Archipelago Resources: Q3 results in line: buy at 62p – target price 95p plus

I first recommended AIM listed gold producer, Archipelago Resources (LSE:AR.) back in December 2004 at 27.5p on t1ps.com, the website I founded in my bedroom 12 years ago and edited until September this year. At 62p today it has not been a bad share tip. However third quarter ( to September 30^th)  numbers out today show that the company is very much on track for its planned ramp up in production at its flagship 95% owned Toka Tindung mine in Indonesia and I reckon that the shares are worth at least 95p. Here is why.

 The headline numbers for Q3 were impressive. Archipelago boasted record quarterly production of 36,184 gold equivalent ounces giving year to date output of 96,570 ounces. The grade for Q3 was 2.79 g/t  and thus the company maintained full year guidance at 135,000-145,000 oz at a cash cost of between $580 and $640 oz. The exact cash cost will depend on the exact grades mined. But the trend on costs is clear. It is downwards as grades increase, stripping ratios decrease and output continues to ramp up. 

Toka Tindung has a mine life of 9 years with an additional 7 years output guaranteed from stockpiled rock. Output is sustainable at c140,000 oz for the Life of Mine. But.. Actually it gets better. That LOM estimate is based on the current 2.58m oz Au Resource and 1.47m oz Au Reserve.  However Archipelago is continuing to drill the area around its existing pits and a few weeks ago it announced a series of drill hole results. The release read:

Archipelago is pleased to announce a series of exceptional drilling results from its high grade southern deposits, close to infrastructure at the Toka Tindung Mine (“Toka Tindung”) in North Sulawesi, Indonesia. 

 HIGHLIGHTS

 ·           Archipelago’s targeted near site exploration programme continues to yield significant results at Toka Tindung (with mineralisation remaining open at depth and along strike).  Within the southern mineralised zone, assays have been received from 239 drill holes totalling 34,489m.

 ·           Encouraging drill intersections from the deeper mineralised zones can be reported for the Kopra, Blambangan and Pajajaran deposits (in addition to those previously announced at Blambangan and Pajajaran on 9 July 2012).  Highlights include:

 ·       Kopra (22 holes for 2,946m):

 27m at 5.56g/t Au                  (KIP020, 169 – 196m)
9m at 5.32g/t Au                   (KIP012, 135 – 144m)
7m at 3.49g/t Au                   (KIP013, 122 – 129m)
8m at 4.72g/t Au                   (KIP013A, 146 – 154m)

·       Blambangan/Blambangan South(58 holes for 8,403m): 

 

3.1m at 49.76g/t Au               (BPD042, 205.9 – 209m)   [including 1m at 152g/t Au; 208 -209m]
1m at 5.90g/t Au                   (BSP032, 98 -99m)

·       Pajajaran (42 holes for 8,029m):

13m at 9.44g/t Au                  (PJJ032, 173 -186m)      [including 5m at 20.61g/t Au; 180 – 185m]
16m at 4.26g/t Au                  (PJJ033, 134 – 150m)     [including 3m at 17.39g/t Au; 145 – 148m]
7m at 3.66g/t Au                   (PJJ034, 6 -13m)
6m at 14.75g/t Au                  (PJJ034, 139 -145m)      [including 2m at 35.95g/t Au; 139 – 141m]

·           Significant results can also be reported for the adjacent mineralised zones of Semut Barat, Semut Timur and Makassar, including: 

·       Semut Barat/Semut Timur (74 holes for 9,284m):

2m at 11.70g/t Au                  (SMB038, 145 – 147m)
7m at 4.28g/t Au                   (SMBD023, 231 – 238m)
1m at 9.53g/t Au                   (SMB042, 49 – 50m)
2m at 5.08g/t Au                   (SMB042, 72 – 74m)
4m at 6.91g/t Au                   (SMP050, 20 – 24m)
1m at 9.97g/t Au                   (SMP028, 61 – 62m)

·       Makassar (43 holes for 5,827m):

5m at 8.10g/t Au                   (MAK025, 95 -100m)      [including 1m at 24.6g/t Au; 95 – 96m]
4m at 4.98g/t Au                   (MAK027, 100 – 104m)
6m at 5.98g/t Au                   (MAK028, 114 – 120m)   [including 2m at 13.95g/t; 115 -117]

Ends.

The conclusion is the critical element:

The results confirm the highly prospective nature of Toka Tindung and indicate significant potential to extend Archipelago’s already substantial 2.58m oz Au Resource and 1.47m oz Au Reserve. Drilling will continue over the remainder of the year and an updated ‘Resource & Reserve Statement’ is expected to be published in early 2013.

This clearly indicates that the company can increase the Life of Mine but also by tackling higher grades earlier can increase its output in earlier years as well. With a fixed cost base that would have a material impact on free cashflows and any DCF based valuation.

For now I treat all of that as upside and allow very little for it or for the non Toka exploration assets. Instead I value the company purely based on the nine plus seven years production we have at Toka and using a 10% discount rate (arguably harsh) and a $1600 gold price ( again arguably harsh for the first half decade at least) I arrive at a valuation of 95p per share.

And so 95p is my initial target but with the risks are very much on the upside both from the near and medium term gold price but more critically from that new study due in early 2013 which will, I suspect increase both output forecasts and also the estimates of the Life of Mine. Given operational gearing that could trigger a very significant re-rating indeed. The shares remain a buy.

Archipelago is one of 5 gold stocks I flagged as key sector buys in an article published on 22^nd October. To discover the other four click here

 

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