INVESTMENT COMMENTARY — Kemess acquisition viewed as attractive for Royal Oak

Two investment houses have rated Royal Oak Mines (TSE) as a “buy,” based on the company’s recent acquisitions and the settlement the company has reached with the government of British Columbia for compensation over the Windy Craggy deposit.

First Marathon Securities and T. Hoare & Co. are both optimistic about Royal Oak’s Kemess deposit in British Columbia, although Hoare’s optimism is more guarded. Kemess, acquired in Royal Oak’s takeover of El Condor Resources and St. Philips Resources for a total cost of about $137 million, has reserves of 220 million tons grading 0.22% copper, plus 0.018 oz. gold per ton. This represents 4.1 million oz. of minable gold, dwarfing Royal Oak’s present reserve of 2.5 million oz.

The analysts differ on the probable cost of production, with First Marathon estimating US$170 and Hoare US$210 per oz. But Royal Oak’s average production cost, now around US$350 per oz., would certainly improve once Kemess went into production. The only concern is the low grade, which could spell difficulties if prices became soft.

Both firms emphasize the importance of the British Columbia government’s compensation package for the Windy Craggy deposit. The package consists of $29 million in cash, $20 million in matching exploration funds, $50 million in infrastructure spending and $49 million for a hydroelectric line. The capital cost of bringing Kemess into production has been estimated at $350 million, but Hoare cautions that the $150-million compensation package cannot simply be subtracted from the capital cost, since the funds do not all go directly to bringing the deposit on-stream.

The British Columbia government’s package also provides for a 4.8% royalty on copper production from Kemess. This can be seen as an additional cost of production, adding about US$14 per oz. to production costs.

Royal Oak’s acquisition of the Red Mountain deposit from Barrick brings it another 800,000-oz. reserve. The deposit could potentially come on-stream by the year 2000, and at a relatively low production cost.

The company’s Ontario division has increased its reserves by acquiring Ronnoco Gold Mines and by exploring its Nighthawk Lake, Pamour and Matachewan properties. First Marathon notes that 2.8 million oz. of minable reserves could soon be added to the 700,000-oz. inventory at the Ontario division. More reserves were also expected at the Colomac mine in the Northwest Territories.

With production from existing divisions increasing to 500,000 oz. in 1996 from 410,000 oz. the previous year, Royal Oak’s cash flow is expected to improve. First Marathon notes that the company has the lowest ratio of market capitalization ($610 million) to estimated cash flow ($633 million) among senior Canadian gold producers, and suggests that this represents good shareholder value.

Hoare uses another measure of Royal Oak’s value, noting that, when Kemess reserves are taken into account, Royal Oak has about US$90 of market capitalization for each ounce of gold in reserves, compared with an average of US$175 for most large North American gold producers. Royal Oak’s ratio of capitalization to annual gold production is near US$850 per oz., versus an average of US$2,100.