Setting aside the current unrest in Libya for a moment, the fact remains that Africa presents a wealth of opportunity and growth for companies and investors. For resource companies in particular, the bounty of riches is there for the taking. Companies like Redback Mining (acquired by Kinross), Semafo, Teranga Gold, Keegan Resources among others are all examples of Canadian companies that have ventured into the African continent and met with success. However, despite these successes a number of factors, be they political, economic or cultural, a number of investors in Canada have this built up this invisible wall of fear about African resource companies, which may or may not be justified. To find out if these fears really are valid or not, I turned to Michael Cooper, CFa an analyst at Cooper Financial Research, who has spent a lot of time delving into the politics, economics and most of all, investment opportunities in the Democratic Republic of Congo (DRC).
Disclosure: I have positions in both Kinross & Keegan Resources.
Enjoy.
Michael Cooper, CFA
Q: Mr. Cooper, why don’t you start by telling us what led you to your current role and inspired your interest in researching and analyzing gold mining companies in Africa?
A: My role with Banro Corporation (BAA:TSX) and Loncor Resources (LN:TSX-V) originated from a long-term search for undervalued stocks. Mineral resources have been in an upswing and I have been searching for assets that are well positioned to benefit from high price levels. The range of prices for mineral resources in the ground is surprisingly high. In historically troubled geographies such as many countries on the African continent, resources can still be purchased for very low prices. However, what really excited me was the potential throughout Africa for improvement of its economies and politics. In the summer of 2010, the CFA European Investment Conference published one conclusion that sealed my interest in the potential improvements in Africa. The conference speakers, including Nouriel Roubini highlighted that Africa could be the next investment frontier. With this inspiration, I started my investigation and became very excited by the possibilities for the African continent. Africa occupies a huge land mass and is very diverse with 53 countries, and growing, with the new Southern Sudan, and more than 2,000 languages spoken on the continent. Obviously with this heterogeneity, there are many opportunities to spot positive and negative changes in investment conditions. My search led me to the Democratic Republic of Congo (‘DRC’) as the go-to country. The DRC has massive endowments of natural resources and resource potential that has yet to be tapped. And most importantly, the government, although slower than many would like, is making important strides in improving the investment conditions in the country. The DRC is on the verge of signing a regional free trade agreement with its neighbors. This COMESA free trade agreement represents an important step toward more regional integration and stability. Also, the DRC has taken important steps toward joining the 16 country Organization for Harmonization of Business Law in Africa that will strengthen DRC’s rule of law and improve conditions for all investors in the DRC. These are critical steps toward improving investing conditions in the country, lowering risks and increasing asset values. One strong signal that this is working is the recent ratification of a $6 billion investment by China that will lead to the rapid build-out of thousands of kilometers of roads, new sewer systems, medical facilities and hydro electric facilities. We expect that the future will continue to include some unpleasant surprises however the trend is toward overall improvements in the investment environment.
Q: What is your reading on the perceptions of Canadian investors in Democratic Republic of the Congo and the valuations and multiples they are willing to pay for projects in the DRC as opposed to Johannesburg or even Ghana?
A: DRC has experienced a traumatic history since independence in 1960. This is what the majority of Canadian and American investors consider first when they think DRC. However, essentially everyone also understands that this is elephant gold country in addition to being extremely well endowed with other resources such as oil, copper, tin, cobalt and hydro development potential. And now, with some of the improvements in the DRC, people are rethinking the return potential and risks. DRC has been rated as one of the most improved countries in Africa, albeit up from last place, in terms of governance and economic development. These improvements are increasing investor interest in DRC. At the Indaba conference (a pan-African investment conference) held in early February, DRC was referred to as one of the most compelling countries for investors. This is an encouraging development among those of us who are working and investing in Africa.
With regard to valuations and multiples compared to some other countries in Africa, such as South Africa or Ghana, DRC assets are cheaper but perhaps growing more quickly than some of the more developed countries. Each of the African countries has its own set of issues and opportunities. It is difficult and perhaps somewhat misleading to view Africa as a homogeneous investment region. DRC multiples are very low. As an example, in our index of 16 companies operating in various countries throughout Africa, the average value per oz of gold in the ground, in the measured, indicated and inferred category, is $770 whereas Banro Corporation, which goes into production in Q4 ‘11 is trading in the $400 per oz range. (We add cash cost per oz and market cap per oz to determine value per oz). Gold values for investors in South African operations have relatively high and growing extraction costs as their miners dig deeper and encounter lower grades of gold.
Q: Are these perceptions on the part on Canadians justified?
A: We are seeing a change in Canadian perceptions of Africa in general and the DRC specifically. Investor conclusions about the potential of this region tend to improve with more knowledge and understanding of the current situation and future prospects. Therefore, I would say that initial superficial perceptions are increasingly less justified, however, upon investigation perceptions tend to align with a more optimistic outlook. We believe, we are on the cusp of a major global recognition of the value of the DRC. Over the next decade we expect strong improvements in infrastructure development, mineral exploration and development, and financial capacity of the people and their resources.
Q: To dig a little further what are some of the challenges (in terms of politics or permitting or electricity or labour/unions etc.) faced by Canadian resource companies working in Africa, especially countries like the Democratic Republic of the Congo. Most people have a fear of the unknown and if you can go into detail about the some of the problems then perhaps some of the ‘unknown’ doesn’t remain that way.
A: I think you have hit on the main points of fear and risk in Africa. Africa is a continent for long term investors. These are the investors that will be exceptionally well rewarded. We segment Africa into 3 regions; north, central and south. North Africa or the Islamic component has their own set of problems which are well exposed. Central Africa is the underdeveloped portion that is so well endowed with untapped resources. Here we have a lack of infrastructure however, with the new government efforts to strengthen their rule of law and a dramatic increase in infrastructure investment, things are changing. We now have major companies from around the world investing in oil exploration and development, hydro projects, mining projects, road and other infrastructure development. China is one of the major investors in Africa and we expect their long term investment philosophy will increasingly result in additional new infrastructure development. Even financing and insurance costs are decreasing and accessibility of financing is improving. These were major hurdles to development in the recent past.
Q: Having talked about the challenges of mining in the DRC, I would like to turn our attention to the potential and opportunities that the DRC has to offer. Both Loncor and Banro, two companies that you cover have focused their efforts in the DRC – why is that? In terms of geology, what makes the DRC such a great place to be exploring for gold?
A: I am not a geologist, however I have read and continue to read everything I can get my hands on regarding the geology of this region. I have not heard anyone dispute the attractiveness of the geology of this region. Much of the previously discovered gold in Africa has been found in South Africa as well as the Birimian Greenstone Belt which centers on western Africa and has resulted in the discovery of over 200 million oz of gold resources, and counting. This greenstone belt has rewarded Ghana, Senegal, Ivory Coast, Burkina Faso and other Western African nations and pulled many people out of poverty. More recently, the discovery of vast tracks of greenstone belts around the Lake Victoria region has resulted in, arguably, one of the fastest growing greenstone belts in the world. This region has spawned world class gold deposits including African Barrick Corporation’s (LON:ABG) Bulyanhulu 15 million oz deposit, the Buswagi 5 million oz deposit and AngloGold Ashanti’s Geita 17 million oz gold mine. This geology in Tanzania is similar to the greenstone belts in N.E. DRC where Loncor Resources (TSX-V:LN)(PINK:LNRFF) and Kilo Goldmines Ltd. (TSX-V:KGL) and Randgold Resources Ltd. (Nasdaq:GOLD) are exploring. Newmont Mining of Canada also has a stake in this region through its Loncor investment. Because of the historical political situation, these large greenstone belts had been unexplored. Now with the improvements in the DRC, we believe this will become a hotbed of exploration and development activity.
Q: Banro has delineated 11.2 million oz. of gold resources (including inferred) in four deposits along the Twangiza-Namoya gold belt and is fully financed for development of Phase 1 of Twangiza with construction expected to be completed in Q3/2011 and production to begin in Q4/2011. Given this backdrop, Mr. Cooper, can you elaborate on the more salient points about the company that we missed? What are your thoughts on the company’s current valuation? When do you see the company get re-rated as it turns into a gold producer and at that point where do you see the stock trading?
A: The company is trading at 30% to 50% of its intrinsic value in my opinion. Banro is now less than 7 months from production. I believe a revaluation process is inevitable imminently. There is little choice for this stock but to move substantially higher over the next 12 months. Banro should produce $0.60 per share in cash flow in its first full year of operation. That on a share price of less than $3.50. Therefore I strongly believe in the steady, or sharp, rise of Banro’s share price.
Some of the complimentary points of the Banro story include the quality and track record of Banro’s management team. Arnold Kondrat founded the company and has led the company through 15 years of challenges to emerge as a successful first mover in the country. Martin Jones heads up the Banro Foundation which ensures that the interests of the local people are being met. Simon Village has a very strong background with leading institutions throughout Africa and Europe. Also, do not forget about the exploration potential. With 210 km of highly prospective land along the Twangiza-Namoya gold belt, Banro could be producing exciting new discovery potential for decades to come. Another major benefit that has come to light with rising oil prices includes the ability to generate inexpensive hydro electric energy in the DRC. The DRC is loaded with mountains, rivers, and plenty of rainfall. These are ideal conditions to generate electricity. The cost of energy is critical for a mining project. At some projects, power can account for 40% of the cash operating costs. By switching from oil and diesel to electricity, Banro’s costs structure could fall from $350 per oz to an estimated $250 per oz. To understand the extent of hydro potential in the DRC, consider the capacity of the Congo River, which is reported to have the ability to increase the world electricity capacity by 13%. This is a staggering figure and points to the attention the DRC will continue to receive in a world that needs clean renewable sources of energy.
Q: Loncor, on the other hand is a much smaller company and still young in its life cycle when compared to Banro. Can you tell us a little more about the company and its prospects?
A: Loncor controls approximately 20,000 sq kilometers of exploration property. The properties are largely Archeaen greenstone belt in the heart of elephant country. These gold regions can stretch for hundreds of kilometers. In Quebec, the Abittibi Archeaen greenstone belt has been under development for 100 years. It has yielded over 130 million oz of gold. Loncor’s Ngayu greenstone belt is unexplored but we are excited by its potential.
Q: What about valuation? How does this company compare to its peers? Also, what does the company’s balance sheet look like? Do you have a target price?
A: I find it difficult to do peer group analysis on exploration companies however, one exploration company with two primary exploration properties and a new acquisition which operates in neighboring Tanzania, is Canaco Resources Inc. (CVE:CAN). Canaco has a market cap of $1 Billion based on some wide intercepts of low grade gold and including some higher grades. However, comparisons can be deceiving. Another peer company is Kilo Goldmines (TSX-V:KGL) which is also exploring the Ngayu greenstone belt, however they do not have the financial resources or management team quality of Loncor so there is some question in the market as to their ability to exploit their land position. Newmont Mining of Canada is an investor in Loncor and they believe, according to their recent investments, that Loncor has significant upside potential.
Q: What catalysts do you see that could move the stock?
A: The single biggest catalyst I see for stocks in the DRC, is the improvement in the legal and political landscape. This is in process with regional integration through the COMESA free trade talks and progress with the Organization for Harmonization of Business Law in Africa. In addition, China’s $6 Billion investment in infrastructure will produce shareholder dividends for those who gain exposure to the DRC early. These are the catalysts that will invite new investment from around the world and start to unlock the substantial value of both Banro and Loncor’s assets. These steps cannot be underestimated as positive developments for the country and the central African region.
In addition we expect to see company specific developments such as drill results from LN from their three to four drill rigs on the property. Also, neighboring drill results such as Kilo Goldmines Ltd. who is also exploring the Ngayu Greenstone belt in the region of LN. Kilo recently announced wide intercepts of gold over 136 meters which highlight some of the potential of this greenstone belt.
Also, we are seeing Rangold increase its activities in the DRC as well as Glencore International AG, Anvil Mining Ltd. (TSX:AVM), Katanga Mining Ltd. (TSX:KAT) and Lundin Mining Corp. (TSX:LUN). Of particular note is Ivanplat’s potential IPO this year. Ivanplat is led by Robert Friedland with a major copper discovery in the DRC.
The other activity to watch is the progress of elections. 17 African elections are expected in 2011. Some such as Uganda have proceeded relatively smoothly while countries in North Africa are not proceeding smoothly.
Q: What is your opinion of Loncor’s management? Lastly, what are some potential risks associated with this stock that could hamper your investment thesis?
A: Loncor’s president is Peter Cowley. Peter has impeccable credentials and a successful track record. Peter was credited with the Geita deposit in Tanzania which is a 17 million oz deposit now being developed by AngloGold Ashanti Limited (NYSE:AU). Peter was also head of Ashanti Gold which merged with Anglo Gold to become one of the leading gold companies in the world with a focus on Africa. The high profile management team is complimented with a exploration team of talented and dedicated North Americans, Europeans and Congolese engineers and explorers.
The risks to both of these stocks include political risk, however, I believe these risks are fully priced into the stock and as mentioned previously, these risks are abating rapidly now. Large investors must also keep liquidity issues in mind.
Thank You, Mr. Cooper!
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