The biggest punt on M&A
The pouncing moment arrived last September when the 100 per cent owner and operator of Red Chris, Imperial Metals, was driven by financial hardship to open its doors to asset hunters.
It is said that the Imperial data room was joined by one other big miner with a similar command of the block caving technologies that sit essential to the Red Chris value story. If that is right, then I would be betting that, if this was a contest then it was one between Newcrest and Rio Tinto.
The other quirk in this deal is that Imperial is nearly half-owned by the now-London-based Canadian billionaire, N. Murray Edwards. A lawyer by training, Edwards made his name in oil sands and has since become an active investor in mining and ice hockey. He owns the Calgary Flames.
We are assured that making this deal meant getting Edwards comfortable with Newcrest, its people, its methods and its plan for Red Chris.
Whatever the preamble though, Red Chris has now emerged the biggest punt on M&A that Newcrest has made while under the reforming stewardship of chief executive Sandeep Biswas.
It is an investment that affirms a newly self-confident Newcrest. Biswas leads a team that is prepared to back itself but is strong-willed enough to avoid sectoral distractions and instead stick to a mission statement that asserts the need to live within the company’s means and its capabilities.
Interestingly, Biswas took a passing shot at a gold industry whose majors seem determined to repeat failed sectoral consolidation past.
“We prefer this approach to growth rather than financial engineering or seeking nebulous synergies that rarely add to shareholder value,” Newcrest’s man said in what was unmistakably a reference to the Barrick-Newmont-GoldCorp contest.
Brightest and biggest
Like those other early-stage investments, Red Chris is all about what we can’t see. And that is probably a good thing given the public data flow presented by Imperial.
Imperial is routinely described in Canadian media as embattled. That appears to undersell the quality of its financial and operational dilemmas. The business owes about $C800 million ($846 million), it has recently missed interest payments and last Thursday it confirmed the maturity dates of its senior, second lien and bridge loan facilities had been extended by between a week and a mere two days to a point where all are due this coming Friday.
Red Chris is Imperial’s brightest and biggest business but, as things stand, the quality of the ore body is not translating into financial performance. Imperial’s most recent detailed financial data shows that the mine’s owner was cash-flow negative to the tune of $C11.8 million through the September quarter.
The short-form full-year production report shows that gold production hit 41,935 ounces in 2018 with copper production running at 27,374 tonnes of copper, which was a 3 per cent miss on guidance. The market has been guided to expect 10 per cent less gold production through 2019 but up to 25 per cent more copper production.
Newcrest is aiming at a two-stage revitalisation of Red Chris. The first step is to drive material improvement in the performance of the open pit operation by overlaying the Newcrest operating and technology model over the Canadian asset and then by changing the mine plan to reflect a future that will see Red Chris go underground earlier and in a bigger way than anticipated by the current owners.
And here is where our technology play thesis comes into the story. Newcrest likes Red Cliff because its geologists recognise it as being very similar to the collection of porphyry gold and copper deposits that make up the company’s Cadia-Ridgeway complex in the Cadia Valley of NSW.
Cadia is a showcase for the transformative potential of block caving, a technique that makes mining low-grade ores and great depths a highly profitable business. Block caving has made Cadia a world-class gold mining province and it has made Cadia East one of the lowest-cost gold mines in the world. Right now Newcrest is one of a handful of miners that have successfully deployed this bulk mining technology and Biswas & Co are working to take another leap forward in the company’s proficiency.
Block cave refinement
As Biswas explained on Monday, at the turn of the century the consensus valuation of Cadia was $US284 million. But then a succession of block caves were rolled out, first deep under the Ridgeway open cut and then at Cadia, where panel three is now under construction. Step forward 18 years and Cadia is valued at $US8.1 billion despite grade erosion.
Because lower grade ore can be profitably mined, the reserves at Cadia have held up strongly despite its increased rates of production. The reserve grade at present is 0.47 grams per tonne of gold with 0.3 per cent copper. To a world of underground mining not so proficient at block caving, that would be regarded as something a whole lot closer to mining waste than to reserve.
The other special thing about block caving is that it is like mining upside down. Put simply, you undercut the deposit with a very large hole (or two holes actually) and then you collapse the ore into the holes and busy yourself moving the stuff to the surface.
This technique is perfect for ore bodies that are richer at the bottom of the deposit rather than in the middle bit. That is part of the Cadia story and it is very much the story at Red Chris. There, grades are richer at depth but there is also a greater proportion of gold.
At present Newcrest is working on a refinement of block caving that will cut cost by up to 30 per cent. That would be a material saving given that the next panel at Cadia East is projected to cost $US540 million.
The new technique is called “undercut-less block caving” because it removes the need to dig a second void in the deposit that sits above the one at the base of the deposit. Right now this second cut is needed to help trigger the controlled collapse of the ore body. Newcrest is running trials of the “undercut-less” method at Telfer in WA and at Cadia. Success would deliver Newcrest a cheaper, safer and speedier option for something like Red Chris.
Like a whole lot of folks, we wondered whether the Imperial deal should be seen through the prism of portfolio management and that maybe Newcrest’s bias had tilted towards growth in copper. We were left in no doubt. Not on.
The Newcrest view is that it is a gold company that is certainly not embarrassed to have a growing exposure to copper, which now represents about 15 per cent of production.
Newcrest is committed to keeping its place in the gold index. There is leeway there given that a place on that index is secure as long as gold is 50 per cent of overall production. That is sensible not least because, over time, nature is forcing a change in weighting of production. Increasingly, where explorers go looking for gold they need to look ever deeper into the earth and they increasingly find it co-existing with copper.