Highland Gold Mining 20 Nov 03

A Welcome Addition

Highland Gold (HGM) is a leading Russian gold producer whose objective is to acquire and develop a portfolio of gold mining projects in the Russian Federation with solid growth potential. The company's shares have traded on the Alternative Investment Market (AIM) since December 2002, and over the past 18 months, HGM has acquired a high-quality portfolio of operating and growth orientated development assets. In aggregate these acquisitions contain gold reserves of 8.1 million ounces and resources of 16.7 million ounces.

"The acquisition of Mayskoye has transformed the Group, with HGM acquiring a world class, long life, low cost deposit and in so doing, doubling the resource base."

We continue to maintain a positive view of the prospects of Russian gold miners (see POG, Fat 9), and believe the fallout from the Yukos affair will not significantly affect Highland. In our opinion, the Russian gold industry has strong underlying fundamentals and the current concerns surrounding Russian stocks provides an ideal opportunity to gain exposure to quality gold plays in the Federation.


Highland's main asset is the Mnogovershinnoye mine (MNV) in Eastern Russia which was acquired in 2002 and is country's third largest gold mine in operation. Current production at the mine is expected to reach 194,000 ounces this year with a mine life of around 15 years. HGM also owns three advanced development projects - Darasun, Novoshirokinskoye, and the recently acquired Mayskoye.

Situated in the Chita Region of Eastern Russia, Darasun is at an advanced stage of development and commissioning is planned for May 2004. The mine itself has been producing for around 70 years (around 3.8 million ounces to date), and the remaining mine life is more than 20 years. Darasun consists of an existing, but currently non-operational, gold mining complex having both open-pit and underground facilities.

In September HGM completed the acquisition of the high grade Mayskoye deposit for US$34.9 million. The acquisition of the mine in North East Russia is significant as it doubles the resource base of the Group to almost 17 million ounces. The deposit was discovered in 1972 and extensive exploration has identified a resource of nearly 9 million ounces of gold. Highland expects that the capital requirement to bring the deposit into full production will be approximately US$90 million. Management believes the mine can produce approximately 180,000 ounces of gold per year from 2007 onwards with a mine life of at least 20 years. The deposit is low cost with total cash costs expected to be in the region of US$160-170 per ounce.

Highland also has the Novoshirokinskoye gold and polymetallic mining project, which contains a total of 1.8 million resource ounces of gold. Subject to ongoing feasibility work, the project should be commissioned in 2005.

Along with the company's growing reserve base, we have been impressed by HGM's solid operational performance this year. Interim results to 30 June 03 showed a solid increase in gold production and a significant increase in profitability. Total gold production was up 3.4 percent to 90,133 ounces and net profit rose a massive 57.4 percent to US$8.5 million. Highland continues to establish itself as a low cost producer, with cash operating costs down by 4.4 percent to US$152 per ounce. The company's earnings have been boosted by the strong price of gold, and we are pleased that management continues to maintain an unhedged policy. This strategy makes HGM highly leveraged to rises in the gold price.

Following the recent acquisition of Mayskoye, together with existing operations at MNV and development projects at Darasun and Novoshirokinskoye, HGM is well placed to achieve a target annual production of 500,000 ounces in 2006. The acquisition of Mayskoye has transformed the Group, with HGM has acquiring a world class, long life, low cost deposit and in so doing, doubling the resource base.


We are further encouraged by recent movements in the share register with HGM last month completing a 31.7 percent equity placement (formerly held by Harmony Gold of South Africa). Canadian producer Barrick Gold took 10 percent of this, and has agreed to a further placement which would raise Barrick's interest in the enlarged share capital to 29 percent. We believe this is a highly significant arrangement as Barrick is one of the world's largest gold producers, and will provide valuable expertise as Highland seeks to develop and extend operations in the Russian gold sector. The deal provides HGM with a further £70 million in funding, and allows the miner to refinance existing bank debt and to finance the capital requirements of development projects.

Another recent positive development for HGM was the resolution of legal issues surrounding the ownership of operating assets at MNV. In September, Highland successfully purchased the outstanding assets at MNV that were previously leased for US$26.7 million.

We firmly believe that management is well placed to consolidate HGM's position as a low cost gold producer with excellent growth prospects. Going forward, we would not be surprised to see management use surplus funds from the recent share placement to pursue further acquisitions to drive earnings growth and production volumes. This is especially likely now that Barrick has become a significant shareholder. We believe further additions will increase the company's profile as a gold producer and may spur re-ratings in the shares. Technically, the foundations for such a move are supported by the large range between 280p and 178p which has held HGM during 2003.

In our opinion, the current resurgence of the precious metal, along with the company's solid fundamentals makes HGM an exciting prospect. HGM's prospective price earnings ratio is around 20 but this falls to 8, once expected production at mines currently owned are included. On a market capitalisation to reserve and resource basis, we regard HGM as relatively inexpensive at $58 and $28 per ounce, respectively. A healthy balance sheet and earnings flows also raise the prospect of further increases in dividends.

"There are around 700 small sized producers in the Federation, and we expect miners such as HGM, which are well capitalised and have respected local expertise, will drive consolidation within the industry."

From a macro perspective we believe the market has somewhat neglected the prospectivity of Russia's goldfields. In 2002 for instance, only 180 tonnes of gold was produced in the country yet total reserves are estimated at 10,000 tonnes. Prior to the financial turmoil of the 1990's, many quality projects were discovered, extensively explored and in many cases partially developed. However, many of these assets were driven into bankruptcy due to commercially inexperienced management, the economic crisis and a lack of Western capital due to perceived country risk.

A second reason we are optimistic about the Russian gold sector is due to the highly fragmented nature of the industry. There are around 700 small sized producers in the Federation, and we expect miners such as HGM, which are well capitalised and have respected local expertise, will drive consolidation within the industry. We regard the overall prospects for growth as significant with annual Russian production forecasted to grow towards 300 tonnes in the next 6 years.

As stated on various occasions, we believe gold is in the early stages of a long term bull market. HGM is poised to benefit from this, especially given the company's limited hedging policy. Production from the group's core asset at MNV will continue to underpin profitability and cash flows, whilst the group's other assets are being developed and further acquisitions are being sought.

Over the past month, Highland's share price has pulled back from this year's highs due to fears surrounding Russian equities, and we believe that this has created a buying opportunity. The recent strength of gold already appears to have hastened the pullback and once the macro view becomes more rational, we expect HGM will be re-rated. Whilst we believe Highland has excellent potential, we caution Members that the miner is a speculative recommendation. For those Members with a penchant for risk, we recommend HGM as a buy up to 260p.


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