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Archipelago Resources: 129% ahead so far but still a buy at 63p – target (at least) 95p

By Tom Winnifrith | Monday 15 October 2012

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

I first recommended AIM listed gold producer, Archipelago Resources (AR.) back in December 2004 at 27.5p on a website that I do not mention and few read anymore. After publishing some pretty impressive drill results today which indicate real upside possibilities at its 95% owned flagship Toka Tindung mine in Indonesia the shares are 63p. But I reckon that they are worth at least 95p (probably more) and here is why.

Archipelago has properties in Vietnam and the Philippines but these are exploration assets. The core value lies in the Toka Tindung mine in Indonesia which in the first half of calendar 2012 produced 60,386 oz at a cash cost of $783 oz. That meant that the group generated a gross profit of $37.7 million, an operating profit of $32.5 million and net income of $17.1 million. Cashflow generated from operations was $35.4 million and at the period end it had debt of $63 million and cash of $22.6 million.

The second half will see increased output and thus lower cash costs per ounce. The guidance is for full year output of 135-145,000 oz and at a cash cost of $580-640 oz. The increase in output will be largely down to greater tonnage being processed but also down to the fact that Archipelago is now consistently finding higher gold grades in situ.

Toka Tindung has a mine life of 9 years with an additional 7 years output guaranteed from stockpiled rock. Output is sustainable at c140,000 oz for the Life of Mine. But.. Actually it gets better. That LOM estimate is based on the current 2.58m oz Au Resource and 1.47m oz Au Reserve.  However Archipelago is continuing to drill the area around its existing pits and today it announced a series of drill hole results. The release reads:

Archipelago is pleased to announce a series of exceptional drilling results from its high grade southern deposits, close to infrastructure at the Toka Tindung Mine ("Toka Tindung") in North Sulawesi, Indonesia. 


 ·           Archipelago's targeted near site exploration programme continues to yield significant results at Toka Tindung (with mineralisation remaining open at depth and along strike).  Within the southern mineralised zone, assays have been received from 239 drill holes totalling 34,489m.

 ·           Encouraging drill intersections from the deeper mineralised zones can be reported for the Kopra, Blambangan and Pajajaran deposits (in addition to those previously announced at Blambangan and Pajajaran on 9 July 2012).  Highlights include:

 ·       Kopra (22 holes for 2,946m):

 27m at 5.56g/t Au                  (KIP020, 169 - 196m)
9m at 5.32g/t Au                   (KIP012, 135 - 144m)
7m at 3.49g/t Au                   (KIP013, 122 - 129m)
8m at 4.72g/t Au                   (KIP013A, 146 - 154m)

·       Blambangan/Blambangan South(58 holes for 8,403m): 


3.1m at 49.76g/t Au               (BPD042, 205.9 - 209m)   [including 1m at 152g/t Au; 208 -209m]
1m at 5.90g/t Au                   (BSP032, 98 -99m)

·       Pajajaran (42 holes for 8,029m):

13m at 9.44g/t Au                  (PJJ032, 173 -186m)      [including 5m at 20.61g/t Au; 180 - 185m]
16m at 4.26g/t Au                  (PJJ033, 134 - 150m)     [including 3m at 17.39g/t Au; 145 - 148m]
7m at 3.66g/t Au                   (PJJ034, 6 -13m)
6m at 14.75g/t Au                  (PJJ034, 139 -145m)      [including 2m at 35.95g/t Au; 139 - 141m]

·           Significant results can also be reported for the adjacent mineralised zones of Semut Barat, Semut Timur and Makassar, including: 

·       Semut Barat/Semut Timur (74 holes for 9,284m):

2m at 11.70g/t Au                  (SMB038, 145 - 147m)
7m at 4.28g/t Au                   (SMBD023, 231 - 238m)
1m at 9.53g/t Au                   (SMB042, 49 - 50m)
2m at 5.08g/t Au                   (SMB042, 72 - 74m)
4m at 6.91g/t Au                   (SMP050, 20 - 24m)
1m at 9.97g/t Au                   (SMP028, 61 - 62m)

·       Makassar (43 holes for 5,827m):

5m at 8.10g/t Au                   (MAK025, 95 -100m)      [including 1m at 24.6g/t Au; 95 - 96m]
4m at 4.98g/t Au                   (MAK027, 100 - 104m)
6m at 5.98g/t Au                   (MAK028, 114 - 120m)   [including 2m at 13.95g/t; 115 -117]


The conclusion is the critical element:

The results confirm the highly prospective nature of Toka Tindung and indicate significant potential to extend Archipelago's already substantial 2.58m oz Au Resource and 1.47m oz Au Reserve. Drilling will continue over the remainder of the year and an updated 'Resource & Reserve Statement' is expected to be published in early 2013.

This clearly indicates that the company can increase the Life of Mine but also by tackling higher grades earlier can increase its output in earlier years as well. With a fixed cost base that would have a material impact on free cashflows and any DCF based valuation.

For now I treat all of that as upside and allow very little for it or for the non Toka exploration assets. Instead I value the company purely based on the nine plus seven years production we have at Toka and using a 10% discount rate (arguably harsh) and a $1600 gold price ( again arguably harsh for the first half decade at least) I arrive at a valuation of 95p per share.

And so 95p is my initial target but with the risks are very much on the upside both from the near and medium term gold price but more critically from that new study due in early 2013 which will, I suspect increase both output forecasts and also the estimates of the Life of Mine. Given operational gearing that could trigger a very significant re-rating indeed. The shares remain a buy.

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