We were originally interested in Metanor Resources (MTO.V) because of its production potential, as the company declared commercial production at the Bachelor Lake mine a few years ago. As the mill was processing ore at an average head grade of 6 g/t gold and the recovery rates were pretty high (consistently above 95%), things looked bright for Metanor Resources, but then the gold price started to slide and despite the weaker Canadian Dollar, Bachelor Lake remained a rather marginal producer.

However, a recently conducted regional exploration program unveiled a very interesting new exploration target within walking distance from the Bachelor Lake mill, and in this report we would like to have a closer look at this exploration potential.

The production results in Q1 FY 2016 didn’t meet our expectations, but the head grade should improve

As Metanor Resources’ financial year ends in June, the production results of the third quarter of calendar year 2015 were actually the results of the first quarter of Metanor’s financial year 2016. The production was actually pretty disappointing with just slightly over 8,000 ounces of gold having been produced.

The total amount of tonnes that were processed was pretty good and the recovery rates also were in line with our expectations, but the head grade fell to just 4.5 g/t and this simply isn’t enough to produce a sufficient amount of gold to be cash flow positive (despite the weaker Canadian Dollar which obviously is an advantage for gold producers right now). However, Metanor expects the contribution from the Hewfran zone to increase gradually and as Hewfran’s average grade is much higher, we would expect to see a gradual increase in the average head grade of the ore that will be processed at Bachelor Lake.

The total revenue in the first quarter of FY 2016 was C$10.75M and as this was lower than expected, Metanor had to post a gross loss (compared to a gross profit in the same quarter a year before). The net loss was C$2M and that’s not something one can be happy about.

Of course, the income statements only tells you a part of the story, and here at Caesars we do believe the cash flow metrics are a better way to determine how a company is performing. Unfortunately the operating cash flow was also negative, and even if you would exclude the changes in Metanor’s working capital position, the operating cash flow would have been just marginally positive at C$120,000 for the quarter. Fortunately the capital expenditures remained limited to C$600,000, so the negative free cash flow would have remained limited to less than 1 million Canadian.

Of course, we cannot be happy with a cash-losing company, but keep in mind the past quarter was a ‘special’ quarter as the average head grade was much lower compared to the previous quarters. As the grade should increase again over the next few quarters, so will the operational cash flow on the back of the higher production rate. The weak Canadian Dollar is now working in Metanor’s favor, but the production rate will have to increase again to reach the free cash flow neutral/positive stage again. If we would reach a production rate of 10,000 ounces per quarter again in the next few quarters, Metanor Resources will very likely be able to generate quite a bit of free cash flow as our estimates would point in the direction of C$5M of free cash flow at a gold price of C$1575/oz.

But after Metanor’s most recent exploration update, our focus has shifted a bit from the production-story to the exploration story, as a recent IP-survey and follow-up drill program has uncovered a potential new game-changer.

A new exploration target might boost the company’s valuation again

As Metanor continued to explore on its rather extensive and promising land package, a new exploration target suddenly popped up on the company’s radar screen, and Metanor is now even so optimistic to call the Moroy target ‘the next gold mine’. This target was discovered through an IP-survey that was conducted below the tailings facility of the Bachelor Lake mine.

Fine, that’s an interesting description, but what exactly is this exploration target and what could it mean for the company’s total operations?

Moroy is located less than one kilometer away from the Bachelor Lake mine and this means it already ticks our first and second boxes. The first box is the proximity to the mill. As the IP-target identified a specific zone of interest very close to an existing, permitted and operating mill, Metanor Resources won’t have to figure anything out on the processing front, and the haulage distances will be negligible.

A second box is the proximity to the existing underground developments at the Bachelor Lake mine. As the Bachelor Lake shaft and the underground workings at the mine are also extremely closeby the Moroy zone, it would make a lot of sense to just push an exploration drift from the Bachelor Lake mine towards this new Moroy zone as it will be cheaper to conduct an underground drill program rather than continuing to drill holes from surface (as the sweet spot of the IP target is located approximately 600 meters below surface).

The discovery hole was already very interesting (with an intercept of almost 6 meters at 10 g/t gold) in hole 15-14, but we weren’t too excited just yet. And then we talked to the company’s management team at the past Cambridge House show in Vancouver. Metanor now has an exploration target of 500 meters by 570 meters (and the most aggressive expectations are now pointing in the direction of a 500 X 700 meter zone of interest), and is assuming an average width of 4 meters.

That’s roughly in line with the first exploration results at Moroy which returned for instance 6.6 meters (true width: 3.6 meters) of almost half an ounce (!) of gold per tonne of rock, as well as 10 meters at 5.4 g/t (with a true width of 8 meters!). These exploration results are very intriguing and as the higher grade mineralization seems to be starting close to surface, Metanor could still upgrade the current exploration target as the Moroy mineralization could be more widespread than originally thought.

If we would now base a rough exploration target based on a 500 X 600 X 4 meter target zone, this zone would contain 1.2 million cubic meters of ore. Using a density of 2.65 tonnes per cubic meter, we are talking about an exploration target of 3.2 million tonnes of rock. It’s of course way too early to discuss numbers, but if Moroy would have an average grade of 6 g/t, these 3.18M tonnes of rock would contain almost 600,000 ounces of gold.

Should the internal target of 500 X 700 meters be realized, this exploration target would increase to in excess of 700,000 ounces of gold. We compiled a table with different tonnages as well as average grades to give you a better idea of how sensitive the total amount of ounces is versus the total tonnage and average grade.

[table caption=”” colalign=”left|left|left|left|left”]
Tonnage/Grade;4 g/t; 5 g/t; 6 g/t; 8g/t
2.5Mt; 321,000; 401,000; 482,000; 643,000
3Mt; 386,000; 482,000; 579,000; 772,000
3.5Mt; 450,000; 563,000; 675,000; 900,000
4Mt; 515,000; 643,000; 772,000; 1.03Moz
5Mt; 643,000; 804,000; 965,000; 1.29Moz
[/table]

Again, these are just preliminary back of the envelope calculations and Metanor will have to spend quite a bit of cash to drill the mineralized system, but we just wanted to explain how interesting this target really is. 2016 will be a very important year for Metanor on the exploration front as the Moroy project has the potential to increase the mine life of Bachelor Lake quite substantially.

The deal with Sandstorm Gold

As you might remember, Metanor Resources has signed a deal with Sandstorm Gold (SSL.TO, SAND) whereby Sandstorm acquired a gold stream on the ounces produced at Bachelor Lake. According to the original agreement, Sandstorm is entitled to purchase 20% of the Bachelor Lake production rate at a fixed cost of US$500/oz.

Of course, the most important question on our minds was to know whether or not Sandstorm Gold would also be entitled to receive proceeds from any potential future production of the Moroy target. According to Metanor Resources’ management team, this is indeed the case, as Sandstorm would be entitled to 20% of the ounces that will be produced from ore zones within a 1.5 kilometer radius from the Bachelor Lake shaft.

Metanor Resources – Financial Update

If Moroy turns out to be what it looks like, Metanor could be a very interesting acquisition target

We would like to take a step back now and have a look at the bigger picture. Bachelor Lake by itself had a short mine life and the Barry project (which contains in excess of 780,000 ounces of gold) was too low grade to truck the ore from Barry to the Bachelor Lake mill.

This doesn’t mean the Barry project is worthless, not at all. The production stop only means the trucking distance was too far compared to the average grade of the Barry project, so the economics didn’t make any sense. But you should also keep in mind the production was ceased when gold was trading at C$1200/oz, whereas we’re closing in on C$1600 per ounce right now, so the economics of trucking the ore to Bachelor Lake could be looking much better.

This does NOT mean the economics of a new mill at the Barry project (or perhaps just a concentrator to upgrade the ore before trucking it to Bachelor Lake) will be negative as well, and we would actually expect Barry as a standalone project to be quite profitable as the grade is in excess of 1g/t and the weak Canadian Dollar is definitely providing a very nice tailwind for Metanor Resources.

Not only is this exciting for Metanor’s shareholders, we’re certain the developments on Metanor’s exploration front will also draw a lot of attention from other companies that are either active in the Abitibi greenstone belt or would be interested in gaining exposure to a safe region with proven gold production. Barry has the potential to be enormous and the new Moroy zone is now also shaping up to become a new source of high-grade underground material that could keep the Bachelor Lake mill up and running.

In any way, Metanor Resources now seems to be fully focusing on bringing a second asset into production to reduce its reliance on the Bachelor Lake mine. Barry seems to be the easiest solution as Metanor can simply truck the ore to the mill. But should Metanor find a decent average grade at Moroy, developing that zone could be more exciting.

Conclusion

Metanor Resources seems to be moving away from a pure production play towards an exciting exploration play supported by a pretty decent gold production at the Bachelor Lake mill. It will be important to indeed increase the average grade of the ore that will be processed at Bachelor Lake as it obviously doesn’t help anyone if the mine is losing cash.

Our first impressions of the new Moroy gold zone are quite positive, and the size of the IP hotspot might be even larger than what we were anticipating and the potential to discover at least half a million more ounces of gold is actually very realistic now. Metanor is now waiting for the ice bridge to be completed before it will go back in with some drill rigs to gather more information about this ‘area of interest’. After having closed a C$3.5M placement, Metanor can spend quite a bit of cash on defining how big Moroy could be.

Yes, the company has a lot of shares outstanding, but with an operating mill, an exciting exploration target at Bachelor Lake and almost 1 million ounces of gold at Barry (which is still open in most directions), the current market capitalization of C$17M (and enterprise value of around C$30M), Metanor is still very reasonably priced. And should Moroy confirm our expectations, there’s no reason why this stock couldn’t go back to a double-digit share price.

The author holds a long position in Metanor Resources. They are a sponsor of the website. Please read the disclaimer