The SK-1300 unveiling
SK-1300 disclosure: For the first time, the life-of-mine (LOM) plans for DRD’s operations at FWGR and Ergo have been disclosed. This provides considerable detail about their potential upside as well as their risks and allows us to recalibrate our fair values.
Positive impact: The disclosures are net positive compared to our previous DCF valuations. The lower capital intensity and operating costs embedded in the LOM of both operations more than outweigh the lower-than-expected gold production forecasts.
More detail: For all operations, the predicted recovered grades are lower than we had forecast, although the scheduling at FWGR will result in more gold production than we had assumed over the next 10 years. Capital costs are estimated to pre-feasibility study accuracy only, so negative capex surprises are likely. Real unit operating costs at ERGO are expected to fall by over 60% in the next decade as the operation transitions to fewer dump sources.
Risks: The SK-1300 forecasts assume that the approvals for FWGR and Ergo TSFs are in place within four and three years respectively. Other risks include the potential litigation on its resources that have resulted from the legislative ambiguity surrounding old dump ownership.
Further risks: Recent regulatory changes have increased the ongoing work to reclaim sites. Power instability has worsened although the SPP under construction should dilute the impact.
Upside: Until now, the Crown Dumps that are currently being rehabilitated have not been broken out of the resources allocated to ERGO. We now learn that the dumps contain 231mt at a recovered grade equivalent to what Daggafontein is expected to yield. These very large dumps represent an unvalued but valuable long-term gold option.
Further upside: The SK-1300 discloses that Ergo is expecting a large increase in production in FY2024E and a rapid fall in real costs in FY2025E. This promises shareholders two unexpected bumper years, if realised.
Valuation: The SK-1300 predicts considerably better cash flows at Ergo than we have previously assumed, which adds several R/s to our DCF-based valuation models. Risks to DRD are also higher than previously assumed and we have increased our discount rates from 5% to 7.5% for the base case and from 7.5% to 10% (real) for our optimistic case. Fortunately, the negative impact this would have on valuations has been more than offset by the rapid and substantial increase in the spot price of gold to more than R1.1m/kg. As a result, our base-case estimate of fair value has increased from R9.7/s to R16.4/s and our upper case from R13.1/s to R18.6/s.