Serabi Gold Plc - Focus on Costs Reduction to Maintain Healthy Margins

Serabi Gold Plc (LON: SRB) is a mining company based out of London, which is engaged in the activities for production and exploration of gold in the Brazilian region. The Company holds 100% interest in Palito Mining Complex and also have interests in recently acquired Coringa Gold Project located in the northern Brazil-based Tapajos region.

The Palito Mining Complex includes over 50,800 hectares of land with gold production of around 40,000 ounces per annum. The Coringa project covers about 13,000 hectares with a production capacity of approximately 38,000 ounces per annum. The Company funds future development activities and exploration activities through operational cash flow capabilities. SRB shares are listed on TSX (Toronto Stock Exchange) with a ticker SBI and on LSE (London Stock Exchange) with a ticker SRB.

(Source: Annual Report, Company Website)

Growth Prospects and Risk Assessment

The Company has a strong cash position to pursue near and long-term business growth opportunities. The relentless development in Coringa project, ore sorting improvements at the Palito plant and exploration programmes at Palito, São Chico holds the significant growth potential for the future. Since 2005, the Company has produced over 305,000 ounces of gold, while they are continuously focusing on expanding the resource base.

Moreover, the largest two shareholders – Fratelli and Greenstone have been a long-tern supporter of Serabi and provides experience management guidance for strong operational performance and growth. In future, the Company aims to produce 100,000 ounces per annum of gold and generate a lucrative return for shareholders.

 (Source: Kalkine Research, Refinitiv)

However, there are certain risk and uncertainties to business growth. The financial performance is highly dependent on the Gold price, and the Gold market is cyclical and sensitive to the economic changes and numerous factors, which are beyond the Company’s control. The Global Covid-19 pandemic could result in the suspension of operations and increase the labour absenteeism, and thus, the operation costs. Moreover, there are several financial risks associated with fluctuation in the foreign exchange & interest rates, availability of adequate working capital, and credit defaults.

Industry Outlook Dynamics

The Gold investment is an efficient way of preserving the purchasing power as the one ounce of gold cost has risen from US$ ~20.67 in 1993 to US$ ~2,000 in 2020. However, in present times, Gold has also been outperforming the major asset classes, in terms of return. Therefore, it is provoking a fundamental shift in asset allocation. During 2019, the demand for precious metals was sparked by uncertainty around global economic prospects, rising geopolitical tensions, and declining interest rates.

In 2020, the onset of the Covid-19 pandemic has made Gold’s relevance as a hedging tool even more prominent, which accelerated the price performance. The Gold prices increased by ~17% during the H1 2020 and soared by an additional ~10% in July. Meanwhile, the Gold-backed ETFs and similar products (Gold ETFs) reported the eighth consecutive month of positive flows. The Covid-19 pandemic may bring structural shifts to asset allocation, and there are strong fundamentals to support the Gold investment in the longer term.

The chart below shows the performance of Gold Price over the past 3 years, which was trading at US$1,957.60/oz on 21 September 2020, reflecting around 44% growth over the last 3 years.

 (Source: Kalkine Research, Investing.com)

Snapshot of global demand and supply in Q2 2020 (ended 30 June 2020) can be seen in the table below:

(Source: Kalkine Research, WGC)

According to the global demand trends report from WGC (World Gold Council), the gold demand fell in H1 FY20 vs H1 FY19. However, the increased investment by Central banks and robust inflows into gold ETFs amid the pandemic zoomed the Gold prices.

Key Risks

• The long-term price performance is dependent heavily on retail purchases, which makes demand a critical factor for long-term growth. According to the global demand trends report from WGC, the Gold demand in H1 2020 declined by 6% against the last year comparatives. The jewellery demand plunged by 46% (year on year) in H1 2020 as consumers were deterred by the high price and with a reduction in the disposable income. Similarly, the bar and coin investment declined sharply in Q2 2020 due to Covid-19 led lockdown.
• The scale and continually evolving nature of coronavirus pandemic are causing unprecedented disruption to the supply chain. It can lead to reduced gold production as small-scale refineries and fabricators also halted their operations during H1 2020.
• With travel restrictions, logistical and supply concerns can deplete the dealer inventories for coins and small bars.
• Supply from gold producers can decline as only US$4.4 billion was spent on exploration in 2019 against US$11.8 billion in 2012. Consequently, there were only three gold discoveries in 2019 as compared to 42 major gold discoveries in 2000. In short, there would be less gold, if a lesser amount is invested on exploration.

Growth Catalysts

• Central banks have been adding to the gold reserves since the financial crisis. Presently, the official reserves are more than 5,000 tonnes higher than they were in 2009. The central banks own nearly 35,000 tonnes of Gold, equivalent to ~17% of worldwide above-ground stocks.
• Record inflows into Gold-back ETFs should continue to offset the demand weakness in other sectors.
• Reduced opportunity cost of holding Gold with persistently low-interest rates would bolster the demand for Gold.
• Uncertainties arising from US-China trade tension and Brexit, followed by dented economic indicators after Covid-19 outbreak, has further encouraged investors to reconsider Gold as a traditional hedging tool in times of turmoil.
• Moreover, the economic downturn has devalued the Forex market, which is compelling investors to switch to more tangible metal resources.

Gold Outlook

Gold can act as a genuine diversifier tool in an investment portfolio for a long-term due to the attributes pertinent to scarcity, highly liquid and uncorrelated asset nature. Moreover, it has been proven over time that beyond merely a safe-haven asset during the high-risk time, it can also be an asset to outperform and generate positive returns too. Such dynamics are likely to persist amidst high political and economic uncertainty, battered stock and bond markets, and historically low-interest rates scenario.

Overall, the Gold industry landscape is going through an unparalleled wave of change, which is arising from various aspects, such as demand patterns, regulatory changes, innovation, and the entrance of new participants. Furthermore, the resurgence of coronavirus cases denting equity market sentiments with speculations regarding another round of lockdown, which would eventually attract investors towards the Gold, as a safe-haven investment.

Key Fundamental Statistics

Key Shareholders Statistics

Recent Developments

25 August 2020: Serabi Gold announced the acquisition of additional tenement of 946.54 hectares, adjacent to Sao Chico exploration interests.

4 August 2020: Serabi Gold announces the agreement with Greenstone (Greenstone Resources II LP) for extension of the period by 6 months during which the Company can draw down on the Convertible Loan Facility of $12 million.

A Glimpse of Business Segments

(Source: Annual Report, Company Website)

Key Performance Indicators

(Source: Annual Report, Company Website)

Financial & Operational Highlights – H1 FY2020 (30 June 2020)

(Source: Interim Report, Company Website)

• In the first half of FY2020, the revenue slightly declined for the period, while revenue in Q2 FY2020 increased. The average gold price realised improved in both H1 and Q2 FY2020 period as compared to FY2019 data for the same period.
• The Company witnessed an increase in cash cost and AISC (All-In Sustaining Cost), while EBITDA for Q2 FY2020 and H1 FY2020 improved by 89% and 24%, respectively.
• The net income increased significantly by 142% in the first half of the financial year 2020, with earnings per share stood at 7.05 cents.
• The Company repaid the outstanding loan of $6.9 million from Sprott in full and concluded an agreement with Greenstone to subscribe for Convertible Loan Notes of $12 million.
• SRB also reached to an agreement with Equinox (Equinox Gold Corp), and will pay remaining consideration of $12 million in monthly instalments, for purchase of Coringa.
• The gold production for Q2 FY2020 remained strong with 8,504 ounces, while total production for H1 FY2020 stood at 17,524 ounces.
• The Company has mined ore of 43,519 tonnes in Q2 FY2020, with the gold of 5.85 g/t (grams per tonne), and 44,235 tonnes of ROM (run of mine) ore was processed through the plant, with average grade gold of 5.91 g/t.
• In the Q2 FY2020 period, the Company completed the horizontal development of 3,004 metres, which is the highest level of development metres to date.
• The production for H1 FY2020 was impacted due to covid-19 crisis; the Company is focused on expanding the camp to return to full staffing levels before Q3 FY2020.
• SRB is continuously advancing Coringa’s licensing process and is actively looking for securing financing package to fund plant assembly and site developments.

Financial Ratios – Strong Profitability Margins versus the Industry Median

Reported profitability metrics for the first half of the financial year 2020 were higher against the industry median, reflecting higher revenue generated and better control over expenses as compared to the industry. Serabi Gold Plc has delivered a decent return for the shareholders’ as return on equity of 6% was higher as compared to the industry median of negative 1.5%.

On the liquidity front, Serabi Gold Plc’s current ratio was lower than the industry median of 1.81x but had sufficient liquidity to meet short-term obligations. On leverage front, the debt-equity ratio was 0.02x, which was lower as compared to the industry median of 0.43x, reflecting that the company is less leveraged as compared to the industry.  

Share Price Performance Analysis

 (Source: Kalkine Research, Refinitiv)

 (Source: Kalkine Research, Refinitiv)

On 21 September 2020 (before the market close, at 10:10 AM GMT+1), Serabi Gold Plc shares were trading at GBX 110.10, down by 3.84% against the previous day closing price. Stock 52-week High was GBX 118.40 and Low of GBX 42.00, respectively.

In the last one year, Serabi Gold Plc share price has delivered ~35.54% return as compared to ~9.14 % return of FTSE-AIM index, which shows that the stock has outperformed the index during the last year.

 (Source: Kalkine Research, Refinitiv)

From the technical standpoint, shares were trading well above the support level of 20-day (GBX 105.05), 50-day (GBX 93.71), and 100-day (GBX 89.33) simple moving average prices, which reflects an uptrend in the stock and carrying the potential to move up further.

Valuation Methodology: Price/Earnings Approach (NTM) (Illustrative)

(Source: Kalkine Research, Refinitiv)

Business Outlook Scenario

In H1 FY20, production stood at 17,524 ounces of gold, which reflected the impact of Covid-19 pandemic. However, the Company is working hard to revamp the production by the end of Q3 FY20. With continuous efforts, the full-year production shall be between 34,000 and 37,000 ounces. The key objectives of FY20 includes advancing the licensing process for Coringa, securing a financial package for the Coringa project, minimizing the impact of Covid-19 pandemic, and complete exploration discovery drilling programme over the west and south of Sao Chico.

Overall, the Company has demonstrated flexibility, commitment, and resilience to weather the prevailing storm and is in a good position to emerge stronger in the future. However, as Gold has moved sharply higher in the past few months, the price may experience some consolidation in the near term. Nevertheless, if quantitative easing and other factors encourage investors to treat Gold as money, the potential for Gold price outperformance is extremely high over the next five to ten years. Therefore, we believe that the fundamentals of the Gold bull market are still intact from a long-term perspective though short-term consolidation can be expected with demand downturn and supply chain disruption.

(Source: Presentation, Company Website) 

Considering the improved production, increased financial performance and support from the valuation as done using the above method, we have given a “Speculative Buy” recommendation on Serabi Gold Plc at the current price of GBX 110.10 (as on 21 September 2020, before the market close at 10:10 AM GMT+1), with lower double-digit upside potential based on 10.66x Price/NTM Earnings (approx.) on FY20E earnings per share (approx.).  

*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.

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