Mining companies with operations predominantly in Africa tend to trade at a significant discount to comparable companies that operate in North America. As Americans, we read headlines about dangerous working conditions, underpaid workers, political uprisings, civil wars, and other red flags that lead us to the conclusion that we shouldn’t invest in African mining companies.
The fact of the matter is that Africa is an enormous continent with all sorts of different peoples, political systems, and geographies, and it is counterproductive to lump all African mining companies together. Yet a look at these companies’ valuations tells us that many Western investors are guided by such an undifferentiated investment approach. As a result, savvy investors can make money if they are willing to put in the effort to understand which African mines are high risk, and which are low risk.
Generally, there are two questions that investors need to ask and answer when determining whether an African mine is low risk or not. First, is the mine a surface mine or an underground mine? Second, is the mine located in a politically stable region?
Surface mines, as opposed to underground mines, make for far safer working conditions. When we read about worker strikes and dangerous working conditions, this is often in reference to deep underground gold and platinum mines in South Africa. Workers there have to go deep underground, where they can potentially be injured, and where they have to breathe in a lot of soot.
Surface mines, on the other hand, are generally far safer for the workers involved. Their work consists primarily of operating giant bulldozers and transporting ore to a milling and refining facility. These machines require highly specialized abilities and their operators command surprisingly high salaries; while there are dangers, they are minimal and similar to working on a construction site.
Therefore, concerned investors should first limit their scope to companies that own and operate surface mines in Africa.
Investors must also concern themselves with the political stability of the region in which a mine is located. Deciding a region is not as simple as differentiating between a surface mine and an underground mine, as the distinction is more open to interpretation. Generally, investors should look for areas in Africa where there have been stable and consistent mining going on for a long time without any serious issues. Western Africa has been such a region, and companies that have operations in Mali, Senegal, Burkina Faso, and Ghana should be relatively safe compared to companies operating in South Africa or Tanzania. There are several companies that meet both criteria.
My favorite is Asanko Gold (NYSE MKT:AKG), which owns the Esaase mine in Ghana. The company recently placed a bid to acquire PMI Gold (PMVGF.PK), which owns a large neighboring mine called Obotan. The combined company will have $280 million in cash. This is enough to develop the Esaase project, which will produce 200,000 ounces annually by 2015 (180,000 attributable ounces, since Ghana’s government owns 10 percent of the mine’s production). Furthermore, the cash flow from Esaase can be used to develop Obotan, which will add 200,000 ounces of production by 2017. As an unloved African miner, the shares trade at just a hair over the cash Asanko has on its balance sheet, making it an excellent risk/reward proposition.
Investors should also consider Semafo (SEMFF.PK), which owns an enormous project called Mana in Burkina Faso. Semafo had a rough time after peaking in 2010 at $12 per share, although the shares have bounced back from just more than $1 per share in June to thrice that today.
The shares have been doing well despite the fact that the company’s Mana project is losing money. It recently shed two non-core assets, and it added more than 1 million ounces of gold resources at Mana; these actions have lifted investor confidence. While production of about 150,000 ounces of gold doesn’t justify the company’s $900 million valuation, the Mana property has a lot of exploration potential, being over 2,000 square kilometers. If you own the shares, you are betting not just on the gold price but on exploration success at Mana, and given the size of the property and management’s track record, this is a good bet to make.
Finally, investors should consider Teranga Gold (TGCDF.PK), which owns a producing mine and a large land package called Sabodala in Senegal. Teranga has the potential to bring production at Sabodala to more than 250,000 ounces annually, up from roughly 150,000, after its recent takeover of Oromin Explorations. Yet it has a low valuation of just $187 million. This is extremely inexpensive considering that the company just received $150 million from Franco-Nevada (NYSE:FNV) in exchange for a 6 percent net smelter return royalty on the Sabodala property. This cash will give the company the means by which to fund its expansion. Given its low valuation, I believe that its share price can soar even if the gold price rises modestly from here.
These companies have depressed share prices yet excellent properties that are or will be profitable. Their properties are located in relatively stable parts of Africa and they have surface mines. With this being the case, I believe that these companies, along with their peers that meet the aforementioned criteria, are excellent contrarian ways to get exposure to the gold market.
Disclosure: I own shares of Asanko Gold.
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