Ground value - calculating the worth of a resource
How do companies confidently calculate the worth of a resource? Edison Investment Research in London, UK, has developed a new method of valuation. Michael Forrest reports
The art of mining finance is to recognise projects that will make a return for investors. During the time it takes to discover, prove resources and complete a feasibility study, many years may pass depending on the size of the planned mine. Over this time, it is essential to maintain investor interest and the inflow of funds, and this is achieved by reporting exploration results. The value of ounces of gold in the ground is dependent on a number of factors, says Charles Gibson of Edison Investment Research, London, UK, Including the cost of exploration, the degree of confidence in the resource estimate and the stock market where the developing company is listed. At Edison Research we have examined over 130 companies listed in London, Australia, Canada and South Africa whose exploration programmes have identified resources in the classifications described in the PERC, JORC, 43-101 and SAMREC reporting codes.
These codes have been moving towards common definitions of inferred, indicated and measured resources that represent increasing levels of confidence in their accuracy. However, the problem remains of what value to place upon them. Historically, both the cost of discovery and the value of an ounce of gold in the ground were said to be US$35. But there is reason to believe that the rise in the price of gold and its equities in the past nine years has now rendered this benchmark obsolete.
One way to provide benchmarks is to calculate the average value placed by investors on an ounce of gold in the ground by comparing companies enterprise figures (market capitalisation minus net debt) with their resource bases, for a large sample of companies, says Gibson.
In addition to calculating the average value of an ounce of gold in the ground, by varying the approach it is possible to derive values for measured, indicated and inferred ounces. This is achieved by determining the value of those companies with only inferred ounces to calculate the average, then using this alongside the average price of an indicated ounce for companies with indicated and inferred ounces. With these figures calculated separately, the same approach can be used to establish the average value of a measured ounce by considering those companies with all three categories of resources.
At the exchange
As the companies reviewed are registered on four exchanges (Johannesburg, South Africa; London, UK; Sydney, Australia, and Toronto, Canada) the research also determines regional differences. Edison teamed up with BDO – the worlds fifth largest accountancy firm – to determine the cost of discovering an ounce of gold to see which stock exchanges offered the largest uplift in value to investors. The London market has 41 gold companies of which three have inferred ounces with a weighted average of US$3.78/oz. In this case, the weighted average of an indicated ounce was found to be US$6.74/oz. However, of the 147.9Moz in the inferred category of the London companies, 140Moz are based in Witwatersrand, South Africa, which have been found to have a much lower values.
Excluding these Wits basin ounces, Edison has calculated the weighted average value of an indicated ounce listed in London to be US$85.94. It is then possible to calculate a weighted average for measured ounces listed in London of US$403.53/oz. Looking at 41 companies listed in Toronto (with an aggregate resource base of 737.8Moz in all categories), the inferred value is US$62.01, indicated US$243.76 and measured as US$283.98/oz. One of the most striking characteristics relates to the structure of Canadian companies balance sheets. Whereas London firms have cash in the bank, Canadian ones (particularly those with measured ounces) were, on aggregate, financed by debt.
In Australia, the 31 companies surveyed had a market capital of US$32.7bln, twice that of London, but only one fifth that of Toronto. They, like their London counterparts, had cash in the bank in all sectors (on aggregate). London companies, however, had double the ounces in total. Values for Australian inferred, indicated and measured were US$91.47/oz, US$143.43/oz and US$738.55/oz, respectively.
The Johannesburg stock exchange accounted for the largest number of ounces – 848.4Moz. Unlike the other markets, none of the five companies listed here have one type of resource. As a result, Edisons methodology had to be revised. Nevertheless, it was possible to determine that the value of an inferred ounce cannot exceed US$36.27/oz, while the value of an indicated ounce lies in the range US$36.27-53.14/oz and the value of a measured one between US$36.27 and US$156.09/oz. This illustrates the difference in valuation across four exchanges. The analysis is based on a level playing field of a 0.5g/t cut-off grade and share prices. Obviously there are other considerations in valuing individual companies, says Gibson, highlighting mining and processing costs. However, it is also important for investors to know where their benchmarks lie before they finalise their valuations. Australian companies are accorded the highest valuations in inferred and measured categories, while Canadian companies are highest in the indicated category. By contrast, Johannesburg-listed companies attract the lowest valuations in all categories with the possible exception of rhe inferred ounces in London, which have such a poor rating on the London market that listing with only the inferred category of ounces could be value destroying.
Meanwhile, Australia offers the greatest uplift between enterprise value and discovery costs for measured and inferred ounces, and Canada offers the greatest uplift between enterprise value and discovery costs for indicated ounces. On the prospects for gold, Gibson is positive. Our analysis of the gold market is that it is due to experience a second leg to its bull run. The present quantitative easing and loose monetary policy has yet to be expressed in inflation statistics, but when it is (by about 2013, if not before) we expect gold to rise to around US$1879/oz.
Further information: Edison Investment Research