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Morningstar | RRL Updated Star Rating from 25 Sep 2018

The proposed acquisition of 100% of ASX-listed Capricorn Metals for about AUD 80 million net of cash looks a good one for Regis. The proposal is to acquire Capricorn for AUD 0.114 per share, a 93% premium to the last close, by issuing new Regis shares. This is smart, as at a share price of about AUD 3.90, we estimate Regis shares are about 35% overvalued. Management is in effect issuing about 22 million of new shares for Capricorn Metals. Based on our stand-alone AUD 2.90 per share fair value estimate for Regis, this values Capricorn at about AUD 60 million net of cash. Capricorn brings the undeveloped Karlawinda gold project, which we value at AUD 170 million. Regis shares were down 7% on the day, despite it being a good deal. We think Regis’ use of scrip for the acquisition suggests to the market that the shares are overvalued.

The purchase is small but valuable, and we increase to AUD 3.05 per share from AUD 2.90. This assumes a 75% chance it proceeds, acknowledging the unanimous support of Capricorn’s board, but also that a few key conditions remain. Regis wants the support of Capricorn’s major shareholders and a binding implementation agreement before making a formal offer. Management will meet with Capricorn’s largest shareholder this week, but if backing is not secured by Sept. 26, Regis could walk. If successful, all else equal, our fair value estimate will rise to AUD 3.10 per share; otherwise, we will revert to our prior AUD 2.90 per share estimate.

Regis is well placed to finance and develop Karlawinda. Management has a strong track record in buying, building, and running gold mines, particularly smaller open pits in Western Australia. We have not factored in any improvement on Capricorn’s feasibility study estimates, but Regis typically delivers mines reliably and efficiently. That said, the shares remain overvalued, with the market factoring in more exploration or acquisition success, or a lower cost of capital, than we think reasonable.

Regis is in strong financial shape and should be able to finance Karlawinda with relative ease. It had AUD 180 million net cash at the end of June 2018, and we forecast operating cash flow of about AUD 230 million a year for the next three years from existing operations. This places Regis at a distinct advantage to develop Karlawinda, relative to Capricorn. Capricorn has no operations or cash flow, and getting debt to finance Karlawinda on reasonable terms and at a reasonable price is a challenge. Based on our forecasts, and assuming both Karlawinda and McPhillamys are developed in tandem, we expect Regis will require at most AUD 200 million of debt. This would see debt/EBITDA comfortable at less than 1.0, and we expect that once McPhillamys and Karlawinda are in production, debt should easily be repaid by the end of fiscal 2021.

The Karlawinda gold project hosts reserves of 892,000 ounces of gold. Capricorn Metals’ June 2018 feasibility study update estimated life of mine production of 823,000 ounces of gold over an 8.5-year life. Output is expected to average 97,000 ounces a year from fiscal 2020, with a life of mine cash cost of AUD 1,011 per ounce before royalties. Cash costs are competitive and basically in line with our expectations for Regis’ current operations.
We estimate a post-tax project valuation of approximately AUD 170 million for Karlawinda, assuming a long-term gold price of USD 1,300 per ounce from 2020, 2.25% inflation, and a weighted average cost of capital of 7.5%, in line with our current WACC for Regis Resources. Our Karlawinda valuation assumes only the current reserves are mined. Additional exploration could bring upside, but it’s also not without risk, given the cost of exploration.

Using a higher discount rate of, say, 11%, more in keeping with the higher risk profile of a stand-alone Capricorn Metals, our valuation for Karlawinda would fall by 30%, illustrating one aspect of the value added from the deal. We estimate the acquisition to be earnings-accretive to the tune of AUD 0.03-AUD 0.04 per share, or about 10%-15% a year, from fiscal 2021. In the near term, the purchase is mildly earnings-dilutive due to the approximate 4.4% increase in shares on issue, and the draw-down of cash required to develop Karlawinda.