Company Overview: Red 5 Limited (ASX: RED) is an Australian-based gold production company with high-quality assets in Western Australia’s eastern goldfields. The company aspires to become a well-established and respected mid-tier Australian gold producer with safe, profitable and sustainable business. The company currently has a solid and growing production base at the Darlot and King of the Hills (KOTH) gold mines. KOTH is believed to be having the potential to become Australia’s next premier gold mine. The company also holds interests in Mapawa Gold Project and Siana Gold Project, both located in the highly prospective and established mining region of Surigao del Norte Province on the island of Mindanao.


RED Details


Improvement in Top-line and Bottom-line: Red 5 Limited (ASX: RED) is an Australian-based gold production company with established mining projects located in the Eastern Goldfields of Western Australia and the Philippines. It is worth noting that the company’s two gold mines - Darlot gold mine and King of the Hills (KOTH) gold mine, are located in one of the world’s most attractive gold regions, offering the company a standout growth opportunity. One of the company’s objectives is to generate surplus operating cash flows and take the necessary decisions to position itself as a long-term, low-AISC cash cost producer. Further, it intends to grow as a well-established and respected mid-tier Australian gold producer. From 2015 to 2019, the company’s top-line and bottom-line have improved significantly. Over the same period, the company’s revenue has increased at a CAGR of 53.4%. 


Revenue and Net loss Trend (Source: Refinitiv, Thomson Reuters)

Amid Covid-19 situation, the company’s mining operations at both Darlot and King of the Hills are running in-line with the revised production guidance. The company aspires to establish 5-10 years of Ore Reserves at Darlot, as part of its Darlot Mining Hub Strategy, which will elevate Red 5 into the ranks of Australia’s leading mid-tier gold producers. Further, the company is focused on the development of its King of the Hills mine which is believed to be having the potential to become Australia’s next premier gold mine. With sufficient funds to support the company’s growth strategy, Red 5 limited is currently well-placed to deliver a substantially increased production profile from its two gold mines in Western Australia.

FY19 Performance Highlights: During the financial year 2019 or FY19, the company saw the successful ramp-up of production at the Darlot and King of the Hills (KOTH) gold mines to over 100,000oz per annum. Further, the company also made significant progress in advancing the opportunity for largescale bulk mining at KOTH and witnessed a strong operating performance at the Darlot underground mine.

The combined Darlot and KOTH gold production stood at 102,012oz with gold sales of 98,240oz, resulting in a gross profit from operations of $11.34 million. For the full year, the company reported a net loss after income tax of $3.03 million. The net cash flow from operating activities stood at $23.18 million in FY19 with $24.87 million in cash and metal accounts achieved at period end.


Summary of Key Production Statistics

H1FY20 Highlights: During the first half of FY20, the company maintained steady-state production and witnessed a strong operational and financial performance. For the half-year period, the combined gold production from Darlot and King of the Hills stood at 51,995oz with gold sales of 52,664oz. The company generated sales revenue of $105.31 million during the period and earned a gross profit from operations of $24.14 million. For the half-year period, the company reported net cash flow from operating activities of $32.69 million and Net profit after income tax of $8.24 million.

During the period, the company invested $26.24 million in exploration and development activities, with the primary focus being on the evaluation of a stand-alone bulk mining operation at KOTH.


H1FY20 Income Statement (Source: Company Report)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together forms around 49.24% of the total shareholding. Franklin Advisers, Inc. and Ruffer LLP hold maximum interest in the company at 12.02% and 9.07%, respectively.


Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)
 
A Quick look at Key Ratios: For H1FY20, the company’s gross margin and net margin stood at 20.1% and 7.8%, respectively, both higher than the margins reported in the previous corresponding period, demonstrating the company’s improving profitability. The company reported ROE of 9.3%, higher than the industry median of 5.3%. The company has an asset to equity ratio of 2.21x, higher than the industry median of 1.70x.


Key Metrics (Source: Refinitiv, Thomson Reuters)

March Quarter Results: During the March quarter, the company reported total production of 20,077 ounces from Eastern Goldfields operations in line with revised guidance of 20,000 to 22,000 ounces. The production was affected by the short-term crusher and ball mill performance issues at the Darlot Gold Mine and lower grades than planned at the King of the Hills (KOTH) underground mine. During the quarter, the Darlot Mineral Resource increased to 1.2Moz and KOTH Mineral Resource increased to 4.1Moz. At the end of the March quarter, the company had cash on hand and bullion of $14.11 million. 

$125 million Share Placement: During March 2020, the company undertook a $125 million share placement which significantly de-risked the equity funding component for the KOTH project development. The capital raising comprises a two-tranche placement to sophisticated and professional investors, both of which are now completed. The proceeds from the placement are going to be used for the development of an integrated bulk open pit and underground mine and stand-alone 4Mtpa process plant at KOTH, ongoing exploration and working capital. This placement will ensure that the company remains funded to continue its long-term focus on exploration, where it has a strong track record of creating significant value for its shareholders. 

Acquisition of The Cables and Mission Deposits: The company recently exercised its option to complete the acquisition of the Cables and Mission gold deposits, located approximately 10km north of its Darlot Gold Mine in Western Australia, in line with the company’s Darlot Mining Hub Strategy of expanding its Mineral Resource base for the Darlot gold processing plant. The total cost of the acquisition is $2 million, with a $500k deferred payment on delineation and reporting of a 500koz JORC 2012 Resource.

Bank of America Corporation Becoming a Substantial Holder: Recently, Bank of America Corporation and its related bodies corporate became a substantial holder in the company by holding 103,807,335 ordinary shares in the company. Bank of America Corporation now holds 5.3% voting power in the company.

Covid-19 Update: In response to Covid-19, the company has implemented a wide-ranging series of measures and new work protocols designed to protect the health and well-being of its workforce while maintaining business continuity. Till now, the company’s production is not unimpacted by the COVID-19 global pandemic. However, the situation is evolving, and there remains some uncertainty and risk relating to potential impacts at Red 5’s operations.

Key Material Risks: Like several other gold production companies, Red 5 Limited is also exposed to the risks of Covid-19 which could impact the operations of the business. Further, the company is also exposed to the risk of fluctuations in gold prices which could significantly affect the revenues of the company. The objective of the company’s market risk management is to manage and control market risk exposures within acceptable parameters while optimising the return.

What to expect: Moving forward, the company aspires to establish 5-10 years of Ore Reserves at Darlot, as part of its Darlot Mining Hub Strategy, which will elevate Red 5 into the ranks of Australia’s leading mid-tier gold producers. With substantial investment in organic growth, the company is currently well placed to deliver on its medium and long-term growth strategy. Following the recently completed capital raising, Red 5 Limited is currently well funded to continue its long-term focus on exploration and works towards a transformational development opportunity at KOTH. The company’s production is expected to recover in June quarter, with an expected range of between 26,000 ounces to 30,000 ounces at an all-in sustaining cost of A$1,400 – A$1,525 per ounce. The full-year production for FY20 is expected to be between 100,000 to 105,000 ounces.


Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: P/E Multiple Based Relative Valuation (Illustrative)

P/E Multiple Based Approach (Source: Refinitiv, Thomson Reuters)

Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months

Stock Recommendation: The combination of a solid and growing production base at the Darlot and King of the Hills (KOTH) gold mines together with a rapidly evolving bulk mining opportunity at KOTH establishes Red 5 as a producer with significant upside as it works towards a transformational development opportunity at KOTH. We have valued the stock using Price to Earnings based illustrative relative valuation method and have arrived at a target price with lower double-digit upside (in % terms). For the purpose, we have taken peers like Bellevue Gold Ltd (ASX: BGL), West African Resources Ltd (ASX: WAF), Perseus Mining Ltd (ASX: PRU), etc. Considering the company’s solid and growing production base at Western Australia’s eastern goldfields, its decent production performance, and recent capital raising, we give a “Buy” recommendation on the stock at the current market price of $0.280, down by 1.754% on 9 June 2020. 

 
RED Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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