A comprehensive guide to the stages of mining company development

In Part 1 of this two-part educational series, we discussed how investors interpret important information regarding a mining company’s resources and reserves, as well as its drilling results.

In this part, I’ll expand the analysis with a clear walk through of each step a mining company must take in its journey from exploration to production. I’ll also look at the most common way companies portray the value of their projects, and close by showing you several tips you can use to ensure you don’t get caught out by a mining company's capital raising.

Let’s dive in!

Stages of Development

• Kicking over rocks in the desert! I.e., the preliminary exploration stage where a company is trying to understand what might be in the ground. You will hear terms like "rock-chip sampling", "geochemical surveys", "geophysical surveys" which could be "airborne", seismic", "electromagnetic (EM)", "gravity", etc. It's all very early stage activities in the broader context of the journey from exploration to production.

• Drilling - If you think you've kicked over enough of the right rocks, you want to start drilling so you can see what's actually in the ground. You'll want to get the drill cores "assayed" to check the chemical composition of the relevant rocks - that's going to give you an idea of your grades and intercepts, and ultimately the economic value of your project.

• "Pre-Feasibility Study" ("PFS") - You're pretty sure you've got something in the ground by now, so you'll take this first step towards understanding the economics of your deposit. Is it worth getting what you've probably got in the ground out of the ground? Here you'll do detailed analysis on costs, production estimates, methods of processing, etc.

• "Definitive Feasibility Study" ("DFS") - You intend to go to a mine and production. You will determine very specific processing methods and mine engineering, as well as forecasts for mine life and a production profile, and very specific project economics. Super detail oriented here.

• "Bankable Feasibility Study" ("BFS") - Often there's some overlap between the DFS and the BFS with respect to project economics, but it's this aspect which the BFS is specifically focused upon. This is the document you'll need to take to your shareholders or bankers to get the funding required to turn your deposit into a producing mine. Project economics will include calculation of a "Net Present Value" ("NPV").

• Funding - Pass the hat around, because you'll need to raise enough cash to pay for the construction of your mine, as well as keeping the business ticking over until first production occurs. Fully-funded projects are obviously more likely to get into production, and therefore are more valuable.

• "Front-End Engineering and Design" ("FEED") - Due diligence for mine construction, plenty of flow diagrams, drawings, and layouts. This is the stuff you need to do if you want to build an efficient and cost effective mine. You might also hear words like "procuring long lead time items" which just means ordering important equipment and materials early enough to ensure they're ready for the next step…

• Mine construction - As the name suggests, it's time to build the mine. A typical build may generally take around 12-months, but this can vary significantly with the scale and complexity of a project.

• Production - This is the most exciting part of this very long process! It's where you

  dig up your ore and send it to…

• Processing - Many companies will look to process their ore into a product which is more marketable/valuable in the commodity's supply chain. Project economics tend to be better if production and processing occur at the same site.

Valuation/Net Present Value

• As mentioned above, this bit is often done at the DFS or BFS stage.

• NPV represents the total value of a project in today's dollars by assessing all of its future cashflows, and then discounting them back to a present value based upon a specified discount rate.

• NPV's are a great tool for comparing the potential value of a project, and for comparing the relative value of projects of different companies.

• I like to compare the NPV of a company's project to its current market capitalisation to get an idea of how much of a project's potential is already reflected in the company's price. Note: There are many (many, many!) factors which can cause a company's market capitalisation to be significantly less than its NPV, but, as a very general rule of thumb, as a company progresses through the various stages of development, its market capitalisation and project NPV should converge. (Assumes a one-project company).

• To estimate cashflows, one needs to estimate both costs and revenues.

• With respect to revenues, a good NPV should take into account the value of the project based upon several scenarios of mineral pricing. Minerals prices are volatile, and you should consider the price of the mineral used in a NPV calculation might be very different from the present price, and from the price when production eventually commences. An NPV could be worthless if it assumes a very high price of the mineral in question compared to the price expected at production.

• With respect to costs, you'll want to look at the project's "All-in Sustaining Cost" ("AISC"). This is a standardised measure for per-unit (e.g., an ounce for gold, or a pound for uranium) costs which includes various costs of production incurred over the life of a mine. AISC's are standardised across industries, so try to compare one company's AISC to another. Obviously, lower is better!

• The higher the discount rate, the more punitive the discounting of a project's cashflows back to a present value (i.e., a higher discount rate equals a stricter/more conservative NPV calculation). So, you have to compare NPVs based upon a common discount rate or make an adjustment to compensate.

Cash is King!

• Most exploration and development stage mining companies are "burning cash". This is the term commonly used to describe a company whose operating cash receipts are less than its operating cash expenses. It makes sense these companies tend to burn cash because they're not yet in production.

• As a company's cash reserves dwindle, they are more likely to go to existing shareholders (and potentially the broader market) to raise more capital. The cheapest way to do this is by issuing new shares. This is because smaller, cash burning mining companies usually have to pay a high price for debt at the bank. Selling new shares in the company is therefore a much quicker, easier, and cheaper way of accessing new working capital.

• Equity capital raisings may be required to be priced at a discount to the current share price to ensure sufficient demand to raise the desired amount of capital. Steep discounts typically trigger a fall in the share price and can hurt existing shareholders. So it's important to know when a mining company is prone to raising capital.

• Keep an eye out for your mining company's "Quarterly Cashflow Report", otherwise known as an "Appendix 4C" if you're scanning its ASX announcements.

• Section 1 is the "Cash flows from operating activities". Check here for a company's cash burn at the bottom of this section under the heading "Net cash from / (used in) operating activities". Then compare this value to how much cash the company has left in the kitty in Section 5. These two values should tell how many quarters of funding a company has remaining before they run out of cash.

• If you can't do the maths, Section 8 does it for you, and, if the company has fewer than 2 quarters cash available, it must specify how it intends to rectify the situation.

• You can get an idea of a company's cash burn "run rate" by checking the "Year to date" burn, or by checking previous Quarterly Cashflow statements.

• Typically, I start to get nervous about an imminent capital raise when a company has less than a year's funding remaining.

Start analysing those mining company announcements!

Remember, mining companies want to portray their results in the best possible light. This will draw attention to their cause, hopefully boost their share price, and make it easier to raise the vital capital required to progress their activities - whichever stage they might be at. 

It's important to be able to sort the jargon and hype from reality, and to compare one company's announcement to another's. With this in mind, I hope you're now in a substantially better position to read that ASX announcement which just popped up for your favourite mining company!

Related Article: How to interpret mining company resources, reserves, and drilling results