Caledonia Mining - Edison Research raises price target to 1.59 GBP per share

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2015 for Caledonia featured stable gold production at Blanket, albeit at slightly higher costs due mainly to a reduced average gold grade and additional sustaining capex. Investment accelerated with the implementation of the revised investment plan (RIP), significantly yielding ore production for the first time from below the 750m reduced level (RL) via the completed No. 6 Winze. This level is a key ‘watermark’ in that the company’s longer-term growth hinges on gold production below this depth. Such an important milestone mirrors a management team that is delivering on its 2014 initiated RIP and one that has taken precautionary measures to ensure its successful completion (inter alia, a small gold hedge)

Collar/cap hedge provides certainty over cash flows In early 2016 Caledonia entered into a small 15koz gold hedge valid until July 2016. There are no forward sales of any of Caledonia’s gold production, and the hedge is structured such that the company achieves a minimum price of US$1,050/oz (termed the collar value) regardless of the gold price being below this, while maintaining full price participation above US$1,079/oz (the cap value). The maximum cost of the hedge, if the gold price stays above the cap value for the hedge period, is US$0.435m. This hedge position is described by management as an insurance product used to maintain certainty over cash flows during a key phase of Blanket’s expansion, as market volatility continues to dominate.

Zimbabwe support for Blanket Government support for the RIP has been via a suspension of indigenisation payments (for 2015) and a narrowing of refining costs. With these set against a backdrop of South African political turmoil and adverse mining industry taxation changes elsewhere, Caledonia’s total RIP investment of c US$65m starts to appear a more astute choice than developing elsewhere in Africa and poses the question of whether a narrowing of Zimbabwe risk is now overdue for the company.

Valuation: Underlying RIP assumptions maintained We adjust our model for Caledonia’s FY15 accounts and its US dollar accounting format. On this basis, our DCF valuation of Blanket’s cash flows, based on the RIP’s production and cost profile, is £1.59 per share, at a 10% discount rate to reflect general equity risk and our gold price assumptions (see pages 6-7). On the same basis but using a flat gold price of US$1,200/oz, our valuation becomes £1.05. We also note that Caledonia should realise a 190% uplift in earnings in FY16, based on an average gold price of US$1,224/oz and achieving 50koz of gold production.

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