Euromax Resources — Potential US$87.2m in initial capex savings

Macedonia held parliamentary elections on 11 December. The elections were called following an EU-brokered agreement after the prime minister, Nikola Gruevski, stepped down in January 2016 amid opposition allegations of the widespread wiretapping of Macedonian citizens. In the ensuing elections, his party, the nationalist VMRO-DPMNE, won 51 of 120 parliamentary seats (a reduction of 10 compared to the previous election). The opposition Social Democrats won 49 seats, while the main ethnic Albanian party – the Democratic Union for Integration (DUI) – which has long been junior partner in coalition with the governing VMRO-DPMNE, came third with 10 seats. Election observers from the Organization for Security & Co-operation in Europe (OSCE) said that the voting had been conducted smoothly. Observers said there had been some irregularities but that no political party had complained about either the electoral process or the result.

While the election had been seen as a delaying factor regarding construction permits at Ilovica-Shtuka, the eventual granting of the permits was never perceived as being in doubt, given that both main parties in the election had voiced their support for the project. While the election gave the government a technical majority of one however, a genuine coalition government in partnership with the DUI has proved difficult to form, with the latter’s demands in return for its support being perceived as onerous by the ruling party. As a result, something of a political vacuum has developed and informed opinion appears to incline towards the expectation of a second election in the foreseeable future. Notwithstanding the resulting absence of political leadership however, technical government in the form of the requisite bureaucratic processes is reported to have continued, more or less, uninterrupted.

As a result of the continuation of bureaucratic, if not political, government, Euromax has achieved two key milestones in the granting of an exploitation permit:

Of the two, the latter milestone is arguably the more significant, since Euromax’s exploitation plan was presented on a combined basis and the subsequent merger of the two concessions now allows this submission to be formally considered by the government, having previously been held up.

Following additional mine plan work, Euromax embarked on a contract mining tender process in November 2016. The tender was focused on the first seven years of mine life (ie the two-year construction and pre-strip period plus five years of operation). Compared to the owner-operated business model envisaged in its definitive feasibility study, the average cost per tonne of material mined was 10.5% higher (US$1.79/t vs US$1.62/t), while capex was c US$42.2m lower (US$58.5m vs US$100.7m).

In the meantime, Euromax has also agreed a binding Memorandum of Understanding (MoU) with Ausenco Engineering Canada for further initial, detailed engineering and design and a framework to allow Ausenco to proceed through a two-step process to provide Euromax with a lump-sum turnkey (LSTK) price for the construction of the process plant and related infrastructure for the project. The first step of a two-step process is for Ausenco to provide Euromax, within 90 days of commencing the work, a guaranteed maximum price (GMP) for the project, based on an agreed scope of work on an ‘open book’ basis. Following the delivery of the GMP (and assuming that the GMP is at or below the project capex as envisaged in the DFS), Ausenco will then proceed to negotiate with Euromax the terms of a final LSTK price for the development of the project that will be at, or below, the GMP.

Ausenco has already made a site visit to Ilovica-Shtuka and is reported to have identified a potential c US$45m in (stage 1) savings, largely based on a tighter plant footprint, which thereby requires less steel, concrete and civil engineering etc. In addition, management believes that further savings may be made in the related infrastructure budget (currently estimated at US$23.7m) – eg via reduced mining infrastructure costs, many of which are incorporated in the mining contractor tenders.

Once stage 2 is completed therefore, Euromax should benefit, not only from a reduction in cost inflation risk as a result of the LSTK nature of its development contract with Ausenco, but also the fact that the capital cost of the mining fleet will have been removed from its balance sheet. Moreover, under the terms of the MoU, the cost of Ausenco’s work to deliver the GMP will be settled via the issuance of Euromax shares to Ausenco at a premium to the share price immediately prior to the delivery and announcement of the GMP. Based on Euromax shares’ market price immediately prior to its 23 February announcement (C$0.58/share), management estimated that the number of common shares to be issued to Ausenco in connection with the MoU would be “less than 5%” of the 116.8m that were then issued and outstanding ie less than 5.8m shares at a price of C$0.58 each, or C$3.4m.

Euromax now expects final construction permits to be awarded in approximately six months’ time, after which it will complete the Ausenco LSTK negotiations and marshal the winning contract miners. After pulling together interim mining and metallurgical work, it intends to publish an optimised technical report (effectively an optimised DFS) in approximately August this year, including a detailed plan of execution.

After raising the required equity finance in c Q417, Euromax plans to break ground on the project in early FY18 and, after two years of construction, to pour first gold in early FY20.

As stated in our Outlook note of March 2016, Euromax envisages financing Ilovica-Shtuka’s funding requirement via debt, equity and streaming in approximately the following proportions:

Assuming the following:

We estimate an updated value for Euromax’s shares of C$0.87 per share, based on the net present value of maximum potential dividends payable to shareholders over the life of operations, discounted at 10% per year:

This valuation increases to C$1.50 in 2023, when conventional debt (ie excluding the Royal Gold stream) has been repaid and the first substantive dividend distribution is payable. Also of note is the fact that execution of the mining plan at the parameters indicated implies future potential (fully diluted) EPS as high as C$0.34/share and average sustainable (fully diluted) EPS in the order of C$0.15/share, which compares favourably with Euromax’s current share price of C$0.46.

Stated alternatively, investors buying Euromax shares at the current price of C$0.46/share may expect a 19.6% internal rate of return from their investment in Canadian dollar terms over 24 years to FY41 (inclusive).

A summary of the components in the evolution of our updated valuation of Euromax compared with that in our last update note is as follows:

As noted on page 3, Ausenco has identified a potential c US$45m capex saving as a result of its site visits, based largely on the presumption of a tighter plant footprint, which will therefore require less steel, concrete and civil engineering etc. In combination with the US$42.2m capex reduction in the event that a contractor, rather than an owner-operator, business model is chosen, this would reduce initial capex from its original US$431.2m to US$344.0m and increase our valuation of Euromax by a further C$0.10, from the C$0.87/share noted above, to C$0.97/share.

Excluding the contingent liability relating to its streaming agreement with Royal Gold, Euromax had C$14.7m of net debt as at end-December 2016. We assume that it will raise c US$100m (or C$134.1m) later this year, approximately coincident with the signing of final debt funding agreements with its consortium of banks. As it draws down debt to fund the initial capital expenditure on Ilovica-Shtuka, net debt (excluding the contingent liability relating to its Royal Gold streaming agreement) will increase to peak at C$289.1m (US$215.6m) in FY19 – equating to a contemporary leverage (debt/[debt+equity]) ratio of 75.1% – before reducing under the influence of positive operational cash flows until it is eliminated in FY22.

Note that this estimated C$289.1m, or US$215.6m, net debt requirement is below the figure of US$240m (C$321.8m) for which Euromax’s consortium of financial partners has been mandated (Exhibit 1). If Euromax instead decides to maximise its debt funding capability, it would require the raising of only C$102.8m (US$76.6m) in equity and would result in a 13.8% uplift in our valuation of Euromax’s shares (albeit with proportionately greater financial risk) to C$0.99/share.