The Shoeshine Column: Otter struggles to stay afloat as gold price sinks

Thursday 22nd March 2001

Back in November 1997 Normandy Mining chief Robert Champion de Crespigny told Shoeshine gold mining had a bright future. Sure, the spot price had plunged from $US406 an ounce to around $US330, de Crespigny conceded. But it would be back at $US400 soon, maybe not next year, but in the foreseeable future.

After all, he claimed, if every Chinese person on earth bought just one gold earring the gold price would be $US800.

Two and a half years later his words have proved less than prophetic. The Chinese population apparently remains stubbornly unadorned and gold closed on Monday at $US260 an ounce.

So Otter Gold's $11.6 million December first-half loss hardly seems surprising at first glance.

As its report noted, all three of its mines performed significantly below budget in the December quarter, each for a different reason.

The first-half loss wipes out the $11.7 million it raised in a rights issue only last October and the company is again in need of funds. It says it hasn't decided yet what to do but in the meantime it has arranged with Macquarie Bank an additional $2.4 million of short-term debt and a deferral of the March and June interest payments of $1.8 million each on its existing bank debt, which stood at $62 million on June 30 last year.

Given shareholders' funds at the half-year were $43 million the situation doesn't yet look perilous.

What's more, fellow miner Goldfields is riding to the rescue. It's negotiating to buy Otter's 58%-owned subsidiary Allstate Explorations out of the Beaconsfield project in Tasmania.

If the deal goes through Otter will be repaid the $25 million-odd it has lent to Allstate and will presumably use it to retire some of its own debt. Its stake in the cashed-up Allstate will be worth around $3.5 million. Its share of claims against the Beaconsfield contractor could be worth a further $6.5 million, against which must be set "associated costs which may be substantial."

But at the operating level Otter's figures bear further scrutiny. It appears no longer to have its financial nostrils above water.

Before accounting for a huge Allstate writedown and for tax, the company lost $3.7 million, compared with a $3.6 million gain in the December 1999 first half.

Why such a big turnaround?

The operating results include, for the first time, an equity contribution (Otter's share) of 10,477 ounces from Beaconsfield. That took total production to 65,493oz, up 10% on a year earlier.

Taking out Beaconsfield, the other mines in which Otter has an interest - Martha Hill near Waihi and Tanami in the Northern Territory - produced an equity contribution of 55,016oz, 7.7% down on last year's 59,643oz.

That hardly seems disastrous. Yet Otter's report suggests both mines have been hit heavily by local conditions.

In Tanami's case heavy rainfall cut the mine off in December. The deluge has apparently carried on in 2001.

But in the previous half-year the mine was cut off for 10 weeks and Otter still managed to turn a profit.

A more likely candidate is Waihi. In the 1999 year Otter completed an expansion programme of pit cutbacks and commissioned an upgraded conveyor/crusher system.

In the October annual report Otter triumphantly forecast a big lift in gold and silver recovery. That hasn't happened. The half-year report laconically blames "lower-grade ore from the expanded pit cut-back" for below-forecast production.

But even Waihi's woes aren't enough to account for the operating loss.

Shoeshine suspects the answer lies in the continued decline of the gold price.

Otter is lucky enough to be one of the lowest-cost producers in Australasia.

In the December half-year its average cash operating cost for digging up each ounce of gold was $558. Gold's average spot price was $644 and the company's hedge cover bumped its average sale price up to $678.

But on top of a gold miner's cash costs come its projects' financing, depreciation and amortisation costs, so a company can still make a loss even when its cash cost is lower than its average sales price.

Hedges provide - well, a hedge. But hedge contracts expire and have to be replaced at the current spot price. And the spot gold price has been in steady decline for five years. In short, gold miners' hedge cupboards must be almost bare.

What's more, miners have been shielded from the worst effects of the gold-price decline by the drop in the Australian and New Zealand dollars against the US dollar, in which gold sales are denominated. Now the currencies seem to have turned the corner.

So the fact Otter has gone into the red despite substantially higher production and relatively low cash costs seems ominous.

Shareholders pondering what to make of all this should watch for the attitude adopted by their biggest fellow-holder, Guinness Peat Group.

GPG appeared in August 1999. As underwriter it took up most of last year's rights issue and now owns 44%.

It's a value investor and must have thought Otter's assets and prospects were significantly undervalued by the market.

Now it seems not so sure.

If GPG thinks Otter's financing and the apparent profitability problems at Waihi and Tanami can be sorted out - and that the gold price will go into an uptrend in the near future - then now seems as good a time as any for it to take control, or even 100%.

After all, at the market price of 31c it could buy the rest of Otter for a piffling $14.5 million.

Without a(nother) gesture of confidence from the biggest stakeholder other holders might want to consider whether their money would be more usefully employed elsewhere.

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