K92 Mining Inc. (TSX: KNT), formerly Otterburn Resources Corp., is engaged in the exploration and development of mineral deposits in Papua New Guinea, specifically the Kainantu Gold Mine that includes Irumafima and Kora deposits. The Company's Kainantu property covers a total area of approximately 410 square kilometers and is located in the Eastern Highlands Province of Papua New Guinea, approximately 180 kilometers west-northwest of Lae. The Kainantu property comprises an exploration license EL1341; a mining license ML150; two mining easements ME80 and ME81, and a license for mining purposes LMP78.

Investment Rationale

• Kainantu Mine, a Key Value Driver: K92 Mining is focused on operating and expanding the Kainantu Gold Mine, located in Eastern Highlands province, Papua New Guinea. Since acquiring the project from Barrick Gold in 2014 and restarting in late-2016, K92 has transformed Kainantu into a rapidly expanding both producer and mineral resources. Production has also been low cost, which is a testament to the high grade, continuity, solid thickness, geotechnical and metallurgical characteristics of the deposit. The mine has expected life of 12 years and production profile of the mine is encouraging.

Source: Company 

• Rapid, Self-Funded Production Growth: The company has completed Stage 2 expansion commissioning in 3Q20 to 120koz AuEq pa. The company is planning on Stage 3 expansion where PEA run-rate is expected to be of 315koz AuEq pa. In the past, the firm has consistently met or surpassed production targets, which is commendable. AuEq output is expected to be in the range of 115-135koz in FY 2021, representing a 36.4 percent increase at the top end of the estimate. It will also be able to attain multifold output figures for several years following the completion of stage three expansion, which they have started.

Source: Company

• Solid Jump in Margin: In Q2 2021, the Company continued its momentum and had strong growth in gross margin, EBITDA margin, operating margin, and net margin, all of which outperformed the prior sequential quarter. It's a huge gain for the corporation since it's shifting the odds in its favor. The company’s gross margin expanded to 41% from 29.2% reported in the first quarter of 2021. EBITDA margin reported at 34.3% against 21.6% in the previous quarter, operating margin stood at 26% against 9.6% and Net Margin stood at 12.4% against 7.4%. The margin expansion was largely driven by an increase in the gold realization prices. We expect the current trend to continue in the near term, as the Company has large capital expenditure plans to support future development. Higher average realized commodity prices were also important in attaining healthy revenues and margins.

• Gold Prices to Remain Firm in Mid-term: The opportunity cost of investing in gold continues to improve as the real earnings yield plus the dividend yield of the S&P 500 are trending lower. Further, recent commentary out of the Fed and ECB suggests the US and possibly other countries may place less emphasis on inflation and more on employment which could prolong tapering activity. A Lower rate would continue to keep gold in the investor’s limelight.

• Gold Realization Prices is Likely to Remain Higher: Average realized price for gold was US$1,754/oz, an increase of US$123 per ounce from the same period of the corresponding previous financial year. Despite a recent correction in the gold prices, we believe that gold would continue to hover above US$1,750/oz for the coming few quarters. Hence, it would continue to bolster realization prices and margin expansion.

• Strong Balance Sheet: The company has a strong balance sheet with zero debt. The group fully repaid its debt during the first quarter and maintained a strong cash balance at the end of the quarter with US$56 million available in the book. This implies negligible balance sheet risks.

• Industry Leading Liquidity Position: The company has an industry-leading liquidity profile, with a current ratio of 4.25x at the end of the Q2FY21 compared to 2.77x of the industry median, which implies that the company has a strong liquidity position and can manage its short-term expenses comfortably.

• Received new exploration license: On June 3, 2021, the firm received a new exploratory license, EL2620, covering 201.40 square kilometers, bringing the entire K92'S mining package to 860.27 square kilometers. In addition, the firm currently has five exploration licenses.

• Risk Associated to Investment: The company’s business is largely exposed to volatility in the gold prices; any sharp plunge in the gold could have a substantial impact on the company’s financial health. Further, the company’s business is exposed to forex risk, interest rate risk and other macro front risks. Also, a resurgence in the COVID-19 cases could hamper production and supply chain issues could also arise.  

Financial Highlights: Q2FY21

 Source: Company Filing

• Revenue during the quarter under review declined by ~26% to USD 35.5 million against USD 47.8 million reported in the same quarter of the previous financial year, driven by lower gold ounces sold.
• Record quarterly tonnage of 75,667 tonnes treated, a 53% increase from Q2FY20.
• During the quarter under consideration, the company reported gold equivalent production of 25,015 oz, or 22,153 oz gold, 1,098,730 lbs copper and 14,914 oz silver.
• Cash costs stood at US$736/oz gold and all-in sustaining costs came in at US$1,057/oz gold ounce.
• Production during the quarter was materially impacted by a surge in COVID-19 cases in Papua New Guinea and the suspension of expatriate travel between Australia and Papua New Guinea from mid-March to mid-May.
• During the quarter under consideration, the company sold 18,939 oz of gold, 862,407 lbs of copper and 12,472 oz of silver in the quarter. Gold concentrate inventories stood at 5,456 oz as of June 30, 2021, a quarterly increase of 3,077 oz.
• Following the positive drilling, underground development, and metallurgical results to date at the Judd Vein System, first production stoping is now planned for Q4. Development on the J1 Vein is underway on its second sublevel, the 1265 Level, and Judd has been prioritized to eliminate its core logging and assaying backlog.
  

Drilling Update

The company announced the results from the ongoing diamond drilling of the Kora deposit at the Kainantu gold mine in Papua New GuineaThe results continue to demonstrate the high-grade and continuity of Kora, with intersections largely focused on increasing drill density up-dip, down-dip, to the south and near surface to upgrade resources for the Stage 3 Expansion Feasibility Study. Results also include step out drilling to the south outside of the existing resource envelope. From the drilling results, all drill holes intersected mineralization, with 8 intersections exceeding 20 g/t AuEq, 24 intersections exceeding 10 g/t AuEq and 41 intersections exceeding 5 g/t AuEq. 

Recent Update:

The company announced that it will be added to the S&P/TSX Composite Index effective Monday, September 20, 2021, prior to the open of trading on the Toronto Stock Exchange (the "TSX"). The S&P/TSX Composite Index is the headline index for Canada and is the principal benchmark measure for the Canadian equity markets, represented by the largest companies on the TSX. 

Top-10 Shareholders

Top-10 shareholders together holds 41.01% stake in the company, with Van Eck Associates Corporation, and RBC Global Asset Management Inc. are the major shareholders in the company, with an outstanding position of 10.77% and 5.8%, respectively.

Valuation Methodology (Illustrative): EV to Sales based Valuation Metrics

Note: Premium (discount) is based on Company’s assessment of the growth drivers, economic moat, competitive advantage, stock’s current and historical multiple against peer group average/median and investment risks.

Stock Recommendation: The company reported sequential quarter growth in various financial metrics, driven by higher realization prices and growth in topline. The group has captured the benefit of higher gold prices through disciplined operational execution, driving strong operating cash flow and free cash flows. Further, the balance sheet remains strong, and the group exited the quarter with zero debt on the balance sheet. Further, the company is offering a strong Return on Equity (ROE) of 15.17%, which is quite decent.

Phase 2 drilling at Blue Lake has commenced deeper targeted drilling with two drill rigs operating. Subsequent to quarter-end, hole KTDD0020 was drilled to a record depth of 1400.6m. The new twin incline development has made considerable progress, with the #2 (6m x 6m) incline now advanced 496 metres, and the #3 (5m x 5m) incline advanced 530 metres as of July 31, 2021. Development of the incline resumed on May 21, 2021, after the COVID-19 Papua New Guinea and Australia travel restrictions were lifted and the COVID-19 situation in Papua New Guinea improved.

Hence, based on the above rationale and valuation, we recommend a “Buy” rating on the stock at the closing price of CAD 6.94 on September 08, 2021.

*Depending upon the risk tolerance, investors may consider unwinding their positions in a respective stock once the estimated target price is reached.

Technical Analysis Summary

1-Year Price Chart (as on September 08, 2021). Source: REFINITIV, Analysis by Kalkine Group

*The reference data in this report has been partly sourced from REFINITIV.

*Recommendation is valid at September 9, 2021 price as well.

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