This week, we take our third look at Gran Colombia Gold, the largest underground gold and silver producer in Colombia. Early in 2016, the company concluded a complete debt restructuring. Since that time, it has continued to excel, posting excellent gains in both production and revenues. Its Q2 and YTD results showcase a company that is thriving.
Adjusted EBITDA for the first six months of 2016 was $29.9 million, double the adjusted EBITDA of the first half of 2015.
Q2 revenue of $48.0 million was up 54% year-over-year.
Q2 gold production was up 34% over Q2 2015.
Q2 total cash costs per ounce decreased by 13%.
Interest coverage on a go forward basis appears to be an astounding 9x’s.
The company recently engaged GMP Securities to conduct a strategic review process. GMP is exploring alternatives to enhance shareholder value including a possible sale of the company. A sale of the company could possibly increase the value of both Gran Colombia’s stock as well as its bonds.
Gran Colombia’s August 2018 bonds are currently priced to return a scorching 22.5% yield to maturity. In addition to this unusually high yield, the convertibility feature on this bond could prove to be an extremely lucrative windfall for bondholders that would push returns even higher. With a current market capitalization of about $22 million USD and outstanding debt now estimated to be about $150 million, it’s adjusted EBITDA of nearly $40 million and complete lack of analyst coverage leads us to believe that the markets simply haven’t yet discovered and realistically valued this greater than 100,000 oz producer of gold. Considering the company’s escalating earnings and significant reductions of debt, the overall health of its balance sheet and continuing operations makes a yield over 22% look insanely high. Furthermore, this kind of strong performance can eventually change a convertibility feature from what might initially be seen or thought of as a risk, into a treasured asset that propels the price of the debenture far above its par (or face) value. In light of these factors, these short term, 22 month, convertible debentures from Gran Colombia Gold (denominated in US Dollars), couponed at 1% and priced under 70, deserve serious consideration for added overweighting in both of our FX1 and FX2 global high yield income portfolios, as well as our high performing Distressed Debt 1 Hedge fund.
We have reviewed Gran Colombia twice, once in February and again in May. Since our last review, Gran Colombia has continued on its upward trajectory. Its latest quarterly results reveal a company that continues to make excellent progress since its debt restructuring completed in January this year. Production has increased, costs have decreased, and the company’s revenues and adjusted EBITDA have shown outstanding growth.
Gold production in Q2 totaled 38,229 ounces, up 34% from Q2 of 2015. This brings the total for the first six months of 2016 to 69,718 ounces, a 33% improvement of the first half of 2015. These increases were led by strong performance at the company’s Segovia operations. As production numbers continued to improve, Gran Colombia reevaluated its 2016 guidance after a record production of 13,583 ounces in July, increasing it to 135,000 to 145,000 ounces for 2016.
Gran Colombia has hit the sweet spot, with increasing production and decreasing costs. The company’s total cash cost per ounce decreased 15% in H1 2016 to $682 (as compared to H1 2015). AISC (all-in-sustaining-cost) is also down by 10% year-over-year to $802 per ounce. In fact, Gran Colombia has routinely decreased its cash costs per ounce of gold sold since 2014. Since that time, cash costs have decreased from $1,054 per ounce to $682 per ounce, a 35% decrease.
Revenues and Adjusted EBITDA for Q2 as well as for the first half of 2016 also showed tremendous increases. Revenues in Q2 were $48.0 million, up 54% over Q2 2015. This revenue increase not only reflects the company’s increased gold production, but also the 47% increase in gold ounces sold, as well as the improving market price for gold. This strong quarterly result brings the company’s total revenues for the first six months of 2016 to $82.5 million, an increase of 33% over the same period in 2015. Equally impressive is Gran Colombia’s adjusted EBITDA for both Q2 and the first half of 2016. For Q2, adjusted EBITDA increased to $18.3 million, bringing the total adjusted EBITDA for the first half of 2016 to $29.9 million, double the adjusted EBITDA for the first half of 2015. A devaluation of the Colombian peso in H2‐2015 positively impacted US$ equivalent costs in H1‐2016 vs H1‐2015.
About the Issuer
Gran Colombia Gold is a Canadian-based gold and silver exploration, development and production company. Its primary focus is in Colombia, with its Segovia, Marmato and Zancudo projects located in the north central region of Colombia. Gran Colombia is currently the largest underground gold and silver producer in Colombia. The company is currently advancing a project to develop a modern large-scale gold and silver mine at its high grade Segovia operations (which currently is responsible for about 84% of its total production.) The Marmato Project is one of the top 20 largest undeveloped global gold deposits, having reserves in excess of 14 million ounces of gold and almost 90 million ounces of silver. The Zancudo project is a former high grade producer the provides additional exploration upside.
The Convertible Debenture
Under the restructuring terms, the 10% 2017 Gold notes were exchanged in January of 2016 for 6% couponed convertibles maturing in 2020, while the 5% 2018 Silver notes were exchanged for 1% couponed convertibles maintaining the same maturity in 2018. These notes now pay 1% annual cash interest, or a PIK interest at twice that rate (i.e., 2%), and at the bondholder’s option, are also convertible to Gran Colombia common shares of stock at a conversion price of US$0.13/share (calculated using the full face value of $1000 per bond) anytime prior to maturity. With bonds currently priced at less than 70% of face value, for a slight premium (about 10% above the stock price) investors are effectively holding 20 month call options (trading at or near par with its strike price) as a result of its convertibility feature, and any increase in the underlying stock price should result in a corresponding increase in bond pricing. Recent share prices for Gran Colombia (since July) have ranged between CAD $0.10 and $0.16 (US$0.075 to $0.12). Only at maturity, Gran Colombia has the option to repay up to 81% of the principal by issuing common shares at US$0.13 per common share.
As a result of the company’s debt restructuring earlier this year, ongoing interest expense for the company’s outstanding 2018 and 2020 debentures has been significantly reduced. This bodes well for bondholders, especially as the company continues to increase production, thereby increasing its revenues and profits. For the first six months of 2016, Gran Colombia had operating income of $23.93 million and interest expense of $5.3 million, which calculates to an impressive interest coverage ratio of 4.5x.
In July, Gran Colombia launched Normal Course Issuer Bids (NCIBs) to use cash accumulated in the sinking funds for its senior debentures to repurchase debt on the open market for cancellation. Since that time, the company has decreased the aggregate principal of its notes by $22.9 million, from $175.2 million down to $152.3 million, through a combination of NCIBs as well as conversion of notes to common stock (per the notes’ conversion feature). The total amount of outstanding 2018 debentures as of September 6 is only $49.8 million. If all of these remaining notes were converted to shares, the market capitalization of the debt free company would still only amount to about $150 million. We see this as an unprecedentedly low enterprise valuation for a company with such significant reserves and on track to produce over 135,000 ounces of gold and $60 million of adjusted EBITDA this year, as it appears to only be about one-third of the valuation widely given to its peer group.
The default risk is Gran Colombia’s ability to perform. Since its restructuring in early 2016, Gran Colombia has done a fantastic job of increasing production and decreasing costs. This has translated to outstanding growth in both revenue and adjusted EBITDA as evidenced by its Q2 and YTD results. With the recent short lived strike now in the rearview mirror, the company can focus on improving access to its Segovia mines to further increase production. The high 22% yields on these very short, 22-month bonds, appear to significantly outweigh the risks we can identify.
Gran Colombia’s mining assets are all located in Colombia. Mining in other countries can carry additional risks as the political and economic climates are often very different from our own. Colombia has recently struggled to maintain orderly mining operations in some of the areas where Gran Colombia maintains its mines. In September, miners operating without permits inside the company’s Segovia concession blocked access roads which prevented company workers from reaching the main mining complex. A peaceful conclusion to the strike was accomplished after 10 days with the company agreeing to continuing discussions to analyze and propose solutions to improve social and economic matters in Segovia. The impact of the disruption on Gran Colombia’s production is still being assessed but is not expected to have a significant effect on 2016 production. However, investors should take note that negotiations with these artisanal miners is an ongoing issue. The communities in the regions where Gran Colombia operates are economically poor and for many, traditional mining is their only possible source for a sustaining income. While company management has calmed local tensions for the time being, the issues surrounding the conflict between the company and the local communities has not yet come to an ultimate resolution.
As a majority of the GCM’s revenues are from its sales of silver and gold, the company is exposed to volatility in the prices of these commodities on the open market. Gold prices have risen roughly 16.5% YTD (as of mid-September) and silver has also risen an impressive 26% YTD. If gold and silver continue to trade at these levels (or even appreciate more), this could definitely benefit Gran Colombia’s revenues and profitability.
In September, Gran Colombia announced it had engaged GMP Securities to conduct a strategic review to explore alternatives for enhancing shareholder value. The alternatives being considered include third-party investment in the company, a business combination with another entity, recapitalization, reduction of principal on outstanding notes, a sale of the company, or a possible combination of these options. Any of these actions could have an effect on current bond and stock holders of Gran Colombia and should be considered for prospective investors.
The hardest risk for us to identify is the geopolitical risk. It is our opinion that diversification into a wide variety of global debt vehicles often reduces risk. Our strategy here, as with other Yankee bonds, is to focus on core services that add key economic value to the countries they are associated with. GCM continues to operate as a key player in this sector, as it has been for many years, maintaining a very good working relationship with the government of Colombia.
This Yankee (US dollar) convertible debenture has similar features and maturity length to other convertible notes previously reviewed on Bond-Yields.com, such as the highly successful 14.38% Brigus Gold (now Primero Mining) and the 9% Lakeshore Gold (now Tahoe Resources) bonds (which increased to over 150% of par value.)
Summary and Conclusion
Since our initial review of Gran Colombia earlier this year, the company has continued to excel, increasing production, revenues and adjusted EBITDA while decreasing it cash costs. Gran Colombia has successfully continued to expand its mining operations, notwithstanding challenges from worker strikes and illegal miners. The company’s surprisingly low market cap as compared to its adjusted EBITDA, indicates potential hidden value, not only for stockholders, but for bondholders as well via the conversion feature. The stunning 22+% yield on this very short Gran Colombia Gold note continues to overlooked by the market, and therefore, we see it as an opportunity for possible increased weighting in both our Fixed-Income1.com and Fixed-Income2.com global high yield income portfolios.
Issuer: Gran Colombia Gold, Inc.
Ticker: GCM.TO (TSX)
Price: $0.105 CAD (10/13/2016)
Conversion Option Price: $0.13 USD (currently ~$0.17 CAD)
Coupon: 1% Cash / 2% PIK rate
Yield to Maturity: ~22.8%
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Disclosure: Durig Capital, Distressed Debt 1 LP, and certain clients may have positions in Gran Colombia Gold’s 2018 convertible debentures.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.