Disclaimer: I own, through a company I control, 10000 shares of MML and intend to likely increase this position in the future. This article is for educational purposes only, please do your own diligence, as this does not constitute investment advice. Full disclaimer can be found HERE.
This article is part 2/3. Here are the links to Part 1 and Part 3.
If you are still reading, I assume you have at least some interest in investing in commodities/miners/gold. And that the sneak peeks of Medusa Mining (MML) financials got you interested.
Before we look deeper at MML's balance sheet and earnings, I needed to see if the company has any red flags that would indicate that no matter the price, the risk is too high. Below is what I found, and I will welcome any feedback from my readers.
The location
Let's start with the worst part about the company. Its only running mine is in the Philippines, in one of the South islands. The Philippines are certainly not the worst, as they do not have a regular history of expropriation and kleptocracy like Zimbabwe. But this is definitely not considered a prime jurisdiction either, like for example Canada or Finland. This is something to keep considering when looking at this company. There is an inherent risk in overseas investment in developing countries, where the government might decide to suddenly increase taxes or nationalize mineral resources.
The country itself is relatively prosperous and stable but has experienced a surge in a radical religious insurgency in the south island in 2015. The situation is now more stable, following a quite brutal but effective reaction by the central government. Instead of IS-style insurgency, there are only suicide bombings happening infrequently, but this adds extra geopolitical risk to MML, as it is located on the south island of Mindanao.
The Philippines have so far been a relatively friendly jurisdiction for miners. Mining is an important, but not a central industry in the Philippines, which is in my opinion the ideal situation. If the country relies heavily on mining or one commodity, it will always be tempted to increase taxes and rely entirely on it for its tax base. If the industry is barely present at all, the local government might have an interest in staying "mining friendly". So the Philippines seems to be in that sweet spot in between these 2 extremes.
The country has been tightening environmental control over open-pit mining, which has been responsible for serious ecological damage over the last few years. This includes an actual ban on the practice by local courts, the freezing of some major mining projects.
In case you do not know, open-pit mining is what people mean when they describe mining as an overly destructive process. I frankly feel a little uncomfortable knowing we, as a species, are destroying areas at that scale... not really something you want in your backyard...
Open-pit mines are inherently more polluting, and also a lot more visible and creating more opposition by locals seeing the nearby forests and mountains getting completely destroyed. It is often allowing for cheaper production costs, but comes with a lot more risk of extra regulations, litigations, pollution disasters, protests, mining permit cancellations and so on.
Luckily, MML is an underground mine, with very little impact on the surface, comparable to a small factory or logistical center. You can compare the image of the monster above to the one of MML website front page and investor presentation. A lot more green and a lot less likely to get an angry mob of locals protesting the mine's very existence.
This does not mean that the mining operations are always risk-free or nonpolluting, but generally, I have a preference for underground operations, as they have fewer chances of leaking harmful chemicals into the environment, nor create such a visceral and emotional hostile reaction from the local communities. I did not find any past or present scandals regarding pollution and hope it will stay this way. But like for all capital-intensive industries, this is another risk to keep in mind.
Medusa's public relations
Speaking of community relations, as far as I could see, they seem to be pretty good. The company is doing the usual public relations operations, financing nearby hospitals and schools and water treatment systems. This is especially valuable in the region, which is the poorest in the whole Philippines.
I am not naïve and know this is a rather cheap way to get a friendly rapport with the local community. Nevertheless, the absence of conflict or protests seems to indicate that MML has at least an okay relationship with the population living nearby and the local authorities. And MML might even be a positive force in the area, creating well-paid jobs in the countryside and building valuable infrastructures.
The company also seems to promote a reasonably good level of health & safety procedures, shown by a well below industry-level injury rate. I am not sure if I would call it outstanding as injuries still occurred on the mining site, but this does not seem to be something that could trigger increased scrutiny from the relevant governmental agencies.
Continuous training is provided to the employees, and the general approach to health & safety seems satisfactory.
The mine is also carbon-neutral, thanks to reforestation efforts. This effort also ensures the preservation of water quality. On top of that, a 140 hectares (345 acres) fruit tree plantation has been made to keep contributing to local job creation and environmental preservation. This also gives the company a decent ESG profile.
The Co-O mine
I hope I did not bore you too much with that look at MML environment. Now let's get started with the heart of the business, its mine. The only running mine of MML is the Co-O mine. The mine is located on the Southernmost island, right in the middle of a known deposit of gold. The larger gold mines of Diwalwal and King-King are just South of Co-O, and the one of Silangan is to the North.
I should point out that compared to much larger miners able to spread risk among multiple projects, MML is extremely dependent on Co-O's operation running smoothly. The company has successfully operated the mine continuously since 2004, but potential disruptions in the future are always possible.
Over a long enough time, I do not expect MML to have more problems on average than its industry peers. But relying on only one asset means that MML's investors should be ready for more volatility in production. For example, if an earthquake or a COVID outbreak shuts down the operation for a while, cash flow will suddenly drop to zero, even if this does not affect the long-term value of the mine deposits.
As described in the company's history section, the mine was previously exploited on a small scale by a local company in 2004, which later merged with Medusa to form the modern MML. The production steadily rose from the initial 40,000 ounces to 60,000 ounces in 2009. It then rose to 100,000 ounces in 2011 but fell to only 60,000 in 2012. Deeper shafts, an improved processing plant, and generally upgraded operations have allowed the company to go back to 90,000+ ounces since 2015.
The mine itself is located along a national highway, which I appreciate as this means good road infrastructure to bring equipment in and out, personnel and product. The mill crushing the ore is located a little bit to the north of the Co-O mine, right in the middle of the existing deposits.
The Co-O deposit is also just 30 km from the Bananghilig deposit, under exploration by MML and considered for the opening of a new mine. I will write more on that a bit further down. Overall, the operation seems well designed and does not carry the risk of needing new costly infrastructures like building access roads or a dedicated electric power plant.
Deposits at Co-O have recently been revised downward. The previous estimation was that the mine contained 890,000 ounces of gold.
Of this amount, only 520,000 should be considered "sure", representing what is called in the mining industry as measured and indicated resource. This is the amount either directly accessible (measured) or almost certain to be there (indicated).
Another 369,000 ounces was "inferred, meaning that geology seems to indicate further deposits deeper in the rock, but are not yet confirmed. Generally, such estimations are somewhat reliable, especially when the deposit is located in a generally mineral-rich area with much larger mines in the direct 50-70 km line of mineral deposit, sharing similar geology.
Now the inferred resources are judged smaller. The latest estimation in the 2020 annual report is that the Co-O mine has at least 513,000 ounces of Measured and Indicated gold. To which another 271,000 ounces of inferred could be added.
When I first bought some of MML's stocks, the reserves seemed to be good enough for 10 years of operation. The mine now seems to have a slightly shorter lifespan, but is it a long-term trend? Hard to say.
But was that going to be the end of the Co-O mine? This was anyone's guess. But I notice looking back at old annual reports that MML seems rather careful in its estimates and tends to revise them upward every year.
The 2020 annual report shows that indeed, management had been overly cautious in its estimates. At 95,000 ounces/year, MML has now 8 years of operation ahead, with a potential for more depending on reserve replenishing or not when the drill deeper.
Will it happen again in the future? I honestly have no idea. But I can say that the 9-11 g/tons ore concentration is rather high by industry standards, so I would not be surprised that other lower grade larger deposits are still to be found. This in itself, is positive optionality contained in MML and the Co-O Mine that I am very interested to see as a long-term investor. If in 8-10 years new deposits at "only" 5-6 g/tons are found, this could give the mine a lifespan of many more years.
Exploration projects
MML gives a good overview of its exploration projects in the Philippines on its website.
Bananghilig Deposit
The most important exploration is the Bananghilig I mentioned earlier. The total amount of gold expected to be in there is 435,000 ounces. So this would represent around half of the Co-O mine, but also requires some investment to be up and running. MML is not really clear about their plans for it, but the deposit has been analyzed with an assumption of gold price at $1500. I am under the impression that they will develop it if they feel that gold prices are going to stay above this level for a while, as the opening of the new mine would be a significant capital investment.
Frankly, my very basic knowledge of geology from my first year of university does not allow me to really judge if the reserves estimations are accurate. But at least, the company is very open about its exploration results, going into an extremely (too much?) detailed description of it in its annual report. I mean really, how many investors are even looking at such tables or maps at all, and are able to judge their veracity?
I guess this is the result of management having very technical profiles. Trust me, it does not make the annual reports very easy to read at times. Nevertheless, it indicates a willingness to expose their analyses to scrutiny, so it's anyway positive.
Royal Crown Vein Project
As you can see in the map above, the Royal Crown Vein in just 3km north of the center of the Co-O mine. This would represent around 36,000 ounces, so not much to move the needle for a producer making 90,000/year.
Saugon deposit
The deposit, 15km south of Co-O is expected to contain 15,700 ounces of gold. The last analysis was done in 2013.
Calavera & West road 17
The Calavera zone exploration, south of Co-O, has returned poor results and is unlikely to produce any gold in the future. Similarly, the West road 17 has returned too poor concentration to be worth exploiting at today's gold price. We can appreciate MML's management's willingness to admit their failure on this one, but not much else positive about it.
TSF1 tailing project
Leftover rocks from mining operations in the 1980s have leftover dug-up ore that still contains some amount of gold that could not be extracted with the technology of the time. Around 28,200 ounces should be left to extract from it. Details of the procedure or production costs are still unclear, as a study on that matter is still ongoing.
Overall non-Co-O reserves.
MML's main resources stay in the Co-O mine by far. The tailing project and Royal Crown Vein are only 64,000 ounces together, or barely 6-9 months of extra operation. So short of a large investment in the Bananghilig, I still expect MML to have an approximate production lifespan of 10-11 years at its current level of production. Bananghilig would increase that by 4-5 years, but its cost structure is still to be seen, so I am reserving judgment about its relevance of it for the company's future. Of course, the relevance of Bananghilig will also depend on the future gold price, as almost everything about MML.
Out of Philippines exploration
MML has been doing some exploration and also apparently entered into partnership/acquisition discussions around South-East Asia.
The Australia exploration has not found any gold and has been discontinued. Management is extremely tight-lipped about other possibilities beyond the map below, so I am not sure what to think about it. Obviously, they want to advertise as little as possible potential acquisitions or discoveries to rival miners. But as an investor, it is of little help to only be given a statement like this one: "The Company continues to evaluate opportunities within the Asia Pacific Region with the objective of growing the Company’s portfolio".
Other countries are being investigated, but we do not know much about how or why. The mention of Myanmar is worth a bit extra attention, as I will explain below in the profile of the CEO.
I am however worried about the risk of overpriced acquisition wasting the accumulated cash on the balance sheet. In that respect, one or two more years of somewhat stable or even low gold price might be a good thing, as it would allow MML to do acquisitions at a reasonable price.
Historically, mining companies have been, as a whole sector, terrible at capital allocation, squandering cash on overpriced projects during boom, to suffer even more from bust. The long bear market of 2010-2020 in gold price have taught some capital discipline to miner managers, switching their focus toward efficient capital allocation and reasonably priced acquisitions.
At the moment, the industry still seems very careful about new projects, which I appreciate. I hope the lessons learned in the last downturn will be remembered for long enough and global production will stay in the range of the market demand.
Management
The leading figure of the company is Andrew Teo. Since 19 March 2021, he is now the Managing Director/CEO. He was previously the CFO of BGC Pty Ltd, one of the largest firms in Australia. He is also involved with Myanmar Metal, a company doing exploration for a silver mine and a gold mine in Myanmar.
I have no idea how the Myanmar political situation might evolve; so far, let's say it does not look good. I would prefer the 2 companies to stay separate entities, as any acquisition of Myanmar Metal or a merger would increase the geopolitical risk of MML. No mention of such an idea has been made in MML's reports, but Myanmar does appear in their region of interest. Besides, with a market cap of $133 millions, Myanmar Metal, the company has almost the same valuation as MML, so it would significantly dilute MML shares to merge the 2 companies.
The rest of the directors are less remarkable in their past experiences. Most have been involved with MML since the early 2010s, and the overall management turnover seems very low. Their profiles are either geologists and mining specialists, or from a more financial/legal career path (lawyer, accountant, etc...).
Among the management, the 2 main shareholders are Andrew Teo and Roy Daniel, the former CFO of the company and now a non-executive director. Frankly, I would have liked to see more ownership by the rest of the management board, in order for it to have a more aligned interest with the shareholders. But at least, 2 key figures of the board of directors have some of their net worth in the form of the company shares.
Total remuneration of all directors is $1,6 million, which is quite reasonable for a company with a very strong positive cash flow. The executive officers have a part of their remuneration in the form of long-term incentives, which is always a plus. This includes some large sums of stock options (representing less than 1% of total shares) with exercise price ranging from AUD1.00 to AUD1.75, so above the current valuation. Combined with other options distributed to retired directors and employees, dilutions from option exercise should not be higher than 3-5% by 2023, so not really a concern for the other shareholders.
These stock options will stay valueless as long as MML stocks stay below AUD1.00. So they are an incentive for the management to get more press coverage and investors’ attention to MML to increase share prices. Actually, if it stay that low for the next 3 years, they will lose money. So management has a strong incentive to see the company run efficiently AND get the market to notice it. As an outsider investor, this is good to have.
I prefer to not clutter this article with too many details, so for more information about the details of management compensation, I invite you to look at the 2020 annual report, page 58.
Conclusion of the company profile
Overall, I like the look of Medusa Mining. Its management might not be world-famous, Elon Musk style, but seems solid and competent, and also has been able to restrain impulsive or careless developments and acquisitions despite the company's cash balance. They seem rather prudent as reflected by the complete absence of long-term debt compared to current assets, as well as their conservative reserves estimation. Most of them are veterans of the mining industry with 35-40 years experience and have therefore lived through many price cycles.
The geopolitical and jurisdiction risk is not the best but seems manageable. The Philippines does not seem overly hostile to the mining industry, nor has shown a recent direction toward communist/collectivist politics that could result in nationalization. The main risk in that domain stays a flare-up in terrorism or insurgency.
Community and local government relations seem rather good. The nature of underground mining reduces the risk of sudden and massive pollution disasters. To me, the main environmental risk could come from natural disasters, especially earthquakes, as the mineral-richness of the region comes from its geological activity. With only one mine, MML could suffer from a disaster if a strong earthquake would strike. An abnormal hurricane could also be a possible risk of flooding, even if such storms never interrupted operations in the last 10 years.
The mine itself has an okay/good lifespan, with 8-10 years of visibility. At current cash flow levels, the company is likely to produce several times over its market capitalization in the next decade. And this does not even include the optionality of finding more gold in deeper levels of Co-O or starting to exploit the nearby Bananghilig deposit. Results of exploration in other countries could also be a nice surprise.
The AISC production cost oscillates between $1000 to $1250 depending on the year and the investments into more modern and powerful machinery (especially at the mill, but also for lifting the rock from the tunnels underground). Considering gold price behavior and the more recent persistence of low real interest rates over the last 10 years, this gives us a reasonable expectation of steady cash flow for the leftover of the mine's life.
So as far as the qualitative analysis goes, I could not find a reason for the very cheap price MML is trading at. I will, in the third part of this article, show you the financials themselves to illustrate why, in my opinion, the company is selling surprisingly cheap, and my hypothesis why this is the case. I will continue the analysis of MML in part 3.