Tasiast May Finally Be Ready to Shine for Kinross Gold

At the beginning of the decade, precious-metal mining stocks could literally do no wrong. Gold had been in an uptrend for more than a decade, and mining companies were seemingly throwing capital at every project that had even the slightest hint of promise. We know how that story ended, with the multi-year decline in gold prices miring many large gold miners in debt and forcing some massive writedowns.

Image source: Kinross Gold.

Kinross Gold's roller-coaster ride with Tasiast

Perhaps one of the most memorable of the bunch was Kinross Gold's (NYSE: KGC) acquisition of Red Back Mining in 2010, which allowed the company access to the highly prized Tasiast Mine in Mauritania. Kinross ended up paying $7.1 billion for Red Back during the height of the gold market and wound up taking two massive writedowns on its acquisition in the years to follow. In 2012, Kinross took a $2.49 billion writedown on the Tasiast Mine, and in 2013 it shaved another $3.09 billion off its valuation.

By early 2015, with gold prices falling for a fourth straight year, expansion plans for Tasiast were put on indefinite hold. Initial capital cost plans from its 2014 feasibility study had called for a $1.6 billion investment to develop a 38,000-ton-per-day (t/d) plant to handle the expansion, which was far too much with the net present value of the mine hovering around $500 million at the time. In other words, it looked as if Kinross' investment would be a complete bust.

But what a difference a year and change makes.

Image source: Getty Images.

Since the beginning of the year, physical precious metals have been on fire as fundamental and psychological factors have altered investors' opinions. Physical gold is up more than $220 an ounce in 2016 to the $1,300 per ounce range, and it had its best quarter in 30 years during Q1.

Gold demand, especially for investment purposes, has been soaring, while supply has been relatively stagnant, which suggests based on the basic rules of economics that physical gold prices should head higher. Opportunity cost for gold also remains exceptionally low. Investors aren't giving up much to own bank CDs or bonds with lending rates near historic lows, meaning an investment in gold or precious-metal miners could make more sense.

This new bull market in physical gold has paved the way for Kinross to step on the gas for the first time in six years and finally move forward with the expansion of its crown jewel, Tasiast.

Tasiast could easily become Kinross' crown jewel

In March, Kinross announced that it was finally economically feasible to expand production at Tasiast. The initial cost of such a move is slated to be $728 million, with $300 million of that amount allocated to capital spending and another $428 million for stripping costs. This aggregate $728 million investment in Tasiast dramatically increases Kinross' capital expenditures budget for 2016. But the returns could be huge.

According to Kinross' initial figures, this expansion, known as phase 1, would increase throughput capacity at Tasiast from 8,000 t/d to 12,000 t/d, with full production capacity expected by the end of the first quarter of 2018 following a fourth-quarter 2017 commissioning. Annual production between 2018 and 2027, based on this expansion, should be 409,000 ounces of gold per year, with production costs of $535 an ounce (nearly half of what they are now) and all-in sustaining costs of $760. This would give Tasiast a better than $500 margin over current spot gold prices.

Image source: Kinross Gold.

However, there's a phase-2 portion of this expansion that Kinross will have to decide on by the end of 2017. Should the company move forward with its considerably more expansive second expansion, throughput would more than double from 12,000 t/d to 30,000 t/d, and average annual production between 2020 and 2026 (the second phase would take until early 2020 to reach full production) would hit 777,000 ounces. Production costs, should Kinross proceed with phase 2, would drop to an estimated $460 an ounce, with all-in sustaining costs (AISC) of just $665 an ounce. An AISC this low would be practically unheard of in an African mine.

The second phase of expansion would include $620 million in capital costs, meaning Kinross has reduced the expansion of Tasiast from its 2014 projection of $1.6 billion to around $920 million in capital costs. Comparatively, the net present value of the mine at phase 2 with gold at $1,300 an ounce is $1.275 billion, representing an internal rate of return of 22%. If gold were to get back to $1,500 an ounce, which isn't unreasonable over the next couple of years, considering the fundamental supply and demand factors behind this recent rally, Tasiast's value could increase to nearly $2.1 billion, providing an internal rate of return of a blistering 33%. Based on a $1,200-per-ounce assumption, $1.66 billion in free cash flow after tax should be generated over the life of the mine.

If Kinross proceeds with its extensive Tasiast expansion late next year, by 2020 it could very well become the company's most prized asset, especially with Fort Knox having a life of mine through only 2020.

Two risks to be mindful of

Though it finally looks as if Kinross' fortunes are about to turn around, there are still some risks that Kinross investors should be aware of.

Image source: Kinross Gold.

To begin with, Tasiast's expansion plans are still very much dependent on the price of gold "behaving." Though the wheels are very much in motion for phase 1, Kinross could still put the kibosh on phase 2 if hold prices fall considerably over the coming year. If the Federal Reserve has a change of heart and begins raising interest rates perhaps three or four separate times over the next 12 months, it's possible that gold could fall as the opportunity cost of owning gold rises. Though it's the obvious factor, investors should monitor the price of gold closely.

Secondly, political instability and higher labor costs are always an outlier concern for miners that operate in certain countries in Africa, Mauritania being one of them. Earlier this year, a government inspection of Tasiast that led to a dispute of expatriate work permits caused a production shutdown that lasted three weeks. Though the company recently reached a three-year collective bargaining agreement with its unionized employees, political instability and higher labor costs are often issues miners with exposure to parts of the African continent that rear their head from time to time.

Despite these risks, Kinross is beginning to look quite attractive. With Wall Street anticipating $1.03 per share in cash flow in 2017, Kinross is currently trading at a hair below four times its future cash flow per share. That's dirt cheap, even with Tasiast's history and the risks presented here. If you've looking to make your portfolio a bit more lustrous, you may want to give Kinross Gold a look.

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Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.

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