Analyst: Tom Winnifrith
Email: tom.winnifrith@t1ps.com
Tel: 01624 676 848

AIM listed Hambledon Mining is on a roll. An upbeat AGM statement was followed by record quarterly production numbers. However, the company has had a history of disappointing investors by missing production targets at its flagship Sekisovskoye project in Kazakhstan for a number of reasons. The rating of the shares reflects, we believe, its past record rather than its current performance or future potential. With net cash - and generating cash - we believe that output in calendar 2010 will increase from 21,000 ounces of gold equivalent to 26,000 ounces but that within three years output could - without the need for Hambledon to secure external finance - reach 100,000 oz of gold equivalent per annum with cash costs falling during the period from $664 to $500 oz.

If this target is reached, the cost base at the 100% owned Sekisovskoye operation means that Hambledon could at current gold prices be generating pre-tax profits of up to GBP50 million per annum. At 6.375p the market capitalisation is just GBP32.9 million which suggests that investors are still focusing on past non-delivery rather than the enormous future potential. We believe that this is mistaken and, at 6.125p our stance is buy with a price target of 16.8p - just three times forecast 2012 earnings per share.

Forecast Table

Background

Hambledon Mining listed on AIM in June 2004 raising GBP2.5 million at 5p a share. The month before it had completed a feasibility study on the Sekisovskoye mine in Kazakhstan. It acquired the mining rights to this prospect in 1998 giving it the right to exploit the mine with a 20 year license with a right to renew. An open pit on this prospect (which lies in the East of the country) had been worked by the Soviets from 1976. Exploration and metallurgical studies were carried out from 1979 to 1994 on the open pit and underground ore bodies by the Russians so this was far from virgin territory.

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Hambledon initially used AIM to some success raising steadily greater amounts at increasing prices in March 2005, February 2006, November 2007 and May 2008 which in total means that the company has had around $40 million to spend on its mining and treatment facilities, notably the treatment plant which can handle 850,000 tonnes of rock a year and cost $25 million to construct. While developing the flagship mine at Sekisovskoye, Hambledon sought to broaden its portfolio in Kazakhstan and in May 2007, it acquired a processing plant at Ognevka from its creditors in bankruptcy. In the past, it had treated tantalum, niobium, lithium and feldspar from ores located below the plant, and more recently had been treating zinc clinker containing high values of copper, gold and silver. It was intended to re-open it to treat some of these minerals.

However from late 2008 the company was struck by a combination of unfortunate circumstances. The Ognevka plant failed to meet expectations and has now been mothballed. At the flagship project an open pit mine failed to deliver the output analysts had hoped for while the processing plant was struck by repeated mechanical failures and by weather which was severe even by the standards of the region. In September 2009, Hambledon raised GBP2.8 million (at just 6p, less than half the price of the previous placing) from shareholders to enable it to proceed with its long stated aim of starting the development of an underground pit on the site.

This was arguably close to the nadir of the company's fortunes. Although unusually cold weather reduced output in Winter 2009/2010, by the Spring of 2010 the processing plant at last started to operate well. In addition, the company had secured contracts from another Kazakh miner to process its rock which added to the cashflow generated from its own processing facilities. Hambledon was able to state explicitly that it would generate enough cash to develop an underground mine at Sekisovskoye which would result in a transformational increase in output. First underground production should be around the end of 2011.

Operations

Hambledon currently generates income from two sources " the potential of this company lies in a third. For the purpose of this report we are ignoring the mothballed plant at Ognevka, the value of which is " at this stage " far from clear, although the company is carrying on testwork on the possibility of retreating the lithium-rich tailings and is looking for other ores to treat.

The most important asset currently operating is the open pit operation at Sekisovskoye. This was extensively explored back in the 1980s by the Russians although it was first discovered in 1833 and periodic exploration has taken place ever since. The deposit is in the North West marginal zone of the 40 thousand square kilometre Rudny Altai Palaeozoic metallogenic belt that occupies the Eastern border of Kazakhstan and the Altaisky region of Russia.

Since Hambledon took control in 1998 its primary aim has been to get this asset generating cash via the open pit operation but it has also drilled extensively to establish the size and nature of the underground deposit. A detailed diamond drill programme has identified 244 zones within the higher levels above the 250m elevation (levels are measured from the Baltic sea level, with surface being at about 440 level) and a total of 307 zones for potential underground exploitation below the 250m level. The true thickness of these tabular-like zones may change rapidly along strike and down dip, with a maximum delineated thickness of 45m, and the continuity of mineralisation may reach 700m downdip and 150m along strike. Gold is associated with hydrothermal alteration of the breccia zone matrix and also with hydrothermal sulphide veining. A high percentage of the gold occurs as intergrowths and free grains, with only a minor percentage locked within sulphides. Gold particles can be coarse, up to 0.4mm, and this contributes to an erratic grade distribution.

The JORC resource for the prospect was completed in 2006. Since then gold has been extracted from surface operations and this is reflected in the table below. Underground estimates are unchanged.

Output from the open pit mine is increasing steadily and we believe production has now reached an annualised rate of 30,000 oz per year. However, because of the poor first quarter, output for calendar year 2010 will be limited to around 26,000 ounces, of gold equivalent rising to 40,000 next year which will leave the company cash generative but, as the resource table above indicates, it is not the real prize within this company.

As the company works towards the prize of opening an underground mine it is also generating income from a second source. In March this year Hambledon reached agreement with the owner of another Kazak mine (Beskempir) to treat ore from that mine at its mill. It treated 4,406 tonnes of ore in April 2010 and 4,962 tonnes in May 2010. On 19 May 2010 it announced a second contract for the shipment of 10,000 tonnes and the delivery and treatment of this material commenced in mid-June. The company says that further contracts are expected in due course. The margin earned on this operation is not stunning but it is a profitable operation which generates additional cashflow.

Servicing both its own mine and third party contracts, the mill at Sekisovskoye treated 68,317 tonnes of rock in April 2010, 75,402 tonnes in May and 69,315 in June, just meeting the design capacity of 850,000 tonnes per annum. The company has stated that it is capable of operating the mill at higher rates so there should be more to come.

A 40,000 oz mine with a cash cost of $664 oz should - with the additional third party milling contracts - generate a very meaningful cashflow for the company. We forecast that it will make a profit in 2011 on the basis of such an operation of GBP17 million. But the real potential of Sekisovskoye lies in exploiting its underground potential, which should see annual output increase to 100,000 oz. The big news from the company's AGM on 23rd June is that Hambledon both set a timetable for developing this prospect and believes that it can do so without the need for additional funding. At the AGM it stated: The refurbishment of the existing surface shaft is progressing on schedule. After completion of this first phase of the development, we will carry out a 10,000m drilling programme to further define the upper level reserves and permit detailed design of the mine. Drilling is scheduled to commence in August 2010 and be completed by May 2011. Construction of the surface infrastructure for the main underground workings has commenced and a local contractor will start excavating the decline at the end of this month, once the portal has been completed. The first stoping operations should commence around the end of 2011. Current projections indicate that the Company should be able to finance the development from cash flows.

The current open pit operation extends to a depth of 150 metres and it is assumed that the underground mine will start at this point and head to a depth of 700 metres. The next stage of its development is the detailed 183 hole drill programme referred to in the AGM statement which should commence imminently. We believe that it will cost c$12 million to bring the underground mine into production by the start of 2012, a sum which can be generated from operational cashflows and that once in production the increased output will push cash operating costs down to around $500 oz.

Strategic Vision

In the past Hambledon has explored at other sites within Kazakhstan and when the underground mine is in full production we expect that it will do so again and will also consider opportunistic asset purchases as it did with Ognevka.

However at present the single strategic objective is to maintain the increase in production from the open pit mine at Sekisovskoye in order to generate the cashflows needed to bring the underground mine into production. At that stage, operating a mine capable of producing 100,000 oz of gold equivalent for at least 15 years the company will consider additional opportunities but the sole focus at present is in opening the underground mine.

Strengths

Cash - the company has net cash of GBP1.5 million and a secured debt facility of $2 million and is, we believe, generating free operational cashflow (excluding the costs of developing the underground mine) of at least $1 million per month.

The company has a proven JORC resource which should enable production for at least 15 years at 100,000 oz per annum

The management team has a long track record in the region and strong local connections. Their record of sourcing third party milling contracts demonstrates that they are well established in Kazakhstan

The region in which Hambledon operates has a long mining history and established pool of labour and appears to have a strong legal footing.

The company is exposed to the gold price. We use a gold price of $1200 per oz for each of the next three years in our model but the GE&CR view is that gold will increase in price to in excess of $1500 oz within 12 months and this provides upside risk to our forecasts.

Hambledon already has a processing infrastructure in place to handle increased output without the need for large scale additional capital expenditure.


Weaknesses

This is a one deposit play. As such an unexpected and adverse event in the locality or operational problem could threaten the entire company.

There is an element of political and economic risk involved in operating in countries such as Kazakhstan. Since gaining its independence from the Soviet Union in 1991 the country has pursued a democratic path although it is perhaps not quite the democratic system that some outsiders would like. The country was the first of the Former Soviet Union States to receive, in 2002, an investment grade rating (BBB-) from Standard & Poors. It has been praised by the IMF for its economic management.

The company is exposed to the gold price. We use a gold price of $1200 per oz for each of the next three years in our model and the GE&CR view is that gold will increase in price to in excess of $1500 oz within 12 months but we may be wrong. Operational gearing works both ways and were gold to fall in price the profitability and cashflows generated by Hambledon would fall sharply.

Opportunities

The resource estimate is based largely on drilling to a depth of 300 metres and we believe that further drilling will increase the size of the deposit at depth.

The fact that by 2012 Hambledon will be generating very strong cashflows will put it in a position to expand its presence in the region. With an established processing infrastructure in place, if it can secure additional sources of ore the economics, for it, can be very attractive.

Additional third party milling contracts or acquisitions can generate additional short term cashflow.

The plant at Ognevka which we value at nil may prove to have some commercial value. Testwork is ongoing into the possibility of retreating the existing lithium-rich tailings, and the plant can be used to concentrate most high-sulphide ores such as for base metals or sulphide gold.

Threats

Resource risk - common resource exploration / development risks can only be mitigated with careful planning and judicious research. Even with careful planning, underground mining carries obvious potential risks.

Other resource sector risks - unfavourable changes to legislation, permitting risk, social unrest and infrastructure capacity are all examples of other threats experienced throughout the resources sector.

Directors

Non-executive Chairman - George Eccles. Having graduated from the London School of Economics with a law degree before becoming a Chartered Accountant, Eccles went on to become a partner in the London office of Deloitte Haskins & Sells and then in the Moscow offices of Coopers & Lybrand and Deloitte & Touche. He recently held the position of Chief Operating Officer of the US government sponsored Central Asian-American Enterprise Fund in Kazakhstan, and is currently a member of Hambledon's Audit and Remuneration Committees.

Non-executive Director - Christopher Thomas. Having built a successful career in the advertising industry, Thomas has sat on the Hambledon board since 2004 and is also a member of its Audit and Remuneration Committees. Currently the Chairman and CEO of BBDO and Proximity in Asia, Thomas's past appointments have been as CEO of Proximity London, Director of Abbott Mead Vickers BBDO, Managing Director of Ammirati Puris Lintas and Managing Director of Lowe Lintas.

Chief Executive Officer - Nicholas Bridgen. Bridgen formed the original Hambledon Mining Company in 1997, having worked for companies in the Former Soviet Union since 1993. Bridgen began his career with Peat Marwick Mitchell & Co (now KPMG) in London where he gained his Chartered Accountancy qualifications, before spending 14 years with Rio Tinto plc in their group accounting, business evaluation and group planning departments. A Russian speaker, Bridgen lives in Kazakhstan.

Technical Director - Neil Stevenson. A fellow of the Australasian Institute of Mining and Metallurgy, Stevenson is a mining engineer and holds a post graduate diploma in business administration from the University of Queensland. Experienced in both underground and open pit operations in Australia, Africa, the FSU and Kazakhstan where he has in excess of 25 years of experience, Stevenson currently lives in Ust-Kamenogorsk.

Executive Director - Baurzhan Yerkeev. An experienced exploration geologist, with extensive knowledge of Kazakhstan, the CIS and Altai Region in which Sekisovskoye is located, Yerkeev has managed projects for the State Geophysical-Geochemical Expedition and the State Exploration Expedition. Having recently been a director of Hambledon's geological consultants CRS, he is adept at working with the various State bodies responsible for approving the Company's development. Holding a degree from the Tomsk Polytechnic Institute's Geological Faculty in Russia, Yerkeev is also a qualified Datamine trainer.

CFO & Company Secretary - William Morgan. Having successfully created and restructured companies in the telecoms and mining sectors, Morgan worked in Kazakhstan from 1994 to1997, in addition to stints in the UK, Russia, the Far East and Africa. A UK Chartered Accountant, Morgan has 30 years of experience in accountancy and financial management.

Shareholders

Hambledon Mining currently has 516,089,233 ordinary shares in issue. Those shareholders with a significant holding (3%+) are as follows:

Name	Shares	Percentage
Nicholas Bridgen	90,198,936	17.48
Blackrock Investment Management	74,537,626	14.44
Gartmore Investment Limited	49,918,912	9.67
Barclays PLC	22,577,914	4.37
Alzhan Shomaev	21,521,232	4.14
Majedie Asset Management	21,124,377	4.09
Waterhouse Securities	22,290,925	4.32

 

Forecasts & Valuation

Hambledon currently has net cash of GBP1.5 million as well as a $2 million credit facility and we believe that it is now generating operational cashflows of around $1 million per month. Hence the capital cost of opening an underground mine (we estimate at $12 million) can be funded if gold prices and output rates continue at current levels which we believe to be likely.

With a JORC resource of c2 million ounces at a grade of 2.7g/t of gold plus associated silver the minelife will be at least 15 years and with the mill capable of processing 850,000 tonnes of rock per annum there are no capacity constraints - indeed, at last, Hambledon would be able to start to run its operations at optimal capacity. We therefore forecast that output will increase to 80,000 ounces in 2012 before reaching peak production at 100,000 ounces the year after.

The ramp up in profitability in 2010 is a result of increased output and a sharp rise in the gold price with an added contribution made by the third party ore processing agreement. We assume in our forecasts that gold will remain at $1200 oz for the next three years although the house view is that risks on that front are on the upside. Our forecasts assume a cash cost of production of $664 oz in 2010, falling to $620 in 2011 as output increases and to $500 oz in 2012 as the higher grade underground operations and increased volumes come onstream. The assumption is of a $/GBP exchange rate of 1.3:1.

The huge ramp up in cashflows and profitability makes Hambledon shares look extremely undervalued " this we attribute to poor investor sentiment caused by past disappointments. Sentiment will change if Hambledon continues to deliver at an operational level and hence we expect the shares to enjoy a significant re-rating during the next 24 months as output increases steadily and as the development of the underground prospect accelerates. On the back of two upbeat statements in two months the wider investment community is starting to believe again. We already do and at 6.125p our stance is buy with an initial price target of 16.8p.