Avocet Mining 11 Sep 03

Futher to run

Avocet Mining (AVM) is an Asian based gold miner which is beginning to display earnings growth potential following a debt restructure, disposal of non-core operations, and the expansion of gold reserves. The company owns and operates Malaysia's largest gold mine and has another significant deposit in Indonesia, currently at the planning stage. In 2002 Avocet also took a 49 percent interest, and management control in an existing gold producer in Tajikistan.

"We believe that AVM now has a much more balanced portfolio of operations and exploration properties, which should provide significant leverage to the rising gold price... "

Avocet's main objective is to build an increasingly profitable gold mining business in Asia. It plans to do this by optimising the performance of existing operations and by providing growth through exploration, acquisitions and strategic alliances. AVM's medium-term goal is to produce 300,000 ounces per annum within the next three years.
The Company was listed on the London Stock Exchange in April 1996, having previously been listed as Avocet Ventures Inc. on the Vancouver Stock Exchange. While still listed in Vancouver, the Company came under UK management control in 1989. In July 2002 the company moved to London's Alternative Investment Market (AIM) as management believes this exchange to be more appropriate given AVM's size.

In 1990, the Group was awarded exploration and mining rights over a 1,165 square kilometre area in Pahang, Malaysia, and, following detailed exploration, work began on developing the Penjom mine in 1995. Mining commenced in 1996 and, following the successful introduction of an innovative and cost effective recovery process (currently around 90 percent effective), production is now running at an annualised rate in excess of 100,000 ounces a year. Following a recent upgrade, the balance of ore resources remaining at 31 March 2003, including low grade ore stockpiles, was 684,160 ounces comprising 4,767,500 tonnes at an average grade of 4.46 g/t. Forty-two per cent of this resource is currently estimated to be economically recoverable at an average total cash operating cost of US$180 per ounce.

In the mid 1990's the company decided to diversify operations, and sought to establish an integrated tungsten business. As part of this strategy the company acquired an interest in the Panasqueira deposit in Portugal, one of the largest tungsten mines in the western world. However the decision proved mis-timed with the tungsten price subsequently underperforming. As a result of this investment, along with a bear market in gold, AVM's share price tumbled by more than 90 percent during the late 1990's, reaching a low of 10p.
AVM was forced to exit the tungsten business, and in September 2002 Avocet sold its remaining tungsten assets to Canadian-based Salish Ventures. We believe this has been a sensible move as AVM can now concentrate on its core gold business. This deal also allows AVM to benefit from any upside in the tungsten prices with Avocet retaining a 49.3 percent stake in Salish (renamed Primary Metals Inc.) Primary are currently modernising the mine's operations, and the decision by China (which accounts for over 80 percent of world primary tungsten production) to limit tungsten ore mining, is contributing to a favorable outlook for tungsten prices.

Last November Avocet expanded gold operations through the acquisition of Nelson Resource's gold interests in the Republic of Tajikistan in Central Asia. This includes a 49 percent shareholding in Zeravshan Gold Company (ZGC) whose interests cover around 3,000 sq kms in northern Tajikistan. Previous Soviet exploration in the region identified over 8 million ounces of gold in a number of deposits, including Jilau where ZGC operates an open pit gold mine. Avocet will receive 100 percent of the cashflows from ZGC, having taken over all US$100m of ZGC's debt. Together with ore stockpiles scheduled for processing, these operations have a resource base containing 533,280 ounces of gold.

We believe that this deal puts Avocet firmly on the path towards meeting the overall production target of 300,000 ounces per year by 2006. The area has large exploration potential and AVM is targeting annual production of 100,000 ounces and costs below $US250 per ounce. The acquisition appears to have been a bargain with Avocet effectively obtaining a US$40 million mining operation for US$6 million. Although cash costs are high AVM believes these can be reduced with further investment.

The acquisition may even provide AVM with synergies and opportunities to exceed the production goal. ZGC and Avocet have experienced management teams with complementary strengths in exploration, mining and mineral processing which should enhance the possibility of new gold discoveries and the optimisation of existing operations. Results from the first five months of operations under AVM's ownership are encouraging. ZGC produced 25,675 ounces at US$284 per ounce. AVM has also commenced negotiations with the Tajikistan government to increase Avocet's stake.

We are buoyed by the most recent financial results from AVM which revealed a 150 percent increase in pre-tax profit before exceptionals for the year to 31 March 2003 of £2.4 million. Profitability has been driven by a firmer gold price, record gold production levels, and continuing efficiencies at Penjom. Given our bullish outlook for the precious metal, we are pleased that the group has maintained only a small hedging position of 80,000 ounces.

Production at Penjom for the year was a record 108,905 ounces, with recoveries improved to just under 90 percent. This was achieved from higher than expected ore grades. Total cash costs of production declined by 9 percent to US$204 per ounce due to a lowering of Penjom's waste/ore stripping ratio. AVM expects costs to improve further towards an average of $US150 per ounce over the mine's life.

A bankable feasibility study was completed at the 80 percent owned North Lanut mine in Indonesia. The study focused on assessing the 800,000 ounce mineral resource base estimated by Newmont. Results of these studies were positive and indicated the potential for a low cost open pit operation that could produce around 50,000 ounces per annum for at least five years at a cash cost below $US150 per ounce. Independently verified results to date indicate that one deposit, Riska, contains a mineral resource of 468,000 ounces of gold at a grade of 1.4 g/t. Based on a gold price of $US250 an ounce and a capital cost of $US11 million, AVM predicts an internal rate of return of 45 percent on the mine. AVM is currently seeking necessary permits and development finance with a view to commencing production in early 2004. This purchase looks to have been particularly astute for AVM given it was acquired from Newmont for a mere US$400,000.

We believe that AVM now has a much more balanced portfolio of operations and exploration properties, which should provide significant leverage to the rising gold price (refer gold article in this issue). Following the latest acquisition, the company's resource base totals more than 5 million ounces, and the prospectivity of Jilau increases the likelihood of further upgrades. Going forward, we expect earnings and cashflows to be driven by further production efficiencies and increases in capacity (particularly at Jilau). Accordingly, we believe the company is on course to achieve and even exceed annual production targets of 300,000 ounces of gold by 2006.

Encouragingly, AVM has been able to expand whilst improving balance sheet strength. Debt levels have been reduced from a high of £45.6 million five years ago, to around £9 million. AVM intends to repay a further £6 million of debt by 2004. Current debts have been restructured with maturities much longer than they were previously. At the same time liquidity has increased with Macquarie Bank granting Avocet a US$5 million line of credit until 30 June 2004.

We regard AVM's valuation as compelling. Removal of tungsten losses and additional gold production could see earnings double in the current year to around US$5.5 million putting the company on a prospective price earnings ratio of around 11 times which compares favorably to the FTSE gold mines index average of around 29. On a gold production basis AVM is relatively cheap at around $US400 market capitalization per ounce of gold. Whilst no dividend policy is in place, management are considering ways to restructure the company's debt so that dividend payments might commence in 2005.

Going forward we do not rule out the possibility that AVM may pursue acquisitions to increase earnings and production volumes. Such a move would increase the company's profile as a gold producer and may spur further re-ratings in the shares. In fact it seems this is more likely now - management is currently seeking shareholder approval to double the share capital should they find appropriate acquisitions.

After turning higher in the past twelve months, we believe that a lasting recovery is underway in Avocet's share price. The lengthy period of underperformance prior to this can be attributed to the deep bear market in the gold sector generally. We believe the current resurgence of the precious metal, along with the company's solid fundamentals make AVM an exciting prospect. Furthermore, AVM engages in minimal hedging activities which maximizes its exposure to the price of gold.

Whilst we believe the company has excellent potential we do caution Members that AVM is a speculative recommendation. While we recognise prices are currently trading at a four year high, AVM remains a long way below levels seen in the mid 1990's. With an upward trend now in place, we believe that AVM provides significant upside potential at current levels. For those Members with an appetite for risk we recommend AVM as a buy up to 46p.


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