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Find CIBC research on Bloomberg, Reuters, firstcall.com CIBC World Markets Inc., P.O. Box 500, 161 Bay Street, Brookfield Place, Toronto, Canada M5J 2S8 (416) 594-7000and ResearchCentral.cibcwm.com
Institutional Equity Research
Initiating Coverag
October 31, 2011 Precious Metals
Canaco Resources Inc.There's Gold In That There Hill
As of 10/31, we are initiating coverage of Canaco with a 12- to 18-monthprice target of $4.50 and a Sector Outperformer rating based on a 0.8x
multiple to our 5% discounted NAV calculated at a US$1,500/oz. gold price
Our valuation is based on CAN defining a high-grade open-pitable resource
We believe short-term share price movements will be driven byinfill/expansion drill results at the Magambazi project and any positive drill
results released from MK trend targets to the north. We expect the gold
price will also continue to have a strong influence on the share price.
We estimate that less than 1.5 million oz. are incorporated into Canaco'scurrent share price. We expect 3.5 million oz . will be defined within 12 to
months and that some 2.5 million oz. will be included in an open-pit desig
with a grade that is nearly 60% greater than the African average.
We believe the initial resource estimate at Magambazi and the subsequentPEA will be the major catalyst for Canaco in the next six to e ight months.
Canaco is trading at ~$65/oz. based on our resource estimate compared to
~$115/oz. for other non-producers in our coverage universe.
Stock Price Performance
Source: Reuters
All figures in Canadian dollars, unless otherwise stated. 11-111750
CIBC World Markets does and seeks to do business with companies covered inits research reports. As a result, investors should be aware that the firm may
have a conflict o f interest that could a ffect the objectivity of this report.
Investors should consider this report as only a single factor in making their
investment decision.
See "Important Disclosures" section at the end of this report for important
required disclosures, including potential conflicts of interest.
See "Price Target Calculation" and "Key Risks to Price Target" sections at th
end of this report, where applicable.
Jeff Killeen Barry Cooper
Stock Rating:
Sector OutperformerSector Weighting:
Overweight12-18 mo. Price Target $4.50
CAN-V (10/28/11) $1.75
Key Indices: TSX/SP - Canadian Gold
3-5-Yr. EPS Gr. Rate (E) NM
52-week Range $1.53-$6.45Shares Outstanding 199.0M
Float 150.3M Shrs
Avg. Daily Trading Vol. 450,000Market Capitaliza tion $348.3M
Dividend/Div Yield Nil / Nil
Fiscal Year Ends JuneBook Value $0.60 per Shr
2011 ROE (E) NM
LT Debt NAPreferred Nil
Common Equity $120.0M
Convertible Av ailable No
Earnings per Share Prev Current
2011 ($0.24E)2012 ($0.24E)
2013 ($0.17E)P/E2011 NM2012 NM2013 NM
Cash Flow per Share2011 ($0.23E)2012 ($0.23E)
2013 ($0.17E)
P/CF2011 NM2012 NM
2013 NM
Company DescriptionCanaco Resources Inc. is a Canadian-based ex plorationcompany conducting exploration on the Magambaziproject. The project is in the Handeni region of easternTanzania and is a focus for development.www.canaco.ca/s/Home.asp
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There's Gold In That There Hill - October 31, 2011
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Canaco Resources Inc. Sector OutperformCAN-TSX 10/31/11 $1.75 Jeff Killeen (416-956-6218) jeff.killeen@cibc
12- To 18- Month Price Target: $4.50 Barry Cooper (416-956-6787) barry.cooper@cibc
Precious Metals
Sector Weighting: Overweight
All figures in US$ million, unless otherwise stated. Gold price assumption in yr 2011 @ $1650, yr 2012@ $2000, and yr 2013 @ $2200
Risk adjusted discount rates vary from 8% to 15% depending on the location of the asset and its technical challenges
Key Multiples EV/NAV* EV/NAV^ 2011 PE 2012 PE 2011 PCF 2012 PCF
Canaco 0.3x 0.5x NA NEG NEG NEG
North American Average 1.7x 2.8x 20.9x 11.3x 14.0x 7.4x
Large Cap Average (>$10B) 2.3x 4.1x 17.9x 10.9x 11.9x 8.4x
Mid Cap Average ($2B-$10B) 1.6x 2.3x 25.1x 16.2x 15.0x 9.2x
Small Cap Average ( 1M oz 1.8x 2.7x 24.8x 14.9x 14.1x 10.2x
Intermediate Producers 0.2-1 M oz 1.7x 2.7x 19.8x 9.2x 12.5x 6.6x
Small Producers < 0.2M oz 1.6x 2.4x 19.6x 8.9x 13.2x 6.9x
P/NAV Sensitivity P/NAV P/NAV P/NAV P/NAV P/NAV P/NAV Production Profile
Avg. Gold Px - US$ $1,300 $1,400 $1,600 $1,300 $1,400 $1,600
Canaco 0.4x 0.4x 0.3x 0.6x 0.5x 0.4x
North American Average 1.4x 1.2x 0.9x 2.3x 1.8x 1.4x
Large Cap Average (>$10B) 1.9x 1.6x 1.3x 3.3x 2.7x 2.1x
Mid Cap Average ($2B-$10B) 1.4x 1.3x 1.0x 2.0x 1.8x 1.4x
Small Cap Average ( 1M oz 1.5x 1.3x 1.1x 2.2x 1.9x 1.5x
Intermediate Producers 0.2-1 M oz 1.4x 1.2x 1.0x 2.2x 1.9x 1.5x
Small Producers < 0.2M oz 1.3x 1.1x 0.8x 1.9x 1.5x 1.1x
Income Statement F2010A F2011E F2012E F2013E
Gold Price Assumptions US$ $1,225 $1,650 $2,000 $2,200 Asset Production Cash Costs 2P M & I & I
Magambazi (O/P) 0 0 0 0
Production (000s ounces) 0 0 0 0 Magambazi (U/G) 0 0 0 0
Cash Costs US$/oz 0 0 0 0 Total 0 $0 0 0
Capital Expenditures 5 0 0 0 * Gold (000s oz) 2P: Modeled Proven & Probable Reserves (000s oz)
Revenues 0 0 0 0 ^ Net of by product credits (if applicable) M & I & I: Measured & Indicated & Inferred Resources (000s oz)
Expenses
Operating Expenses 0 0 0 0 Ownership Discount Rate US$ Millions Per Share
D,D&A, Reclamation 0 0 0 0 Current Assets
S,G&A 1 4 5 5 Cash $120 $0.60
Exploration 0 41 40 30
Other Expenses 2 2 2 0 Mining Assets
Total Expenses 3 47 47 35 Magambazi (O/P) 100.0% 5% $763 $3.84
Magambazi (U/G) 100.0% 5% $123 $0.62
Income Before Tax -3 -47 -47 -35 Other Exploration Asset $100 $0.50Income Taxes (0) 0 0 0 Total Assets $1,106 $5.56
Net Income (3) (47) (47) (35) Liabilities
Other Liabilities $5 $0.03
EPS -0.03 -0.24 -0.24 -0.17 Reclamation $5 $0.03
CFPS -0.05 -0.23 -0.23 -0.17 Total Liabilities $10 $0.05
Shares Outstanding 139 199 200 201 Net Asset Value (CAD) $1,096 $5.51
EV Statistics - US$ EV ($mln) EV/Prod EV/2P* EV/R&R^ Asset Locations
Canaco $244 NA NA $65North American Average $11,536 $607 $342
Large Cap Average (>$10B) $3,357 $290 $194
Mid Cap Average ($2B-$10B) NA $268 $139
Small Cap Average ( 1M oz $12,187 $601 $307
Intermediate Producers 0.2-1 M oz $9,622 $538 $331
Small Producers < 0.2M oz $9,794 $1,201 $281
* Proven & Probable Reserves ^ Reserves and Resources
* Cash Adjusted NAV Multiples Using: $1500/oz Gold Pricing And 5% Discount Rates
^ Using: $1500/oz @ Risk Adjusted Discount Rates
5% Discount Risk Adjusted Discount
Production (2011E) Modeled Resource Detail
NAV Breakdown - US$ Gold Price of: $1,500
Investment Thesis
CAN is conducting exploration on a recently dicovered go ld deposit in the Handeni region of Eastern Tanzania. The Hande
Property contains several targets for advanced exploration but the company's current focus is on the Magambazi ridge. Th
ridge hosts five recognized mineralized lodes that are being defined by diamond drilling. The lodes offer a blend of potentia
open-pit and underground development targets. We expect a resource co ntaining several million ounces of gold will beindentified at Magambazi over the next 12 to 18 months and addition to the resource beyond this timeframe is probable. W
anticipate open-pit grades will be nearly 60% higher than the African average for open-pit gold mines and that a premium
should be applied in valuation of CAN. The Magambazi lodes will need to show continuity in detailed drilling to meet our
expectations for grade, particularly within the portion we have allocated for open-pit extraction. We believe the share price o
CAN will be driven by step-out and infill results at at Magambazi, by the initial resource estimate scheduled for release in th
next six months and by drilling results at regional targets outside the Magambazi area, along the MK trend.
Handeni
0
50
100
150
200
250
300
350
2015E 2016E 2017E 2018E 2019E
Production000s
Ounces
$0
$100
$200
$300
$400
$500
$600
$700
$/ozCashCost
Underground Open Pit Total Cash Costs
Source: Company reports and CIBC World Markets Inc.
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Table of Contents
Executive Summary ......................................................................................
Share Price Catalysts....................................................................................
Risks And Challenges.....................................................................................
Capital Structure ...........................................................................................
Handeni Gold Hills Of Africa .......................................................................
From The Hill To The Mill ..............................................................................
Estimating Extraction Costs .......................................................................
Constructing Our Valuation ...........................................................................
Site Visit ...................................................................................................
Price Target Calculation .............................................................................
Key Risks To Price Target ..........................................................................
Appendix A. Property And Geological Overview .............................................
Regional Geology ......................................................................................
Local Geology............................................................................................
Mineralization............................................................................................2
Appendix B. Management Group...................................................................
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Executive SummaryCanaco Resources Inc. (CANSO) is a Canadian-based exploration company
focused on advancing the Magambazi prospect in the Handeni Project of easter
Tanzania. The project is approximately 175 kilometers (km) northwest of Dar e
Salaam, the countrys former capital city, and 30 km south of the town of
Handeni. The company holds 100% ownership in the project and is conducting
diamond drilling with the intention of defining a NI 43-101 compliant goldresource w ithin the next six months. Canaco is drilling w ith nine diamond drill
rigs at the main target of Magambazi and several rigs could be added over the
coming months. The company recently announced an increase to its exploratio
program of up to 500 additional holes for approximately 95,000 meters to be
completed over the next 10 months. An increase in drilling will allow the
company to perform infill drilling at 20-meter spacing across the Magambazi
deposit, in areas where mineralization has been defined.
We have compiled our own non-compliant resource estimate by performing
sectional interpretation of the drilling data made available by Canaco. We
anticipate that there will be approximately 3.5 million ounces (oz.) defined
within the next 18 months. However, we believe it is unlikely that the initial
estimate to be produced in early 2012 will reach our estimated figure. It is ourexpectation that the initial resource will include approximately 2 million oz.
2.5 million oz., but, with subsequent drilling over the next 12 to 18 months, th
number should increase to approximately 3.5 million oz . We also expect that t
majority of the resource will be extracted by open-pit mining and that the grad
of the open pit will significantly exceed the African average for open-pit gold
mines. We base our valuation on this assumption.
The main reasons we believe Canaco to be a good investment are as follows:
Production of the first gold resource at Magambazi is likely to be >2 millio
oz. and include an open-pitable portion with overall grade approximating
3.0 g/t (grams per tonne); our estimate is ~58% greater than the African
average for open-pit mines at 1.9 g/t.
The company holds 100% ownership in a property located in an emerging
gold district in a relatively stable, mining-friendly country in East Africa.
We expect expansion of the initial resource with respect to contained
ounces in the next 12 to 18 months as drilling continues.
The company is well funded to continue exploration at the current rate for
several years with excess for contingency spending.
Portions of the property are subject to a 2% net smelting royalty (NSR), b
the company has the right to repurchase 1%; potential total royalty at
Handeni is 5% (we expect the 1% could be repurchased for less than
$5 million).
The company represents a potential take-out target by another senior
mining company provided it is successful in defining a substantial gold
resource at Magambazi.
The initial resource estimate for the Handeni property will be mostly limited to
the Magambazi Main Lode but will likely have contributions from several other
mineralized zones, namely the Western, Cave, Central Contact and Southern
Gneiss zones (or lodes). Each of these lodes is proximal to the Main Lode and
can be drilled from the Magambazi ridge.
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Several other prospective targets beyond Magambazi have recognized gold in
soil anomalies within the property, namely Majiri, Majiri Bomba, Kijani,
Kwadijava, Kwadijava South, Bahati and Kuta. Of the seven listed targets, five
are located along a recognized geological trend referred to as the MK trend,
which is approximately 4 km in length from the southern-most Kwadijava Sout
to the northern-most Majiri. The MK Trend is being explored by Reverse
Circulation (RC) drilling to further define quality targets for future diamond
drilling in 2012.
Two diamond drill rigs with some 20,000 meters of drilling are planned at the
highest-priority targets of Kuta, Kwadijava and Magambazi Deep. A number of
RC holes already completed at Kwadijava confirm the presence of anomalous
gold grades. If the company is successful in defining further ore-grade
mineralization at other targets along the MK Trend, such as Kwadijava, the gol
resource could well exceed our initial expectations beyond 18 months time.
Chinese resource company Sinotech(Hong Kong) Corp. Ltd., a non-publiclytraded subsidiary of Sinotech Mineral Exploration Co. Ltd., holds a large positio
of approximately 20% of the outstanding shares of Canaco. It became a
significant shareholder in 2009, obtaining over 30% of the outstanding Canaco
shares. The partnership provided Canaco with necessary funding at the time to
continue operations and to bring the Handeni project to the level of developme
it is at today. Sinotech has since divested a portion of its original holding butremains a major shareholder. Two members of Canaco management are also
Sinotech employees: Chaoxian Zhou, Deputy General Manager, and Lingling
Yang, Director Corporate Communications.
Canaco spun out its 70% interest in its Ethiopian asset, the Harvest project, in
July 2011. The Harvest polymetallic VMS project is now operated by new
company Tigray Resources Inc. (TIGTSX-V). At this time, Tigray and Canaco
have the same management group. Ezana Mining Development, a private
Ethiopian company, holds the remaining 30% interest in Tigray. We believe
focusing on Magambazi is a positive step forward for Canaco in streamlining th
company to be a gold-only explorer and de-risks the company by limiting
operations to a single East African country.
Share Price CatalystsContinued news flow from infill drilling within Magambazi Main Lode and
expansion drilling from the Western, Cave, Central Contact and Southern
Gneiss Lodes.
Release of initial resource calculation for the Magambazi deposit expected
Q1/2012.
News flow from drilling at targets north of Magambazi, along the MK trend
Kwadijava, Kwadijava South, Kijani, Majiri Bomba or Majiri.
Revision of initial resource within the next 18 months, including an increas
in the total ounces and upgrading of some ounces from the inferred to
indicated category.
Compilation and release of a Preliminary Economic Assessment (PEA) for
the Magambazi deposit expected in June 2012.
Potential acquisition of project by another major mining company; we
expect that the number of ounces defined will need to exceed 3 million
before the company becomes a viable target for acquisition.
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Risks And ChallengesWe see the following risks for the company and challenges that it will need to
overcome:
Infill drilling at Magambazi proves significant discontinuity of mineralized
zones along strike. Thus far, faulting has indicated that there is a
reasonable probability that the zones will be less continuous than initially
believed. We have factored in less continuity to our assessment.
Potential discontinuity of mineralization reduces the number of ounces to
included in an open-pit scenario, reduces the overall deposit grade within
the open pit below our 3.00 g/t estimate and/or increases the potential
open-pit strip ratio beyond our 4:1 estimate. The greatest uncertainty lies
with grade but the average grade of ore intercepts drilled to date is
approximately 3.73 g/t.
Drilling is geographically restricted to the point at which the program slow
to facilitate construction of sufficient drilling platforms along flanks of the
Magambazi ridge, resulting in increased spending and reduced news flow.
We do not anticipate any major hindrances and believe that access to the
ridge flanks would be feasible if required.
Drilling at targets to the north, along the MK trend, fail to define significan
mineralization, limiting resources to the Magambazi lodes; total resource
figure may not be sufficiently large to garner acquisition attention. We ha
based our valuation on Canaco developing the project.
Infrastructure requirements for mine development significantly exceed ou
costs estimates; the government is undertaking road upgrading but it is n
a continuous project (partially funded through foreign aid) and known wat
sources on s ite will likely be insufficient to support full mining operations.
We have incorporated approximate ly 35% of our capex estimate for
contingency spending to offset potential cost increases due to infrastructu
spending.
Canaco is unable to raise sufficient funds to develop the project as outline
in our valuation; if financing for mine development is not obtained, our
valuation would be negatively impacted.
Capital StructureAs of September 30, 2011, Canaco had 199,396,603 common shares issued an
outstanding. There are an additional 964,965 warrants outstanding w ith exerc
prices ranging from $0.75 to $6.00 and an average exercise price of $5.01.
There are also an additional 13,103,535 options ranging from $0.10 to $4.88
with an average exercise price of $2.95. The options and warrants bring the fu
diluted share count for Canaco to 213,465,103. Canacos current market cap is$348,944,055. Management ownership accounts for approximately 6.5% of the
current outstanding shares; combined with insiders and company contractors,
ownership increases to approximately 27%. The company has a strong balance
sheet with approximate ly $120 million in cash and no debt. The priority
allocation for the cash will be for drilling and related costs with current
expenditures at the Magambazi project totaling approximately $3.5 million per
month. Expenditures are expected to increase to roughly $4.5 million per mont
as additional drill rigs are added to the project. Funds will also be used to
complete a preliminary economic assessment by mid-2012.
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Handeni Gold Hills Of AfricaThe Magambazi project, on the eastern side of the Handeni property, hosts a
number of mineralized targets for exploration. Canaco is focusing on the
southeastern portion of the property, on the mineralization beneath the
Magambazi ridge. Gold mineralization is being defined w ithin a number of
discrete zones or lodes, referred to as the Magambazi Main, Western, Cave,
Central Contact and Southern Gneiss lodes. There are nine other target areas
defined within the property that are to the northwest o f the Magambazi ridge(Exhibit 1). Approximately 10,000 meters of drilling are being completed on a
monthly basis with a ll diamond drills located at Magambazi. The sole Reverse
Circulation (RC) drill is exploring the MK Trend targets and the company plans
complete approximately 23,000 meters in 180 holes by July 2012 via RC drillin
The RC program will allow the company to refine potential targets for follow-u
diamond drilling, expected to begin in Q3/2012.
Exhibit 1 is a plan view of Canacos Handeni property in eastern Tanzania. The
exhibit includes the mineralized targets recognized by the company and display
gold in soil sampling trends. Note that the focus of exploration is at Magambaz
along the eastern boundary of the property.
Exhibit 1. Handeni Property Showing Gold In Soils And Target Areas
Source: Company reports.
Over 40,000 meters of diamond drilling have been completed at Magambazi
since the beginning of this year and an additional 40,000 meters are planned b
the end of 2011. The current program is allocating half of the meters drilled fo
infill drilling at 20-meter spacing in select locations to satisfy requirements for
an initial resource estimate. Drilling at the project site can continue year-round
with minimal to no stoppage despite seasonal rains. There are nine diamond d
rigs on site at Magambazi, focused on the Main, Western, Southern Gneiss,
Central Contact and Cave lodes (Exhibit 2).
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There are, however, some limitations to collar selection for drilling, as the loca
topography in the mineralized area is very steep. As a result, almost all drilling
completed to date has been collared along the top of what is referred to as the
Magambazi ridge. We believe that the current drilling program will be sufficient
to define an inferred resource but further upgrading of the resource to measur
and indicated categories will require drilling along the flanks of the hill. While w
believe drilling on the sides of the ridge will be possible, it w ill require site
modification with construction of some temporary roadways and drilling
platforms. Developing such drilling platforms could cause a nominal increase in
exploration spending and reduce the rate of drill core production but we do not
anticipate any significant hindrances in the program.
A benefit of the project s location is its easy accessibility by roadway. The
current road infrastructure is passable by regular vehicle but will require
significant modification to support the large vehicle traffic associated with a
mining operation. Fortunately, with some funding from Chinese foreign aid, the
Tanzanian government is working to upgrade the main roadway from Dar es
Salaam to the Handeni region to an e levated, paved roadway capable of
supporting large vehicles. With completion of the state-funded road project
Canaco would be required to undertake only local road improvements.
Over 300 holes have been drilled on the main Magambazi ridge, the majority o
which have been directed at intercepting the Main Lode. Subsequent drilling atMagambazi has defined several other mineralized zones. The Cave, Western,
Central Contact and Southern Gneiss lodes are now being targeted with
expansion drilling. While some mineralization from these other zones may be
included in the initial resource estimate at Handeni, the primary component of
the estimate will comprise resources from the Main Lode.
Exhibit 2 illustrates the five main mineralized zones within the Magambazi targ
area as defined by Canaco. The depiction also includes some drill collar location
from recent results released to the public.
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Exhibit 2. Main Gold Zones At The Magambazi Target
Source: Company reports.
The primary host o f gold at Magambazi is an altered amphibolite. The
amphibolite rock-type hosts the Main, Western, Central Contact and Cave lodeThe Southern Gneiss lode is hosted within overlying intermediate gneiss. Canac
initially believed the gneissic material to be barren but subsequent drilling has
intercepted ore-grade gold mineralization in the gneiss.
Since recognition of gold mineralization in the gneissic material, previously
drilled core is now being sampled from collar, through the gneissic layer, to
confirm or deny the presence of gold mineralization. Mineralization within the
gneissic layer could reduce the overall amount of uneconomic overburden abov
the Main Lode; however, at this time we do not anticipate the gneissic unit wil
contribute a large amount of gold ounces.
As infill drilling on the project continues, there is increasing recognition of the
greater complexity with respect to structural influence on the gold
mineralization. Due to the complexity of ore distribution, Canaco has decreasedthe spacing of infill drilling to 20 meters from 40 meters to facilitate proper
geological/structural interpretation through much of the deposit. Although each
of the lodes does appear to have continuity along strike, north-south, the
company is beginning to recognize a number of fault structures that could
displace mineralization from section to section. It is a combination of the
potential discontinuity a long strike and the narrow w idth of some of the
intercepts that leads us to assume that 1.0 million of our estimated 3.5 million
ounces will be extracted by underground mining. We believe the grade of these
intercepts would suggest selective underground mining would be feasible desp
its higher cost compared to open-pit extraction.
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Of the drill holes published to date, the average width of intercepts reported is
approximately 14 meters. Performing a length-weighted average of the grades
reported to date provides an overall grade of approximately 3.73 g/t, which we
believe may approximate the achievable grade of an open-pit model a t
Magambazi; however, given the projects early stage and some recent
lower-than-average grade drilling results, we have applied a 20% reduction to
our estimate of overall grade for an open pit at Magambazi. We apply an
estimate of 3.0 g/t for open-pit operations in our valuation. We believe that
higher grades would be obtained with greater selectivity and grade control in a
underground operation. We have assumed a grade of 5.5 g/t for extraction fro
underground operations. Note that, in our estimate, grades that exceeded
1 oz./t were capped at that figure. Until Canaco offers further guidance, we wil
maintain a 1 oz ./t top-cut of grades.
The company has provided guidance with respect to the average density of the
host-rock at Magambazi. Due to the abundance of garnet within the amphibolit
material, the average density of the majority of the host-rock has been
estimated between 3.0 g/cm33.1 g/cm3 (t/m3), which is slightly higher than
average for typical amphibolite or gneissic material. The typical density of
gneissic or granitic material tends to be on the order of 2.8 g/cm3. Deriving an
estimate for tonnage of mineralized material at Magambazi is still primitive in
origin. We have ascertained a volume by estimating the average strike length
each of the lodes and applying an average width and a vertical continuity baseon the position of each lode. We derive our estimate of approximately 3.5 milli
oz. of gold collectively for the lodes at Magambazi by applying our volume and
density assumptions with weighted average assay values.
Visual review of available sections leads us to assume that approximately 70%
or 2.5 million oz., of our estimate could be extracted by open-pit mining. We
have also assumed that there would be a three-year lag between
commencement of open-pit mining and underground mining but that both cou
be undertaken at the same time. Validation of our assumption is partially relia
on the orientation of mineralization and our expectation that the ore material
becomes increasingly sub-horizontal at depth. Such a change in orientation fro
sub-vertical within the open pit to sub-horizontal a t depth would mean at least
portion of the underground mining could proceed without being directlyunderneath the open pit. A properly sequenced strategic mining plan will be
critical for simultaneous underground and surface mining.
From The Hill To The MillWe have based our valuation of Canaco on a number o f assumptions related to
extraction, processing rate and costs relative to comparable projects with
respect to grade, location, mining style and/or processing method. We estimat
that the combined open-pit and underground mining operations at Magambazi
would have a mine life of approximately 12.5 years. Our model forecasts the
open-pit portion of mining operations beginning in mid-2015, in accordance wi
current company guidance and relying on construction beginning before the enof 2013. We estimate that production for the projects underground componen
will begin in mid-2018.
The three-year lag between commencement of open-pit mining and
underground mining is based on the assumption that Canaco will need to
continue to perform definition drilling for underground mining beyond 2015. A
lag will also allow the company to contribute revenue generated from the
open-pit portion of the operation to capital expenditures (capex) associated wi
underground development, thereby removing the need to secure debt or raise
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For the initial two and a half years of production, our forecast of 7,000 tpd wou
be supplied from open-pit operations. Once underground mining begins in 201
we expect that the open-pit contribution would fall to 5,250 tpd and
underground operations would contribute the remaining 1,750 tpd. With the
open pit producing at an assumed 3.0 g/t and underground producing at 5.5 g
the project could produce approximately 255,000 oz. of gold per year once in
full production.
We have assumed a 90% recovery rate, which is a reduction from the recover
obtained from preliminary metallurgical test work completed in 2010, at94.14%. The means of recovery in testing were by gravitation and cyanidation
with 72.59% of the gold recovered via gravitation. The high percentage of
recovery by gravitation indicates the gold is non-refractory and that our
estimated recovery is likely achievable in an applied processing scenario. The
high recovery by gravitational methods also indicates that a standard carbon-i
process (CIP) or carbon-in-leach (CIL) process could be employed and with a
grind size of 200 mesh. The testing effectively removes any concern that
secondary grinding or higher-cost processing methods will be required. We do
anticipate, however, that some added complexity may be required in the
processing circuit due to the local abundance of graphite alteration associated
with gold in the deposit. The presence of graphite is the principal reason we
have reduced the recovery by over 4% from initial testing stated by Canaco.
We assume a strip ratio for the open pit of 4:1. The strip ratio was determined
by reviewing available geological sections of the Magambazi deposit and it may
be one of the most sensitive assumptions we have incorporated in our valuatio
Local structures have shown to have strong influence on mineralization. If thes
structures result in significant discontinuity along strike or down-dip within the
deposit, our estimated strip ratio could be negatively affected. At this time we
believe our estimated strip ratio is appropriate but we will continue to review o
estimate as new information becomes available.
Estimating Extraction Costs
We apply an average open-pit total processing cost of US$33.42/t for the life o
mine (LOM) in our valuation, and it is based on our estimate for extraction cosof approximately US$1.70/t for both ore and waste. When combined with the
1.0% NSR attributed to the property and a 4% royalty for projects in Tanzania
we derive our average LOM cash cost of US$461/oz. We note that the 1.0% NS
on the property is a reduction from the current 2% NSR and assumes that
Canaco will opt to repurchase the available 1.0%. Canaco management has
indicated that details regarding the repurchase of a 1.0% portion of the curren
property NSR are yet to be finalized but that details will be provided once they
have been agreed upon. We expect the cost to repurchase 1% of the royalty w
not exceed $5 million. We estimate processing costs for the underground porti
of the operation at US$104.54/t average for LOM and cash costs at US$732/oz
We have assumed that some higher-grade material, at 3.75 g/t, will be
extracted in the first and second years of full production from the open pit,
increasing payback and generating more cash for underground developmentcosts. Oppositely, in the first two years of production underground, we expect
lower-than-average grade of 4.5 g/t and 5.0g/t will be extracted. We base our
expectation on the company processing some incremental ore as underground
accesses to ore are being developed.
As a comparison, the North Mara mine has reported 2010 cash costs of
US$472/oz. The operation had a reported grade of 2.8g/t and a recovery of
82.9% for that year. The strip ratio was approximately 2:1. If we input these
criteria into our model for Canaco, our cash cost estimate would nearly equal
North Mara at US$479/oz.
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Geita has projected cash costs for 2011 at US$643/oz. Geita has a lower head
grade by over 20% (from 2010 production) than our expectations for
Magambazi, as well as a higher strip ratio at 5:1, which accounts for the
substantially higher costs at Geita versus our Canaco estimate.
Another African comparison can be reviewed with Banros estimates for the
Twangiza mine in the DRC. Twangiza has estimated cash costs of US$356/oz.
the first five years of the project and a LOM average cash cost estimated at
approximately US$459/oz. The Banro project has a lower strip ratio of
approximately 2:1 but that is offset by a lower overall resource grade that is
nearly half of our estimate for Magambazi. We note that the total resource and
reserve estimate for grade at Twangiza is approximately 1.7 g/t versus our
estimate for Magambazi at 3.0 g/t for the open-pit component of the operation
Exhibit 3 outlines the parameters applied in our valuation of the Magambazi
project. Some figures have been rounded to the nearest dollar figure.
Exhibit 3. Valuation Parameter For Magambazi
Open Pit Undergro
Ounces (000) 2,500 1,
Grade (g/t) 3.0
Ounces Mined (% Of Resource) 100
Process Recovery (%) 90
Process ing Cost (US$/t) 34
Total Cash Cost (US$/oz.) 461
Total Mining Cos t (US$/oz.) 664
Royalty (%) 5
Gold Price (US$) 1,500 1,
Capex (US$ mlns. ) 350
Sustaining Capex/Year (US$ mlns.) 25
Exploration Cost ($ mlns. ) 120
Production Rate (Avg. tpd) 5,250 1,
Source: CIBC World Markets Inc.
We expect the current financial year to encompass the largest exploration
spending on the project as Canaco undertakes extensive infill drilling, regional
target definition and completion of a preliminary economic assessment. The
company estimates that approximately $41 million will be spent on exploration
for the 2011 financial year, ending in June 2012. Of that $41 million, Canaco
estimates $35 million will be spent on drilling and approximately $5 million is
allocated for the PEA.
We anticipate that exploration spending will remain nearly constant next year,
approximately $40 million, as infill and expansion drilling at Magambazi
continues. We also expect an increase in drilling at regional targets identified
through RC drilling in 2012. In subsequent years we anticipate a steady
decrease in exploration drilling. For 2013 through 2015 we reduce our estimatsuccessively from $30 million to $20 million until open-pit mining begins. We
expect exploration spending would range from $7 million$10 million per year
until the underground operations begin, as the company will be refining
interpretations at Magambazi, as well as continuing to explore regional targets
We have incorporated $4 million in exploration spending for each year that
mining continues. We expect replacement of resources will be a focus of drillin
particularly for the underground component of the operation. Underground
drilling w ill aim to extend the LOM at Magambazi but we also expect that
exploration of regional targets would continue. We estimate total exploration
spending at the Handeni project from 2011 onward at $210 million.
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Constructing Our ValuationWe have detailed our estimates for development and extraction at the
Magambazi project in the previous section and we use the described model as
basis for our valuation. Provided the company is successful in defining a
substantial gold resource and obtaining the required capital to develop the asse
at Magambazi, we anticipate that the project could generate positive cash flow
within the first year of full production, which we have estimated to be 2016. W
expect that initial pre-production would begin in mid-2015. The initiation of fulproduction is highly dependant on a successful drilling campaign through
mid-2013 and a construction period of approximately 18 months.
We believe the proposed timeline is achievable, as we expect most of the
regional road construction would be complete by 2013 and facilitate mobilizatio
of large equipment. As noted in the risks section at the beginning of the report
availability of water is one of the largest challenges faced in the successful
start-up of a mine in the Handeni region. The area has sufficient ground water
support diamond drilling but Canaco will need to develop a strategic water usa
system in order to maintain the required amount of water on site for mining
operations.
Exhibit 4 illustrates the estimated development timeline of the Magambaziproject, as outlined by Canaco management. We have incorporated this
estimated schedule in our valuation.
Exhibit 4. Estimated Timeline For Development Of The Magambazi
Project
Source: Company reports.
We expect production from the open-pit operation to begin in the second half o
2015 and that the project will process approximate ly 1.3 million tonnes of ore produce nearly 110,000 oz. of gold. For the following two years through 2017,
we anticipate the project could process approximately 2.6 million tonnes of ore
per year and produce between 260,000 oz. and 275,000 oz. of gold, depending
on head grade. Once underground mining begins in 2018, we expect the annua
average contribution from the open-pit mine w ill be approximate ly 150,000 oz
based on a 5,250 tpd production rate. We estimate the underground compone
will contribute approximately 104,000 oz. a year based on a 1,750 tpd
production rate.
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Calculated at a US$1,500/oz. gold price, we expect that the Magambazi projec
could generate cash flow averaging $201 million per year for the life of the
project. Based on the same gold price, our estimate for average earnings
generated from the project are nearly $123 million. If prices remain near the
current spot price of approximately US$1,650/oz., we anticipate annual cash
flow and earnings would increase to $231 million and $147 million, respectively
We can compare these figures to other junior explorers and emerging produce
in our gold universe. We forecast Nevsun Resources (NSUSP) to generate an
average of $204 million in cash flow and $159 million in earnings for the years
20112015 based on a gold price of US$1,500/oz. For the same period we
expect Banro to generate an average of $270 million in cash flow and
$236 million in earnings. Another African peer is Keegan Resources (KGNSO)
for which we estimate average cash flow and earnings of $102 million and
$53 million, respectively, for a five-year period once Keegan begins generating
positive figures in 2016.
These three companies have higher market capitalizations than Canaco, rangin
from $460 million to $1.1 billion. With a current market cap of approximately
$349 million, Canacos current valuation is below this comparative group. The
principal difference between Canaco and these three peers is that Canaco has
yet to produce a compliant resource. We expect that Canaco should trade with
the range noted once a resource estimate has been provided and a PEAreleased. We believe that Canaco should trade towards the upper end of the
noted range, as the resource grade we expect at Magambazi is towards the
upper end of the group mentioned and we recognize the market typically
attributes a premium for higher-grade projects.
Our expectations for Canaco with respect to overall grade within the open pit a
nearly 60% higher than the average for open pits in Africa. Exhibit 5 displays
the relationship of total resource size versus grade for African open-pit mines.
Based on our expectations for Magambazi, we can see that Canaco plots well
above the continental average with respect to overall grade.
Exhibit 5. Total Resource Ounces Versus Grade For African Open Pits
CAN
Average
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
20,000
0 1 2 3 4 5 6
Deposit Grade (g/t)
Resourceoz.
(000's)
Source: CIBC World Markets Inc.
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In Exhibit 6, we display how Canaco relates to other gold explorers and
producers in our universe with respect to the total resource ounces versus the
enterprise value per ounce. We have incorporated our previously outlined
assumptions for positioning of Canaco in this relationship.
Exhibit 6. Total Resource Ounces Versus EV/oz. For Gold CompaniesWithin Our Universe
DGC
OSK
SGR
RMX
BAA
SMF
GBU
CGA
CRJ
GSS
LSG
RR
R
KGN
BSX
TRR
ORE
CAN
0
5,000
10,000
15,000
20,000
0 100 200 300 400 500 600 700 800
EV/oz
GoldOunces(000's)
Source: CIBC World Markets Inc.
It is evident that Canaco plots among but towards the bottom of the
comparative group of companies with similar-sized resources. In this comparis
there is not a significant discrepancy with its current valuation with respect to peers. However, if we take into account the overall resource grade that we
expect from the resource at Magambazi, Canaco trades near the bottom of the
group despite having a significantly higher grade than many others in the
comparison.
Exhibit 7 illustrates the relationship of Canaco to the same group of companies
shown in the previous exhibit but relates total resource grade versus the
estimated EV/oz.
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Exhibit 7. Total Resource Grade Versus EV/oz. For Gold Companies
Within Our Universe
Source: CIBC World Markets Inc.
When we consider that higher-grade projects often garner a premium with
respect to valuation, we would expect that Canaco will trade at a higher EV/oz
once a compliant resource estimate is released. Our valuation of the company
would imply that Canaco should trade at approximately $250/oz.$270/oz.,
which would shift it to the right in Exhibits 6 and 7.
Exhibit 8 outlines our expectations for ea rnings and cash flow sensitivities for
the years from 2015 to 2017, which represent the first three years of producti
at Magambazi, according to our expectations. The sensitivity is relative to the
gold price and the Canadian/U.S. dollar exchange rate. Figures are quoted as
totals per year and in per share values. Note that we have calculated these
estimates based on a fully diluted share count that assumes additional issuanceof shares described previously in this report.
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Exhibit 8. Estimates For Earnings And Cash Flow Sensitivities For 2015
2017 ($ mlns., except per share)
2015E 2016E 20
US$1,200/oz. Gold C$= 0.90/US$ Earnings $23 $118 $
EPS $0.09 $0.43 $0
Cash Flow $52 $201 $
CFPS $0.19 $0.74 $0
US$1,300/oz. Gold C$= 0.95/US$ Earnings $29 $134 $
EPS $0.11 $0.49 $0Cash Flow $59 $220 $
CFPS $0.22 $0.81 $0
US$1,400/oz. Gold C$= 1.00/US$ Earnings $35 $149 $
EPS $0.13 $0.55 $0
Cash Flow $66 $239 $
CFPS $0.24 $0.87 $0
US$1,500/oz. Gold C$= 1.00/US$ Earnings $42 $167 $
EPS $0.15 $0.61 $0
Cash Flow $75 $261 $
CFPS $0.27 $0.96 $0
US$1,600/oz. Gold C$= 1.05/US$ Earnings $48 $183 $
EPS $0.17 $0.67 $0
Cash Flow $82 $280 $
CFPS $0.32 $1.03 $1US$1,700/oz. Gold C$= 1.10/US$ Earnings $53 $199 $
EPS $0.20 $0.73 $0
Cash Flow $89 $299 $
CFPS $0.32 $1.09 $1
US$1,800/oz. Gold C$= 1.15/US$ Earnings $59 $214 $
EPS $0.22 $0.78 $0
Cash Flow $96 $318 $
CFPS $0.35 $1.16 $1
Shares Outstanding (mlns.) 273 273
Source: CIBC World Markets Inc.
It is evident that, if our expectations are met, Canaco has a market cap wellbelow that of companies generating earnings and cash flows similar to those
detailed in Exhibit 7. The average of our cash flow estimates based on a
US$1,500/oz. gold price is approximately $201 million. If we were to apply a
9.8x multiple to our average estimate, which represents a current average
multiple for intermediate (0.2M oz.1M oz.) gold producers in our universe, we
would obtain a valuation of approximately $1.9 b illion. This figure exceeds our
applied valuation for Canaco; however, given the projects early stage, the lac
of cash flow generation for several years and a large number of uncertainties
still associated with the project, we believe that proper assessment of valuatio
for Canaco is through a net asset value (NAV) calculation. We believe that once
Canaco advances the project to the bankable feasibility or construction stage,
the valuation for Canaco may shift to a cash flow- or earnings-based multiple.
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In reviewing the NAV multiples for the gold companies within our universe bas
on a US$1,500/oz. gold price, we find that the current average is nearly 0.9x.
we limit the companies included in the average calculation to those shown in
Exhibits 5 and 6, the multiple falls to approximately 0.7x. If we further restrict
our inclusion of companies to those non-producing explorers, the figure drops
again, to approximately 0.6x. We believe that Canaco should trade at a premiu
to the group given its average grade is nearly 50% higher than the next highe
within the non-producing group. Similarly, we expect that Canaco should trade
at a comparable multiple to other emerging or single-asset producers. Despite
being some four to five years from generating positive cash flows, the high
grade expected at Magambazi will likely allow it to trade at a premium to other
non-producers. As such, we select our 0.8x multiple in our valuation of Canaco
Factors like operating costs, total capital costs, foreign exchange rates and
overall deposit grade have a strong influence on our NAV estimate. Although th
portion of our non-compliant resource estimate incorporated into an open-pit
scenario is relatively high grade compared to many other operations, the
underground portion of the operation is not. As the underground portion
accounts for nearly 30% of the total assumed resource, variance in the overall
deposit grade has the strongest influence on our valuation compared to the
other parameters. We note that variations in operating cost and foreign
exchange rate have virtually the same impact on our valuations.
Exhibit 9 displays the influence on our 5% discounted NAV/share estimate
relative to the variation of several parameters such as capital costs, operationa
costs, foreign exchange and overall deposit grade.
Exhibit 9. NAV/Share Sensitivity To Variable Parameters
4.50
4.70
4.90
5.10
5.30
5.50
5.70
5.90
6.10
6.30
6.50
-20% -10% Base Case +10% +20%
NAV/Share
(C$)
Capital Cost Operating Cost Gold Grade US$:TZS$ Exchange
Source: CIBC World Markets Inc.
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The total resource ounces defined at the project also have a strong influence o
our valuation, particularly how much of the resource can be included in the
open-pit operation. For instance, if we incorporate an addition of 1 million oz. o
gold and split that equally between the open-pit and underground operations,
our NAV increases by approximately $0.98/share. If we add all of the 1 million
oz. solely to the open-pit operation our NAV increases by $1.32/share, or a 35
increase when split between open pit and underground. Conversely, if we
decrease the overall resource by 1 million oz. split equally between open pit an
underground, our NAV decreases by approximately $1.15/share whereas if
removed solely from the open pit the decrease is $1.55/share.
We can see that the amount of ounces incorporated into the potential open pit
Magambazi has the greatest influence on our valuation as the substantially low
costs and higher mining rate heavily influence potential revenues.
The price of gold also has a significant influence on our NAV estimate. Althoug
the project does have a 5% royalty applied, Canaco could still realize increased
margins with an increase in gold price. Exhibit 10 shows the variance of our NA
with respect to the currentshare price and relative to a change in the price of
gold.
Exhibit 10. P/NAV Variance Relative To The Price Of Gold
0.63x
0.51x
0.43x
0.37x
0.33x
0.29x
0.26x
0.24x
0.22x
0.20x
900
1100
1300
1500
1700
1900
2100
0.16x 0.26x 0.36x 0.46x 0.56x 0.66x 0.76x
P/NAV Multiple
US$
Gold
PricePerOunce
Source: CIBC World Markets Inc.
In comparing Canaco to other gold explorers and emerging producers in ourcoverage universe, we see that Canaco is trading well below the group average
for our select group shown in Exhibits 5 and 6. Based on the current price,
Canaco is trading at a P /NAV multiple of 0.3x versus the group average for go
companies of approximately 0.9x
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Exhibit 11 illustrates a comparative P/NAV of explorers and emerging producer
within our gold spectrum that were included in the previous EV/oz. comparison
(with a few additions). We expect that that Canaco will trade at the group
average for all gold companies once a resource is produced on the Magambazi
property. Despite being at an early stage of project development, the overall
grade at Magambazi will likely exceed many of the peers shown in Exhibit 11
and, as such, we expect a premium should be applied to our valuation compare
to other non-producers/explorers.
Exhibit 11. P/NAV Multiples For A Select Group Of Gold Companies At
US$1,500/oz. Gold Price And A 5% Discount Rate
0
0.2
0.4
0.6
0.8
1
1.2
BeloSun
Canaco*
Keegan
Trelawney
Banro
SanGold
Minefinders
LakeShore
Average
Romarco
Detour
RainyRiver
CGAMining
Osisko
ClaudeResources
GoldenStar
Semafo
KirklandLake
P/NAV
Multiple(US$
1,5
00/oz)
* Valuation based on assumed ounces and is not based on a compliant resource estima te.
Source: CIBC World Markets Inc.
In Exhibit 12 we outline an income statement based on our expectations for
spending and production at Magambazi for the current year through 2016. We
have incorporated our expectations for all exploration spending at the Handeni
property. We also have assumed that a ll options and warrants are exercised a
include our expectation for a share issue into our estimated count .
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