Centerra Gold: Change of Recommendation

"Buy" recommendation with 12M TP of 10.42CAD per share

Andrey KozhokaruOctober 11, 2017

The concluded agreement with the Kyrgyz side reduces the political risks associated with the core asset of Centerra Gold. The company has several projects at the development stage in different jurisdictions, the launch of which will further increase production and geographic diversification of its business. According to our conservative expectations, the Company will increase gold production by 34% in 2017 and will maintain this level of production for the forecasted time period. Considering two active projects, on which the Company generates significant cash flows with strong margins, Centerra's shares continue to be undervalued, even not taking into account projects at the development stage. We increase our recommendation from Hold to Buy Centerra Gold with 12M TP of CAD10.42 per share.

Reducing the risks of the Kumtor project. Under the terms of the agreement with the Kyrgyz side, Centerra Gold must make a one-time payment of $ 57 million, and make annual payments of $ 8.7 million. The Company's obligations are primarily of a financial nature and will not provide a significant burden. The Kyrgyz government, for its part, removes all previously imposed restrictions and claims, what will contribute to the sustainable development of operations at Kumtor. The conflict with the government of Kyrgyzstan, which began in 2012, was one of the main reasons for the reduction in the Company's capitalization, which at those time had only one active project in its portfolio. We expect the market capitalization growth due to the further re-evaluation of risks.

The potential for growth is contained in prospective projects. At the moment, Centerra Gold has two active projects and three projects at the development stage. The acquisition of Thomson Creek will increase the total gold production to 800k ounces per year, as well as diversify the output through copper production, which may account for 15% of total revenue in 2018-2021. Production on the Oksut project in Turkey can begin in late 2018. Approximate volume of production will be 110k ounces of gold per year for a period of 8 years, which will increase the total output by an average of 14% per year. The Oksut project has considerable potential for exploration. The company significantly increased the debt burden from $76mn at the end of 2015 up to $495mn at the end of 2016 due to the acquisition of Thomson Creek. During this period, the debt-to-equity ratio increased from 0.054 to 0.271. As of June 30, 2017, The Company's debt was $438mn, with a debt-to-equity ratio of 0.23. We expect further debt reduction, after which the Company will have the opportunity to acquire new assets.

The current results and assets of Centerra Gold are not fully reflected in the share price. The Company's shares are traded at a discount both when considering its results separately and in a comparative analysis. According to the latest Bloomberg data, Centerra Gold's ROE is 14.8% vs. a median ROE of 9.2% for peer companies, a P/E of 7.7 versus a median of 20.9 for peers, Centerra's financial leverage is 1.33 compared to a median of 1.51. The Company’s ratio of free cash flow to market capitalization is 12.6, which stands out relative to the negative indicators for similar companies.

Raising the target price to CAD10.42 per share, Buy recommendation. We lowered the outlook for gold and raised our forecast for copper for the period of 2017-2022. We adjusted upward forecasted levels for the debt burden and related financial expenses, taking into account the current structure of the Company's liabilities. We also raised the forecast for capital expenditures. We accounted for the reduction of the Company's political risks in the cost of its capital. As a result, our 12M TP equaled to CAD10.42 per share, the recommendation is Buy.