CA - Karora Resources: After A 59% Run There Is Still Plenty Of Upside

Summary

• We are already seeing the impact of the Lakewood mill, as Karora had record gold production of 38,437 ounces in Q3 2022.
• The bonus, and the double bonus.
• The fair relative value for KRRGF is almost 2x its current price. A $1 billion market cap wouldn't be a stretch, assuming the company hits its targets.
• I've been particularly impressed with Paul Huet, Chairman and CEO of Karora. He is passionate about the company and has continually delivered.

In July 2022, I added Karora Resources ( KRRGF ) to The Gold Edge portfolio as shares had lost 65% of their value from their peak hit less than three months prior and were trading around $2.20. As the chart below reflects, the stock had basically gone straight down. But there were many interesting layers to the Karora story, and I saw an incredibly bullish outlook. So much so that I put KRRGF in my top 10 list of gold stocks a few months ago.

Today, shares are trading at $3.45. But despite the almost 60% increase, I still see substantial upside to the stock.

Let's examine all of these layers.

A Brief Overview of Karora And Its Assets

First, a top-down look at Karora. The company is based in Canada, but 100% of its production comes from Western Australia, or more specifically, the prolific Norseman-Wiluna Greenstone Belt, which hosts world-class gold orebodies, including the KCGM super pit, St Ives, Golden Mile, Norseman, and South Kalgoorlie. This belt also hosts world-class nickel deposits.

Karora has a sizable land package in the region, with several mines in production and two mill facilities. The Beta Hunt mine is the flagship operation, while the Higginsville Gold Operation (or HGO) consists of the HGO Central mines and Spargos mine. The Higginsville mill is capable of processing 1.6 million tonnes of ore per annum. Karora was looking to increase the size of the mill to 2.6 Mtpa as they expanded the Beta Hunt mine, but CapEx inflation this year negatively impacted the cost. The original quote for the expansion in 2021 was A$60 to A$65 million; by early 2022, the initial cost had increased substantially and was closer to A$120 million. The sag mill went from A$4.3 million to over A$12 million. Not only did CapEx surge, but the timing was also pushed back from Q4 2023 to 2024 (with no firm completion date). Karora hit the pause button on the mill expansion as it knew the price tag and delay weren't acceptable. However, an opportunity arose last summer, as Karora was able to purchase the nearby Lakewood mill for A$80 million. Not only was Lakewood already processing ore, but Beta Hunt is 20 km closer to Lakewood compared to the Higginsville mill.

So Karora was able to increase its milling capacity to 2.6 Mtpa at a far cheaper price than expanding the Higginsville mill, it didn't have to wait 1.5-2.0 years for the expansion to be complete, and Lakewood was a closer distance to Beta Hunt. The cherry on top is that recoveries at the Lakewood mill are slightly higher compared to Higginsville.

The Huge Impact Of Lakewood

We are already seeing the impact of the Lakewood mill, as Karora had record gold production of 38,437 ounces in Q3 2022, trouncing the previous record set in Q2 2022 by 25%. Meanwhile, all-in sustaining costs dropped 10% QoQ to US$1,069 per ounce. Most gold miners are experiencing rising cost in the current high inflation environment, but not Karora, as AISC are flat to declining compared to 2019-2021.

Rising production and lower cost is a trend expected to continue over the next few years, as Karora expects output to climb from 120,000-135,000 ounces of gold in 2022 to 150,000-170,000 ounces in 2023 and increase even further in 2024. AISC is expected to drop to sub-US$1,000 per ounce as production rises.

Most of this increase in production will come from the Beta Hunt mine. Karora has taken the operation from 30,000 tonnes per month to 100,000 tonnes per month with a single decline, and now they are trying to repeat that success with a second decline, which will increase tonnage from 1 million tpa to 2 million tpa. Interestingly, the company is already above 1.2 million tpa with a single decline. The second decline is in development and should be complete by Q1 2023, which is sooner than the previous mid-2023 completion date. It's also coming in under budget. When the second decline is finished, Karora will get rid of one of the major bottlenecks of the operation. And it has the milling capacity now as well.

Karora also recently announced the hiring of a new COO who was GM of the St Ives gold mine and took the operation from 300,000 ounces of production to 390,000 ounces and reduced all-in cost by 28%, all while improving safety. St Ives is literally next door to Beta Hunt.

Let's dive into the Beta Hunt mine a bit more because it's an incredibly interesting story.

Beta Hunt — A Deep Dive

It's Not Just Gold

Beta Hunt was an underground nickel mine for 40 years. There is 400+ km of underground development already in place, which would cost over A$2 billion at current development prices. All of the grey-shaded areas in the diagram above are the existing infrastructure.

What's a very rare feature of Beta Hunt is that it hosts both gold and nickel resources in separate adjacent mineralized zones. The focus was always on the nickel resources, as most of the gold was low-grade. However, several years ago, Karora discovered coarse gold at Beta Hunt, which had bonanza-grade. There were only a modest amount of resources—not enough gold to build a sustainable mine—but the production of coarse gold provided cash flow and kickstarted aggressive exploration at Beta Hunt.

Since then, gold resources have grown considerably, with almost 2 million M&I and Inferred ounces at Beta Hunt as of January 31, 2022, or more than 4x the amount compared to 4-5 years ago. The grade is low at just 2.6 g/t, but these are wide zones of mineralization that are amenable to bulk mining.

Karora continues to intercept new wide zones of mineralization at Beta Hunt, many of which are well above the current resource grade. At Larkin, 29.8 g/t over 7.8 meters was intercepted. Drill results from the new Mason zone just west of Larkin have confirmed gold mineralization over a 300-meter strike length, with one hole intercepting 12.0 g/t over 17.0 meters. This is such a large system of underground tunnels that Karora can easily explore and find gold that is sometimes just 20-25 meters from the current infrastructure and could be brought into production quickly for just a small amount of development CapEx. But there are two sides to this Beta Hunt story, as Karora is also seeing incredible nickel exploration success. While the gold is mostly lower grade, the nickel is high-grade. The 4C Offset discovery included an intercept of 6.5% Ni over 11.9 meters, and this zone is only 25 meters from existing development at Western Flanks.

If you will notice the Gamma fault in the diagram below. All nickel that was mined at Beta Hunt years ago hit the Gamma fault and then stopped. Nickel prices were depressed at the time, and the company mining it hit the fault, tried to drill through the fault, but there wasn't any nickel. What happened was the fault shifted the nickel up 80 meters. Karora put a tunnel in the area in 2021 and started drilling upwards and hit nickel in all 26 holes drilled. Like with gold, nickel resources at Beta Hunt have increased substantially, with the resource occurring in two main blocks, the Beta Block and Gamma Block. Continuous nickel mineralization has been defined over 800 meters in strike length at the 50C trend, and usually these trends don't stop until there is a fault, so this area has the potential to extend 2.6 km in strike length. What's even more interesting is the company says, "there hasn't been a case at Beta Hunt where there is nickel and not gold below it."

The second decline provides access to the nickel as well, and Karora expects a significant increase in nickel production at Beta Hunt beginning in 2023.

The Positive Economics Of The Nickel Resources

A recent PEA on the current Beta Hunt nickel mineral resource estimated an 8-year mine life that would produce 9,435 payable nickel tonnes at a net AISC of A$16,946 per tonne of nickel sold (US$12,371 per tonne). On a by-product basis, AISC per ounce of gold could be reduced by A$80 to A$100 per ounce thanks to the nickel credits, with potential for even greater by-product credits as the nickel resource base grows.

The cost to ramp up the nickel production is estimated at just A$7 million in year one, as this is a "mine within a mine" and benefits from the shared, or dual-purpose, infrastructure.

BHP ( BHP ) just opened a nickel concentrator 4-5km away from Beta Hunt, and BHP has an offtake agreement with Tesla ( TSLA ) to supply Tesla with nickel, a key metal used to manufacture Tesla's batteries. Karora has an agreement with BHP on nickel, as the BHP facility is right on their doorstep. In other words, Karora has a home for all of the nickel it produces.

A Huge Demand Increase Expected For Nickel Over The Next Decade, And Current Dwindling Supply

About 70% of the world's nickel production is consumed by the stainless steel sector, while batteries account for 5%. However, demand from the battery sector is expected to surge, and 35% of total nickel demand could come from batteries by the end of the decade.

BHP expects demand for nickel in batteries will increase by 500% over the next decade, and anticipates that "demand for nickel in the next 30 years will be 200% to 300% of the demand in the previous 30 years."

Meanwhile, LME nickel stocks are at exceedingly low levels.

And the nickel spot price is starting to turn up again and remains in a multi-year uptrend.

Beta Hunt has tremendous leverage to nickel, as a 20% increase in the nickel price results in a ~60% increase in NPV and ~130% increase in IRR.

The company says it best:

Karora is now in a very unique position, boasting strong gold production growth coupled with outstanding nickel by-product potential over the next several years – an enviable position to be in.

Nickel is the bonus, and then there is still the coarse gold at Beta Hunt.

Coarse Gold At Beta Hunt, The Double Bonus

In August, Karora announced a new high-grade coarse gold discovery at the mine, which contributed 2,436 ounces of gold last quarter. The company isn't relying on this bonanza-grade ore to reach production targets, as these are only "periodic coarse gold injections," and Karora still had record gold production last quarter even without this coarse gold. However, the coarse gold production is considered a sweetener and increases the cash flow and overall value of Beta Hunt.

Exploration Upside At Other Targets That Add More Value To The Story

I've focused heavily on Beta Hunt, as that's the central part of the story, but there are also some interesting exploration results coming out of Higginsville, specifically the Spargos gold mine.

First ore from the high-grade open-pit at Spargos was delivered to mill in Q4 2021, and production continues to ramp up at the mine.

There were only just over 100,000 ounces of gold at Spargos as of June of last year, but the open-pit grade is off-the-charts at 3 g/t. Limited drilling at depth and along strike have occurred at the mine and there appears to be potential strong upside as multiple recent drill results have returned very high-grade gold intercepts within 100 meters of surface and across 400 meters of strike length, including 29.8 g/t over 19.0 meters (which included an interval of 99.5 g/t over 5.0 meters) and 27.3 g/t over 15.0 meters (which included 168.0 g/t over 1.3 meters).

Valuation

Karora has maintained an exceptionally strong balance sheet with just over C$56 million of cash and C$40 million of debt at the end of Q3 2022. The company has no need to raise equity in the near future, as all of its growth is self-funded.

The market cap of the company is ~US$598 million. I'm projecting US$75 million of pre-tax free cash flow in 2023 and US$125 million in 2024 at $1,750 gold, based on the production and AISC estimates from the company. I expect that the 2024 run-rate will be sustainable over the longer-term, and that doesn't include any upside from nickel.

With this level of cash flow and considering the company has some exceptional margins and the safe jurisdiction it operates, the fair relative value for KRRGF is almost 2x its current price. A $1 billion market cap wouldn't be a stretch, but this valuation assumes that the company hits its targets.

The share price has rebounded aggressively from the September 2022 lows, but KRRGF remains almost 50% below its peak back in April of last year. I still think the stock is a strong buy, albeit more speculative than other more diversified and better-established gold producers. Karora is an up-and-comer.

A Final Note

I've been particularly impressed with Paul Huet, Chairman and CEO of Karora. He is passionate about the company and has continually delivered. He has turned Karora into one of the best stories in this sector, or maybe I should say one of the most intriguing. I will reserve the "best" characterization for when the company delivers on future targets.

Huet is one of the reasons why I'm taking a chance on KRRGF.

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