Our New Investment is Kaiser Reef (ASX: KAU)

Disclosure: S3 Consortium Pty Ltd (the Company) and Associated Entities own 4,665,000 KAU shares and the Company’s staff own 35,000 KAU shares at the time of publishing this article. The Company has been engaged by KAU to share our commentary on the progress of our Investment in KAU over time.

We’ve been having a good run so far in 2024 - here are some of our best performers:

• SS1 - up 426% from our Initial Entry Price
• MTH - up 395% from our Initial Entry Price
• AL3 - up 158% from our Initial Entry Price
• EIQ - up 80% from our Initial Entry Price

Past performance is not and should not be taken as an indication of future performance. Caution should be exercised in assessing past performance. This product, like all other financial products, is subject to market forces and unpredictable events that may adversely affect future performance.

Today, we are announcing our latest Portfolio addition.

And it’s in gold...

This one is a bit different to the majority of the usual early stage gold stocks we have looked at on the ASX over the last year.

Which is why we like it.

So far our 2024 precious metals (gold and silver) Investments SS1 and MTH have both been up as high as ~500%.

(the past performance of SS1 and MTH is not an indicator of future performance)

Our new Portfolio addition is Kaiser Reef (ASX:KAU).

KAU is a gold producer (& explorer) in Victoria, Australia.

KAU is capped at ~$38M and will have ~$11M in cash after today’s capital raise announcement.

Meaning the company has an enterprise value of ~$27M.

Today we will be sharing our KAU Investment Memo including our Big Bet for the company and the associated risks we have identified and accepted.

We will share why we think KAU directly and immediately benefits from the surging gold price, why we believe KAU is undervalued and why we have decided to Invest at this point in time.

We first started looking at KAU about a year ago.

Then in March this year we went to visit the company’s operating gold processing plant in Maldon (and again a few weeks ago for an update on progress).

Earlier this month we also went underground at KAU’s operating mine (the A1 Gold Mine near Mansfield):

What became clear to us from both site visits was that KAU was approaching a transformational moment for the company (and its assets).

(perfectly timed with the strongest gold price in history)

KAU is about to mine parts of its A1 mine that have never been touched before - the first time in over 40 years that this has happened on this project.

With the gold price ticking up to new all time highs nearly every week this year, and with KAU operations where they are today, we are adding KAU to our Portfolio as our latest Investment.

11 Reasons why we are Invested in KAU

1. The gold price is surging

Gold is up almost 35% against the USD in 2024 making it one of the best performing commodities this year AND it is trading at all time highs against just about every currency in the world.

At the time of writing this, gold is at AUD ~$4,050 per ounce (US ~$2,700), up nearly 100% from 2021 lows (we track the gold price here).

2. KAU 100% owns the prolific, historical A1 gold mine in Victoria

Discovered in 1861, this mine has produced over 600,000 ounces - that’s ~$2.4 Billion worth of gold at today’s gold price.

The average grade was 25g/t gold which is extremely high grade (considering most mines today operate at ~1-2g/t of gold).

3. KAU 100% owns an operating gold processing plant

It's a 250,000 tonne per annum capacity plant within trucking distance of KAU’s operating A1 mine AND the Bendigo goldfields.

The plant means KAU is able to produce and sell gold to the market straight away.

It also means KAU holds a “hard to replace” bit of infrastructure that is valuable to pre-production gold companies nearby wanting to turn their projects into gold (and cash).

KAU recently spent ~$5M on plant upgrades which should improve gold recoveries.

4. KAU is already producing and selling gold

KAU is already producing and selling gold (and has been for the last few years) by mining the “remnant ore” in the A1 mine that was left over by old time miners who extracted the “easy to get to” high grade ore.

KAU is making around $23-30M revenue per year for the last two years, flirting with break even. A rising gold price means rising revenue for KAU by just doing what they are already doing.

5. High grade gold exploration upside

Drilling about to start at never before reached depths at the A1 mine.

KAU has already spent ~$23.5M in development and upgrade capital to reach, explore and start mining at these virgin, new depths that the old time miners were not able to access.

New higher grade ore discoveries means higher margins when processing.

6. KAU also 100% owns the Maldon Mine

The Maldon mine started operating in 1854, and has historically produced 2.1Moz ($8.5 Billion of gold at today’s gold price). The Maldon Mine contained Australia's highest grade gold mine (Nuggety Reef) which produced 301k ounces of gold at whopping grades of 187g/t gold. This project has been on care and maintenance since 2018 but we think any exploration success could bring the project back to life.

7. Processing plant only operating at ~20% capacity

KAU’s plant was originally built in the 1980s to bulk process lower grade ore from a different mine. This means that in the event of a new high grade discovery at the A1 mine and/or restart of the Maldon Mine, KAU can ramp up production immediately. With the extra capacity KAU could even “toll treat” ore from other nearby gold companies to make some extra revenue.

8. Visited all sites, spent time with management

We had been looking at KAU for over a year now. We visited the KAU’s projects in March and again in October, and spent time with management, board members and the plant and mine operations teams, and were impressed.

9. Unhedged gold producer

Some gold producers commit to sell future gold production at a fixed gold price - which means they do not benefit from rising gold prices (or suffer from falling prices).

KAU is NOT hedged, meaning the more the gold price goes up the better off KAU will be.

10. KAU has a $38M market cap which we think is well below the replacement cost of its assets.

We think KAU’s processing plant and its two gold projects (the operating A1 Mine & the Maldon Mine) are worth a lot more than $38M.

Our view is that just the processing plant on its own would cost more than KAU’s current market cap to replace.

11. Previous investors/owners have done all the heavy lifting for KAU

KAU’s assets have had years of work and tens of millions of dollars spent getting them to where they are today. KAU is now in a position to benefit from all that sunk capital.

Later in this note we list the potential risks we have identified and accepted with our Investment in KAU.

The above are the key reasons we are Invested in KAU, we are hoping a combination of these reasons help KAU achieve our Big Bet which is as follows:

Our KAU Big Bet:

“KAU re-rates to a market cap greater than $300M by increasing gold production at its A1 Mine and/or making new discoveries at either of its two gold projects (A1 or Maldon)”

NOTE: our “Big Bet” is what we HOPE the ultimate success scenario looks like for this particular Investment over the long term (3+ years). There is a lot of work to be done, many risks involved - just some of which we list in our KAU Investment Memo. Success will require a significant amount of luck. There is no guarantee that our Big Bet will ever come true

We have been talking a lot about silver and gold prices running for many months now.

AND how the larger cap gold producers are getting the most attention from the market during gold’s price rise...

The question we asked ourselves - which kind of small cap gold stock can perform the best when the gold price is running?

We think it's one that has material exploration upside AND an ability to produce and sell gold NOW while the gold price is at all time highs and continuing to rise.

KAU owns and is exploring for new high grade gold in some of Victoria’s most prolific historically producing gold mines...

In 2021, KAU acquired the A1 gold mine in Victoria, which has produced over 600,000oz of gold since its discovery in 1861, at an average grade of ~26g/t.

(600,000oz of gold is ~$2.4 Billion at today’s gold price)

For the last 30 years, mining at this project was “remnant mining” from areas that had already been mined out by the old time miners, who had extracted the “easiest to get to” high grade ore.

(KAU still manages to make $23-$30M revenue per year by mining these “leftovers” for gold, flirting with break even and profitability)

But for the first time in decades, KAU has reached deep parts of the project that have never been mined, where new, untouched high grade mineralisation could be found.

And they are just about to start mining and drilling there:

In KAU’s words from their Friday announcement “The best ore is now in-situ and not historically exploited”.

We saw the deepest parts of the A1 mine where the never before mined virgin ore is located and just about to be mined:

KAU also owns a fully permitted and operating gold processing plant and mining equipment.

(and the hard to replace experienced operations team)

... a complete gold processing plant in Victoria, which if built today, would cost 10’s of millions of dollars (we reckon KAU’s would cost about $60M) and take years to permit.

KAU is currently trucking ore from its A1 mine to the plant in Maldon where the ore gets processed turned into gold bars:

We saw two “gold pours” during our site visits in March and October this year.

So KAU can now produce from the never before mined parts of its A1 mine AND IF it makes a new high grade discovery, it can very quickly start mining, processing and selling the gold.

So no waiting for a mine license or permits.

No waiting for a JORC resource.

No waiting for a Scoping Study, PFS, DFS, BFS, or ‘Final Investment Decision’.

No waiting to secure project financing to build a mine and processing plant.

Straight into production at a time when the gold price is at all time highs and looking like it just wants to keep on moving upwards:

Price as at Saturday 19 Oct 2024. The past performance is not and should not be taken as an indication of future performance. Caution should be exercised in assessing past performance. This product, like all other financial products, is subject to market forces and unpredictable events that may adversely affect future performance.

The gold price hit new all time highs again last week on fears about the size of the growing US government debt, enough to catch mainstream financial media attention.

Here are some of the headlines from the last 72 hours:

A rising gold price is great news (and increased cash flow) for a gold producer like KAU.

KAU has mentioned on several occasions that the bulk of the company's costs are fixed - so any incremental increases in production, gold grades or the gold price should translate directly into more bottom line profits...

KAU’s processing plant capacity is 250,000 tonnes of ore per year - it is currently operating at only 20% to 30% capacity and processing lower grade remnant ore.

Millions of $ have already been spent optimising this processing plant.

(Millions of $ of sunk costs that we get to benefit from as new incoming Investors)

At the mine, after years of work and 10’s of millions of dollars of investment, KAU has finally completed a tunnel (in mining this is called a “decline”) to the depth where the old time miners couldn’t reach.

We drove all the way down:

And yes, constructing a deep underground tunnel like this is as expensive as it looks.

(this includes about 40 years of work by previous mine owners to get to this point)

This new depth is where we hope the historic high grades of gold will continue.

As we mentioned above we have been down and seen where KAU has recently reached these never before mined depths:

This is where the risk/reward sits with KAU - we are betting that they can hit a brand new high grade gold reef and can quickly mine and sell the gold.

If the grades are anything like the past (historically averaged ~25g/t gold production) then the mine could be a cash cow for KAU.

Even if they run at just 1/3rd of those grades, at current gold prices it will be game changing for KAU.

The risk is that the mining into the deeper levels disappoints with average or low grades compared to what has been historically mined there.

Everything we have written about so far is just one part of the KAU story.

KAU also has another project - much closer to its processing plant in Maldon.

The Maldon Mine, started operating in 1854, historically produced 2.1Moz at very high grades...

($8.5 Billion of gold at today’s gold price).

The Maldon Mine includes Australia's highest grade gold mine (Nuggety Reef) which produced 301,000 ounces of gold at grades of 187g/t of gold.

Here KAU also has a huge decline (tunnel) that could be accessed to mine any new discoveries.

IF KAU makes a new high grade discovery here - because of how close the project is to KAU’s plant - it could also be a game changer for the company.

KAU’s ground position here is massive and the project already has a 165k to 345k ounce gold exploration target.

We think the market has missed just how significant the exploration upside could be from this project.

Here is what the KAU story looks like on one map:

So with:

• The gold macro theme currently going in KAU’s favour - gold price at all time highs
• The significant investment to get the processing plant humming paid for by previous investors
• Access to the un-mined, deeper part of the A1 mine paid for by previous investors
• KAU share price not reflecting last few years of progress
• And, drilling the unmined deeper parts of the historical mine “imminent”

Today we are adding KAU to our Portfolio.

What we are betting on in the medium term is new high grade exploration drill hits, quick mining of any new discoveries and selling the gold while gold is at all time highs.

Leading to a gradual ramp up in production volumes AND material increases in revenue and profitability from processing new higher grade ore.

(and for the gold price to keep moving up, which nobody can control)

At the same time we also need to keep in mind the various risks related to an Investment like this - exploration risk, production risk, possible plant down time, cost overruns and commodity price risk (which we outline in more detail in our KAU Investment Memo at the end of this note).

Why is KAU only capped at ~$38M and been trading at sub 20c for the last few years?

KAU isn't the first company to hold this set of assets.

Previous owners have tried to use them to spin out as much cash as possible.

The issue has always been that the previous owners were always “chasing their tails”, so to speak.

The A1 mine hadn’t been developed to access the deepest levels where the old time miners HAD NOT yet pulled out all of the highest grade ore.

So the previous owners were just mining “remnant” ore leftover by the old timers.

The remnant ore is what it says it is - leftovers from previous owners.

Then in 2021, KAU took over the A1 Mine and for the next three years (up until now) was doing more of the same...the only difference is that KAU is doing it while the gold price has started running.

Aided by a higher gold price, KAU has been pouring back all of its cash into continuing development works - taking the A1 mine decline (tunnel) to never before mined depths, where more of the highest grade ore might be found.

It's no surprise KAU’s share price has been trading in a range - we think it's because any cash that was made just got reinvested into the project.

And in the final push down deeper to reach the virgin, unmined ground, revenue from mining remnant ore slowed down in favour of extending the decline deeper - market doesn't like slowing revenue...

But all of that reinvestment means KAU is now at the stage where all of that hard work can get repaid.

Here is a list of the key things that KAU has achieved in the last three years since 2021:

• The decline at A1 developed from level ~18 to where it is now at level 23.
• Now, it has reached a point where there has been no previous mining, meaning the best ore is in-situ and has never been touched before.
• Updated processing plant to increase production capacity and recoveries.
• Upgrade power and ventilation to improve production capacity at the A1 Mine.
• Ran multiple drill programs to confirm the continuity of gold mineralisation at the A1 Mine.

The past performance is not and should not be taken as an indication of future performance. Caution should be exercised in assessing past performance. This product, like all other financial products, is subject to market forces and unpredictable events that may adversely affect future performance.

So then why is KAU capped at only $38M (at the placement price)? And why has the share price been going sideways for a couple of years?

We think it could be because of all the time and past investment that was required to get the processing plant humming AND to build a tunnel (decline) down to the deeper, unmined levels of this historical high grade gold mine.

We also think that the market has probably treated KAU as needing to raise cash because the company was still a while away from accessing the never before mined parts of its A1 Mine.

(share prices will usually trade sideways or down if the market is expecting a capital raise)

Now after today’s completed cap raise, KAU has all the cash it needs to get the development work finished and to drill test for high grade extensions at depth.

Now with KAU having reached the “virgin” part of the mine we get to see whether or not the high grade gold systems (similar to the average 25g/t mined over the mine's 160 year life at the above levels) continues at depth.

We are Invested hoping that is the case...

Big thanks to previous investors who did all the heavy lifting to get here over the last 30 years (and the last 3 years while KAU has owned this project).

If KAU is able to get close to break-even mining the old remnant ore, our bet is that the virgin high grade ore can generate cashflow way above its current market cap.

KAU has no debt and no hedging in place...

Another reason we think KAU is highly leveraged to the running gold price:

KAU has no hedging in place right now.

For those who are unfamiliar with the term - hedging is when a company sells future production at current spot prices.

I.e someone sells 50k ounces of gold at today’s prices and promises to deliver them to the buyer depending on the terms of their agreement.

For gold miners it’s a way to get certainty on revenues and lock in high prices - but historically hedging has hurt gold miners - usually they end up delivering the gold when the spot prices are much higher.

Usually costs of mining have gone up as well due to inflation and those extra revenues become extremely valuable to miners.

KAU is currently completely unhedged, meaning any of the production it is able to squeeze out will be sold at CURRENT spot prices.

That means KAU is fully leveraged to the rising gold price (assuming it continues rallying of course).

For bigger companies we don't mind seeing some hedging as it helps smooth out revenues, but for a small cap like KAU, we like that the company has full exposure to the rising gold price.

(even though it can be risky... with small caps that risk taking can make or break a company).

Second, KAU has no debt, meaning it has capacity to borrow and accelerate production (if it makes new discoveries) AND doesn't need to make any debt repayment dates meaning it can be more flexible with its cash.

Debt is usually a widow maker for companies ramping up production - so in KAU’s case we like that the company is going into a transformational catalyst with a clean balance sheet.

Our KAU Investment Memo

What does KAU do?

Kaiser Reef (ASX:KAU) is a high-grade gold producer and explorer located in Victoria, Australia.

What is the macro theme?

Gold is a precious metal that is often used as a hedge against inflation, which remains persistently high, and the gold price is trading at all-time highs at the time of this memo.

Our KAU Big Bet:

“KAU re-rates to a market cap greater than $300M by increasing gold production at its A1 Mine and/or making new discoveries at either of its two gold projects (A1 or Maldon)”

NOTE: our “Big Bet” is what we HOPE the ultimate success scenario looks like for this particular Investment over the long term (3+ years). There is a lot of work to be done, many risks involved - just some of which we list in our KAU Investment Memo. Success will require a significant amount of luck. There is no guarantee that our Big Bet will ever come true

Why did we Invest in KAU?

1. The gold price is surging
2. KAU 100% owns the prolific, historical A1 gold mine in Victoria
3. KAU 100% owns an operating gold processing plant
4. KAU is already producing and selling gold
5. High grade gold exploration upside
6. KAU also 100% owns the Maldon Mine
7. Processing plant only operating at ~20% capacity
8. Visited all sites, spent time with management
9. Unhedged gold producer
10. KAU has a $38M market cap which we think is well below the replacement cost of its assets
11. Previous investors/owners have done all the heavy lifting for KAU -

What do we expect KAU to deliver?

Objective #1: Make new high grade discoveries at the A1 Mine

• We want to see KAU drill out the never tested sections of the A1 mine and make high new grade discoveries

Milestones
🔲Drilling commences

🔲Drilling results

Objective #2: Increase production from A1 Mine

• We want to see KAU mine out the never before touched sections of the A1 gold mine.

Milestones
🔲Decline construction progresses

🔲Mining of virgin ground commence

🔲Increased average gold grade processed

Objective #3: Make new discoveries at the Maldon project

• We want to see KAU make new discoveries and add to its JORC resource at Maldon, which currently sits at 1.2Mt @4.4g/t gold for ~186K ounces of gold. KAU has a current exploration target of ~165K and 345K ounces of gold.

Milestones
🔲Drilling commences

🔲Drilling results

🔲Resources justify bringing the project back online

Objective #4: Increase capacity utilisation at its processing plant

• KAU’s processing plant is currently operating at 20-30% capacity, we want to see the company increase this either from its own projects or through toll treating deals on other assets.

Milestones

🔲Incrementally increase tailings capacity by 200K tonnes and then 1.8M tonnes.

🔲Organically increase production

🔲Toll treating deals

🔲M&A of new ounces

What could go wrong?

Production Risk

The ability of the KAU to achieve production targets or meet operating and capital expenditure estimates on a timely basis cannot be assured. As a producer, KAU is subject to risks such as but not limited to, labour costs and availability, energy prices as well as KAU’s internal ability to forecast costs like these and budget effectively.

Commodity Price Risk

The performance of commodity stocks are often closely linked to the value of the underlying commodities they are seeking to extract. Should the gold price fall, this could hurt the KAU share price.

Exploration risk

There is no guarantee that KAU’s upcoming drill programs are successful and KAU may fail to find economic silver-gold deposits.

Funding risk/dilution risk

As a small cap, KAU is reliant on capital markets to advance its projects. If something negative happens at a macro or company level, KAU could struggle to access capital on favourable terms. These capital raises may take place at a discount, and result in the issuance of new shares which incur dilution to existing shareholders.

Market risk

There is always the possibility that broader market sentiment gets worse and shares as a whole trade lower, taking KAU’s share price with it. Alternatively, there could be further sector specific pain ahead where junior explorers suffer a lot more than the broader market.

Development/delay risk

Should any or all of the above risks materialise, KAU could wind up stuck in “development purgatory” where newsflow dries up and the project remains stagnant for a prolonged period of time, hurting the share price. Additionally, if delays occur in terms of material newsflow, the market could turn on KAU.

Investment Plan

We are Invested in KAU to see it expand its production and bring the A1 Gold Mine back into production.

Our plan is to hold the majority of our position in KAU for 3 to 5 years which we hope is enough time to see KAU materially increase gold production (see “our long term bet” above).

After 12 months we will apply our standard de-risking strategy.

We may look to sell up to 20% of our holding if the company delivers on one or more of our Investment Memo objectives and/or the share price materially re-rates.

Any sell downs will be in accordance with our trading and hold policy disclosure.