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Centerra Gold (OTCPK:CAGDF) is a diversified mid-tier gold producer that operates their flagship Kumtor mine in Kyrgyzstan, Mount Milligan in Canada and the new Oksut operation in Turkey. The company’s share price was hit hard on Tuesday after reporting on civil unrest in Kyrgyzstan following disputed election results, sending the stock down 15%.
Looking at the share price performance over the past year, it’s clear to see the company has underperformed its peer group and the gold miners index (NYSEARCA:GDX) since a poor Q3 result last October. Since then, the company has reported two positive quarters that led to its share price starting to catch up to the sector, but further uncertainty at Kumtor has now caused it to slump again.
One-year share price performance
Kumtor: A World-Class Mine In the Wrong Place
Kumtor is by far the company’s most important asset, churning out between 550,000 and 600,000 ounces per year at $750/oz to $800/oz all-in sustaining costs (AISC). This production profile ranks it as the 20th largest gold mine globally, and it has been operating for 23 years, producing over 13 million ounces of gold over that time.
It is an open-pit mine with a total resource of 14 million ounces gold and a current estimated mine life of 6 years in the open pit. An updated technical report will be released this quarter, including an updated life of mine that will likely detail the long-term underground mining potential at Kumtor.
Kumtor made up 77% of the company’s total gold production of 783,308 ounces in 2019, even after a temporary halt of operations in December due to a waste rock slide that killed two employees.
Kumtor mine overview
(Source: Company presentation)
Despite Kumtor being a potential tier-one gold mine, the main issue that has kept many investors from investing in Centerra is the fact that the operation is located in Kyrgyzstan.
Results of an October 4th vote in the Central Asian country sent people into the streets, protesting what was widely viewed as a fraudulent outcome designed to keep the ruling establishment in power.
On October 6th, the company issued a news release stating that the Kumtor mine was not affected by the ongoing political unrest in Kyrgyzstan, noting that the operation is located in a remote mountainous area 430 kilometres from the capital Bishkek where protests are unfolding. Most investors were likely unaware of the events in Kyrgyzstan before the news release, and the stock dropped 15% despite the company’s reassurances that operations were continuing normally.
At this moment, the disputed election results have been annulled, the Prime Minister and other senior politicians have resigned, and there is no clear date for a new vote or even who is legitimately in charge of the country for now. In the last 15 years alone, the country has undergone two revolutions that replaced elected governments, and this latest development is all too familiar to those previous periods of instability.
Any time there has been weakness in Centerra’s share price over the years, it is almost always due to a dispute in Kyrgyzstan, a country with an unstable political situation and local communities that are opposed to mining. Kumtor is a regular flashpoint due to its outsized importance in the country. In 2019, just this one mine made up 10% of the nation’s GDP and over 20% of its entire industrial output.
Kyrgyzstan’s government is also Centerra’s largest shareholder with a 26% stake in the company, making negotiations over taxation and development a complicated affair. Only last year, Centerra concluded negotiations on an updated ‘strategic agreement’ that resulted in more payments going to the government in return for Centerra continuing to keep its operating licence. The negotiations had lasted years and involved the company launching international arbitration proceedings against the government after a bitter stalemate between the two sides.
Now that there is uncertainty over who the country’s governing party will be, investors should be cautious about the future of Kumtor. A new populist or anti-mining faction could plunge the company into another round of difficult negotiations over profit-sharing.
So far, there has been no impact on Kumtor’s operation, although there are reports that protesters broke into Centerra’s office on Wednesday. KAZ Minerals (OTCPK:KZMYF), another international mining company in Kyrgyzstan, shut down their Bozymchak operation on Tuesday after protesters attacked and destroyed facilities at other mines in the country.
This is a fluid situation in a very high risk jurisdiction. While a 15% dip in the share price of a profitable producer like Centerra could sometimes signal a good buying opportunity, we would stay on the sidelines for now and monitor the situation. Kumtor is by far the largest contributor to Centerra’s valuation, and even a temporary shutdown caused by civil unrest would send the stock much lower. The stock has traded flat since the initial drop on Tuesday, even though from reports it appears as though the situation in the country may be worsening.
The uncertainty in Kyrgyzstan is a good example of how jurisdictional risk is a significant factor that can affect the fortunes of mining companies, no matter how good its operations are or the quality of its management team and shareholder base. Kumtor is a fantastic asset, but as it’s in the wrong place, there isn’t much that management can do aside from diversifying their portfolio with projects in other jurisdictions.
(Source: Company presentation)
The Rest of the Portfolio: Diversified but Lower Quality
Looking at the company’s other core projects, it is clear that the company remains dependent on Kumtor despite acquisitions and new projects being advanced in recent years. Centerra’s secondary operations include the gold-copper Mount Milligan mine in British Columbia, Canada, and the new Oksut operation in Turkey.
Altogether, these operations are expected to produce over 800,000 ounces of gold and 90 million pounds of copper per year at all-in sustaining costs around $850/oz.
2020 production guidance
In an attempt to reduce its reliance on Kumtor, Centerra diversified into Canada with the acquisition of Thompson Creek Metals for $1.1 billion in 2016, which held the Mount Milligan operation and had been struggling with a large debt load.
In the third quarter of 2019, Centerra reported a $165 million net loss due to a $231 million write-down of Mount Milligan. In a news release in March of this year, the company updated the mineral reserves and resources estimate at Mount Milligan. In a material decline, total gold ounces decreased by almost 50%, with proven and probable reserves dropping from 4.7 million ounces to 2.4 million ounces, and measured and indicated resources (exclusive of reserves) decreasing from 2.7 million to 1.4 million ounces. The remaining mine life is estimated to be nine years, with an NPV of $342 million using a conservative gold price of $1,250/oz and a copper price of $3.00/lb.
In another part of the company’s diversification strategy, Centerra recently started up the Oksut gold mine in Turkey. Oksut achieved commercial production on May 31st of this year and is expected to produce 80,000 to 100,000 ounces of gold in 2020. The project’s 2015 feasibility study forecast that the mine would produce 112,000 ounces per year over an eight-year mine life in a low cost heap leach operation. With lower AISC, the mine will help decrease Centerra’s overall cost profile in the coming years.
While Oksut adds a third operating base for Centerra, investors likely aren’t that excited by the fact that the new operation is in Turkey. The country continues to grapple with a currency crisis, an economic downturn and the government’s involvement in multiple conflicts in the region, including the ongoing flareup between Azerbaijan and Armenia.
Whereas other miners have recently had issues in Turkey, Centerra successfully permitted and built the Oksut mine in a timely manner. Management clearly has a good track record of operating in challenging jurisdictions, which bodes well for their ability to potentially weather the new crisis in Kyrgyzstan despite the inherent risks there.
Further down in the company’s project pipeline is the Greenstone gold project in Canada, a 50-50 joint venture with junior gold producer Premier Gold (OTCPK:PIRGF). While the project looks promising at current gold prices, Centerra is currently in a legal dispute with Premier over the development of the project, and the two sides seem far apart at the moment. If Centerra can make peace with Premier and find a way forward, it would be a positive boost for their project pipeline as Greenstone is a well-advanced asset in a top-tier jurisdiction.
Centerra is Cheap Compared to Peers, But Risks are High
After a drop of 16% after a poor Q3 result last year, the company had largely tracked the index, participating in the precious metals rally and reaching a recent high of C$19.59/share on August 6th. The share price is down 32% since then, while the GDX index is down only 15%.
Compared to a peer group of mid-tier gold producers, the company is now trading at a significant discount on net asset value and cash flow multiples. Centerra could be due for a rerate if the situation in Kyrgyzstan stabilizes.
Peer group comparison
At the end of the second quarter, the company had $212 million in cash and zero debt, becoming debt-free after paying off its credit facility in the last quarter. In the previous two quarters, the company generated $246 million in free cash flow, with about 80% of that coming from Kumtor. On an annualized basis, the company is trading at only 6 times free cash flow. While this is cheap for a senior gold producer, it also reflects the risks the market sees in Centerra’s asset portfolio.
Centerra should use this latest shock as a wake-up call to further diversify their production away from Kumtor. They could come to an agreement with Premier Gold over the disputed Greenstone project, or look at further growth opportunities in Canada or other tier-one jurisdictions.
Centerra Gold is a mid-tier producer that has often been in the penalty box over recent years due to anxieties about their flagship Kumtor gold mine in Kyrgyzstan. Centerra’s latest news release highlighting the ongoing unrest there led the stock to drop 15% on Tuesday, although it hasn’t fallen any further over the next two trading sessions despite some volatile gold price moves.
Aside from the shock of new protests that may affect Kumtor, another reason for the recent drag on the share price has been the underperformance at Mount Milligan, which has been suffering higher operating costs, lower recoveries and even downtime related to the availability of water required for processing. After cutting the mine’s gold reserves in half earlier this year, the future does not look bright for this mine that was supposed to be a flagship asset in Canada for Centerra.
As events continue to unfold in Kyrgyzstan, we believe investors should stay on the sidelines for now, even though Centerra appears cheap compared to its peer group. The 15% drop in the company’s share price is not a big enough dip to take the risk yet. Despite having a clean balance sheet after generating healthy free cash flow this year, if the situation deteriorates and Kumtor is impacted, the company would struggle.
For investors, we think there are better risk-reward opportunities in the midtier space. It might be worthwhile to revisit Centerra if the situation stabilizes, and if they can progress their Greenstone project in Canada or acquire a new asset to diversify their production into better jurisdictions.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.