Archipelago Resources - A Lower Risk Gold Producer

Archipelago resources logo

The recent shift in the gold price has been well documented by the markets, with the price per ounce falling as low as $1180/oz in June. The result was a share price collapse pretty much across the board, as producing companies suffered from revenue declines, and some exploration projects became not viable. However, the gold price has recently picked up strongly and is now just below $1400/oz - the highest level seen for a couple of months. Archipelago Resources (LSE:AR.) has been a company that has not suffered as badly as some with the share price only off 31% from the highs set late last year. There is a good reason for that. Archipelago is a well-funded, producer with a low production cost. Due to the gold price weakness and general sector uncertainty, positive news that Archipelago has released has been overlooked and that means the shares do look to offer good value, and a lower-risk way to play the gold price. Archipelago has a market cap of £267m, 582m shares in issue, and a current share price of 46p.

Evaluating the charts, Archipelago has recently bounced off the base of a downward channel. The RSI reflects a ~15+% move up from the lows around 39p to the current price of 46p. The 40p level has proved to be good support on this occasion which is very positive and limits any downside, especially since the gold price is unlikely to decline back to the lows hit in June (in my opinion, for the foreseeable future). Archipelago's share price will remain, at least loosely, tracking the gold price over the next few weeks until the market decides upon a definitive stance regarding the outlook for gold. A bullish stance could see Archipelago higher than 50p in short-order whereas a bearish stance could see it stick around the 45p level. From a technical perspective I cannot see a great deal of short-term downside. Archipelago is not the most liquid of stocks, but the spread is narrow enough at only a couple of percent.

Directors hold a small amount of Archipelago's stock, and so it would be encouraging to see them purchase even a modest amount at the current levels. However, the company does have a strong institutional backing. One of Indonesia's largest conglomerates the Rajawali Corporation holds 53% of the company's shares whilst the next six institutions who hold Archipelago total to a further 28% of shares between them. Consequently, there is not a huge number of shares available for purchase on the market. Nonetheless, as I said earlier, there is a decent level of liquidity. The 50-day average daily volume is around 800,000 shares which at a 46p share price equates to £368,000 changing hands. This figure is much higher than that around 6 months ago, where on average (as a rough estimate) circa 400,000 shares changed hands per day.

For a gold company at the moment, it is fundamentally important to examine the gold price at the moment. As I alluded to earlier, it has been very volatile, which does not make this job an easy feat.
Technically the gold price looks strong on a variety of timescales with the recent pullback seemingly
a brief disruption to the upward flow. The gold price did stagnate at around $1800/oz so the fall was not particularly unexpected, although the extent of it has come as a surprise. There are multiple reasons why the gold price should continue to remain strong, and perhaps even motor on further. Firstly there are a series of macroeconomic issues. Growth recoveries are continuing in the US and parts of Europe, and whilst economic growth may be starting to slow in countries such as China, they have pledged to main a 7% annual growth rate. In addition, incomes are rising in China and this will create demand for physical gold. 

A bearish issue is when the US economy starts to taper Quantitative Easing (QE), but in the grand scheme of things, Eurozone countries will likely remain highly accomodative and if China starts a QE scheme to help its economy there is plenty of room for bullishness within gold. The reason is that demand for gold should rise as it is perceived as an inflationary hedge. Indeed in China, inflation recently exceeded estimates, and whilst that is a short-term indicator, any monetary support will likely provide underlying strength to the gold price. A second factor lies with sentiment. The price fall was over exaggerated because of this. Logically, a sub $1200 gold price meant that a significant portion mines would have to shut and only the most efficient mines would remain open. Furthermore, exploration would be delayed with those that have resources finding it difficult to access financing. In the long-run that would mean a physical gold supply shortage. Once the gold price slide started, many investors ran out until a bottom was formed - that has now happened and many investors have re-entered the fray. It is important to remember 'Nothing goes up in a straight line'.

Courtesy of BullionVault on flickr
It is also important to recognise that most goal trading is done with 'paper gold' as opposed to real, tangible gold. In the physical gold market, supply is strained and this is not being helped by the increasing demand for jewellery in the Asian markets. There is clear reasoning for why a low gold-price cannot be sustained for an extensive period of time. Furthermore, the US housing recovery was dealt a blow recently when it was announced that the sales of new single family homes dropped 13% in July. This is good news for gold as it means that interest rates are less likely to be raised in the coming future as this could suppress a housing recovery. It has been the paper market that has depressed the price of gold, physical prices have been resilient to an extent.

In the very short-term all eyes will be on South Africa next week (which produced circa 6% of the world's total gold in 2012). As is logical, if there are supply worries over a commodity, then prices for that commodity will rise. An example of this happening was with the oil price and the initial Egypt unrest. South African gold miners are contemplating a strike over pay. This would dramatically reduce production of gold and help the price break through the psychologically important $1400/oz level that it current rests below. The miners within the union in question are requesting a 60% pay rise to £500/month equivalent. If anything, these discussions are likely to be protracted considering what is at stake. The companies also have a problem because cash costs in South Africa per ounce remain quite high, and this is materially due to the labour costs. Furthermore, the lower gold price will not help either side. If the deal does go through by force of the government, many mines may have to be shut down due to not be economical. The result is a longer-term supply shortage.

There is a key point to take into consideration though. The recent rise has been on the relatively low volumes that are often associated with August trading. To counter that, this recent rise has not been a dead-cat bounce because of the extent of the rebound, but this is something to be wary of and thus it is sensible to keep this in mind. I am not going to speculate about future gold prices, because genuinely it is all based on so many factors that is is difficult to call. What I will say is that in my opinion, it will continue higher on a medium-term timescale. As a bearish scenario, I cannot see it maintaining a level below $1250/oz over the next few months and even if it does, Archipelago could weather the storm.

Archipelago itself is a mid-cap AIM listed gold explorer, which is headed by CEO and MD Colin Sutherland who recently took the helm off of Marcus Englebrecht who stepped down in late May to pursue other commitments. Normally this would be a bad sign, but looking at the company, the progress has been encouraging so I would expect it may be because he has a higher profile job lined up, rather than due to poor performance. Englebrecht has been in the job for two years. Sutherland's appointment is a sensible one as well. He was formerly solely the CFO so he has experience of working within the company, and you would expect he knows whether any improvements can be made whilst also keeping a keen eye on the finances. The CEO transition has, and should continue to be smooth.

Archipelago's focus is in South-East Asia with exploration agreements in the Philippines and a producing gold project in Indonesia known as Toka Tindung (Toka). Indonesia is currently, like other Asian countries, experiencing strong GDP growth and declining unemployment. This makes Indonesia an increasingly attractive business environment. There is of course a risk that gold miners could start demanding increasing wages which could in turn lead to a rise in cash costs per ounce, but realistically this is not a worry for the moment.

The company has a corporate office nearby in Singapore, and also has a Vietnamese office that helps with evaluating potential Indo-Chinese projects. At Toka Archipelago has a 95% working interest, with major shareholder the Rajawali Corporation retaining a 5% interest. The Toka licence spans 400km2 and recently had its resources upgraded following successful drilling on the outskirts of previous reserves. This revealed further high grade deposits which had the potential to 'extend Archipelago's already substantial 2.58m oz resource and 1.47m oz reserve'. The reserve statement in April revealed a 16% uplift in the contained gold resource, with the total resource increasing to over 3m oz. The company is currently near completing an updated ore reserve as well. The Toka mine has 9 years of pit mining left with a further 7 years of stockpiled resources.

Toka Tindung's gold levels - From Archipelago's August Presentation
The Toka Tindung project is a complete project as well with a conveyer-to-crusher processing plant and an on-site 12MW power station. The whole processing system is very efficient and relatively new which allows for a circa 91% recovery rate. Archipelago also has a sub-average cash cost per ounce, which for H1 2013 stood at just $618. This is far lower than the H1 2012 figure of $753. Furthermore, there is potential for this figure to come down further if either production is increased or if higher quality ores are used. High quality gold deposits have also been drilled south of Toka Tindung which is further increasing the company's resource and reserve base. During the recent resource report, the resource here increased by 34%. The current exploration program at Toka amounts to £7.7m of spending per year. in 2012 just under 600 holes were drilled along a 82,000m stretch. Compared to the market cap and cash in bank, this spending is modest, but that is reassuring and what makes Archipelago lower risk compared to other companies.

In the Phillipines the company does have less significant interests so I won't discuss these in detail for now. As per Archipelago's website: "Archipelago has a number of agreements with the Philippines registered company, Corplex Resources, Inc. ("Corplex"), which give Archipelago a right to acquire not less than an 80% interest in a portfolio of various exploration tenements in the Philippines held by Corplex. These tenements are predominantly located in the gold-copper rich Surigao peninsula of North East Mindanao, which area is host to the high-grade Boyongan copper-gold porphyry, and include a number of tenements in the vicinity of Medusa Mining's Co-O gold mine."

For the remainder of 2013 the company has released estimates for future production with guidance between 140,000 to 155,000 Au equivalent ounces. Cash cost guidance fell between $620/oz and $680/oz (net of royalties and silver credits). Furthermore, the company has outlined that there is potential for increased production through increased plant throughput or via heap leaching (chemical reactions that are used to isolate gold from the ore).

courtesy of Investing In Gold on flickr
The company's accompanying financial results from this production were also highly encouraging. During H1 revenues totalled $110.9m with a $36.9m operating profit whilst cash and cash equivalents totalled $108m vs $100m of long-term debt as of July 2013. This debt should continue to be reduced as the production continues to offset costs. Indeed, the profit after tax for H1 was $19.1m. Is is important to note that H2 revenues and profits tend to be a fair bit higher than H1 due to weather conditions among other factors. In that light, the net profit after tax is actually $2m higher than during H1 2012. Looking at the FY 2012 results, EPS came in at 5p which means the company is trading on a PE ratio of around 9.2.

What is also very pleasing is that the company has started a dividend policy whereby at least 10% of operating cash flows will be paid as cash dividends. A higher gold price will mean greater dividends for shareholders. Based on the 2012 results this means shareholders will be receiving a total of 2.25p in dividends. There is also a 0.5p interim dividend which goes ex-dividend in September. However, by far the more vital point to remember is that this H1 performance came against a backdrop of weaker gold prices. If the gold prices strengthen throughout the rest of 2013, the FY revenues and profits could be very attractive.

Backed by the company's strong cash generation, Archipelago was able to secure further financing facilities in late May. The facility (provided by PT Permata Bank and Standard Chartered) provides up to $160m in funding and will partially used to repay a previous loan. The $160m has a 5 year term with 6 month repayments that Archipelago should comfortably be able to meet.

Commenting on the refinance, Colin Sutherland, Chief Financial Officer, said: "In addition to on-going support from Permata, Archipelago looks forward to building a relationship with Standard Chartered. Both banks have a track record in financing growth companies in South East Asia and evidence a strong commitment to working with Archipelago. Greater funding flexibility will support Archipelago's strong balance sheet and provides further foundation to pursue growth strategies."

A comparison across LSE listed mid-tier gold producers.
Note: MML's cash cost is the average taken from their last two quarterly reports
Based on the above comparison, Archipelago may not have the lowest cash cost (that is Medusa), nor does it have the greatest output, but what it does have is a solid financial footing. The clear anomaly above is Petropavlovsk - a quick check uncovers that it has over a billion dollars of debt hence the striking discount. African Barrick also has a lot of cash and high production, but it's cash costs are higher than Archipelago's. Medusa has an excellent cash cost per oz, but does not have as good a financial footing. It's easy to forget that Archipelago's Toka mine has only been in full operation for over a year - there is plenty of scope to drive further operating efficiencies and drive the average cash cost to below $600/oz (net of royalties & credits). Adding all the CAPEX and overhead costs, the cash cost per ounce rises to around $900 - that is effectively the breakeven gold price that Archipelago could sustain. Therefore any level above it (current $500) is extra profit. This level is far lower than many other LSE companies, and while there aren't directly accessible figures, the average is probably well over $1,000/oz. As I said earlier, this allows Archipelago to weather any storm.

3 brokers currently have recent ratings for Archipelago. They are Liberum Capital, Canaccord and Westhouse securities who all have buy ratings. Canaccord and Westhouse have target prices of 68p and 71p respectively which are 48% and 54% higher than the current share price.

To sum up, Archipelago is a lower risk gold producer compared to a lot of other LSE gold miners. The company has not had any cash problems and the figures at its Toka mine are very good on an overall basis. The Toka production figures are not the best in all respects, but they do make the £267m market cap look undervalued. There is also the issue of whether all gold producers are undervalued following the recent price slip. The last prong to the company's strategy is to complete an M&A deal. This has been said by the company though for quite a while (over a year) so either they are still looking, or they are only looking for the highest quality deals. Considering the recent price weakness, opportunities may have opened up that they can capitalise upon, but that is unexpected upside and should not be used for any valuation. If an M&A deal does occur, equity may need to be raised, but importantly that could inject liquidity into the market - currently a very high percentage of shares is held outside of the market arena. Archipelago's progress has been impressive, and the company should be able to benefit from any sustained high gold price, or rise in the gold price. I have put a buy rating on Archipelago with an initial target price of 60p.

"We expect the Company to maintain its strong production and cash generating profile for the remainder of 2013." - Colin Sutherland. CEO and MD of Archipelago

UPDATE 27/09/13: The Archipelago story has been cut short. The company received a 58p/share takeover offer from the major shareholder (Rajawali Corporation). I have therefore moved Archipelago from 'Buy' to 'No Rating' at 57.75p for a 25.5% profit is just over one month. I cannot see a counter offer being made and there is no attraction in holding out for the extra 0.25p.


  1. Good Stuff El1te. I am very impressed and find the table of gold producers helpful! - Rick

  2. This may well suit my gold portfolio. Time to do some digging (not literally ofc!)


  3. That is it! Gold broke 1400! Time to pile in on Tuesday me thinks!
    I have a lot of respect for you elite so keep it up :-]

  4. A very fair and honest review...THe new ceo knows how to keep the purse strings tight and has the right background to maintain this..Also they are a company looking to bring costs down ie..they are considering changing the power source for the mine

    1. Agreed, no reason why the cash cost can't go down to $550/ounce over the next year! It has been that low before - Rick