Lihir Returns To Market Favour
Lihir has returned to market favour, with its share price hitting an all-time high, on the back of a dramatic improvement in its operating costs and a substantial reduction in the overall level of its gold hedging position, which has made it once again the leverage choice at the big end of the Australian gold scene.
|"The company has regained a significant amount of market credibility with the sound operational performance at its Lihir Island goldmine. Operationally the mine has a history of underperformance, but fresh operational initiatives have boosted production and slashed operating costs."|
The resolution of the management situation at Lihir has been a long time coming, with the company now having full managerial independence from Rio Tinto. One of management's first decisions has been to dramatically reduce the company's hedge position, which has restored Lihir's status as a highly leveraged gold exposure.
Lihir Gold is continuing its operational turnaround, having recently reported a strong September quarter earnings and production result. Improved gold recoveries, record gold production and the commissioning of the geothermal power station in July led to a dramatic 41% drop in gross cash operating costs from US$462 per ounce in the June quarter to US$272 an ounce in the September quarter.
The company produced 193,031 ounces of gold during the period, which beat market forecasts of 190,000 ounces. A major reason for the lift in production and drop in operating costs was the sharply higher gold grade sourced from the Lienitz pit, which rose by 62% from 4.41g/t in the June quarter to 7.15g/t in the September quarter.
The production result is highly encouraging, particularly given the plant experienced a 45-day shutdown due to scheduled maintenance that involved re-bricking of the autoclaves. We anticipate that this exercise will not have to be repeated for another five to seven years.
Further advances have been made on the flotation expansion announced earlier this year. Engineering work is now 25% complete and construction should be underway by February 2006. Annual production is expected to be boosted by ~140,000 ounces (over seven years) when construction is completed in 2007.
More recently Lihir experienced an unforeseen production interruption related to a landslide that blocked road access to the mine-site and also destroyed a portion of the pipeline that supplied water to the plant, halting gold production. Tragically two workers were also killed in the incident. Production has since been fully restored, although production for the current quarter (December) has been revised to ~175,000 ounces, with 2005 full-year production expected to be ~600,000 ounces at a cash operating cost of US$270 an ounce. Production is forecast to rise to 700,000 ounces in 2006 and to nearly 900,000 ounces in 2008.
We support Lihir's strategy of increasing gold production levels, as it will significantly boost cashflows and reduce operating costs over the next three years.
The major plank of this expansion, the flotation project, is being funded by a gold loan, which in turn has necessitated a restructuring of the company's hedge book. What this hedge book restructuring has done is significantly increase Lihir's leverage to the gold price - a traditional attraction of the company that had been lost in recent years as its hedge position grew. Following the restructure, Lihir's committed hedges as a percentage of gold reserves and resources has fallen to 6.5% and 3.1% respectively.
We anticipate further reductions in cash operating costs over the next year. During the September quarter the company benefited from lower mining, processing and contracting costs. One particular highlight was the 38% fall in power generation costs, which reflected the commissioning of the 30MW geothermal power station. Lihir had previously been entirely dependent upon diesel fuel, the cost of which had escalated in recent years.
Annual Gold Production (,000 oz)
Another major development has been the conclusion of the management link between Rio Tinto and the company. Lihir now has a fully independent management team and Arthur Hood has been appointed as Chief Executive. Mr Hood comes with considerable high-level executive experience from global diversified resource giant, Placer Dome, where he spent 16 years.
Although further consolidation is likely in the near-term, Lihir remains one of our preferred gold sector exposures. A primary attraction is its highly leveraged status, along with its significant reserve base of more than 20 million ounces of gold. The re-emergence of corporate activity in the gold sector is an added bonus, with Lihir offering a unique, long-life mining operation for a predator. In our view the stock possesses considerable upside potential over the medium to longer term. Accordingly the shares remain held in the Fat Prophets Portfolio. We recommend Lihir Gold (LHG) as a buy for new Members around $2.
Disclosure: Interests associated with Fat Prophets declare a holding in LHG
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