Ariana Resources · repayments by Zenit to Turkiye Finans Katilim Bankasi A.S. have been made on their scheduled basis and reached $13.2 million at the end of September 2018 with

fn3

27 November 2018

Equity Research

Target Price: 2.82p (2.75p)

Share Price: 1.30p

Key Data Market Cap £14m

DS Mining 13,873

Sector Mining

Stock Codes ARNR.L / AAU LN

Last Published Research: 12 November 2018

Absolute & Relative Performance

— Absolute

— Relative to DS Mining

Source Datastream

Investment Research

0.93

1.13

1.33

1.53

1.73

1.93

2.13

N D J F M A M J J A S O N D J F M A M J J A S O N

Kieron Hodgson +44 (0)20 7886 2773

[email protected]

Panmure Gordon (UK) Limited Please refer to the important disclosures shown towards the back of this note

Panmure Gordon & Co acts as Corporate Broker in the UK to Ariana Resources

Ariana Resources d

Discounted, but for how long?

As noted before, Ariana - the only small-cap gold mining company that carries a

Panmure Buy recommendation - announced that it had met its FY2018 production

targets in just nine months. The company’s shares, despite the wider revaluation of

gold miners, remain, in our view undervalued. We have reviewed the update and

undertaken a virtual Q&A to answer some of the questions that we have received.

Q3 Operational Update – Ariana’s Q3 Operational Update continued the trend of

above plan production, resulting in FY2018 guidance of 20koz almost reached in nine

months. The production and sale of 7,588ozs in Q3 (+6% quarter on quarter) was

supported by average grades remaining above plan at 4.94g/t Au. Income for the JV

during the quarter was $10.12million, at a revenue per gold ounce of $1,334 (due to

silver credits). Operating cash costs for the quarter are estimated at $330/oz, largely

due to the decline in the Turkish Lira during the period (28%). Importantly, capital loan

repayments by Zenit to Turkiye Finans Katilim Bankasi A.S. have been made on their

scheduled basis and reached $13.2 million at the end of September 2018 with

$19.8million outstanding. Monthly intercompany loan repayments from the JV to

Ariana’s wholly owned subsidiary, Galata Madencilik San. ve Tic. Ltd. in the year to date

have now reached ~$1.6 million.

Model updated – Following the Q3 Operational Update, we have undertaken a review

of the Ariana portfolio. After applying our new commodity forecasts as per our recent

commodity sector note “The Quarterly Nugget” and using a 10% discount rate, we

estimate that Ariana is currently trading on a P/NAV of 0.5x. In our view, this discount

is excessive given the low-cost and profitable nature of the operations at Kiziltepe.

Further supporting our view is that, at our 10% cost of capital, the long-term price of

gold to justify the current equity valuation is below $1,000/oz.

Reiterate Buy recommendation with increased target price of 2.82p (2.75p) – Our

target price, normally generated by using a blended average of NAV/Share, EPS and

cash flow/share is not applicable at this time. Instead we use a risk adjusted SOTP for

each operation. Our target price of 2.82p (2.75p) offers significant upside to investors

as Ariana continues to increase its production from Kiziltepe and develop its

longer-term portfolio of assets.

Year End Sales PBTA EPS DPS ord P/E EV/EBITDA Yield

Dec (£m) (£m) (p) (p) (x) (x) (%)

2017A 0.0 0.5 0.1 0.0 26.0 14.2 0.0

2018E 2.4 1.0 0.1 0.0 14.4 12.2 0.0

2019E 0.4 (0.9) (0.1) 0.0 n/a (13.4) 0.0

2020E 2.0 0.5 0.1 0.0 26.0 20.0 0.0

Source Company Data, Panmure Gordon

Ariana Resources Company Overview

27 November 2018 2

COMPANY OVERVIEW

Ariana Resources is a gold exploration and development company with a focus on the

Western Anatolian Volcanic and Extensional (WAVE) Province in western Turkey, host to some

of the largest operational gold mines in Europe. The company’s flagship operation, the Kiziltepe

Mine, held within the Red Rabbit Gold-Silver Project in Western Turkey commenced commercial

production in March 2017. Kiziltepe has been developed within a 50:50 Joint Venture with

Proccea Construction Co.

Additionally, multiple resource opportunities exist proximal to the Red Rabbit Gold-Silver

Project and the company has an exciting exploration portfolio in North Eastern Turkey, at the

Salinbas Project, which has already been credited with over 1Moz of indicated and inferred gold

equivalent ounces.

Location of Ariana’s primary operations

Source Ariana Resources

INVESTMENT CASE Growing resource base to support a longer-life mining plan;

Significant exploration potential;

Commercial production achieved in mid-2017;

Low cost operational profile;

Supportive and capable operational partner in Proccea.

INVESTOR CONCERNS Gold price;

Political/geographical risk;

Development/permitting delays and cost inflation;

Gold production shortfalls.

Ariana Resources Q3 Operational update

27 November 2018 3

Q3 OPERATIONAL UPDATE

Ariana announced its Q3 operational update on 12 November confirming year-to-date

production continues to run ahead of prior guidance. Accordingly, we have increased our

production target for FY2018 and modestly increased FY2019 and FY2020, given the

consistent production witnessed to-date at the Red Rabbit Joint Venture. We have

summarised the recent production results and offered our thoughts as to relevant

questions that should be asked by investors.

Unit Q3 2018 Q3 2017 PG Est

Open Pit – ore mined Tonnes 60,000 55,800 50,000

Process plant throughput Tonnes 46,214 35,049 45,000

Plant feed grade g/t Au 4.43 3.46 3.90

Metallurgical recovery rate % 93.9 94.5 92.0

Gold produced Troy Ounces 7,588 3,762 5,366

Silver produced Troy Ounces 70,346 15,985 30,382

Source Ariana Resources, Panmure Gordon

Ariana’s latest update on 12 November continued a trend of outperformance vs market

expectations that has been a theme for 2018. However, in our view, the shares have

failed to keep apace of the positive developments at Ariana. As a result, we will attempt

to provide a brief virtual Q&A to cover what we believe the salient points are for

investors to consider:

Many small mining companies fail to meet their financial obligations, why is Ariana different

and why does it matter?

The Kiziltepe operation benefits from low total cash costs (TCC) and All-in Sustaining costs

(AISC). We estimate $421/oz and $595/oz in FY2018, rising to $457/oz and $674/oz in

FY2019. But the key to our confidence, at such an early stage of operation and the key to

shareholder returns, is in the All-in cost of production - inclusive of loan repayment

obligations and administrative costs. Inclusive of all these costs, we estimate the all-in cost

of production at Kiziltepe in FY2019 - in a year that loan repayments peak at ~$12m before

falling to ~$8m in FY2020 - to be ~$1,150/oz. This is key for us, as the operations cost

structure remains below the current spot gold price and materially below the silver credit

adjusted average price of $1,334/oz.

How can the operations at Kiziltepe “beat the production fade”?

We believe Ariana offers investors two distinctly beneficial strategies here.

Firstly, processing capacity is an area we believe that can significantly improve returns for

shareholders. The company has indicated its intention to increase production beyond the

original mine plan and we believe that with some relatively low-cost modular

improvements, such as an additional ball mill, output could increase between 50-100%

from current rates offering a material increase in production, project economics and cash

distributions to the Plc. We estimate that at a cost of c$1m for an additional ball mill, the

invested capital would be recovered in less than 18 months.

All-in costs, inclusive of debt repayments

are set to remain below the spot price of

gold at ~$1,150/oz in FY2019

We estimate for an investment of $1m, an

additional ball mill and associated

infrastructure would recoup its

investment within 18 months.


27 November 2018 4

Secondly, Kiziltepe, in our view, has the potential to become a significant “hub” for multiple

sources of ore, extending the life of the operation and returns for shareholders. To this

end, management, whilst still working through the appropriate processes at Arzu North,

Banu, Derya, Kepez and Kizilcukur, retain the option within the portfolio to include

production from additional sources of ore from freehold land (non-forestry) such as Banu

and Kepez West which could be expedited in the event of any delays to permitting. These

additional freehold areas could offer an incremental three years of production on top of

the current mine plan and act as a contingency to the permitting process. We await the

economics of these satellite pits but believe that due to similar geological settings the

incremental costs of extraction will be associated with the haulage of ore. Therefore,

operational costs will likely to be similar to that of operations at Arzu South.

What about the low-grade material being stockpiled as part of normal operations

Interestingly, another incremental option to “beat the fade” is the possibility of

establishing a low-grade (<1.0g/t) leaching operation. We would anticipate this would only

become a viable option once operations at Arzu South cease in 2021. We envisage a

leaching operation targeting production of 5koz pa at a TCC of ~$500/oz for several years.

Grades have been strong, but is this it?

Current grades are in excess of the average reserve grade of 3.11g/t, with the processed

grade of 4.94g/t in Q3 FY2018. In our model update, we increased average grades by 10%

to 4.4g/t for FY2018 and retain an average of 4.0g/t in FY2019. We anticipate this to

moderate and revert to reserves during FY2020 and FY2021 but remain mindful that this

decline may be deferred further, thereby improving production rates in the short term.

Any further concerns regarding permitting

The joint venture operations currently have several permit applications in process and

some have been received in during the past year. In one case expedited forestry permits

were secured with the assistance of the provincial roads authority, for construction to

commence on the road diversion in August. Other applications currently in process include

Arzu North, Derya and Kepez. Given the operational status of the mine we do not expect

that forestry permits will be delayed unduly despite that fact that a new commission for

permitting is being formed at the Presidential office. Applications made by the company

for its Salinbas project are known to have been accepted in Ankara already and have now

been relayed back to local forestry.

Incremental satellite pits will extend and

enhance the overall economics of the Red

Rabbit JV

Whilst near term grades are expected to

remain above reserve, leach operations

may be considered longer term.

Ariana has benefitted from expedited

permit applications


27 November 2018 5

What other changes have you made to the financial model?

As per our Quarterly commodity publication “the Quarterly Nugget” we publish our new

commodity forecasts (see underlying assumptions). We have adjusted our forecasts to

incorporate the average Q3 2018 price of $1,213/oz. vs our initial estimate of $1,250/oz.

As a result, our forecasts for 2018 now assume an average gold price of $1,275/oz. from

$1,290/oz. previously. We believe the current period will likely encompass the lowest

average prices before recovering moderately through Q4 and holding a higher level in

2019. After previously stating the summer months offered profit-taking opportunities, we

move to a more constructive view for the remainder of the year and next. That said, we

have taken a more conservative view on our silver forecasts, reducing our long-term

average to $15/oz from $17/oz.

Importantly for Ariana, we have adjusted our gold/silver ratio to 80 from 70, reflecting

current market conditions. This has undoubtedly detracted from the strong operational

results seen in FY2018 and potential upgrades, as well as reducing our Kiziltepe life of Mine

NPV by 5%.

Underlying gold and silver forecasts

updated as per our quarterly commodity

publication

Ariana Resources What is Ariana Worth?

27 November 2018 6

WHAT IS ARIANA WORTH?

In line with our stated objectives to offer a consistent approach to appraising our gold

equity sector coverage, as per our underlying commodity opinions and appropriate risk

premiums applied to gold equity companies, our key objective is to ascertain whether or

not a valuation anomaly is presenting itself and whether investors can benefit.

In addition to incorporating our new commodity price forecasts, we have undertaken a review

of Ariana’s portfolio of assets. Using a 10% discount rate, we estimate Ariana is currently trading

on a P/NAV of 0.5x. This discount to our normalised intuitive multiple of 1.0x NAV (assuming

our NPV estimates incorporate the changes in production, future production efficiencies and

any change in costs) looks anomalous given the low-cost nature of the operations at Kiziltepe

and the potential for incrementally high margin production growth.

Assuming no significant exploration success in the short term and subsequent capital

expenditure requirements, we estimate that at our 10% cost of capital, the long-term price of

gold to justify the current equity valuation is below $1,000/oz, underpinning our positive view

on Ariana.

In light of the diverse range of views on both appropriate risks and longer-term gold prices, we

have provided a share price matrix for investors to apply their own variables and derive an

appropriate target price for Ariana (p/share).

Ariana valuation matrix

Gold price 1,000 1,100 1,200 1,300 1,400 1,500

Discount rate 12% 1.91 2.29 2.66 3.04 3.42 3.79

11% 1.94 2.34 2.74 3.14 3.53 3.93

1x NAV 10% 1.97 2.40 2.82 3.24 3.66 4.08

9% 2.01 2.46 2.90 3.35 3.79 4.23

8% 2.05 2.52 2.99 3.46 3.93 4.40

Source Company, Panmure Gordon

We conclude that Ariana offers an exciting opportunity for investors to gain exposure to a new

and profitable gold producer, for which the benefits of a weaker host currency (Turkish Lira)

have left the operation as one of the lowest cost operations globally. We believe the partnership

with Proccea and the existing finance arrangements offers investors the confidence that future

development projects will also be managed professionally with a lower risk of delays, additional

capital costs, and equity dilution.

Ariana, we believe trades at an

undeserved discount to intuitive

valuations

Kiziltepe production/cost profile (koz & $/oz) Ariana long term production profile (koz)

Source Company, Panmure Gordon Source Company, Panmure Gordon

0

1

2

3

4

5

6

7

8

9

0

200

400

600

800

1,000

1,200

Total AuEq produced Total Cash Costs AISC

0

5

10

15

20

25

30

35

2017 2018 2019 2020 2021 2022

Kiziltepe Tavsan

Ariana Resources Underlying Assumptions

27 November 2018 7

UNDERLYING ASSUMPTIONS

The principal assumptions behind our valuation of Ariana are as follows:

Commodity price forecasts - Quarterly

New Previous

Q2 Q3 Q4 Q2 Q3 Q4

Gold 1,306 1,213 1,250 1,306 1,250 1,275

Silver 16.5 15.0 15.0 16.5 16.0 16.0

Consensus

Gold 1,306 1,213 1,250 1,306 1,297 1,290

Silver 16.5 15.0 15.5 16.5 16.5 16.5

Source Panmure Gordon

Commodity price forecasts - Annual

New Previous

2018 2019 2020 2018 2019 2020

Gold 1,275 1,250 1,200 1,290 1,250 1,200

Silver 16.1 15.0 15.0 16.4 17.0 17.0

Consensus

Gold 1,275 1,270 1,262 1,306 1,323 1,305

Silver 16.2 16.2 17.0 16.4 17.1 17.5


Operational assumptions

New Previous

2018 2019 2020 2018 2019 2020

Process plant throughput (kt) 183.5 180.0 180.0 165.0 180.0 180.0.

Plant feed grade (g/t) 4.4 4.0 3.0 4.0 4.0 3.0

Metallurgical recovery rate (%) 93.1 92.0 92.0 92.0 92.0 92.0

Gold produced (koz) 24.4 21.3 16.0 20.1 21.0 15.0

Silver produced (koz) 195.8 202.6 202.6 150.0 150.0 150.0

Sales (koz/GE) 26.8 23.8 18.5 21.9 22.8 22.9

Total cash cost (US$/oz.) 421 457 513 575 588 616

All-in sustaining costs (US$/oz.) 595 674 795 749 734 849


Ariana Resources Changes to our Estimates

27 November 2018 8

CHANGES TO OUR ESTIMATES

Summary of changes

New Previous

2018 2019 2020 2018 2019 2020

Sales (£m) 2.4 0.4 2.0 0.0 0.0 Na

PBTA (£m) 1.0 -0.9 0.5 (0.8) (0.8) Na

EPS (p) 0.1 -0.1 0.1 (0.1) (0.1) Na

DPS Ord (p) 0.0 0.0 0.0 0.0 0.0 Na


We have provided a summary of changes to our long-term estimates. The main changes

made are:

Incorporation of new commodity price forecasts as per our “Quarterly Nugget” publication;

Updated production, cost and FX forecasts;

Gold/Silver ratio raised to 80 from 70.

Ariana Resources Valuation Summary

27 November 2018 9

VALUATION SUMMARY

Our target price, normally generated by using a blended average of NAV per share, earnings

per share and cash flow per share is not applicable at this time, given the relatively early

nature of production from Ariana. Instead, we apply a simple sum of the parts NPV for each

operation. At our applied discount rate of 10%, we believe, represents a fair assessment of

the risk factors influencing Ariana, through the resource exploration phase, project delivery

and production, all whilst satisfying outstanding debt commitments within the

joint venture.

In conclusion, we set a new target price of 2.82p (2.75p) and we continue to see further

value opportunities, not accounted for at this time, in the company’s extensive exploration

portfolio, although the route to the monetisation of these assets, is likely to be some

time away.

We also maintain our 25% discount on the mark to market value of the company’s external

investments, allowing for liquidity shocks should Ariana need to realise these investments;

however, these holdings are now largely immaterial.

Valuation Summary

$m Value Ownership Attributable value Value per share

Kiziltepe 35.3 50% 17.6 1.66

Tavşan 14.9 50% 7.4 0.70

Salinbaş 14.2 100% 14.2 1.34

Total 64.3 39.3 3.7

Exploration / Other - 100% - -

External investments 0.05 75% 0.04 0.00

Net cash FY+1 1.0 100% 1.0 0.10

Total 65.4 3.80

GBPUSD X Rate 1.35 1.35

Shares in issue (m) 1,059.7 1,059.7

NAV (£) 48.4 2.82

1.0x NAV 2.82

1.5x NAV 4.20

Target price (1x NAV) 2.82


Ariana Resources The Numbers

27 November 2018 10

THE NUMBERS

Turnover and operating margin

Source Panmure Gordon, Company

EPS normalised


FCF yield & net cash (Pre-Special divi)


Bull Points

Low cost operational profile

Long life resource base

Prospective exploration pipeline

Bear Points

Risk of production shortfalls

Weakness in gold price

Delays to permitting process

Profit & Loss Account (£m) Year to December 2016 2017 2018 2019 2020 2021

Sales 0.0 0.0 2.4 0.4 2.0 2.4

Cost of sales 0.0 0.0 0.0 0.0 0.0 0.0

Gross profit 0.0 0.0 2.4 0.4 2.0 2.4

Administrative expenses -1.0 0.8 -1.4 -1.3 -1.4 -1.5

Other operating expenses 0.0 0.0 0.0 0.0 0.0 0.0

EBITDA -1.0 0.8 1.0 -0.9 0.5 0.9

Depreciation & amortisation 0.0 -0.4 0.0 0.0 0.0 0.0

Operating profit -1.0 0.5 1.0 -0.9 0.5 0.9

Associates & other income 15.3 0.0 0.0 0.0 0.0 0.0

Finance costs 0.0 0.0 0.0 0.0 0.0 0.0

PBT normalised 14.2 0.5 1.0 -0.9 0.5 0.9

Abnormal items 0.0 0.0 0.0 0.0 0.0 0.0

PBT reported 14.2 0.5 1.0 -0.9 0.5 0.9

Taxation -0.5 0.0 0.0 0.0 -0.0 -0.0

Minorities & preference dividends 0.0 0.0 0.0 0.0 0.0 0.0

Profit attributable to shareholders 13.7 0.5 1.0 -0.9 0.5 0.8


Summary Cash Flow Statement (£m) Year to December 2016 2017 2018 2019 2020 2021

Operating profit 14.2 0.5 1.0 -0.9 0.5 0.2

Operating profit discontinued 0.0 0.0 0.0 0.0 0.0 0.0

Depreciation & amortisation 0.0 0.4 0.0 0.0 0.0 0.0

Other non-cash movements -15.1 -1.1 -0.6 0.7 0.7 0.0

Change in working capital -0.4 -1.2 -0.4 0.0 0.0 0.0

Other cash movements 0.0 0.0 0.0 0.0 0.0 0.0

Operating cash flow -1.3 -1.5 -0.1 -0.2 1.3 0.2

Taxation paid -0.1 -0.4 0.0 0.0 -0.0 -0.0

Net Investment Income & Other Funding 0.0 0.5 0.1 0.0 0.0 0.0

Capital expenditure (net) -0.1 -0.0 0.0 0.0 0.0 0.0

Free cash flow -1.4 -1.4 -0.0 -0.2 1.3 0.2

(Acquisitions)/disposals 0.0 0.0 0.0 0.0 0.0 0.0

Dividends paid 0.0 0.0 0.0 0.0 0.0 0.0

Shares issued/(repurchased) 1.5 2.8 0.0 0.0 0.0 0.0

Other financing 0.0 0.0 0.0 0.0 0.0 0.0

Movement in net cash/(debt) 0.1 1.4 -0.0 -0.2 1.3 0.2

Net Cash/(Debt) 0.4 1.9 1.9 1.7 3.0 3.1


Balance Sheet (£m) Year to December 2016 2017 2018 2019 2020 2021

Goodwill and intangibles 17.7 18.9 16.5 16.5 16.5 16.5

Tangible fixed assets 0.3 0.3 0.3 0.3 0.3 0.3

Working capital 0.9 2.5 1.9 1.2 0.4 -0.3

Assets employed 18.9 21.7 18.7 18.0 17.2 16.5

Other assets/(liabilities) 4.3 1.1 1.6 1.6 1.6 1.6

Net cash/(debt) 0.4 1.9 1.9 1.7 3.0 3.1

Provisions -2.1 -2.4 -2.2 -2.2 -2.2 -1.2

Net Assets (REPORTED) 21.6 22.3 19.9 19.0 19.6 20.0

Shareholders Funds 15.6 18.0 21.9 20.8 20.8 24.9

Minority Interests 4.3 3.3 3.6 0.0 0.0 0.0


-250.0

-200.0

-150.0

-100.0

-50.0

0.0

50.0

100.0

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2016 2017 2018 2019 2020 2021

Turnover (LHS) Margin (RHS)

-10%

-5%

0%

5%

10%

2017 2018 2019 2020 2021

0.4

1.9 1.9 1.7

3.0 3.1

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2016 2017 2018 2019 2020 2021

Fre

e ca

sh f

low

yie

ld

Ne

t C

ash

/(D

ebt)

Net Cash/(Debt) Free cash flow yield

27 November 2018 11

164

164

164

164

165

165 w

165

165

166

166

166

166

166 w0

0.5

1

1.5

2

2.5

3

3.5

08-Jul-13 09-May-14 12-Mar-15 13-Jan-16 15-Nov-16 18-Sep-17 20/07/2018

Ariana Resources - ARNR.L

Buy Sell Hold Closing price Target price

Distribution of investment ratings for equity research (as of 24 Oct 18) Rating: GUIDELINE (return targets may be modified by risk or liquidity issues)

Overall Global Distribution (Banking Client*) Buy Total return of >10% in next 12 months

Buy Hold Sell Hold Total return >-10% and <+10% in next 12 months

66% (47%) 27% (8%) 7% (0%) Sell Total return <-10% in next 12 months

* Indicates the percentage of each category in the overall distribution that were banking and/or corporate broking clients

Panmure Gordon is a market maker in this company, has in the previous 12 months made agreements with this company for investment banking services and will be

compensated by the company for these services. This investment research has been prepared in accordance with COBS 12.2 & 12.4 on behalf of Panmure Gordon

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Ariana Resources

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