Global Mining Symposium: Evolution Mining’s Jake Klein on margins over volume

In the first six months of fiscal 2021, Evolution Mining (ASX: EVN) banked over 50% of every ounce of gold it produced in terms of its EBITDA margins, posted a return on equity of 18%, and issued an interim dividend of US$247 per oz., or about 12% of its revenue, well above its peers.

”It’s been all about a journey of trying to improve the quality of our assets and focusing mostly on margin and return on capital rather than on volume,” Jake Klein, the company’s founder and executive chairman, told participants in The Northern Miner’s second-quarter Global Mining Symposium. “We’re not convinced that producing more gold and making the same or less money is better than producing the most profitable ounces.”

Klein added he was “very proud” that the company has paid 16 consecutive dividends.

“It’s our job as a company to safely convert ounces in the ground into cash in the bank and then decide prudently how best to invest that cash, and if we can’t invest it better and get a better return than our shareholders can, we should be giving it back to our shareholders.”

The Australia-focused gold miner has four wholly owned mines in Australia — Cowal in New South Wales, Mungari in Western Australia, and Mt Rawdon and Mt. Carlton in Queensland, as well as an economic interest, also in Queensland, in Glencore’s (LSE: GLEN) Ernest Henry copper-gold mine.

But in the last two years the company has taken a deep dive into Canada with the US$375 million all-cash acquisition from Newmont (TSX: NGT; NYSE: NEM) of the Red Lake complex in western Ontario’s famous Red Lake district, which closed on April 1, 2020, and more recently, the $343 million acquisition of Battle North Gold and its Bateman gold project, also in Red Lake, which closed on May 20.   

Under its deal to acquire the Red Lake underground mine complex, Evolution agreed to invest US$100 million on existing operations and another US$50 million on exploration over the first three years.

Despite the pandemic, Evolution is off to a good start.

“It’s been an amazing almost 13 months of owning the assets,” Klein said. “We put in place initially a first phase transformation of Red Lake, which really focused around building up exploration again. It had been under-explored. Then getting development in place. It was a mine that was depleting more rapidly than it was putting ounces into reserves, so we are doing that now, and we believe the first stage of that transformation is 200,000 oz. at less than US$1,000 per oz. all-in-sustaining costs. We said that we thought that would take us three years and we are well on track to do that.”

Then, having looked at the endowment of the Red Lake complex, which consists of the Red Lake and Campbell complexes, each consisting of an underground mine and associated processing facility, and the Cochenour mine, and recalculated resources at 11 million oz., Evolution realized that it had been conservative. “We are now of the view that we should set our sights higher and our longer term ambition is now 300,000-500,000 oz., and that will restore Red Lake to being one of the premier Canadian gold mines around again … and we are very confident that we can do that. It has a lot of gold, it has a workforce that wants to make it happen, and it is in a legal framework and structure and regulatory system that allows you to be confident of your ownership.”

As for Battle North Gold and its Bateman gold project, Klein noted that Evolution had looked at the company a couple of years before it announced its acquisition of Red Lake in November 2019.

As it happened, Battle North had itself bid for Red Lake once before, but had been outbid, Klein said, “so it was clear from both parties’ perspective that a consolidation make sense. Their leases are contiguous to our leases, some of their orebodies plunge into ground which we own at Red Lake, and it really is consolidating the district into single ownership, so that was our primary motivation. It was only really divided as a result of tenure not as a result of geology; it is one geological system.”

The Bateman project, formerly known as the Phoenix project when owned by Rubicon Minerals, also has a mill, which was attractive to Evolution with its plans to mine more gold at Red Lake. “In our aspirational goal of 300,000-500,000 oz., we need more milling capacity, so that does solve that problem, but really it is about consolidating the district and with that, our view is that we will be mining gold there in 20 years’ time very profitably.”

A recent feasibility study concluded the Bateman gold project could produce an average of 74,000 oz. of gold over a  mine life of about eight years.

Turning to organic growth in Australia, Klein said Evolution’s standout opportunity is Cowal, its open-pit mine, 350 km west of Sydney, which it acquired from Barrick Gold  (TSX: ABX; NYSE: GOLD) in 2015. At that time, Cowal had about 1.6 million oz. in reserves, and mining was scheduled to close in 2020, after which it would process low-grade stockpiles until 2024. But Evolution has mined over a million oz. “very profitably” since the acquisition, according to Klein, and repaid all of its purchase price capital.

“We now have 3.9 million [ounces] in reserves due to discovery,” he said, “and I should point out that we do our reserves at A$1,450 per oz. (US$1,124 per oz.), which is a very conservative number. We do that purposefully to underpin that margin over value approach.” In addition, the mine “has a clear pathway from 200,000 oz. per year to 350,000 oz. and Evolution is almost at the end of a feasibility study for an underground mine at the site.

The Ernest Henry copper-gold underground mine, about 38 km northeast of Conclurry, also has “real mine life extension opportunity as we continue to drill below the current reserves,” Klein noted. Evolution acquired its economic interest in Ernest Henry from Glencore in November 2016, and under the deal the mine will deliver 100% of future gold and 30% of future copper and silver produced within an agreed life of mine area. Outside the life of mine area, Evolution will have a 49% interest in future copper, gold and silver revenue.

Currently copper makes up about 15% of Evolution’s total revenues but Klein says the company isn’t interested in increasing that percentage. “We’re happy where we are,” he said. “It goes to what investors want and they are investing in Evolution as a gold mining company. Rule of thumb would say that up to 20% of copper revenue would be okay; and if we happened to discover a major copper deposit that would be good, we wouldn’t say no to that. But we’re not out there actively looking for copper plays.”

Klein also dismissed the possibility of a secondary listing outside of Australia, despite owning two significant assets in Canada, arguing that secondary listings can be complex and expensive and do not always deliver extra liquidity. “Unless you get to a scale where it really is warranted, I’m not sure the benefits outweigh the costs and the additional compliance needs,” he said. “I have been involved as a non-executive director at a company that had a Toronto and Australia listing, and the additional compliance in regards to 43-101 and JORC compliance, makes it onerous.”

When asked to reflect on some of the lessons he’s learned during his career in mining, which included many years working with Sino Gold in China, Klein joked that the industry is probably best described by the Chinese saying: ‘Sweet torture.’

“This is what the industry is going to deliver to you and therefore humility is a very important part of being in this sector,” he said. “Just when you think everything is going right, things go wrong, so resilience is really critically important — making sure you’re humble about your successes because at some point something is going to go wrong that you didn’t anticipate, and make sure you are always scanning the horizon for both opportunity and for challenges.”

The other key thing, he said, was an ability to make tough decisions around risk.

“This is an industry where opportunity doesn’t come gift-wrapped. You have to go out on a ledge and figure out a way where you’re going to jump off the ledge, whether it’s in your personal career or needing to move into another space,” he said. “When you’re sitting around a board table and you’re thinking about an acquisition, there are always more reasons not to do something than to do something … At the end of the day, you have to take risk and this is an industry about geological and financial risk and you need to get comfortable taking them.”

Taking risk was what built Evolution in the first place.

In 2010, Klein heard of an asset in north Queensland called Mt. Carlton, about 150 km south of Townsville, which everyone believed was not economic based on a failed feasibility study, he said.

Klein, who had worked in China at Sino Gold Mining  as president and CEO from 1995 until Eldorado Gold (TSX: ELD; NYSE: EGO) acquired the company for over A$2 billion (US$1.5 billion) in late 2009, decided to consult his former colleagues, and ask their opinion.

“The first port of call was to one of my colleagues who had actually run a bacterial oxidation smelter in China for Sino Gold, and the metallurgist who used to operate our gold mine, which produced the concentrate,” he explained. Through those discussions, Klein concluded that the key to unlocking value at Mt. Carlton was to produce a concentrate and not try and produce gold on site, and in turn sell the concentrate to China. “We were able to reduce the capital enormously without needing to produce dore on site and ship a concentrate to China, which we’ve done for the last eight years, and that kind of got us into business,” he said. (Evolution commissioned Mt. Carlton in 2013 and the asset has generated an average return of 19% a year.)

Klein and his team went on to make a series of complex deals to form Evolution in November 2011.

This year Evolution expects to produce between 670,000 and 730,000 oz. gold at AISCs of US$930 to US$970 per oz.

Klein says the secret to keeping AISCs under US$1,000 per oz. is really quite simple.

“Get rid of the assets which aren’t performing that well and which are higher cost and keep improving the quality of your asset base,” he says, noting that in the last five or six years the company has sold three assets.  “Focus on margins and AISCs — not wanting to be the biggest, but wanting to be the best.”