1. Introduction

After doing the pretty interesting interview with my Dutch fellow countryman Kees Dekker, it is time to show several examples of his analyst reports. The first one is a critical analysis of a new junior gold producer, Atlantic Gold Corporation. This company was actually one of my favorite holdings for a long time, despite this I no longer have it in my portfolio it as I view it to be fair valued since Q2, 2018. The basis for this article is an analysis privately made by Kees, and after I got to read this report it seemed interesting to me to contact Atlantic Gold management, in order to see if they would be so cooperating to provide constructive feedback.

Fortunately they did, and the result is an analysis with several rounds of feedback by both Atlantic and Kees. Yours truly also added several questions and remarks here and there, as I love doing this anyway, but also in an attempt to provide more reference, additional questions for Atlantic for eventual further due diligence, and get things more clear for myself and the audience. This is the full-length article including feedback and without index, if you have an interest in obtaining the report of Kees without feedback and with index, but also when you want to contact Kees directly, you can contact me through my own website www.criticalinvestor.eu, see menu Contact.

All presented charts are provided by Kees Dekker, unless stated otherwise.

All pictures are company material, unless stated otherwise.

2. Executive Summary

Atlantic Gold Corporation ("Atlantic Gold") (TSX-V:AGB) is a Canadian gold mining company, which has a number of projects in Nova Scotia, Canada, together referred to as the Moose River project.  After acquiring in August 2014 the first two of these projects, Touquoy and Cochrane Hill, it rapidly proceeded to acquire two more projects, Beaver Dam and Fifteen Mile Stream, close to Touquoy.  The combined projects had sufficient critical mass to be developed to a mine and construction at Touquoy was given the go-ahead mid 2016.   Commercial production was reached on 1 March 2018, which was within budget and on time.

The market has greatly rewarded Atlantic Gold’s performance by five-folding the share price since February 2016.

This study has had great problems with reviewing the business plan to determine whether the share price performance and current capitalisation are properly underpinned by the intrinsic values of the projects.  The 2018 technical report, which purports to substantiate the merits of the Moose River project, is basically a cobbling together of two reports.

Atlantic Gold commentary: This is not correct. The recent report published in 2018 supports the disclosure of new Mineral Resources and Mineral Reserves Fifteen Mile Stream and Cochrane Hill underpinned by new drilling, resource models, metallurgical testwork, operating costs, pit designs, plant design, and all other modifying factors that must be considered when assessing economic viability.

The first study, completed in 2015, is about production starting from Touquoy and the adjacent Beaver Dam deposits (referred to as Phase 1).  The other part of the report deals with production from 2021 onwards from Fifteen Mile Stream, followed by Cochrane Hill (referred to as Phase 2 Expansion).  The cobbling-together approach to the combined study report is evident from Phase 1 parameters not having been updated, even including the forecast capital expenditure in 2016 and 2017.

Atlantic Gold commentary: We stated in the technical report that we would update the numbers once we had 12 months operating data.

Response Kees Dekker (KD): It still makes for mixing outdated information into a new study.

The cash flow report refers to Year 1, Year 2, etc., rather than giving actual calendar years.

Atlantic Gold commentary: Please refer to the detailed explanations relative to NI 43-101. (TCI: Atlantic provided a detailed document confirming they did comply with regulations).

Response KD: I am confident that you fully adhered to NI.43-101 regulations, otherwise you would not have been allowed to published. However, if the purpose of technical reports is to fully inform the reader, one should include a lot more. The limitations of NI 43-101 requirements are for example evident by the gross majority of producers being able to consistently publishing “reserves” yet rarely able to pay dividends. Basically the mines/projects at best sustain themselves most of the time. Often shareholders need to chip in to keep the companies afloat.

Atlantic Gold commentary: The company is generating substantial free cash flow.

TCI commentary: I have to admit that actual capex could have been updated in this combined report, with opex pending for the first full year of production. Using one quarter of opex figures of a ramping up mine was not helping anyone in my view, so it made sense to wait for a full first year of production data.

The review of the report raises a number of concerns, such as:

• The grade of estimated resources is heavily influenced by only a few high-grade to very high-grade composite values. These have not been capped, or their influence on the grade of surrounding blocks limited. The average grade of the two Touquoy deposits planned to be mined first is better supported by many assays and less affected by a few high-grade values. Any plant feed grade problems may therefore only become apparent in future.  In this respect early indications of problems with are the actual feed grade in 2018.  This has been 1.35 g/t for the first six months and lower at 1.28 g/t in the June quarter. The milled grade is exactly as forecast at 1.35 g/t for the full year. However, of ore mined 49% was stockpiled at a grade of 0.51 g/t (see MD&A Q2 2018), which is much lower than the planned 0.78 g/t Au.  When back calculating, this indicates that the average grade mined was 0.96 g/t Au, which is far below planned mined grade of 1.30 g/t Au for the full 2018 year as is shown in the table below.

Atlantic Gold commentary: The lower grade in H1 2018 was due to the mine having to modify its working sequence because of the removal of historic tailings that required removal procedures to be approved by the provincial regulators.

Response KD: The explanation by Atlantic Gold management that the lower grade was due to the mine having to modify the working sequence, because of the removal of historic tailings does not explain the lower grade, at best the fact that equipment had to be used for tailings removal and not available for mining or and waste and the lower the planned strip ratio.

TCI Commentary: The company tried to explain this in the MD&A of Q2, 2018:

"During the first half of 2018, a total of 1,852,353 tonnes of ore were mined, at a waste to ore ratio of 0.85:1 with a total of 3,421,473 tonnes of material moved. Approximately 49% of the ore mined in the first half of 2018 was stockpiled as low and medium-grade material which will be readily available for processing later in the mine life. This material was assumed to be waste in the 2015 Feasibility Study. Waste material was used to build the Tailings Management Facility (“TMF”) and the waste dump with its ditches and water collection area."

Wrongly assuming waste to this degree is worrying in my view. The chances of mis-categorizing ore as waste and vice versa seem significant when using the uncapped high-grades with a large search radius to influence neighbouring block grades. These high grades have a nugget component of 80% of the grade. Therefore the risks of much lower average grade than forecast are real, and I am really wondering if they can mine as selectively as they say.

Response KD: How can moving tailings have anything to do with the grade of ore mined?  Refer to the table above; noticeable is that they have mined much less waste than planned, probably to be able to hit ore mining harder (twice planned rate!) to get sufficient higher grade blocks to achieve planned mill grade.  This points to them having grade trouble, I have no doubt about that.

Atlantic Gold commentary: It should be noted that the 2015 FS did not include a stockpiling strategy, which was developed in 2017 to consider both pit discard and economic cut-off grades based on known costs. Grade control drilling on a 5 m x 5 m pattern is used for ore/waste definition not the resource model. For the year to date grade control model to mill reconciliation is within 1%. Reconciliation is done to bullion. On selectively, the author offers an opinion not facts.

• The plant feed grade assumes very low unplanned dilution, whereas the chosen small selective mining unit (“SMU”) introduces much risk of such unplanned dilution.
• The pit designs have been based on pit shells that are very sensitive to small changes in input parameters. At the current gold price they are certainly sized too large, irrespective of the risk of underestimating operating cost (see more on this below).
• The production schedule assumes that stockpiling is such that material can be reclaimed with much higher grade than the average grade. It is very doubtful this can be achieved without much additional grade control effort and expense.
• This study shows that the mining cost suggested by Atlantic Gold is much lower than actual cost at the much larger Detour operation with a simpler mining process and using much larger mining equipment and much lower than the Canadian Malartic operation in H1 of 2018 based on reported figures. Moreover, initial actual Q2 2018 operating unit costs are clearly higher than forecast for Touquoy.

Atlantic Gold commentary: Comparing the mining costs at Detour with Moose River is like comparing apples with pineapples. Detour is by no stretch of the imagination a simpler operation despite the higher mining rate. Also, Detour has higher fuel costs, longer haulage distance and much higher labour costs due to the FIFO nature of their operations. Mining costs at MRC are well-known since Atlantic has the benefit of more than two years of operating data.  Mining cost/t is a bit lower than the PFS, G&A/Processing is a bit higher due to above expected maintenance, but the company is actively working on a large number of tweaks and improvements. The Feasibility study has $9.00 to $10.00/tonne processing cost. We expect the costs to vary between $10.00 and $12.15 depending on the maintenance required. Higher costs are mostly on maintenance while we make tweaks to the crushing circuit and also labour costs because we are building capacity and capabilities for the other projects.

• Atlantic Gold suggests that the operating cost at Phase 2 operations, which are at some distance from Touquoy and require extra handling and transport cost, are lower than for Touquoy. This is not sufficiently substantiated and deemed not credible.
  • Incorporated “Hydrofloat” technology allowing larger grind size thus reducing grinding costs.
  • Reduced reagent costs compared to Touquoy.
  • Transportation costs significantly reduced due to transporting concentrate vs. run of mine ore.
  • Optimization of personnel across projects.
• The business plan looks very much a paper exercise and is not practical as the graph below illustrates.

The planned expansion is for tripling of plant throughput.

• Theoretically this schedule is achievable, but it is a very inefficient approach with the company having to use contract miners, alternatively staff and equip up for a few years, to retrench and dispose of the equipment soon thereafter. The schedule should be seen as impractical.
• The business plan looks even less practical when considering the forecast cash flow using the gold price of US$1,199/oz and exchange rate of C$1.29/US$ at 3 October 2018 shown in the diagram below.

The above graph shows that the company’s financial performance is totally dominated by having to ensure it has the required funding to develop first Fifteen Mile Stream and a year later Cochrane Hill.  Once constructed the Moose Rover project has five years life left should it not be very successful in identifying additional reserves.

At the share price of C$1.59 on 3 October Atlantic Gold has a market capitalisation of C$376 million.  When accounting for dilution and net current assets, but ignoring the effect of loan servicing because the cash flow model has accounted for this, an Enterprise Value of C$370 million (US$287 million) is derived.  This is almost 40% higher than the net present value of the cash flow model, which is C$266 million for a discount rate of 7.5%.  This value was derived assuming that the very low operating cost rates proposed by Atlantic Gold are valid.

3. Conclusion

In conclusion, this valuation points to Atlantic Gold being heavily overvalued, irrespective of the many concerns.  Overvaluation of producing gold companies is a feature of the equity markets.  That is why this report emphasises not the overvaluation, but the concerns about the business plan which could mean that the calculated value of C$266 million, based on the inputs of Atlantic Gold, is far too high.

1    Introduction

*This is a revision of a report distributed on 19 August, after receiving comments from management and updated for the gold price on 3 October 2018.

Atlantic Gold Corporation ("Atlantic Gold") (TSX-V: AGB) is a Canadian gold mining company, which was incorporated in British Columbia in July 1984 under the name Braymart Development Corporation.  It became Atlantic Gold through the acquisition in August 2014 of an Australian company, Atlantic Gold Pty Limited through a scheme of arrangement.

At the time of the acquisition the acquired company was focused on the exploration and development of the advanced and permitted Touquoy gold project (effective interest of 63.5%) and the earlier stage Cochrane Hill gold project, both located in the province of Nova Scotia, Canada.  In September 2014 Atlantic Gold secured two more gold projects in Nova Scotia, the Beaver Dam and Fifteen Mile Stream projects, through the acquisition of Acadian Mining Corporation.  The purchase price was 8.88 million shares and C$4.3 million in cash and debt obligations.

The company subsequently decided in December 2014 that the administrative burden and costs did not warrant remaining listed on the Australian Stock Exchange.

Soon after these acquisitions the company released the results of a preliminary economic assessment (“PEA”) for the projects with various approaches of development and operation, one with a production of 0.70 million ounces (“Moz”) gold, another with 1.13 Moz.  The PEA study was followed by a feasibility study in parallel to drilling at Beaver Dam and metallurgical testwork for the material from there.

In July 2015 the findings of the feasibility study was released, which included Beaver Dam.

In May 2016 Atlantic secured loan financing of C$115 million for mine construction plus an equipment lease agreement of C$20 million and an Engineering Procurement and Construction (“EPC”) contract concluded for the main mine facilities.

Construction started at Touquoy in June 2016 with commissioning scheduled for September 2017 with the company beating this date by one month, but actually milling started in September 2017.  In the same month the company raised more funding to cover the cost of a study and permitting relating to the Phase 2 Expansion.  Commercial production was declared on 1 March 2018, five months after milling started.

Figure 1_1 shows the share price of Atlantic Gold on the Toronto Stock Venture Exchange since its listing on September 2014.

The graph shows that the performance was outstanding especially since February 2016 a few months before the construction finance was arranged.  As the mine developed without any mishaps, the share rose from C$0.35 to its peak of C$1.97 in 31 March 2018.  The pattern is a typical example of a rerating based on de-risking of a project.

2    Historical Financial Performance

Table 2_1 gives the historical financial performance from 1 January 2013 until 30 June 2018 for Atlantic Gold.

Table 2_1 shows that:

• With good cash generation from operations in H1 2018 the sum of cash flow from operations has turned positive. Total investments made since the company started trading as Atlantic Gold was C$168.6 million.  Of the C$153.7 million raised to cover these activities shareholders covered C$64.9 million.
• The cash balance was run down by C$12.8 million, but at C$16.1 million at the end of June 2018 is more than adequate now that the mine is generating net free cash flow.

The following sections will investigate what value the investors got for their money.

3    Valuation of the Moose River Project

3.1  Background

The technical information in his report has been drawn from a NI. 43-101 compliant technical report by Atlantic Gold, dated 24 January 2018, summarising and combining the findings of previous feasibility studies on the Phase 1 Project and Phase 2 Expansion.

The Touquoy-Beaver Dam-Fifteen Mile Stream properties are located in Nova Scotia, Canada, between 60 km and 100 km northeast of the provincial capital, Halifax.  Cochrane Hill is located 140 km northeast from Halifax (see Figure 3.1_1).

Atlantic Gold holds 31 exploration licences and one mineral lease with a collective area of 194.7 km².  Figure 3.1_2 shows the extent and outlines of the tenement areas.

The details of the various rights are:

• The Touquoy property consists of one Mineral Lease (ML11-1) comprising 49 claims and covering 763 ha, and one adjoining Exploration Licence (EL10377) comprising 64 claims and covering 99 ha. Atlantic Gold owns the rights 63.5% beneficially and the minority party (in which Atlantic Gold holds 8.7%) only entitled to their 40% share of pre-tax profits after Atlantic has recouped its investment.  The property is subject to a 3% net smelter royalty (“NSR”) on all metals produced payable to Maverix Metals Incorporated.  Within three years of the commencement of production, up to two-thirds of this royalty may be purchased for C$2.5 million.  Atlantic Gold recently announced that it was acquiring 1% point of this royalty.
• The Beaver Dam rights comprise 76 contiguous claims covering an area of 1,184 ha. It is subject to a variable NSR payable to Acadia Mineral Ventures Limited.  Different parts of this area are subject to two sliding scale royalties, one based on grade mined (varying between 0.6%-3.0%), another on gold price (effectively 2% at foreseeable gold prices).
• The Fifteen Mile Stream property consists of one Special Licence, SL 11/90, and two Exploration Licences (EL 10406 and EL 05889). The three licences comprise a total of 45 contiguous claims covering a surface area of 701 ha.  Royalties between 1% and 3% apply for different portions of the area.
• The Cochrane Hill mineral tenure consists of one Exploration Licence EL51477 comprising 76 contiguous “map-staked” mineral claims for a total area of 1134 ha. The area is subject to a NSR royalty of 3% of which 2% points can be purchased for C$1.5 million.

In addition to the above royalties 1% of the net value received by the producer is payable to the province of Nova Scotia.

3.2  Geology and Mineralisation

The project deposits are interpreted as orogenic gold deposits, which typically are structurally hosted lode-gold vein systems in sedimentary terrains that have undergone intensive structural deformation and metamorphism.  After paleoplacer deposits (e.g. Witwatersrand, Tarkwa) it is the deposit type that account for most of the world’s gold endowment (18%).

The mineralisation at Touquoy is hosted within an argillite (= metamorphosed clay rich sediment) unit, which is folded around an anticline (= arch like fold structure with hinge above and the oldest unit in the centre).

Figure 3.2_1 has at the top a cross section through the Touquoy deposit, showing the fold structure and how the mineralisation is closely associated with the argillite unit (in dark brown) within this fold structure.

The Touquoy anticline is tightly folded and upright to overturned with both limbs dipping north.  The anticline hinge is doubly plunging, with shallow plunges to both northeast and southwest.  It has been disrupted by a number of northwest-trending faults with contrasting fold geometries occurring on opposite sides of some of those faults.  Two major faults appear to have a significant effect on mineralisation thickness; the curvilinear West Fault and the relatively planar Northeast Fault (see again Figure 3.2_1).

Gold mineralisation is best developed in the northern limb of the anticline where it broadly conforms to bedding over a strike length of approximately 600 m.  Mineralisation is less persistent in the anticlinal hinge, but is well developed in the southern limb over a strike length of approximately 250 m where a bedding control is less apparent, but where mineralisation is associated with shearing near the contact between the Touquoy argillite and hanging wall Touquoy greywacke (light brown).

TCI commentary: A question for Atlantic: the study described differences between fire assay and KMS-15 sampling, contemplating adjusting Measured into Indicated. What is the status of this?

Touquoy and Beaver Dam seem to have mineralization based on veins, grains and stringers, which is not really disseminated. FMS does have disseminated alongside veins etc, CH seems to be based on veins but wide veins. This probably accounts for the high CV values.

The Beaver Dam deposit is hosted in the southern limb of a north-dipping overturned anticlinal fold.  Gold mineralisation at Beaver Dam has been recognised over a strike length of approximately 1.4 km, extending northwest from the Main Zone to the Mill Shaft Zone.  The mineralisation is terminated to the east by a fault.  The deposit can reach as much as 100 m in width with better gold grades (>0.5 g/t) typically confined to 5 m - 40 m width.  Drilling has identified mineralisation to 600 m depth and it remains open at depth.

The cross section for Beaver Dam at the bottom of Figure 3.2_1 shows how the mineralisation appears to gently cross cut the stratigraphy.

The Fifteen Mile Stream deposit is also hosted in folded and faulted strata within the axis and limbs of a north-dipping, overturned regional anticline (see Figure 3.2_2).

The anticline is isoclinal with an approximately east–west-trending axis that dips at about 65–75º to the north and plunges in both east and west, defining a dome.  The overturned southern limb is also cut by a series of approximately northeast–southwest-trending faults dipping at about 55– 65º to the north, resulting in the structural repetition of the mineralised axis and southern limb of the fold.  Numerous decimetre- to decametre-scale parasitic folds have been identified within thick mudstone units in the broader hinge zone.  Together with localised faulting, this has resulted in structural thickening and repetition of mineralised mudstone units and creates a wide zone of potentially bulk-mineable mineralisation.

Gold is mostly associated with the meta-mudstone, because folding and faulting is more intense in this comparatively incompetent rock, creating more conducive conditions for veining.

The Cochrane Hill anticline is a tight to isoclinal fold in the vicinity of the Cochrane Hill deposit, overturned with both limbs dipping to the north at between 55° and 80° (see Figure 3.2_2 at the bottom).  Here there appears very little disruption of the mineralised zone by faulting.  Mineralisation is in the form of a tabular zone of parallel, planar quartz veins in well-bedded argillite and greywacke rock, dipping steeply to the north at approximately 70°, parallel to bedding in the southern limb of the Cochrane Hill anticline.

Gold mineralisation occurs over true widths of up to 60 m to 70 m, within which better grade material (e.g., >0.8 g/t Au) is persistent over true widths varying from 5 m to 30 m.  The base of the gold mineralisation is relatively sharp in terms of grade, but the hanging wall contact is less defined, with an erratic distribution of weakly anomalous grades and occasional >1 g/t Au grades.  The mineralisation has been defined over a strike length of 1,500 m and down to a vertical depth of 250 m.

3.3  Mineral Resources and Reserves

3.3.1                Mineral Resources

A total of 470 diamond drill holes (47,940 m) form the sample basis of the Touquoy resource estimate, 191 drill holes for Beaver dam, 220 for Fifteen Mile Stream and 216 for Cochrane Hill.  Fifteen Mile Stream has itself three mineralised zones: Hudson in the west, Egerton in the east and Plenty 300 m south of the other two zones.

The report does not consistently detail the drill spacing except that at Hudson it is 50 m, at Egerton 25 m and at Cochrane the section spacing is 25 m section over 1 km strike distance.

The approach to resource estimation uses mineralised domains with consistent statistical properties in terms of their histogram and spatial continuity.  For Touquoy two domains were defined: for the north-western end of the deposit, which has a more pervasive style of gold mineralisation and lower proportion of very low grade values, and another, much larger domain with lower overall grade, but higher maximum gold grade resulting in a higher coefficient of variation.

For Beaver Dam and Fifteen Mile Stream no geological models were constructed and for each area a single domain used.

Atlantic Gold commentary: This is not correct – geological models were constructed but the details of these models were not used to constrain the resource estimation.

Response KD: Refer to wording in Section 14.5.2 and 14.6.2 “No geological models were constructed”.

The sample populations of all project deposits were found to be heavily positively skewed with, for example, at Beaver Dam the highest 95 sample composites accounting for 48% of the gold content.  At Plenty the statistics are strongly influenced by a single composite grade of 131 g/t Au.  In the Egerton Zone four out of the total 9,844 composites have a grade exceeding 750 g/t Au and three of these exceeding 1,500 g/t Au.  No grade capping was used for Beaver Dam, but the four samples at Egerton reduced to 300 g/t Au.

For Cochrane Hill two domains have been defined based mainly on the difference in the histograms of composite gold grades with Domain 1 in the western portion of the deposit (roughly 1/3 of the total strike) having an average grade that is 40% higher then Domain 2 towards the east.

For grade estimation multiple indicator kriging (“MIK”) was used, as it is a statistical method that deals better with sample populations that are heavily skewed with a long tail of high-grade to very high-grade values.  A method that would cap these would have a great effect on overall average grade.  The MIK method assumes highly selective mining practices.  For this reason, the block model assumes a small selective mining unit (“SMU”) of 5 m x 5 m x 5 m (vertical, which at some deposits is assumed 2.5 m) and grade control drilling sampling at 2.5 m intervals.

Atlantic Gold commentary: Note that highly selective mining practices are the norm in many gold deposits. MIK was chosen because it can provide better resource estimates where highly selective mining is required. Mining equipment determines if highly selective mining can be achieved.

Response KD: Correct, that is why the above text just factually states that the method assumes highly selective mining practices.

Furthermore I am curious how an open pit operation can have very low dilution and ore loss at the same time with highly selective methods at very low costs. 1.6% is extremely low for both.

MIK essentially deals with the various grade intervals separately, calculating their direction and radii of influence separately.  This is done through variography for each chosen grade interval.  The analyses show that grade continuity is heavily influenced by the direction with the best continuity along strike and lesser continuity down dip direction.

Figure 3.3.1_1 shows variograms for the Egerton Zone for the medium grade threshold and 90-percentile threshold grade interval.  The codes presumably indicate the azimuth direction first (“azm”) and plunge (dip?) thereafter (“plg”).

A few aspects stand out from the variograms: the nugget effect, which is a measure of variability between grades at a distance of virtually nil next to each other, is very high and increasing with grade (as one would expect).  The variograms for the higher grade are much more poorly defined, being virtually flat. The same pattern is evident from variograms included in the technical report for other deposits.

Atlantic Gold commentary: This is wrong – a high nugget effect on an indicator variogram does not mean that the variogram or the spatial continuity of the grade or the indicator is poorly defined. It does mean that spatial continuity for that indicator is weaker when compared to a variogram with a lower nugget, assuming other characteristics of the continuity are similar. As per the comment above, these are characteristics that the Goldenville mineralization has in common with most other gold deposits. This kind of commentary is either uninformed or deliberately designed to mislead rather than inform.

Response KD: I will rephrase somewhat.  There are two points: the suggested radius of 25 m until the sill is reached is not particularly convincing, especially when using 95% of the sill, which I have seen some practioners use.  The other point is that using data with a very high nugget effect for interpolation without placing limits on the search distance greatly adds to risk of the “nugget” component dominating the overall results.

Table 3.3.1_1 shows the assumptions used to generate a conceptual pit shell for resource estimation.

The table shows that substantially different cut-off grades were used for the various deposits, probably reflecting conditions at the time of estimation.  The cut-off grades used are 17%-22% higher than calculated.  This may reflect the impact of items not specified (royalty, dilution, etc.).

Table 3.3.1_2 shows the estimated resources for the Atlantic Gold deposits using a cut-off grade of 0.5 g/t Au.

The table shows that the deposits contribute roughly equally to the overall Measured and Indicated Resources, but with Touquoy, which is currently being mined, having the best grade.

The nature of the deposits with the very skewed grade distribution, the poor variography and high nugget effect indicate that there is much risk associated with the resource estimation.

TCI commentary: Some questions for Atlantic: what does Atlantic have to say about the nugget effect, and why weren't the assays capped? What would have been the result for each deposit if capped at decent grades? It sounds a bit like Brucejack, but they have much more drilling and high grade intercepts to back things up, and still there is a lot of doubt about the continuity. Payback for Brucejack is also scheduled for 3 years I believe, which is unusually quick, normally 8-10years. What is the payback schedule for Atlantic?

3.3.2  Mineable Reserves

The mineable reserves for Touquoy and Beaver Dam were estimated in 2015 and for Fifteen Mile Stream and Cochrane Hill in 2018.  The technical report has not depleted Touquoy reserves for actual mining as minimum material was mined and treated in 2017.

The reserve estimation is based on mining by conventional open pit methods, assuming bench heights of 10 m. The term bench is used variably with elsewhere in the technical report referring to 5 m benches and elsewhere 2.5 m benches.  The largest number refers to mining the waste and the smaller numbers to mining in ore for greater selectivity.  Unplanned dilution of only 1.6% at a grade of 0.20 g/t Au - 0.28 g/t Au was applied (essentially negligible) and a mining recovery of 98.4%.  These are very small values for deposits where the resource estimation assumed a high degree of selectivity when mining.

Atlantic Gold commentary: This is incorrect, 5m in ore zones and 10m waste. The comments below are irrelevant. Also, it is standard practice to double bench in waste to increase productivity while reducing operating costs..

Response KD: Yes, of course, but it goes at the expense of being less able to control the ore/waste transition. I am just using the wording in the document.  Refer to Section 16.1.1.2 “Pit designs are configured on 10 m bench heights”. In section 16.1.8 there is reference to “5 m half benches” and later “Loading in ore zones will be completed with hydraulic excavators on either 2.5 m or 5 m split benches, depending on grade control requirements; and in waste zones with hydraulic excavators and wheel loaders on 10 m benches or 5 m half benches”.There is generally a very inconsistent use of the term in the technical report with elsewhere reference to “5 m benches” (e.g. Section 16.2.8) and “either 2.5 m or 5 m benches” (Section 16.2.8)  I will however rephrase somewhat.

The pit optimisation uses essentially the same inputs for Touquoy and Beaver Dam as for the conceptual resource pit shells, except that the impact of royalties and offsite cost are included (which have a minor effect), but much lower unit cost for processing (C$11.44/t versus C$15.22/t) for Touquoy.  With these the cut-off grade dropped to 0.40 g/t Au compared to the resources cut-off grade of 0.50 g/t Au.

For the reserve estimation of Phase 2 deposits (Fifteen Mile Stream and Cochrane Hill) the gold price in Canadian Dollars was dropped by 1.5%, royalties and off-mine cost includes, much compensated for by a much lower mining cost of C$2.50/t mined with bench increments of C$0.015/t (versus a constant C$3.25/t), and processing cost (including haulage to the Touquoy plant!) of between C$10.16/t and C$10.76/t treated.  With these the cut-off grade dropped to 0.30 g/t Au compared to the resources cut-off grade of 0.40 g/t Au.

Whereas the very favourable input parameters are a concern, it gets worse when considering the pit shells were chosen for mine design as is shown in Figure 3.3.2_1 for one Phase 1 deposit and one Phase 2 deposit.

The way to read the graphs is to look at the change in net present values (orange line) for increasing pit size capturing more of the resources (blue line).  For both pits it is evident that there is initially substantial waste stripping required before the resources exposed yield a value (pits up to 5 at Touquoy and pits up to 4 of Fifteen Mile Stream do not give any positive NPV value.  Thereafter most of the value is added up to pit 11 at Touquoy and pit 9 at Fifteen Mile Stream.  Thereafter larger pits add very little in terms of value, but yield respectively approx. another 9% and 14% plant feed.

The graphs show the Atlantic Gold has elected to maximise the life of mine (“LOM”).  However, should the input parameters prove in aggregate too optimistic, these pit designs would destroy value.

Given the very flat nature of the NPV curves this must be seen as highly likely and a major risk.

Table 3.3.2_1 gives the mineable reserves estimated for Moose River and the conversion rate compared to mineral resources.

The conversion rates points to 90% of the gold contained in Measured and Indicated Resources converted to reserves with the losses equally shared between grade and amount of material converted.  The overall number hides that the reserve grade at Beaver Dam actually exceeds the resource grade, which is surprising and of concern.

Atlantic Gold commentary: It is not surprising! Reserves grade should always be higher than the overall resource grade. If not it means that the selected phases for pit development are not optimal and the mine sequences not properly designed.

Response KD: Not when you use a much lower cut-off grade for reserves compared to resources.  This explains capturing much of the metal content, but not an increase in average grade.

The Touquoy deposit that is currently being mined combines the best grade with the lowest strip ratio.

Atlantic Gold commentary: This is untrue – there is a logical mining sequence that is followed. The comment also ignores the fact (as per Atlantic’s disclosure) that Atlantic had been trying to identify more waste in the pit in order to continue the Tailings Management Facility’s construction.

Response KD: The numbers in the table speak for themselves.  Sequencing has no impact on the reserve statement.

3.4  Mining Operations

The approach to mining the various deposits is to sequentially mine these with a preference for higher grades in earlier years and the plant feed grade further improved through stockpiling of low grade material.  The technical report production schedule had mining starting at Touquoy in the west, which contains higher grade gold than the east portion (and with less variability in grade that may problematic for the average grade).  This is followed in Year 5 by mining Beaver Dam, which has a similar grade, but higher strip requirements.  Also at Beaver Dam first production is planned from the high-grade, lower strip portion in the south.

According to Atlantic Gold management mining is currently not in the west, but east of Touquoy as it requires waste for the construction of the tailings dam management facility, which has been brought forward compared to original plan.  Without a revised production schedule this valuation is still based on the original schedule assuming mining start in the west of Touqouy.

The Phase 2 Expansion deposits are to be mined from Year 4 onwards (2021) to push mill throughput up from 2.0 million tonne per annum (“Mtpa”) to 6.0 Mtpa by 2023.  Each deposit is planned by be serviced by its own mill with flotation concentrate shipped to Touquoy for final doré production.

Ore control drilling will be carried out to better delineate the resource in upcoming benches.  An ore control system is planned to provide field control for the loading equipment to selectively mine ore grade material separately from the waste.

According to the technical report, rock is drilled and blasted on 5 m half benches to create suitable fragmentation for efficient loading and hauling of both ore and waste rock.  According to Atlantic Gold management the rock is soft and fragmentation “exceptional”, which points to relatively low drilling and blasting cost.

Loading in ore zones will be completed with hydraulic excavators on either 2.5 m or 5 m split benches, depending on grade control requirements and in waste zones with hydraulic excavators and wheel loaders on 10 m benches, or 5 m half benches.  To minimise losses and dilution, hydraulic excavators with a relatively small bucket size of 4.5 m³ will be used.  For haulage 64 t rigid haul trucks are proposed.

The above indicates that mining operations are tricky, requiring much supervision and control.  One expects the unit mining operating cost to reflect this, despite the amenability of the rock to drilling and blasting.

Atlantic Gold commentary: This is not true - Mine operations is in reality as simple as it gets since the ore is soft, the fragmentation exceptional and loading very efficient. Atlantic takes great care maintaining haul roads, ramps and pit bottom to ensure it achieves the planned productivity while minimizing the impact on its mobile fleet.

Response KD: Mining requiring much grade control, selective mining of ore, different “bench” heights, use of different types of equipment, stockpile management.  Nowhere in this document has doubt in operational excellence been expressed.

3.5  Processing Operations

The business plan assumes construction of a full processing plant at Touquoy, which will produce gold in doré.  Later, for the Phase 2 expansion, other plants will be built at both Fifteen Mile Stream and Cochrane Hill.  These plants will produce two concentrates -a gravity concentrate plus a flotation concentrate that will be transported to Touquoy for further upgrading to doré.

With the Touquoy processing plant up and running and performing as forecast this section will not review metallurgical testwork for its process design.  The process design for the Touquoy plant assumes a conventional flowsheet, including crushing to 80% passing (“P₈₀”) 10 mm, grinding in a ball mill to P80 150 μm, gravity recovery, CIL, desorption/ electrowinning/refining, tailings management and cyanide destruction.  The gravity concentrate will be leached separately in an intensive leach reactor and its pregnant solution treated separately in a dedicated eluate tank in the gold room.

Processing of Beaver Dam ore envisages crushing at site with a stockpile of two days production as a buffer before transporting the material to Touquoy.  This introduces extra handling cost in the process.

The Touquoy plant is designed to treat 2.0 Mtpa.  It will accept Touquoy ore for the first five years of operation and thereafter ore from the Beaver Dam deposit at the same treatment rate using the same process flow.  Only relatively minor equipment modifications are expected to be needed at Touquoy to treat the Beaver Dam ore; the main difference being harder and more abrasive ore.

The plants at Fifteen Mile Stream and Cochrane Hill are also sized at 2.0 Mtpa.  These plants include crushing in two stages to -240 μm, which is screened to +150 μm fines fraction for treatment in flotation cells and the +150 μm fraction reporting to a HydroFloat cell.   The HydroFloat process works with a rising column of water, with particles not having any sulphides on its surface sinking and rejected.  Eriez Manufacturer Company, holder of the patent, claims that sulphide surface exposure down to 1% is sufficient for the particle to float.  The concentrate can then be reground and cleaned through further flotation.  The process therefore saves by requiring less grinding in the earlier stage of concentration.   The process flow therefore includes a regrind stage of the HydroFloat concentrate before being combined with the rougher flotation concentrate ahead of cleaning in flotation cells.  The flotation concentrates are thickened and filter pressed before transport to Touquoy.

3.6  Economic Valuation – Moose River Project Phase 1 + Phase 2

3.6.1  Introduction

Atlantic Gold has made it difficult to model the latest business plan that includes Phase 1 and Phase 2.  The information has simply cobbled together two studies, one for Phase 1 dated 2015 and the other for Phase 2 dated 2018.  There has been no attempt to update operating and capital expenditure cost for Phase 1 based on actual developments since that date.  This gives some oddities of sustaining capital expenditure of US$75,000 for year 1, which is effectively 2018, whereas the actual sustaining capital expenditure in the first six months of 2018 was CAD$4.4 million, which is to some extent caused by bringing tailings dam construction forward.

Atlantic Gold commentary: We don’t know where the author obtained this. We were not that granular in our disclosure., We also commenced the scheduled TMF raise ahead of schedule due to favourable weather conditions in the spring of 2018.

Response KD: Table 1-14 Ausenco report dated 13 August 2015.  Information not updated to “reflect the mine development” as per Section 1.2 of the 24 Jan 2018 report.

Furthermore, important information is absent, for example available balance as tax allowance.

This valuation will have to make major assumptions in drafting the cash flow model.

3.6.2  Metal Prices Assumed

For the Base Case of this valuation, the spot prices on 3 October 2018, US$1,199/oz Au and exchange rate of C$/US$ of 1.29 were used to determine the value of the discounted cash flow.

In order to check the validity of assumptions in the cash flow model, a case was run using Atlantic Gold’s gold price of US$1,300/oz and an exchange rate of C$/US$ of 1.25  together with the input parameters suggested by Atlantic Gold.

3.6.3  Production Schedule

Table 3.6.3_1 shows the combined Phase 1 and Phase 2 production schedule over the LOM.

There are a number of aspects and observations about this schedule:

• There are small differences between contained gold mined and contained gold milled, which is attributable to the level of accuracy of grades provided.
• The schedule clearly shows the high grading approach (yellow highlighted cells) towards plant feed compared to mined grade.
• The amount of total material mined is highly variable from year to year, better illustrated in Figure 3.6.3_1.

Theoretically this is possible, but it is a very inefficient approach with the company having to use contract miners, alternatively staff and equip up for a few years, to retrench and dispose of the equipment soon thereafter.  An IRR based on thin air can be very good, but it will not be realised. Atlantic Gold has not costed the inefficiencies.  Talk to any experienced mining executive and he will tell you that this schedule is impractical and extra expensive, and in general you do not let operational and project management be done by the same team.  You will need to hire people specifically for supervising the Phase 2 project.  You will have to hire, train and retrench people and you will have to hire equipment all just for two years.

The schedule should be seen as impractical.

• Another indication of the theoretical nature of the production plan is grade stockpiled and withdrawn. Lack of space in the above table prevents from reflecting all inward and outward stockpile movements, but the cells highlighted light brown are years where the grades between average stockpile grade and grade of material reclaimed differ very materially.

Some movements do not make sense, others are not credible as practically achievable.  For example, at Phase 1 operations it has been assumed in year 2022 that higher-grade material (i.e. 1.33 g/t) is stacked than treated (1.27 g/t), a feed grade that was brought down by reclaiming stockpiled material at a grade of 0.60 g/t.  So much for the concept of high grading!   In year 2025 material is reclaimed at 1.55 g/t Au from stockpiles with an average grade of 1.23 g/t.  For Phase 2 operations material withdrawn in 2027 at a grade of 0.67 g/t, which is substantially higher than the average stockpile grade of 0.44 g/t.

The only explanation for the difference between grades for withdrawn and stacked material is the assumption of very good grade control and stacking of different grade material in clearly defined designated areas.  On paper this may be possible, but in practice very hard to accomplish.

• The actual production performance in H1 2018 points to grade problems as illustrated in Table 3.6.3_2.

The table illustrates that total mine production is close to plan, but more ore had to be mined to find enough higher grade material to achieve planned grade.  Much more material was stockpiled than planned at a much lower grade.  This could point to problems with the resources model, or problems with selecting ore and waste blocks, or higher dilution than forecast.

The explanation by Atlantic Gold management that the lower grade was due to the mine having to modify the working sequence, because of the removal of historic tailings does not explain the lower grade, at best the fact that equipment had to be used for tailings removal and not available for mining or and waste and the lower than planned strip ratio.

This valuation has however adopted the production schedule.

3.6.4  Operating Expenditure

The discussion on operating cost for Phase 1 operations still refers to the 2015 study and has not been updated for latest labour cost rates, etc.  The cost provisions for Phase 2 are not presented using the same breakdown as for Phase 1 and are only given to one decimal point accuracy.

Atlantic Gold suggest that the cost structure at Phase 2 operations are equal to lower than Phase 1 operations despite having to double handle and haul the concentrate to Touquoy.  The extra cost of hauling and double handling is somehow compensated for by lower overall processing cost.  The processing cost highlighted in light brown amount to C$2.0/t – C$2.4/t, which is much lower than the Phase 1 processing cost of C$4.56/t – C$5.58/t.

Atlantic Gold commentary: Costs are not directly comparable because Phase 1 is gravity + CIL compared to a concentrate productions costs for Phase 2.

Economies of scale can also not explain the lower cost structure of Phase 2 operations, as these are two modules of 2.0 Mtpa, each requiring its own supervisory structure.

The overall cost structure compares very low to actual cost at other operations.  For example, unit costs for 2019 estimated by Detour Gold were used.  These are unit mining cost of US$2.82/t mined (i.e. C$3.67/t), processing cost of US$9.48/t treated (C$12.3/t) and G&A of US$3.19/t treated (C$4.15/t).  Detour’s mine is a bulk mining operation not needing detailed grade control activities, it is using very large equipment, has economies of scale and does not need to double handle and transport over large distances.

When referring to the Management Discussion and Analysis (“MD&A”) reports of Yamana and Agnico Eagle on their Canadian Malartic mine, in which each owns 50% and each gives information relevant to benchmarking, again overall higher unit costs are indicated.  For the first half of 2018 the mine moved according to Yamana (on a 50% basis) 6.9 million tonnes ore and 7.2 million tonnes waste, whereas 5.1 million tonnes was milled.  Agnico Eagle gives cash operating cost (on a 50% basis) of C$125.3 million before inventory adjustments and before by-product credits.  When using the C$12/t milled suggested for milling and G&A cost for Touqouy, this would result in unit mining cost of C$4.51/t, much higher than suggested in Table 3.6.4_1.  It may well be lower, but only when processing and G&A cost are higher.

Finally, Atlantic Gold has declared cash operating cost of C$13.90 million for the quarter ending 30 June 2018, excluding share based payments.  This converts to C$24.50/t milled, or C$7.67/t mined.  The strip ratio in the quarter was 1.39, below the ratio of 2.35 and well below the long-term ratio of 3.0.  Even when adding the mining cost of one more tonne of waste (i.e. C$3.0/t) to the current operating cost the total of C$27.50/t still compares very low to Detour’s costs.

As the MD&A for the period ending 30 June 2018 states “initial production commenced at Touquoy in late 2017, where the relatively low waste to ore ratio and short haul to external waste dumps translates to a smaller production fleet, minimizing production costs in the process”.  Yet the above calculation indicates that cost are already overshooting long term averages.  Operations are in the early stages and recent numbers cannot be seen as representative.  There are also opportunities for re-categorisation and thereby artificially reducing unit operating cost in the short term.  For example the cost of mining waste used for construction purposes could be classified as capex cost and dropped out of operating cost.  The MD&A gives no information about whether this applies or not.

Atlantic Gold commentary: Again we commenced the scheduled TMF raise ahead of schedule due to favourable weather conditions in the spring of 2018. (as above: the actual sustaining capital expenditure in the first six months of 2018 was CAD$4.2 million).

Response KD: This statement raises more questions than gives answers.  The reported strip ratio is actually lower than plan as was shown in Table 3.6.3_2.  Does the above statement mean that the waste mining involved was not incorporated in the reported strip ratio?  Was the cost involved charged to capital expenditure, thereby reducing total operating cost and reducing the unit mining cost rate?

This study suggests that the forecast cost structure is not credible.

3.6.5  Capital Expenditure

To arrive at forecast overall capital expenditure takes a bit of an effort because the 2018 technical report makes no effort in presenting a combined capital expenditure table, let alone an annual forecast over the LOM of the combined Moose River project.

Table 3.6.5_1 presents what can be gleaned from the various tables, ignoring sunk cost in 2016 and 2017.

Atlantic Gold commentary: The inclusion of this capex contradicts the authors statement that we didn’t consider Cochrane Hill capex in our economic analysis.

Response KD: You did consider it in the text, but it appears it was not included in the cash flow model.

It should be noted that this valuation has assumed that capital expenditure for Phase 2 projects relating to the “mine” and “owners cost” are considered to relate to waste stripping and labour cost and assumed already accounted for under operating cost.  For this reason the numbers in the table above are C$21.2 million and C$33.6 million less for respectively Fifteen Mile Stream and Cochrane Hill than shown in the technical report.  This may be a wrong interpretation and favour the Moose River valuation.

Atlantic Gold commentary: The exclusion of this capex is inappropriate as they are not accounted for as opex.

Response KD: They are accounted for in the opex of this valuation and to avoid double counting removed from capex in this valuation.  I am not that interested in reclassifying cost to reduce cash cost per ounce as a mining company.  As long as the net free cash flow is not affected, this simplification is in order.  Using it all as opex it has a small favourable effect as it reduces cash outflow on taxes.

The table shows the assumption of minimal sustaining capital requirements.  In this respect it is of interest that the actual sustaining capital expenditure in the first half of 2018 was C$4.4 million, orders of magnitude higher than the forecast of US$0.08 million provided for full year 2018.  A possible reason for the large variation is capitalisation of certain operating costs.  It shows that the forecast is probably much too optimistically low.

The schedule does not include exploration expenditure.  In the first half of 2018 C$7.0 million was spent on exploring directly around the project areas and elsewhere.  As no benefit of any discoveries can be modelled, this valuation has ignored outlays on exploration.

Another aspect that is noticeable from the table is the complete absence of closure costs.  The technical report mentions a budget of C$10.4 million for Touquoy alone and that the “Industrial Approval” required a bond to cover this.  When referring to the financial statements it is clear that instalments are made until the full C$10.4 million is posted by 31 December 2019.  At 30 June C$5.53 million had been posted, leaving another C$4.9 million.  This outlay is not evident in the technical report economic evaluation.

Atlantic Gold commentary: Reclamation costs have been provisioned for in the capex

Response KD: It is not evident in the technical report how and what quantum in each year.  Without this I have simply used a provision at the end of LOM. By being discounted the NPV impact is much reduced.

TCI commentary: A question for Atlantic: the report states that reclamation costs are included in sustaining capital for TQ and BD, but a bit later it says reclamation bond falls under Owners cost as part of capex. Two different reclamation items?

For Beaver Dam the reclamation cost are estimated at C$1.6 million and the report states that “provisions have been made for this bond in the feasibility study”, but this is nowhere evident elsewhere.

For the Phase 2 projects all that refers to closure is that “conceptual plans will be included”.  It is safe to assume that the costs involved have at this stage not been included in the Atlantic Gold cash flow model.

This valuation has assumed total closure cost of C$15 million incurred upon the end of LOM.  In reality such outlays are incurred at intervals over the LOM.

Since this is a valuation of the company and not only the Moose River project, corporate overheads equal to the current rate of C$5.33 million (excluding share based payments) have been included.

3.6.6  Working Capital

The feasibility study reports totally ignore the investments in net current assets required for the operation, except for First Fill requirements.  Phase 1 is at steady state and the investments in current assets must be seen as sunk.  When referring to the financial statements for the quarter ending 30 June 2018 it is evident that the current assets are financed by current liabilities when ignoring the cash balance and current portion of debt.  For this reason this valuation assumes that the expansion will not require any investment in net current assets.

Atlantic Gold commentary: Working capital is provided for in capex.

Response KD: As the valuation model has not included any provisions, this is a non-issue.  It may well prove to be an underestimation in due course.

3.6.7  Royalties and Taxes

The technical report gives no information on applicable tax regulations.  For this reason reference was made to “A Guide to Canadian Mining Taxation” by KPMG dated February 2016 and a note by PWC entitled Canadian Mining Taxation – 2016.

Applicable taxes for mining companies in Nova Scotia are:

• Nova Scotia Mining Tax, which is levied in two tiers: a royalty and net profits levy.
• Nova Scotia Corporate Tax at 16%.
• Federal Corporate Income Tax at another 15%

The Nova Scotia Mining Tax has a royalty portion that becomes applicable after the mine reaches commercial operation.  It is levied at 2% on “net revenue” which is calculated as at-mine revenue.

The second tier is tax of 15% on net profit.  It is calculated on Earnings before Tax and Depreciation (“EBITDA”) minus further deductions for depreciation and a processing allowance.

The depreciation allowance is 100% in the first three years of production on the un-depreciated balance, dropping to 30% thereafter.  The processing allowance is 8% of the cost of the processing assets plus 25% of the assets necessary to the servicing and management of processing activities.  The allowance cannot exceed 65% of the net income before the processing allowance is applied.

However, as Atlantic Gold management advised that a mining tax of only 1% of net revenue was confirmed by the Nova Scotia Mine Assessor to apply, this valuation has overridden the calculations suggested by KPMG and used the 1% royalty only.

The tax base for Federal and Nova Scotia Provincial taxes has the same basis: EBITDA minus Nova Scotia Mining Taxes.

To arrive at taxable profits the following tax allowances are available:

Canadian Exploration Expenses (“CEE”) are all expenses incurred before March 2013 to explore and delineate a deposit and develop a new mine, with expenditure during 2015 qualifying 80% as CEE, 60% in 2016 and 30% in 2017, with thereafter all such expenditure classified as Canadian Development Expense (“CDE”).  CEE and CDE exclude the costs of depreciable property such as machinery and equipment, which fall under Capital Cost Allowance (“CCA”, discussed below).  The cumulative CEE balance may be deducted in full to the extent of its income for that particular year.  Any unredeemed balance is carried forward indefinitely for offset against future profits.

The cumulative CDE balance includes expenditure on acquisition of a mineral property, expenditure to bring a new mine in production and costs incurred on main underground infrastructure such as shafts and main haulage ways after the mine has come into production.  An amount up to 30% of the cumulative CDE balance may be deducted in a year (subject to proration for short years).  The deduction that a taxpayer may claim in respect of its CCDE account is discretionary.  As for CEE, any unredeemed balance is carried forward indefinitely for offset against future profits.

Capital Cost Allowance (“CCA”) is an annual deduction in respect of depreciable property owned at the end of the taxation year.  Each depreciable property is allocated to a class, and the amount of the deduction varies according to the class in which the property belongs.

There are relatively few CCA classes that are particularly relevant to the mining industry and most mining property is included in Class 41.  Class 41(a) includes buildings, machinery, and equipment acquired prior to the commencement of production of a new mine, or for a major expansion of an existing mine.  A major expansion is an increase in mill capacity of 25%.

The same type of items, but acquired for a producing mine, is referred to as Class 41(a1).  Where expenditure on such items exceed 5% of gross revenue in that year, this excess can be accumulated for offset against future profits at 25% on the cumulative balance.

The balance on Class 41(a) (i.e. spent pre-production) can be deducted up to 100% against available profits after having deducted the allowances for Class 41(a1) and CEE/CDE.  The accelerated allowance is however been phased out with 100% until 2016, 90% in 2017, 80% in 2018 and 60% in 2019.  Thereafter it is no longer available and any remaining balance allowed at 25% per annum.

The CCA deduction that may be claimed in a particular year is calculated on a declining balance basis.  Any balance remaining in the particular class at the end of a taxation year is referred to as un-depreciated capital cost (UCC) and represents the opening balance for the following taxation year.  New acquisitions add to the UCC, but the half-year rule applies that limits the increase in the year of acquisition to half the net cost for computing CCA for that year.

The technical report and the financial statements provide no to little detail about deductible balances for tax purposes in terms of the definitions above.  The financial statement for the year ending 31 December 2017 gives a total balance for C$178.7 million for property, plant and equipment and C$32.9 million for exploration and evaluation assets.   In addition it is stated on page 25 that it has “unrecognized Canadian tax losses of C$53,7 million, which expire between 2025 and 2037.

According to the technical report, MRRI’s 40% interest (beneficial interest of minorities = 36.5%) is applied to the profits before income tax (post Nova Scotia Mining tax) from the Touquoy deposit, after the Touquoy project capital and corporate sunk capital have been recovered.  For simplicity this valuation cash flow model deducts 36.5% of the after-tax profits on Touquoy’s production.  There should effectively be very little difference between the results as the tax rates of the two entities are probably similar.

3.6.8  Financial Commitments

Subsequent to 30 June 2018 Atlantic Gold secured a C$150 million senior secured revolving credit facility to replace an existing facility amounting to C$110.8 million, which attracted interest at the Canadian Dealer Offered Rate (“CDOR”) plus 4.5% and was repayable in three years post commencement of production.  The new facility has a 3-year term from closing date.  Unfortunately the details about the interest rate are very vague (“will vary depending on the type of borrowing and the Company’s total leverage ratio at the appropriate time”).  This valuation has assumed an improved overall interest rate 1% lower than the original facility by using 5.4% per annum. This is in line with the press release dated 20 September, which states that the interest rate charged for the initial draw down is “approximately 5%."

As condition for the original facility the company had to enter into margin free gold forward sales for 215,000 ozs at a flat forward price of C$1,550/oz and scheduled over the life of the project loan (i.e. 3 years).  The June 2018 quarterly statements indicate that management will maintain the forward sales agreement (“with the lenders”) and had delivered 25,527 oz by 30 June 2018, which is actually unfavourable at the current gold price.  This valuation has assumed delivery of the remainder in equal amounts over the period until 31 December 2020.

In addition, it had an equipment facility covering 23 lease contracts, which amounted to C$9.2 million at 30 June 2018.  The term of the leases is 4-5 years from delivery (sometime in 2016), payable on a quarterly basis and attracts interest being Canadian Dealer Offered Rate (“CDOR”) plus 5.35%: approx. 7.3%.  For simplicity, this facility is accounted for when establishing the Enterprise Value.  This valuation has used the balance at 1 January 2018 of C$10.4 million, assumed fully repaid by mid 2020.

3.6.9  Results

The cash flow model was first run to compare with the results given by Atlantic Gold for a gold price of US$1,300/oz to check whether the results matched.  The problem here is that Atlantic Gold gives very little information on results and in a manner that is not auditable.  The most annoying aspect is Atlantic Gold reporting the results back to 1 January 2016 including estimates of capital expenditure. No effort was made in the 2018 report to present an up-to-date and coherent cash flow forecast.

Atlantic Gold commentary: We have stated in the technical report that we intend to update the cash flows after we have at least 12 months of operating history at Touquoy.

Response KD: I need to work with what is currently in the public domain.

TCI commentary: In my view at least capex numbers could have been updated for sure. Atlantic should have provided investors with a complete DCF model in my view.  I have seen the DCF models of Kees and these were very extensive, and support the tables.

Table 3.6.9_1 compares the results on an annual basis, ignoring 2016 and 2017.

The table shows that, corrected for differences in total taxes calculated, the two models give very close results, differing over the LOM by only C$13 million or 1.7%.  The difference in 2020 of C$26 million is compensated for in 2021 being minus C$25 million pointing to timing differences in the assumptions.

The above table gives comfort that this valuation model, generated from combining information from the various reports, is reasonably accurate.

Table 3.6.9_2 gives the forecast financial performance at the 3 October 2018 gold price and exchange rate.

Response KD: No, this is a company valuation and that is why I prefer to include such outflows as well as corporate cash expenses to get an idea about future annual cash flow.

The above summary table only tells part of the story.  Figure 3.6.9_1 shows the cash flow over the LOM illustrating that by far most of the positive net free cash flow is from year 2022 onwards, which explains the relatively low NPV values compared to undiscounted total cash flow.

Considering the above picture, shareholders of Atlantic Gold should not expect any dividends before 2023.  The company will probably hoard any cash inflows in 2018 and 2019 to reduce funding requirements in 2020 and 2021 and will need all 2022 cash inflow (and probably beyond) to repay additional funding raised.  It puts into question the rationale behind production expansion instead of bringing in the Phase 2 projects more gradually and allowing for internal cash flow to fully fund these.

Table 3.6.9_3 expresses the sensitivity of the value of Atlantic Gold as the change in Net Present Values per percentage point change in the economic main parameters.

The table shows that, for every percentage point increase in gold price (i.e. US$12.0/oz) the NPV_7.5 increases by C$7.9 million and for every percentage point increase in the cash operating cost (i.e. C$0.23/t treated) the NPV_7.5 drops by C$3.5 million.  This means that the value of the company, based on a 7.5% discount rate, doubles for a gold price increase of 34% to US$1,610/oz.  It is suggested here that a 7.5% discount rate is at this stage appropriate, because the risk involved with early production and the large impact of Phase 2 projects.

4    The Enterprise Value of Atlantic Gold at 3 October 2018

At the share price of C$1.59 on 3 October 2018 and with 236.64 million shares issued, according to the TMX money website, the market capitalisation of Atlantic Gold is C$376.3 million, or US$291.7 million.

Since 30 June 2018 9.05 million share warrants were exercised at C$0.60 each and 0.05 million stock options at C$0.40 each.  Remaining are 4.4 million warrants and 14.8 million options, of which 10.60 million are currently in the money.

At 30 June 2018 the company had net current assets, ignoring the short term portion of loans, of C$14.37 million when adding the cash raised from the exercise of the warrants and options, this increases to C$19.82 million.

Based on the above a diluted Enterprise Value for Atlantic Gold of C$370.2 million is derived as shown in Table 4_1, which ignores loans as these have been accounted for in the cash flow model.

The Enterprise Value converts to a value of gold in mineable reserve of US$181/oz.

Atlantic Gold commentary: Enterprise value should add debt and deduct cash. We are not familiar with this type of calculation.

Response KD: Yes, usually Enterprise Value is calculated corrected for cash and loans. The loans servicing and repayment has been modelled to arrive at forecast cash flow based on commitments. To avoid double counting the derived “Enterprise Value” is not increased by the loans. As cash flow model does not include net current assets and their monetisation at the end of the LOM, the calculation here gives full credit to available net current assets, not just cash.

By ignoring loans the derived “Enterprise Value” can be compared to the net present values calculated in the cash flow model.  Comparing it to the NPV7.5 of C$266 million indicates that the market overvalues the company by almost 40%.  This is however only valid when the suggested grades and operating costs/capital expenditure levels are applicable.  This valuation places big question marks behind these assumptions with the largest risk associated with actual LOM gold feed grade.

Conclusion

In conclusion, this valuation points to Atlantic Gold being heavily overvalued, irrespective of the many concerns.  Overvaluation of producing companies is a feature of the equity markets.  That is why this report emphasises not the overvaluation, but the concerns about the business plan which could mean that the calculated value of C$266 million, based on the inputs of Atlantic Gold, is far too high.

This ends the full analysis of Atlantic Gold by Kees Dekker. If you have an interest in contacting Kees Dekker, this is possible through using the contact form on my website www.criticalinvestor.eu. Stay tuned for more analysis by Kees coming soon.

I hope you will find this article interesting and useful, and will have further interest in my upcoming articles on mining. To never miss a thing, please subscribe to my free newsletter on my website www.criticalinvestor.eu, in order to get an email notice of my new articles soon after they are published.

Disclaimer:

The author is not a registered investment advisor, and currently has no position in any of the companies mentioned in this article. Kees Dekker is also not a registered investment advisor, and currently has no position in any of the companies mentioned in this article. All facts are to be checked by the reader. For more information go to the websites of the mentioned companies and read the available company information and official documents on www.sedar.com, also for important risk disclosures. This article is provided for information purposes only, and is not intended to be investment advice of any kind, and all readers are encouraged to do their own due diligence, and talk to their own licensed investment advisors prior to making any investment decisions.  

Tailings facility; MRC project