Serabi Gold - A Higher Risk Gold Explorer

Serabi Gold Logo
In my last article I covered Archipelago Resources, a relatively low risk gold explorer in South-East Asia. However, I recognise that some investors have more of an appetite for risk, or want balance to their portfolio. Over the past couple of weeks, there have been a number of cases where microcap and smallcap miners have rallied sharply amid what can only be described as a systematic flood of buying in the market with investors moving from share to share, pushing the share prices back up following the disappointment of the last two years. The gold price currently lies above $1400/oz, which clearly bodes well for gold producers, and unsurprisingly, good value remains within the sector. To fit the higher risk bill, I suggest a look at Serabi Gold (LSE:SRB) - a Brazilian focused company that is set to have production recommence by the end of 2013 having halted it in 2008.  Serabi has a current market cap of circa £26m, 450m shares in issue and a current share price of 5.75p. There is no doubt that Serabi is higher risk than Archipelago, but that means there is potential for greater returns.

Looking at the charts, Serabi's technical position is bullish. The increase in volumes recently means that Serabi is poised for a strong move, and the break of the downtrend is also positive. Based on the recent rally of gold miners, a swift return to the levels of 8-9p is not unreasonable. Liquidity has been an issue in the past, but recent deals using shares and a share placing has improved the situation and the spread is reasonable. Nonetheless, it means that the Relative Strength Index is not particularly useful. The MACD is around the neutral level and poised for a move in either direction. The most important point though is that there looks to be a golden cross as it is likely any upward movement will force the 15-day MA to surpass the 50-day MA. Backed by higher than normal volumes, this could initiate a bull run in Serabi's stock.

Directors hold just over a million pounds worth of Serabi shares although most of these are through Non-Executive Director Christopher Kingsman. The CEO only holds a small number of shares and it would be encouraging to see the management take a larger stake. The lack of holdings may be due to the company's share option scheme although disappointingly, the options granted in January 2013 only require a share price of 6.13p. That will likely get surpassed meaning that the incentive that the options supposedly creates is lost. Disregarding this though, there is a strong institutional background with several companies holding large stakes in Serabi. One firm alone (Fratelli Investments) holds 185m shares with other companies including fellow gold miner ElDorado holding over 100m shares between them. One holder (Drake PIPE Fund) recently increased their stake from 6% to 7% which is a sign of confidence. I have outlined my thoughts on the gold price in the article on Archipelago, but I have re-copied the final paragraph below:

"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."

Courtesy of Serabi's website gallery
Serabi itself is a highly prospective play. The company is dual-listed with the shares also on the Toronto Stock Exchange albeit the price movements on there are more erratic. The company operates within the Tapajos gold province of Northern Brazil where is has a flagship project at the Palito deposit. Brazil itself is a relatively secure area for mining as there is a favourable tax and fiscal regime for the sector.

Palito was formerly in production until 2008 when it was suspended, but it now looks set to be brought back into reproduction. Between 2005 and 2008 alone, Palito produced over 110,000 ounces of Au eq. That means the deposit is de-risked and has already passed any permits (governmental and environmental) required. The re-start will allow the company to exploit any rise in the gold price, and fund its forward work programme. Production from Palito is scheduled for Q4 2013 and the output rate is expected to be 24,000/oz Au per annum. For the current market cap, that is not bad at all. To add to this, cash costs are only expected at $739/oz Au equivalent - that means that full cash costs including CAPEX, overheads and other charges will still be fairly low compared to the LSE average. Considering the current gold price is above $1400/oz, there is plenty of profit to be made from this production, especially if either production levels are increased, or cash costs are brought down. The mine contains high grade deposits with the average life of mine grade of 9 grams.

At $1400/oz, the post-tax project cash flow is estimated by the company to equal $11m or around £7m. At $1600/oz that cash flow figure rises to $14.7m or £9.5m, and even at $1200/oz cash flow is expected to be around $7.3m or £4.70m. The project delivers a healthy post-tax Internal rate of return of 68% and considering CAPEX is only expected to be $18m, there is a quick payback that is expected to be less than 21 months at a $1400/oz gold price.

Admittedly the issue that Serabi faces is that its gold resource is not as high as some of the major gold companies. Serabi currently has a gold asset base of over 600,000 ounces measured, indicated and inferred, with further resources not yet added to these estimates. As I said though, compared to some producing companies, this is not much. However, to counter this, the company has a two pronged approach.

The first prong is like all gold companies; using the cash flow generated by production to fund exploratory drilling. Indeed, Serabi has 3 discoveries within close proximity (3km) of the plant meaning an easy tie-up and the chance for increasing gold production. The licences owned by Serabi total 143,000 hectares and considering there is only 7m ounces gold identified in the area, there is plenty of potential for unexpected drilling upside.Furthermore, mains power is available on-site.

The second prong is less common, and involves Serabi forming various partnerships within the region. Serabi has already initiated this process with a deal with TSX Venture listed Kenai Resources in May. Kenai operates a high-grade gold project 23km away from Palito, and the route is accessible meaning that Serabi has effectively just increased its asset base, with the potential to deliver larger quantities of gold for processing. Kenai's project, Sao Chico, holds around 100,000 ounces of indicated and inferred resources combined. A distinct benefit to the company is that the Sao Chico ore does not contain copper thus does not require copper extraction methods meaning that costs can be reduced. The Kenai deposits are also very high grade with grades around 28 grams - that is substantially better than the vast majority of gold mine grades. That means better gold margins for Serabi and thus higher future profits.

"The existing Palito gold recovery plant is currently being refurbished and upgraded, and Sao Chico is expected to be the first satellite gold resource to supplement Palito mine production with high grade material, taking advantage of the excess plant capacity available to quickly expand Serabi's future gold production."

Therefore, this deal has the potential to boost Serabi's production further past 24,000 ounces/year. Once again, Kenai's resource base is not huge, but it is expected to only be the first of the satellite projects that Serabi may buy. Furthermore, Kenai's acreage itself holds some prospectivity, with plenty of unexplored areas. To that end, a 6000km drill campaign was pencilled in for mid-2013. This should increase the resource at Sao Chico. The all important question is of course: how much did Serabi pay for the asset? The answer is that Serabi paid shares. That is a highly astute move from the company as this has improved the liquidity. Kenai's shareholders now have a vested interest in Serabi, and this will only boost interest in the stock considering it is dual-listed. Admittedly, the premium for the purchase was 87%, which is usually considered at the top range of the spectrum, but the fact is that is was done in shares. Therefore, if Kenai's shareholders believed in the prospects, they will be inclined to hold into Serabi shares. Nevertheless, this will allow Serabi ample time to build up the resource base at the asset. the company has stated that there are many other TSX juniors that offer sensible synergy opportunities, so it will be interesting to see how this may be completed. Any further acquisitions would probably be completed post the production re-start as to not risk a funding shortfall, but of course it could be done in shares.

CEO of Serabi Michael Hodgson commented: "The current Sao Chico resource comprises just 3 veins, and with 10 more veins identified we hope to add gold ounces by drilling these areas. This work will also support the upcoming application for a long term Mining Licence for the property. Both Boards consider the combination to be highly accretive and beneficial for both sets of shareholders as it unlocks value neither could have realised on their own".

Courtesy of Serabi's website gallery
The deal makes sense for Kenai's shareholders, both considering the large premium, but also because  Serabi is one of the only gold firms in the region with the infrastructure to develop any nearby resources. A common question for companies of this size is, how well is the company financed? The answer is that Serabi is fairly well financed through to production and this was done through a share placing that was completed in early 2013. The placing did triple the share capital, but most of the shares were available to Fratelli Investments who are a long-term shareholders - that means that you get the benefits of the funds, without as much of the subsequent overhang. The placing was completed at 6p for 270m shares. CEO Hodgson said: "I would like to record the thanks of myself and the rest of the Board to Fratelli Investments. Their support will allow the management of the Company to continue the development of the Palito Gold Mine and ensures an exciting future for the Company. Their willingness to underwrite the share placement is, I believe, a demonstration of their belief in the Palito project and the opportunity that we have to develop a robust and bigger gold company around this."

The placing raised gross proceeds of £16.2m so when discounting brokers fees and other charges, the likely net proceeds would have been around £14m-£15m. Looking at the company's Interim Results for the six months to July we can analyse the figures and project progress:
- Palito on schedule to re-start by 2014 with contract negotiations for output at an advanced stage
- 1st Half of the assay results for Sao Chico from themid-2013 drilling expected in early September
- Geophysics programme commenced in August for the Sao Chico project. Remember that Kenai's average gold grades are very high, so this could prove a catalyst for the share price
- 2 NEDs appointed. One from major shareholder Fratelli and also the Chairman of Kenai
- At the end of the period cash stood at £9m. Once the exploration work at Sao Chico is completed, this will likely fall by another couple of million, but should be sufficient to see the company through to production starting. If not, then chances are that Fratelli will be happy to stump to some cash (Whilst this acquisition has necessitated additional expenditures which were not foreseen, management considers that the company holds and can access adequate capital to be able to complete the necessary mine development and process plant and infrastructure rehabilitation works that are required at Palito in order to be able to commence gold production before the end of 2013 - Interim Report)
- Net Asset Value of 13.09p/share meaning that Serabi is trading at a 56% discount to NAV which is could indicate that Serabi is undervalued

That caps off Serabi. Currently a smallcap gold miner, soon to become a producer. Happy to build on its position in the region, and the promise of appetising cash flows. There are of course issues, and that is why it is relatively high risk. The company funding is not obvious and there could still be a shortfall should there be issues prior to production. On the other hand the company has dedicated investors and a strong negotiating hand with production imminent. Admittedly, with all the uncertainties around the gold sector and slightly issues with the acquisition could push production back to Q1 2014, but this is still just around the corner, and the figures touted should be able to fund exploration and M&A's meaning the company can increase its high grade resource base. The assay results are the first point to look for. In terms of broker targets, Fox Davies has a speculative buy rating with an 8p target, whilst Sanlam recently initiated coverage with a buy rating and a 10p target. With the same number of shares in issue a 9p target capitalises Serabi at £41m - as the company moves towards production that should be achievable. With many miners seeing swift moves higher at the moment as well, there could even be an opportunity for a quick return here. I have put a Buy rating on Serabi with a 9p target.

UPDATE (December 2013) - It has become clear that the quick return scenario is unlikely to materialise, especially since sentiment towards the gold sector has weakened coupled with the unveiling of a financing scheme (which involves an equity element).  That will boost the market cap reducing the upside for Serabi. There is a very real chance of a takeover from the investors (via Fratelli), but in the interim, there is little that is really going to drive the shares upwards post placement, in my opinion. For that reason I have moved Serabi from Buy to No Rating at 5.88p for a small 2% profit. The main concern still is the gold price which is showing little strength


  1. Now this I do like the look of!


  2. Cheers El1te. It does seem a fair bit riskier than Archipelago but greater payback and all that comes with it

  3. fab review

    long run SRB holder

  4. Great review, bounced of 6p twice in last few months, with the placing issuing so many shares at 6p - do you think we will surpass this without a very strong RNS? Or will we keep floating between 5-6p and potentially drift lower.

    1. Currently the share price is fairly stable around the 5.5p region (give or take 5%). The shares remain illiquid, primarily due to a lack of interest, but any rises are being sold into (most probably due to Kenai shareholders selling out). That will probably continue to suppress the share price for a short while longer. In these cases, more news tends to be needed to clear the overhang, but when that is done, a sharp move upwards (should news allow) should be expected. I can't see this drifting much lower as 5p and above is an established base in any circumstances

  5. Gold price is starting to show strength, maybe a follow up on SRB?! love the reviews ;)

  6. Hi there,

    Yes, the gold price is showing strength, although quote a lot of the small and mid cap companies have completely failed to respond so far.

    The problem I see with Serabi are the 6p warrants that are likely to cap investor bullishness. I am however, continuing to keep a tab on SRB as it is one of the few companies that has delivered operationally, plus the gold grades are exceptional. Currently though, the market's lack of interest is telling. A takeover down the line, remains on the cards as being a real possibility, but that is merely speculation.


  7. Love the reviews, Serabi Update Please as movement up to 7p.

    1. Serabi is now very much a play on the gold price. Personally I am witholding from taking a position based on the gold price at the moment, until its technical position plays out. It's currently near a point that will likely determine the medium-term outlook. Thus, not overly interested in Serabi at present. Serabi is now trading on a PER in the right sort of ballpark by the looks of it

      Hope that helps,