Erdene Resources: A Look At The Bayan Khundii Feasibility Study (OTCMKTS:ERDCF)

It’s been a busy year for gold developers as several companies race to get economic studies out to the market to showcase their projects at higher metals (GLD) price. The most recent name to report a Feasibility Study is Erdene Resource Development Corp. (OTCPK:ERDCF), a gold explorer in Mongolia that’s been delineating its Bayan Khundii Gold Project the past several years. The project benefits from one of the highest-grade projects amenable to open-pit mining in the world and low upfront capital, with the ability to move into production for less than $60 million. Meanwhile, costs are industry-leading below $750/oz, which would translate to nearly 60% margins at current gold prices. Based on the robust economics at Bayan Khundii and a project that’s relatively easy to finance, I see the stock as a Hold at US$0.35. However, I personally prefer development projects in more attractive jurisdictions than Mongolia with similar economics.

(Source: Company Presentation)

Erdene Resource released a Feasibility Study this week on its Bayan Khundii Gold Project in Mongolia, and the project economics are exceptional. The study envisions a 6-year mine life with average annual gold production of 64,000 ounces per with year. The operation is relatively straightforward and is based on open-pit mining, with mill throughput of 1,800 tonnes per day and total recovered gold of 382,000 ounces. However, it’s worth noting that this represents barely 20% of Erdene’s total 1.83 million-ounce resource in the district. The estimated head-grade for the deposit is quite high at 3.7 grams per tonne gold, which is well above the average grade for open-pit gold deposits of closer to 1.0 gram per tonne gold. This is one of the main factors driving the industry-leading costs that are expected at Bayan Khundii, with all-in sustaining costs expected to come in at $733/oz. Assuming things go as planned, this would make Erdene one of the lowest-cost gold producers worldwide, with a rank of 13 among miners from a cost standpoint. Let’s take a closer look at the study below:

(Source: Author’s Chart)

(Source: Company News Release)

As the table above shows, the project has a rapid payback of less than two years at a conservative gold price of $1,400/oz and an After-Tax NPV (5%) of $100 million at $1,400/oz gold, and $112 million at $1,450/oz gold. These are impressive economics when considering the relatively low gold price used, as the spot gold price is currently more than 20% above the prices used in the study. However, the most attractive part about Bayan Khundii is the pre-production capital, which comes in at a very modest $59 million.

(Source: Company Presentation)

The problem with many smaller junior gold companies is that they’re too ambitious and have outlined large projects with $125 million or more in capex needed to move into production. While this isn’t impossible to raise, it’s not easy for companies with sub-$100 million market caps. In Erdene’s case, the $59 million is more than manageable even for a junior with a $68 million market cap, as it can accomplish this through the issuance of shares and debt. Erdene plans to start with a small-scale operation and then grow into a larger producer using cash flow to fund exploration and potential acquisitions. This is a wise plan, as so many smaller juniors are too ambitious and try to begin with a 100,000-ounce per year operation and end up sitting there for years with no way to develop it. Therefore, I would argue that Bayan Khundii has a good shot at going into production based on the plan outlined here, and the company has noted it’s hoping to begin production by Q3 2022.

(Source: Author’s Chart)

If we take a look at the chart above, which compares Bayan Khundii (right) to peers, we can see that the project stacks up very well to other development-stage projects. This is because Bayan Khundii has the lowest capex in the peer group for small-scale gold projects at $59 million, which is 27% below the peer average of $82 million. While the average gold production profile comes in lower than the peer average of 77,000 ounces for the above-listed projects, this is not a huge deal, as a 64,000-ounce annual gold production profile is still respectable for a small-scale gold project. In fact, I would rather see a modest initial capex with a slightly smaller production profile than a project with higher production that will never see an ounce produced. Based on these above metrics, Erdene stacks up great with its peer group, with the closest comparison being Gold Springs Resource Corp. (OTCQB:GRCAF), which has a similar production profile but an $84 million upfront capex bill.

(Source: Author’s Chart)

If we look at Erdene’s Bayan Khundii from an After-Tax NPV (5%) vs. Initial Capex ratio standpoint, the project also stacks up great, with a current ratio of 1.90. This figure is based on dividing the After-Tax NPV (5%) of $112 million by the upfront capital of $59 million. As the chart above shows, Erdene Resource has the best ratio among small-scale gold development projects, with the average for all projects being 1.43. While large-scale gold projects that benefit from size can see an After-Tax NPV (5%) to Initial Capex Ratio above 2.50 like Integra Resources (IRRZF), it’s much more challenging to achieve these economics with small-scale gold projects. When it comes to sub 100,000-ounce annual production profiles, a respectable figure is 1.60 or higher. Therefore, from an economics standpoint, there’s a lot to like about Bayan Khundii here as well at 1.90.

(Source: Author’s Chart)

From a valuation standpoint, Erdene Resource is reasonably priced with a $68 million market cap based on 193 million shares outstanding and a share price of US$0.35. If we factor in the company’s current 1.83 million-ounce resource at 2.51 grams per tonne gold, Erdene is currently trading for a valuation of just $37.16/oz, well below the average paid for the best gold projects worldwide of $63.71/oz. However, I believe a 30% discount is fair due to a much weaker jurisdiction, as Bayan Khundii is located in Mongolia, a country ranked in the bottom 60% of jurisdictions. Despite this 30% discount to the $63.00/oz average to account for the weaker jurisdiction, Erdene is still slightly undervalued at $37.16/oz vs. $44.60 at a 30% discount to the 4-period moving average paid for gold explorers. I arrived at $44.60 by discounting the 4-period moving average price paid per ounce worldwide by 30%.

(Source: Company Presentation)

(Source: Company Presentation)

It’s worth noting that the upside case from a regional exploration standpoint for Erdene is immense, and the company’s ambitions to become a larger-scale gold producer are not unfounded. As noted earlier, the Feasibility Study outlined here is based on only 20% of the known resources, and the company continues to make discoveries within 10 kilometers of the proposed plant. Meanwhile, Erdene has barely scratched the surface at the polymetallic Altan Nar deposit 30 kilometers to the northwest, which holds 40% of the 1.83 million-ounce gold-equivalent resource on Erdene’s properties. Therefore, for investors comfy with Mongolia as a jurisdiction, Erdene certainly has a compelling story here, which is made better if the company can move into production and use cash flow to systematically explore the district versus having to dilute shareholders like most explorers.

(Source: Company Presentation)

While Erdene Resource isn’t in the greatest jurisdiction worldwide, the exceptional economics at the newly released Feasibility Study have certainly de-risked the investment thesis. Assuming the company can find favorable funding and build out its project according to plan, there is a long-term upside from the current modest valuation of barely $40.00/oz. This is because the company has delineated a project with industry-leading costs, nearly 60% margins at a $1,800/oz gold price, and further exploration outside to increase the mine life and production profile. Having said that, there are other developers out there trading at similar valuations in Tier-1 jurisdictions, which is why I am not long Erdene Resource Development Corp. and continue to focus elsewhere. For those comfy with investing in Mongolia, though, I believe any 20% plus pullbacks to US$0.265 would provide low-risk buying opportunities.

Disclosure: I am/we are long IRRZF, GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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