Pan African Resources for 2006

From uk analyst 24/12/05

Buy Pan African Resources at 3.375p
Writes Tom Winnifrith of t1ps.com
I had said that I would not tip another mining stock. In part this was just to stop PR people pestering me, but it was also because I think that the mining explorers as a whole will have a tough 12 months, as some of the utter rubbish floated 18 months ago by greedy stock promoters and corporate financiers runs out of cash and credibility. But rules are meant to be broken, and Pan African Resources (PAF) has everything one would want in a mining junior: a cracking management; supportive shareholders; superb assets; and, above all, a lowly valuation. At the current share price Pan African is valued at just 12 million pounds, yet it is distinctly possible that within a year or two its lead project could be throwing off 11 million pounds per annum in free cashflow in a country which is politically stable. Since I remain a modest gold bull this is an opportunity that should not be ignored. The shares are a speculative buy at 3.375p and at up to 4p, with a one year price target of 6.5p.

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The Management
I cannot describe quite how useless some of the promoters and managers of gold stocks who I have met over the past two years have been. There are the old failures whose records are so bad that only in a raging bull market do they dare show their faces in public. Almost as bad are the newbies: men and women who know sod-all about mining, but reckon that in the current climate they can float anything. My only surprise is that young Conrad has not floated a mining stock. I am waiting for a resource stock with a 13 year old CEO to arrive for a meeting at T1ps Towers. And then there are the plain cynical promoters. They know the game and I can spot their game a mile off.

Pan African is different. The non executive chairman is Colin Bird who - as t1ps members will know - has had a long career in mining and has already rewarded us well at Jubilee Platinum (JLP). Colin's right hand man, the geologist Andrew Sarosi, is also on hand to offer his guidance. The Finance Director is Nathan Steinberg, who also takes that role at Golden Prospect (GOL), which itself has not exactly underperformed. Malcolm Burne of Golden Prospect is happily hovering around in the background having stepped down as a director last year. The CEO, Jan Nelson, is - I hate to admit this - a year younger than me, but has extensive experience of mining in Southern Africa with big-name companies such as Harmony and Gold Fields. Perhaps the most interesting board member is Rob Still, a non-exec, who has 20 years mining experience, has run several big-name companies and funds, and is widely viewed as a real BSD in the mining world. Still's chief geologist, Anton Esterhuizen, works closely with Sarosi advising the company on matters geological.



The Bird/Burne (no offence to Nathan Steinberg)/Still axis is interesting. These are three heavy hitters who will not mess around with a mining junior going nowhere. Indeed Nelson was brought in by the trio to replace the former CEO who did not cut the mustard. Moreover these three men have enough financial clout to ensure that Pan African - unlike many of the mining tiddlers - will not have a funding problem going forward. Put simply, if the trio in charge did not think that this company offered huge upside, they would not waste their time - they would walk.

The Assets
The company currently has three projects of note in: Mozambique, Ghana and the Central African Republic.

In the CAR it has detected an anomaly 1 kilometre long, and early stage drilling has located grades of up to 17.38 g/t over 19 metres, but this is very much early stage work. So at this point I am not attributing much value to this project (Bogoin), but if it comes good - or other, (not necessarily gold) assets in the CAR are secured - then I am happy to be proved wrong. In Ghana, the Wa Project contains three prospects: Julie, Josephine and Collette. Again the work done here has not been extensive, but my chats to the company indicate that it is fairly certain that it has a 400,000 oz resource, and it could be larger. But Wa is not really large enough to excite the big fish behind Pan African. However Ghana already has a large number of producing mines, and my guess is that Pan African will sell its assets on to an existing producer who can simply extract the rock and process it through facilities already constructed. This disposal could therefore realise a significant sum, but that is not what interests me.

It is Mozambique and the Manica project which grabs my eye. As followers of Kenmare will know, Mozambique was for many years the sort of Marxist paradise which Guardian readers must dream of. But with most of the populous starving and the country bankrupt, Mozambique decided that it was time to embrace capitalism and, as a result, it is now one of the most dynamic and stable economies in Africa. The company offers big tax breaks to Western companies to attract them, and even offers barren land to white farmers thrown out of Zim by Africa's Hitler who then bring that land into productive use. In short, it is a very good place to operate.

The Manica gold mine is not far from the border with Zim, and Pan African has identified a 22 kilometre strike length, of which it has so far explored on 12% by length, and it has only drilled down to a depth of 130 metres. The drilling on that 12% of the prospect has been intensive, and with grades consistently above 3 g/t, it has proved up a resource of some 800,000 oz. I would expect another upgrade to that resource estimate over the next couple of months. The joy of this project is that the gold can be mined using an open pit - the construction of a mine is therefore both relatively cheap and also relatively quick. My estimate is that it would cost less than $30 million to build an open pit mine capable of producing 100,000 oz of gold per annum. Let us assume that the total operating cost of such a project (including finance costs) worked out at $200 oz (I think I am being harsh) and let us assume that the gold price averages $400 oz over the next decade (with gold at $480 oz and rising I think I am being prudent). That means that this project would be chucking off $20 million (11.1 million pounds) of free cash per annum for a decade.

If one assumes that this project is 70% debt funded, then that debt would be repaid within 18 months of the mine being opened. My assumptions on both costs and on the gold price are cautious, but so too are my assumptions on the Manica project itself. Given how intensive the drilling has been on the 12% of the project drilled to date, I do not think that the grades are a fluke. I think the company will not find it hard turning the current resource into a reserve for a bankable feasibility study, but critically I see no reason why the other 88% of the mineralised zone should not increase the resource significantly. It would not cost a great deal (perhaps another $10 million) to double the output. So while my base case scenario views this as a mine producing 100,000 oz pa for ten years, a second model sees capacity doubling in year three (as cash generated from the mine is re-invested in increased processing facilities) and the mine running for an additional ten years. Clearly case two is mere speculation, but it is very plausible speculation.

Cash
I estimate that Pan African has net cash of around 500,000 pounds - a sum boosted by a small placing the other day. This will fund (low) corporate overheads and more drilling work (mostly in Mozambique) over the next six months, but clearly, at some stage, it will need to raise perhaps 1- 1.5 million pounds to fund accelerated drilling work in Mozambique, and to take Manica up to the bankable feasibility stage. At that point a second fund raising will be needed to fund the equity component of the project, and my estimate is that Pan African will need to stump up around 5 million pounds. However I do not see that with its backers either fund raising should be much of an issue and, if the drilling results from Mozambique follow what has already been announced, any fund raisings will be done at a price very much north of today's 3.375p.

Valuation
Why am I so confident? Partly because this company's odd history (it was a dotcom shell into which mining assets were reversed) and historically City-unfriendly management means that it has not been over-hyped and over-promoted in the way that so many mining stocks have been. But there is a more important reason for my interest, and that is simply because the maths look so attractive. My model uses a 12.5% discount rate, and makes assumptions about the tax regime based on Kenmare's experience. There is clearly a margin for error, but my base case valuation for Manica (100,000 oz pa over 10 years) gives this project a Net Present Value of 36 million pounds. The "case 2" model shows a NPV heading towards 90 million pounds.

Thus, even were Ghana to be a washout (which I doubt), the CAR gold project a washout (which I doubt), Still and his team to fail to conclude other corporate deals (which I doubt), this stock is still cheap. No doubt there is some country specific risk, but I am a lot more relaxed about the climate in Mozambique than I am about the climate in most of Africa. Even allowing for some political risk, this stock looks remarkably cheap. Throw in the bonus of its top-notch management team and I am prepared to ignore the charges of hypocrisy in tipping a mining stock. Pan African Resources is a buy at up to 4p. Speculative Buy.

Key Data

EPIC: PAF
Price: 3.25 - 3.5p
Market : AIM

Tom Winnifrith edits www.t1ps.com. Past performance is no indication of future success but, 1 in 6 of his tips over the past 5 years have gained 100% or more. 1 in 3 have gained 50% or more. The average gain per tip is 46%. JOIN BEFORE DECEMBER 28TH AND RECEIVE A FREE COPY OF THE INFAMOUS DIARY OF EVIL KNIEVIL - THE BOOK OF THE YEAR. To sign up click here.