Wednesday, January 06, 2016

Caledonia Mining Corporation Goes Full Bore Into Zimbabwe

Caledonia Mining Corporation (Canadian ticker CAL.TO, US ticker CALVF) is optimistic about its prospects in Zimbabwe. That country ranks 156th out of 174 on Transparency International's Corruption Perceptions Index and 175th out of 178 on the Heritage Foundation's Index of Economic Freedom. It's a bad country for any kind of business. Caledonia Mining had recent success in spite of such geopolitical risk.

The current CEO is an accountant, not a geologist. It's surprising to see such a background in a profitable mining company. It's also surprising to see a geology PhD whose biography leans more on financial analytical work than on successful project discovery. I have more respect for applied competence than I do for luck. A mining company can rely on production from a good ore body for a long time while management teams come and go.

The Blanket mine's ownership structure is unique to the Zimbabwean government's requirements for indigenous participation in foreign direct investment. Caledonia still owns a stake in Blanket after accounting for a partial sale supporting a local participation requirement. The complex governance and financing of this agreement is typical of countries with high geopolitical risk. Suffice it to say that success with such a corporate structure requires investors to heavily discount any new discoveries or operational improvements in such a jurisdiction.

I looked through Blanket's latest NI 43-101 technical report dated July 9, 2015. The total P2 reserves of 2.9M oz Au at 3.67 g/t grade look really good. Those are some of the best numbers I've seen in a junior mining company's project in recent memory. The mine finances its own infrastructure maintenance. It's too bad the report used a gold price estimate of US$1250/oz in its DCF valuation; the world gold price is now under $1100/oz. Consider how further declines in the gold price will reduce the project's estimated valuation. A more appropriate forecast would use gold's long-term historic average price of about $640/oz since 1968. Caledonia's cash cost of production is $513/oz, but its AISC is certainly higher.

Caledonia's gold recovery rate at Blanket is 93%, which is remarkably high. The company is doing the best it can given the political requirements of its local hosts. Good grades and plentiful reserves can make any management team look brilliant even after surrendering ownership of half the project. The company's 43-101 report predicts mine production will start to decline after 2019. Caledonia must then replace production with new discoveries or additional engineering to maintain the company's valuation. The stock currently trades under a dollar because the market recognizes the difficulty of operating a good project in a bad country. It's tough to live in a good house in a bad neighborhood.

Full disclosure: No position in Caledonia Mining Corporation at this time.