mining Inc — Update 30 January 2017

Orosur’s H117 results show the company, as guided, had not maintained the run-rate required to meet half its 35koz to 40koz FY17 production target, reflecting the transitioning of UG operations from Arenal to the new San Gregorio West UG mining area. However, as this transition has now been made, we consider the company should be able to make up the shortfall from H117 as fresh higher-grade ore is fed to the processing plant through H217.

Orosur’s stated FY17 production guidance is for 35koz to 40koz at a unit cash operating cost of between US$800/z to US$900/oz. Orosur has, year-to-date, produced 16,802 ounces at cash operating costs of US$783/oz. And although H1 saw a q-o-q decrease in production of 31%, alongside a commensurate increase in cash operating costs of 32% (Q117: US$693/oz, Q217: US$914/oz), Q3 and Q4 performance should be marked on the onset of mining higher-grade SGW UG ore, which was originally planned for extraction during H117.

To meet its 35koz to 40koz gold production target, OMI will have to mine between 18,198oz and 23,198oz of gold over H217. We believe that the lower bound of its guidance is achievable based on past operating performance. Meanwhile the deferred higher-grade SGW UG material should increase H217 gold production as well as help to bring costs back in line with FY17 guidance of US$800/oz to US$900/oz.

Orosur has budgeted for 9,000m of drilling in FY17, and by end Q217, 4,250m had been drilled, concentrating mainly on the San Gregorio area. This area includes SGW UG, SG Central and SG East, all of which are underground deposits located close to existing mine development to allow, when appropriate, for economical extraction.

A persistent (and in our view decreasing) risk to the company’s valuation is funding exploration and increasing its mine-life at SG, and, as appropriate, realising value from its Anillo and Anzá assets in Chile and Colombia, respectively. Relating to SG, OMI has budgeted for 9,000m of drilling for FY17 (over half has already been drilled), and results so far have been positive especially as drilling has focused on deposit areas close to existing infrastructure. Our view of SG assay results in the year to date is that an increase in SG reserves, as planned by Orosur, towards end FY17 is feasible and now expected.

The well-developed and considered exploration programme currently underway at SG and also Anzá provides for a potential swathe of catalysts through the second-half of FY17 and into FY18. A successful exploration campaign at Anzá should de-risk Orosur’s profile and potentially change the view on the stock from being a single asset, short-life gold mine to one expanding growth at SG, developing its Chilean Anillo project via a farm-out agreement with third-party Asset Chile, as well as exploring its semi-greenfield Anzá project in Colombia.

We discussed the impact of OMI’s exploration in our December 2016 note Production prowess provides profits. This note gives a description of the main target areas for exploration at SG, as well as the company’s non-production focused exploration further afield in Colombia.

The main objective of Orosur is to extend SG’s mine life beyond the approximately four years provided by its current (as at 31 May 2016) reserve base. Orosur for the past four years has managed SG production via a mix of roughly two-thirds underground (higher-grade, higher-cost), one-third open-pit derived (lower-cost, lower-grade) ore mining. So far this has consisted of one core underground operation, previously Arenal UG, which has now transitioned to SGW UG.

Anzá was acquired by Orosur via its all-paper takeover of Waymar Resources in 2014. Located in the middle Cauca region of northern Colombia, the project comprises a permitted gypsum mine (small scale, with two UG operations), and 17,408m of historical drilling undertaken on the project area. It is worth noting that the drilling undertaken previously was targeted along the main Aragon fault line, in effect chasing high-grade intercepts, and not concentrating on the identification of a working geological model. This historical drill data has been the subject, by Orosur, of partial re-logging and testing, including the aforementioned metallurgical results, and has allowed a preliminary geological model to be completed.

The partial re-logging of 3,000m of drill core focused on defining lithological boundaries, alteration assemblages and grade distribution. Considering the overall regional geological context in which Anzá resides, it would be interesting to see whether Anzá’s currently mapped mineralisation is dominated by vein style gold mineralisation, or whether mineralisation relates to a potentially much larger mineralised system. Although future exploration and drilling is required to understand the precise geological controls on mineralisation at Anzá, work undertaken by previous owners Waymar, and their consultants Snowden, suggests that volcanogenic massive sulphide (VMS) processes could be the overarching geological process governing Anzá’s mineral depositions. However, we would also add that the regions geology also offers the potential for epithermal style gold deposits. In either case the main objective for Orosur, will be to prove economic viability of any mineralised deposit.

From first-hand experience we understand the incredibly dynamic processes that go on during the formation of VMS style deposits, and how their formation over protracted periods of time allows for further complexity to be overlaid via structural controls on mineral deposition and ore deposit genesis. As such it is critical to the eventual understanding and completion of a working geological model that the project is drilled to such an extent that the evolution of Anzá mineral deposition can be illustrated and used to target future drill holes. At face value, we would expect 30,000m of drilling to provide such information, and by extension deliver a measured and indicated maiden resource for the project.

If a type of VMS (or other type) system is verified at Anzá, it could provide a step-change in fortunes for Orosur. While San Gregorio is a known and well-endowed mining complex that has yielded over 1Moz in its 15-year history, Anzá potentially breathes fresh air into the exploration side of Orosur’s operations and diversifies its risk profile away from only one mine. This at a time when the market appears to be valuing growth projects again (see exhibit 3).

We note that the data provided so far is very early-stage. But we also note from our discussions with management that the data sets compiled by previous owner Waymar Resources required a careful and highly systematic approach to organising and analysing the approximately 17km of drilling data. We expect this same methodical approach to be continued into the 30,000m drill campaign to be undertaken over the next 12 months, which once completed should leave little or no ambiguity over the type of geological landscape Anzá sits within. Further, this holistic and systematic approach to exploration should, all other things remaining equal, increase the probability of success by allowing far more accurate drill target generation.

The resurgence in the gold price over the past 12 months has had an obvious and material impact on mining equities. Orosur, though small, is a company that has outperformed some of its much larger (by market capitalisation) peers. In Exhibit 2, we compare share performance for Randgold Resources, Newmont Mining, Barrick Gold and Orosur. In all instances (aside from Randgold over H216/Q117, which saw, in large part, an improving ramp-up at its new Kibali mine) Orosur in large part outperformed all these majors. Though only operating a single mine in a single jurisdiction, the data does support the view that Orosur, an AIM-listed gold miner, is viewed favourably by the market as a sound operator and one capable of navigating tough gold price conditions and undertaking M&A without undue stress to its balance sheet. This latter point is best highlighted by Orosur’s successful farm-down of an interest in its Anillo project to Asset Chile in June 2015, as well as a nil-premium all-paper takeover of Waymar Resources in 2014. The release of new positive Anzá drill data over the coming months should receive a positive market reaction, as once again the market starts to value growth-focused projects (see page 6 and Exhibit 3) instead of just (low-risk) cash flows as was seen since the gold price cash of April 2013.

There appear to be indications that the stock market is starting to look more favourably on exploration/growth stocks, which should bode well for Orosur as it plans to ramp up exploration in Colombia, and specifically its highly prospective Anzá project which the market appears not to place any value on at present.

For example, we note SolGold’s (LON:SOLG) recent strong share price performance. SolGold has released highly positive drill data for its Ecuadorian Cascabel project, which is still at the pre-resource stage, yet attracts a market valuation of some $400m+. We note the company’s Solomon Islands projects, but see these as relatively non-core next to the potential size and scope for mining Cascabel. Cascabel is a large-scale copper-gold porphyry of the world-class Andean copper belt.

Two other notable examples of exploration-stage companies attracting attention are Mariana Resources and Kodal Minerals (AIM:KOD). Mariana Resources released a swathe of positive exploration results from April 2016 for its Hot Maden copper-gold porphyry in NW Turkey. Since April 2016 its share price has risen by c 4x, from around 20p to 80p (as of 25 January 2017).

Kodal Minerals (AIM:KOD) is a lithium explorer, and has experienced a tenfold increase in its share price, with the earliest of material increases related to the acquisition of a Malian lithium project. Its share price performance may also be in part due to the announcement of ‘anomalous gold assays’ over its Nangalasso project, also in Mali.

A closer regional peer, as stated in Orosur’s H217 release, would be Red Eagle (TSE:R), which is currently building out its 48kozpa, eight-year LOM, San Ramon gold mine, also located in Antioquia, Colombia. San Ramon is situated within Red Eagle’s Santa Rosa gold project. Red Eagle currently has a market valuation of C$202m, roughly 10x that of Orosur’s, and yet Red Eagle has only just entered production and does not have the exploration potential that Orosur has.

The geological structures governing gold deposition in the Caucus region can be related to the fault system accountable for the drilling success seen at Cascabel in Ecuador. This is because the Colombian Caucus region, which hosts San Ramon, APTA and a number of other projects (including the giant La Colosa gold project owned by Anglo-American; see Exhibit 1, left-hand figure for others), is a convergent fault margin associated with the main Andean subduction fault zone that dominates the geology of the west coast of South America.

At this stage we maintain our previous £0.34 per share valuation. The small amount of dilution resulting from exercise of options offsets the 4% strengthening of the pound versus the Canadian dollar since our last note, published December 2016. Note that we do not yet provide any quantitative assessment of the value of its Colombian assets until a maiden resource is released, due later in H217.

We also maintain our operational model for SG, noting management’s guidance over the delayed (now underway) transition to SGW UG from Arenal Deeps UG. As a result we anticipate management will be able to meet its 35koz to 40koz production guidance for FY17 at cash operating costs of between US$800/oz and US$900/oz. We estimate Orosur will produce 37.5koz (mid-range of guidance) at cash operating costs averaging US$885/oz.

A summary of our operating and cost assumptions through to end FY17 are given below:

Orosur will start to see the result of its efforts to increase San Gregorio’s mine life through H217 as it starts to mine resources defined in areas highlighted by exploratory drilling undertaken over at least the past year (ie SGW UG, Central Area, SG East). We consider that the company is able and willing to take further steps to support its longstanding San Gregorio mine, by continuing to concentrate drilling in areas close to existing mining infrastructure.

Though early stage, the longer-term potential of the Anzá project should now start to be recognised. Further, the potential for Anzá to de-risk the investment profile of Orosur is an important factor to consider. Though much more exploration of the Anzá project is needed, a maiden resource is due in H217, which will help benchmark the exploration potential of this asset against its peers. We consider this is the first secure entry-point to placing a valuation on Orosur’s Colombian project.

Based on our view of available data for Anzá, we have high confidence for a successful drill campaign being completed and results to be announced through H217. To provide a first-pass indication of value we have looked to apply our in-house gold resource multiple values to Orosur’s stated exploration target of 1.6mt to 3.2mt of mineralised material grading 3.2g/t Au to 3.7g/t Au, for between 164.6koz and 273.6koz contained gold.

Our in-situ gold resource multiples can be viewed alongside the constituent supporting data in our October 2016 sector publication Mining Overview. The result of us applying the average value of a gold ounce in the ground across all exchanges (AIM/TSE/ASX) is given in the following exhibit:

With 30,000m of new drilling aimed at proving up the above exploration target into a code compliant resource, we consider the above secure enough for at least a first-pass illustrative value of Anzá.

Taking the mid-point between the lower bound (US$5.1m) and upper bound (US$8.5m) as US$6.8m, equates to a per share value of 6.8c or 5.4p. Alternatively, a valuation of US$6.8m for Anzá would add 32% to Orosur’s current market valuation. Considering that this exploration-type target was based on 17,000m of drilling and a further 30,000m is planned, we consider that this illustrative valuation is likely to be a conservative view of Anzá’s eventual resource size and in-situ value.

Comparable transaction or ‘deal’ type valuations of very early exploration stage (or worse production stage) assets are unwise as no detailed scoping or feasibility level (ie cost input) data are available to compare between two projects. Further, it would require accurate knowledge down to a stratigraphic level to understand whether Anzá is related geologically to peers located close by to even start to be certain that projects are indeed ‘comparable’.

The above in-situ valuation is based purely on empirical data derived from the stock market in August 2016, at a time when the gold price was trading at c US$1,340/oz.

Net profit after tax in the six months to end November 2016 was US$0.9m; cash flow from operations was US$7.0m (a 536% increase y-o-y) and the company ended November with net cash of US$5.1m.

As long as Orosur maintains its production and cost guidance, and gold prices stay at or near to current levels, we estimate an increase in net cash to US$5.4m by year-end. This is based on the operating costs given in Exhibit 4 as well as factoring in committed investment of US$8.0m for capital expenditure and US$3.1m for exploration.

H117 earnings per share were 4.0 cents; for the full year to May 2017 we estimate 3.9 cents, rising to 10.5 cents in FY18e. This would place the company on a FY17 P/E of 5.2x, compared with the FTSE Mining Index P/E of 31.1x.

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