-Sandspring Resources is an out-of-the-money call option on gold with a $1,300 strike price and no expiration date.
-Sandspring Resources is highly undervalued offering one of the best risk-reward prospect in the entire gold universe.
-Its Toroparu gold project needs a 30% higher gold price to make it economically viable.
On Sandspring Resources
Sandspring Resources (OTCQX:SSPXF) is a $36MM market cap junior gold explorer with $3MM cash and no debt. SSPXF has a respectable insider ownership of 15%, including 12.7% ownership by Frank Giustra whose firm, the Fiore Group, has a seat on the Board of Directors. Based in the emerging western Guyana gold district, SSPXF owns 100% of the Toroparu Gold project which is the 4th largest undeveloped gold deposit in South America with 4.6MM ounces of proven + probable (“P&P”) gold equivalent.
Besides Toroparu, SSPXF continues to explore its 63K hectares concession with much success. In February 2017, the company disclosed a resource estimate at its Sona Hill deposit, and in the same time, it announced a new discovery of gold mineralization at Wynamu Hill. Including the resources at the SE Zone, SSPXF has a total gold-only resource estimate of 10.4MM ounces.
SSPXF’s assets are located in Guyana. Unlike many countries in South America, Guyana is a mining-friendly jurisdiction where gold was the top export in 2015, representing one-third of the total value exported by the country, according to the MIT. It is the only English-speaking country in South America, and it follows the British common law. Among the miners already producing gold in Guyana are Guyana Goldfields (OTCPK:GUYFF) and Troy Resources (OTCPK:TRYRF).
On Toroparu
SSPXF’s flagship project is the Toroparu gold project. To get a better appreciation of it, it is worth comparing it side by side to the Aurora gold mine (“Aurora”) from GUYFF. Aurora and Toroparu share similar characteristics as shown below:
Despite certain similarities, GUYFF is a gold producer with a market cap of $720MM (20x larger than SSPXF). By being a producer, GUYFF enjoys a premium in the enterprise value/total gold equivalent resources multiple compared to a non-producer. That premium, however, does not explain the large valuation gap between the two companies. The other reasons lie in the economics of their deposits:
Toroparu requires almost 2x the pre-production capital expenditures of Aurora
Its average gold grade is a one-third of Aurora
Its recovery rate is projected to be lower during the life of the mine
Those key differences make Toroparu economically non-viable at today’s gold price (more on that in the next section). In May 2013, SSPXF reported a prefeasibility study of the Toroparu gold project (“PFS”). Based on that PFS, I created a discounted cash flow (“DCF”) model from which I analyzed the risks and the returns of the project. It is worth noting that SSPXF is expected to finalize the feasibility study of Toroparu by the end of 2017.
On the valuation of Toroparu
The DCF model (see below) uses key assumptions highlighted in the PFS like the tonnes processed, the capital expenditures, and the annual cost per tonne. I increased by 15% the latter assumption to account for lower prices of copper and higher general expenses due to inflation since 2013. The DCF also assumes an all-equity financing. Therefore, excluded from the DCF are the gold and silver streams as per the purchase agreement with Wheaton Precious Metals (WPM).
Let’s look in more details as to why at today’s gold price (i.e. $1,244), Toroparu is not economically viable. Even with an extremely low (and unreasonable) 5% discount rate, the NPV would only reach half of the pre-production CAPEX. The IRR would barely reach double digits implying that the project would not receive any external financing. And, 70% (in case SSPXF activates the streams with WPM) or 100% equity financing would be unreasonable to assume as extremely dilutive to shareholders.
The question now is at what price Toroparu would become economically viable. If we use Aurora as proxy, it seems that a gold price above $1,600 would be required at today’s market standards. The IRR would then be in the mid-20s for a relatively attractive AISC of $864. The cash on cash return, although not a standard KPI in mining, would be 4.75 which would secure the financing of the project without risking a high dilution of shareholders.
Toroparu needs at least 30% higher gold price to be financeable and economically viable. However, at $1,300 gold price, the project valuation should become more apparent and impact meaningfully the share price of SSPXF (see sensitivities below). Between $1,300 and $1,400, the project should command a stock price more than twice the current price as the NPV (10%) reaches $100MM. It is thus not surprising that when gold traded at $1,350 in July-August 2016, SSPXF shares exchanged hands at around $0.70. This also implies that investors assigned zero value to all other SSPXF resources (more on this in the next section).
Experts in the gold space forecast higher gold prices, possibly up to $1,500, by the end of 2017. I personally do not know whether gold will reach that level this year or next. But I surely believe that the secular bull market in gold has resumed in January 2016, and when the gold price breaks $1,500, SSPXF market cap should catch up with that of GUYFF today.
On the upside potentials
SSPXF has a moratorium of understanding with Guyana to develop its own power plant to support Toroparu. It would save $430MM in operating expenses for a $120MM upfront cost, according to management. This represents $0.40 per share on a fully diluted basis using a 10% discount rate. However, I would argue that those savings are easier to be captured by a senior producer like Newmont Mining (NEM) or a large intermediate producer like IAMGOLD (IAG) (both present in the region) due to the relatively high total pre-development capital requirement of $600MM.
The company continues to explore and drill its mineral concession within 10km radius of Toroparu (see the map below). Earlier this year, it disclosed a resource estimate of 178Koz gold-only indicated resource and 218Koz inferred resource at Sona Hill. This is in addition to the resource estimate of 384Koz M&I gold resource and 278Koz inferred resource at the SE zone. Using a conservative $20 and $8 per gold equivalent M&I and inferred, respectively, the valuation of these resources, in addition to those unaccounted in the DCF at Toroparu, is estimated at $86MM or $0.76 per share. Shareholders today can virtually buy those ounces for free.
On Risks
SSPXF is an out-of-the-money call option on gold with no expiration date. Its premium can be attributed to the cost of rounds of funding necessary for management to fund the company’s working capital and drilling campaigns. As a result, the risk of dilution will continue until gold trades high enough to either attract a buyer or fund one of its deposits e.g. Toroparu.
SSPXF is highly correlated to the gold price. Given its significant operating leverage, SSPXF share price should experience a fairly high volatility on the upside as well as on the downside. Although SSPXF is currently extremely undervalued, it does not mean it can’t get cheaper. In January 2016, SSPXF was trading at $0.50 per ounce of gold equivalent compared to $3 today. This underpins the risk of investing in a junior gold explorer like SSPXF.
SSPXF is a relatively illiquid stock. Its 90-day average volume is 48,083 shares, according to Fidelity. A flight to liquidity can lead to heavy losses as any large sell order may increase and move rapidly the bid-ask spread to the downside. To mitigate this investment risk, an investor may need an exit strategy and exercise patience.
Conclusion
The market has clearly not paid attention to Sandspring Resources which remains one of the most undervalued junior gold explorers in the gold universe. It has over 4MM ounces of gold in P&P (10MM ounces of gold total) and a PFS outlining outstanding economics at a not too distant gold price. Although frustrating, investors may need patience to realize their investments until this happens (6-18 months?). But as the current gold bull market is unfolding, I believe investors will be handsomely rewarded with SSPXF market cap reaching $400MM again.
