Gold explorer Echo due for a re-rating on back of fat margins

The underwriter to Echo’s recent $15 million placement, Canaccord Genuity, has upgraded its price target on the stock from 40c to 45c on the strength of a reserve upgrade, writes Barry FitzGerald in his weekly Garimpeiro column.

It’s a good time to be an Aussie gold producer.

The Aussie gold price has remained nice and strong at $1,665 an ounce, delivering the bulk of the industry margins of more than $500 an ounce despite early signs that inflationary pressures are building on the sector.

What’s more, investors are switched on to the idea that with margins of $500 an ounce, it makes good business sense to be growing reserve bases by adding new ounces from successful exploration at a cost of $30 to $50 an ounce.

The only trouble with all that is the gold producers are pretty much fully valued.

That has prompted investors to dive a bit deeper in to the sector to look for value among the gold explorers with near-term potential to get into production to capture the fat margins on offer.

Echo Resources (ASX:EAR) is one of the explorers/developers to benefit from the theme. At its current price of 27c a share it is valued at $130 million, up from $57 million back in early September.

Still, a recent reserve upgrade for its Bronzewing project on the Yandal gold belt in Western Australia has got the market thinking that the stock is in line for a further re-rating.

The underwriter to Echo’s $15 million underwritten placement of shares at 22c in later October, Canaccord Genuity, is one those tipping a re-rating. It upgraded its price target on the stock from 40c to 45c on the strength of the reserve upgrade.

Echo Resources shares over the past year. Source: Investing.com

In previous years, Bronzewing was a headache for its previous owners.

They were continually scrambling to keep the hungry 2 million tonnes per annum mothballed processing plant full. Since acquiring ownership, Echo has set out to first build a long-life reserve base before switching the plant back on.

It delivered with the reserve upgrade. The reserve soared to 15.6 million tonnes at 1.7 grams of gold a tonne for 856,000 ounces – enough to support an initial 8.5 year mine life with further upside to be had from the on-going exploration to the north and south of the processing plant.

The new reserve estimate is now being fed in to a feasibility study which is expected to be released in the March quarter next year. Assuming the all-clear, first production from Bronzewing would be possible by late 2018.

The market is assuming an annual production rate of about 100,000 ounces, with Echo planning a staged approach to maximise returns.

Stage 1 envisages 100,000 ounces of annual output at an all-in sustaining cost (ASIC) of $A1,034 an ounce.

The robust nature of Stage 1 is down to head grades of about 2g/t gold, a low strip ratio, and knockdown start-up capital cost of about $22m thanks to the existing treatment plant.

ASIC in stage 2 increases to a still very competitive $1,171 an ounce on account of increased stripping requirements.

‘Well funded to accelerate’

And all the time, Echo will be hitting its big ground position on the Yandal belt to come up with additional resources and reserves over time.

Announcing the reserve upgrade, Echo’s chief executive officer Simon Coxhell said that after the September placement, the company is well funded to accelerate its regional and near-mine exploration efforts to continue to grow the scale of the project.

“We have a unique opportunity to be able to quickly monetise the reserve base thanks to our 100 per cent ownership of the Bronzewing processing hub.”

While it is well-funded, Echo still needs to arrange financing for the push in to production at Bronzewing, some 400km north of Kalgoorlie.

Canaccord Genuity reckons that it will still have about $10 million in the till on completion of the feasibility study, putting it in a good position to a negotiate a favourable funding outcome.

“We assume the company secures a further $25 million ($10m in equity and $15m in debt) to comfortably fund the project while maintaining an aggressive exploration budget,’’ the broker said.