How to Value A Mining Asset?
At any given time, we know the international spot price for an ounce of refined gold or other metals but what about the resources an exploration or mining company has in the ground. Mining assets are really challenging to value. Given the degree of geologic uncertainty around reserves and resources, it’s hard to know how much metal is actually in the ground. This guide to mining valuation will teach you all you need to know to value a mining asset!
The best way to value a mining asset or company is to build a discounted cash flow (DCF) model that takes into account a mining plan produced in a technical report (like a Feasibility Study). Without such a study available, one has to resort to more crude metrics.
Here is an overview of the main valuation methods used in the industry:
- Enterprise Value Per Resource (EV/Resource)
- Net Present Value (NPV)
- Price to Net Asset Value (P/NAV)
- Price to Cash Flow (P/CF)
- Total Acquisition Cost (TAC)
Enterprise Value Per Resource (EV/Resource)
In the enterprise value per resource approach, the value the market is giving a company per ounce or a pound of resources in hand is compared against the average value the market gives companies with similar resources. The most obvious way to define “similar” resources in the ground is to use the three resources and two mining reserves categories defined by Canada’s National Instrument NI43-101 regulations – the industry standard. These are combined into three broad groups:
- Inferred Resources: The lowest-confidence category, based on just enough drilling to outline the mineralization.
- Measured & Indicated (M&I) Resources: These higher-confidence categories have been drilled enough to establish their geometry and continuity reasonably well.
- Proven & Probable (P&P) Resources: These are bankable mining reserves – basically, Measured and Indicated resources with established value.
The enterprise value per resource ratio takes the total resources contained in the ground and divides the enterprise value of the business by it.
This metric is typically used for early-stage development projects, where there is not a lot of detailed information. The ratio is very basic and doesn’t take into account the capital cost to build the mine, nor the operating cost to extract the metal. The formula is as follows:
EV/Resource = Enterprise Value / Total Ounces or Pounds of Metal Resource
Example: Junior Gold Miner’s Valuation
Enterprise value per ounce is the most commonly used valuation method for a junior miner’s gold in the ground when the discounted cash flow (DCF) method is not applicable. Let’s assume the average EV per ounce numbers for the publically listed gold mining companies in the three resource groups were:
• US$20 per ounce Inferred
• US$30 per ounce for M&I
• US$160 per ounce for P&P
Armed with this information, if you didn’t know anything else about an M&I resource (political risk, type of ore, etc.), but you saw that the company that owned it was trading at $10 per ounce, whereas its peers are valued at around $30 an ounce, you can conclude that there must either be something very wrong with the project or the stock is great speculation. If there’s nothing wrong with the project, there’s implied growth potential in the stock price, based on the difference between what the company is getting per ounce and the market average for similar ounces. In this case, it would be $20 x # Ounces ÷ # shares.
Net Present Value NPV
Given sufficient data, you can estimate a reasonable net present value (NPV) for a project and deduce what each of the company’s ounces should be worth. To do this, you need to know the annual output of the proposed mine, proposed capital expenditures, energy and other costs, and many more things. Unfortunately, for most deposits held by the junior companies, there is just not enough data available. The formula is as follows:
Net Present Value (NPV) = Cash Flow / (1+rate of return) ^ number of time periods – Initial Investment
Price to Net Asset Value P/NAV
Price to net asset value (P/NAV) is the most important mining valuation metric. “Net asset value” is the net present value (NPV) or discounted cash flow (DCF) value of all the future cash flow of the mining asset less any debt plus any cash. The model can be forecast to the end of the mine life and discounted back today because the technical reports have a very detailed Life of Mine plan (LOM). The formula is as follows:
P/NAV = Market Capitalization / [NPV of all mining assets – net debt]
NAV is a sum-of-the-parts approach to valuation, in that each individual mining asset is independently valued and then added together. Corporate adjustments are made at the end, such as head office overhead or debt.
Price to Cash Flow Ratio P/CF
The price to cash flow ratio, or “P-cash flow” is also common but only used for producing mines, as it takes the current cash flow in that year, relative to the price in the security. The ratio takes the adjusted cash flow of the business in a given year (i.e. 2019E) and compares that to the share price.
Operating cash flow is after interest (and thus an equity metric) it’s also after taxes, but it does not include capital expenditures. The formula is as follows:
P/CF = Price per Share / Cash From Operations per Share
Total Acquisition Cost
Another commonly used metric in the mining industry for early-stage projects is Total Acquisition Cost or TAC. This represents the cost to acquire the asset, build the mine and operate the mine, all on a per ounce basis.
An example of calculating TAC:
Suppose that a publicly traded stock, had a market capitalization of $100 million dollars, and it had $1 million ounces. I could, therefore, acquire the asset for $100 dollars per ounce.
I know that the cost of building the mine divided by the number of ounces would be $200 dollars per ounce. I also know that the average all-and-sustaining cost to operate this mine is about $900 dollars per ounce. Based on some studies. All this combines for a $1,200 per ounce TAC. The formula is as follows:
TAC = [Cost to Acquire + Cost to Build + Cost to Operate] / Total Ounces
Sources: CFI Education Inc., Casey Research