After a discovery, the key deliverable of a mineral exploration play is a positive feasibility study.
Up until then, all the drilling, testing, and other work can be encouraging, but it doesn’t provide a clear read on the most basic question: “What—if anything—is this worth?”
Given a boatload of assumptions applied to drill results, one can make a wild-a** guess about valuation. But really, anything more detailed than “this looks potentially economic,” or “this doesn’t look economic,” can’t be supported by such data.
Even with an official, 43-101-compliant resource estimate, it’s still guessing when we say what a deposit might be worth. A single factor—like an unknown metallurgical issue or an undetected source of heavy water flow—can make a project that looks like it should gush cash totally uneconomic.
That’s why we do feasibility studies before building mines—or at least, responsible companies following industry best practices do.
This starts with a preliminary economic assessment (PEA). For historic reasons, this is commonly called a “scoping study” in Australia. As the Aussie name suggests, a PEA can’t be relied on for accuracy—it just gives us an idea of the scope and potential profitability of a project. It will be chock full of assumptions about commodity prices, recovery rates, energy costs, and more. If management is smart, they’ll use conservative assumptions so the value and returns don’t plunge upon closer study.
Still, if done well, a PEA can give us a reasonable ballpark guesstimate to answer the “What’s it worth?” question.
A PEA is usually followed by a pre-feasibility study (PFS), and then a full feasibility study (FS).
You’ll see a FS sometimes called a bankable feasibility study (BFS) or a definitive feasibility study (DFS) or other variations. They’re all the same, just a different choice of words.
A PFS is a thorough engineering study based on specific project parameters. It gives us more detailed estimates of costs and returns based on an actual mine plan and process design. It still includes placeholder values, however, as prices of materials, energy, equipment, and services change a lot between a preliminary study and a construction decision.
A PFS is much more specific than a PEA, and should provide a more realistic idea of what a project might be worth.
By the time one gets to a full FS, more time has passed and there’s more data, but the key difference is that a FS includes actual cost figures quoted from the specific equipment suppliers, energy sources, construction companies, contract miners, and such that would be used to build the mine. That said, no matter how detailed a study, it’s still just a study—not reality. Even if all cost figures prove to be 100% accurate, commodity prices always fluctuate. That means that even in a full FS, the value and return figures remain estimates. They can and should be used to hold management accountable for the reality once a mine is built and in operation, but they should not be taken as gospel.
Any of these types of studies provide investors with a lot of data to chew on—so much that most non-engineers find them to be a great remedy for insomnia. I don’t want to dismiss the importance of all that work, but to keep things easier to digest, there are two key figures:
- Net present value (NPV). This is a discounted cash-flow number. The discount is often 5% in safer mining jurisdictions and can be 7%, 8%, or even 10% in riskier places. That’s appropriate—and watching for inappropriate discount rates is smart. NPVs are often given pre-tax and after-tax. I always look for the after-tax number when making a comparison to a company’s market valuation.
- Internal rate of return (IRR). This is a return-on-investment figure that accounts for the discount rate applied to the NPV. Generally, it takes at least a 15% IRR to get bank financing for a project. That makes anything above 20% good. Above 30% counts as robust. Above 40% starts to get harder to believe, unless there’s some exceptional circumstance.
Key points to keep in mind:
- By Canadian 43-101 regs, a PEA can include Inferred resources, but a PFS or FS cannot. Some companies will do multiple PEAs rather than advance to higher levels of study for this reason; they can keep including Inferred resources and not have to spend a bundle drilling them off to higher confidence categories.
- A PFS can’t use Inferred resources, so it’s based on the higher-confidence Measured and Indicated (M&I) categories.
- It’s the publication of a full FS that converts M&I resources into Proven and Probable (P&P) mine reserves.
- In the US, there are no 43-101 resources. You either have P&P mine reserves, or you have nothing. In Australia, there are JORC resources similar to Canadian 43-101 resources.
- It’s common for both the NPV and IRR of a project to decline from PEA to PFS to FS. That doesn’t necessarily mean management was gilding the lily early on, though I’m sure that happens a lot. Remember that any Inferred ounces included in a PEA that don’t get drilled off to M&I standards get cut from the mine plan at the PFS level. Time also passes between PEA, PFS, and FS—and costs (almost) always go up over time.
- Very small projects often yield incredibly high IRR numbers. This is because the initial capital expenditure (capex) is small, making it easier to get high returns. However, the NPV is also small. What’s “small?” Anything less than the equivalent of 100,000 ounces of gold per year is small, and anything less than 50,000 is very small. Generally, small mines are subject to many of the same permitting problems and unwelcome surprises as large mining projects, but don’t pay as much. This is why industry veterans often pass over small projects; they fail the “go big or go home” test.
- Megaprojects tend to have lower IRRs. That’s because of their size and the higher capex needed to build them—often several billion dollars. However, the biggest miners that have been around for decades don’t have much trouble arranging financing for such projects, so the 15% minimum IRR doesn’t apply. I’m not aware of another minimum used for such projects, but I can’t remember seeing one built that had less than a 10% IRR.
- PEA, PFS, FS—none of these studies age well. If a study doesn’t result in the project promptly moving ahead, investors should beware. In the first place, if the project is as good as the study suggests, why was the company unable to advance? In the second place, contractors may become unavailable, engineering firms can get booked by others, equipment can become unavailable, and there’s always inflation. There’s no accepted rule on this, but as a speculator, I’m generally okay with a study published within the last year. If it’s two years or older—especially if it’s a FS—it should be updated.
- Metal/commodity price assumptions are—obviously—critical. A trailing three-year average price is commonly used. In a rising price environment, this is a reasonably conservative figure for most projects a junior miner might build. For long-lived projects of the sort majors might build (some mines last 30, 50, or even 100 years), I'd argue for a much longer-term average price. But watch out; in a bear market a trailing price average results in a price assumption that's higher than the current spot market price. I never bet on a project that needs current spot prices—let alone higher. Generally, the more conservative the price assumption, the more confident I am about a study's results. A project that has a great IRR well below current price levels commands my attention.
- There are many other key figures to look for in feasibility studies, including recovery rates, cash and “all-in” sustaining costs (AISC). For me, the most important one after NPV and IRR is payback. That’s the number of years it will take the mine to deliver enough cash to pay for its construction. Because commodities prices fluctuate so much—and costs always rise—the longer the payback, the weaker the value proposition. Anything less than two years is good. One year is exceptional. Three years isn’t too bad, but it’s pushing it. More than that and it becomes a reason for me not to invest. I think project financiers think similarly, which is why we often see projects that look profitable but have long payback times fail to raise the money needed to go into production.
- Because even a full feasibility study provides only an estimate, it’s appropriate to discount an NPV when evaluating a company. Yes, the NPV has a discount already built in, but getting from a discovery to profitable production is notoriously difficult. Unless we know that a project is already bigger and better than shown in its FS, a development company with a market valuation equal to the NPV is overpriced. An exploration company getting fully valued for an NPV in a PFS or PEA is way overvalued. I want a discount to NPV to present me with a compelling case for capital gains… or I look elsewhere. What’s compelling? A 50% discount is enough in a fully funded, permitted project in a good mining jurisdiction. The more warts on the project and the riskier the jurisdiction, the deeper the discount it takes to interest me.
As always, the devil is in the details, but these are my main considerations when I review economic analyses of mining projects I’m thinking of speculating on.
You can think of them as a sort of cheat sheet to help you evaluate company press releases on their feasibility studies—or references to past studies in corporate presentations.
One more thing: all of this relates to economic feasibility—not political. That’s a whole ‘nother can o’ worms I won’t get into today. Suffice it to say for now that the NPV and IRR don’t matter if a project is stuck in Permitting Hell and is unlikely to ever get built.
That’s my take,
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