Australia | Jan 25 2007
By Greg Peel
If Lihir Gold (LHG) is to be considered a valuable gold sector investment then it is not because of the announcement that reserves were 23% more than first thought. Lihir has not suddenly tripped over 23% more gold.
If anything, analysts were underwhelmed with Lihir’s announcement, considering the reserve upgrade of 4.4Moz to be either on or below the level expected. It all comes down to “cut-off grades”.
Lihir has reduced its cut off grade from 1.25g/t to 0.87 g/t. This means that for every tonne of ore mined, as long as that ore contains 0.87 of a gram of gold, mining is considered economically viable. Imagine having to use that measurement with a pan in a river!
The reason Lihir suddenly has 23% more reserves is that the cut-off reduction equates to such an increase given the known orebody. If the price of gold increases, then it becomes economically viable to mine orebodies with less gold content. And therein lies the rub – Lihir has increased its long term gold price assumption from US$380/oz to US$475/oz.
Given spot gold is currently around US$640/oz, it’s hardly an unjustifiable increase. As UBS points out, it brings price assumptions into line with other miners such as Newcrest (NCM) and Oxiana (OXR). But for those investors envisaging a dusty geologist kicking a rock and discovering the mother lode, forget it. This increase was all done on paper at head office.
This doesn’t mean the news is bad, of course. Lihir’s challenge, though, is how to get it out of the ground so that the benefits can actually be realised. This requires expansion, and that’s the focus of broker attention. Analysts consider Lihir a good bet not because it has announced greater reserves – they were expecting that anyway – but because Lihir is well advanced in increasing its production capacity.
In fact, Credit Suisse suggests “the reserve increase should shortly become redundant, with the expansion plan more material as a driver of reserves, production and earnings”. It also notes that the most positive aspect of the 23% is that it will drive a reduction in depreciation.
UBS says “we expect to hear more about the proposed capacity expansion to greater than 1Moz and further reserve upgrades which this project should enable”. The fourth quarter result is due on January 30.
Macquarie also likes Lihir’s reserve growth potential, but throws in the fillip that the company is always rife for takeover. It is, effectively, one of only two world class Australian gold miners (Newcrest – all the other biggies are diversified). In fact, Lihir is ranked in the top ten of Merrill Lynch’s global coverage.
Lihir currently holds a 4/4/1 B/H/S ratio in the FNArena database at an average target of $3.31 ($2.90 at yesterday’s close). The dissenter is ABN Amro. The analysts were worried about the Ballarat Goldfields (BGF) acquisition, but they haven’t piped up again since the reserve announcement.
A lot of the analyst enthusiasm for Lihir can also be credited to a generally bullish view on the forecast price of gold.