Kryso Resources – Initiation of coverage at 14.25p – Speculative Buy with a 37p target

	Key Data
	EPIC	KYS
	Share Price	14.25p
	Spread	13.75p-14.5p
	Total no of shares	79,239,024 shares (2.72 million options and warrants outstanding)
	Market Cap	£11.29 million (£11.68 million fully diluted)
	12 Month Range	10.375p-16.5p
	Net Cash	£500,000
	Market	AIM
	Website	www.kryso.com
	Sector	Mining
	Contact	Vassilios Carellas –Managing Director – 020 7371 0600

Kryso Resources was incorporated in England & Wales on the 27th July 2004 with the sole purpose of exploring and developing gold and other precious and base metal deposits discovered in Central Asia during the Soviet Union era, but not yet developed. Kryso’s stated goal was to bring such assets into production. In December 2004, Kryso floated on AIM in order to secure funding to continue the development of its flagship property, namely the Pakrut Gold Deposit in Tajikistan and to further explore the wider Pakrut licence area. As part of its IPO, the company raised £2.6 million at 10p through the issue of 26 million shares The company’s senior executive directors are from South Africa and New Zealand but the senior management is based in Tajikistan’s capital Dushanbe. Kryso's experienced board of directors has many years of work experience in Tajikistan’s gold mining sector. The company also has  a prominent Tajik businessman on its board, Abuali Ismatov, who is well respected in Tajik business and political circles.

Kryso was the first foreign company to obtain a 100% interest in a mining and exploration project in Tajikistan, when in April 2004, LLC Pakrut, a wholly owned subsidiary of the company, was granted a geological lease and licence to explore the Pakrut licence area. This license covers the Pakrut Gold Deposit and the surrounding 6,300 hectare exploration area. The licence and the geological lease, which both expire on April 1st 2014, allow LLC Pakrut the use of the mineral resources in the area, including the right to mine 300,000 tonnes of ore per year. The area is located in the mineral rich southern Tien-Shan Fold Belt, a belt of folded rocks that extends from near the Aral Sea in Uzbekistan through the northern part of Tajikistan and further East into China and Mongolia. The Tien-Shan Fold Belt hosts many world-class mesothermal gold deposits, and is claimed to be the second largest known gold resource belt in the world, after the South African Witwatersrand Belt. The Tien-Shan province hosts the rare-metal polymetalic Zeravshan-Hissar belt of mineral deposits and the Kugiturinscky low sulphide gold quartz mineralization belt. In addition to Pakrut, Kryso was awarded an exploration licence in June 2006 for the Hukas Nickel-Copper deposit, which is located south- east of the Pakrut licence area.

Although the wider region has been characterized by political instability in recent years, Tajikistan is viewed as a business friendly developing country with active foreign investment policies, encouraging capital and expertise to flow in to the country. Its two neighbors, Uzbekistan to the west and Kyrgyzstan to the east have had their fair share of political turmoil in recent years but Tajikistan’s domestic politics have been since independence was gained from the FSU and the country has consistently adopted policies which have been geared towards progress, active investment and development of its key industries and business sectors. However the troubles of the wider region cannot be ignored and as such we have included an extra risk factor in our valuation to reflect this risk of political instability in the wider Eurasian region.

Pakrut Mine and Licence Area

The Pakrut Gold Deposit and Licence area are located in the Vahdat region, approximately 107 kilometres north-east of the capital Dunshanbe. The Licence area can be accessed from Dushanbe over a three and a half hours journey, initially via a 57 kilometre sealed bitumen road to the town of Ramit on the Kafarnigan River, followed by a 50 kilometre dirt road along the Sardi-Miena River. The Pakrut region was subject to extensive exploration during Soviet times until the early 1980s, when an initial resource of 1.03 million oz gold in C2 (JORC inferred equivalent) and P1 (no JORC equivalent) Soviet categories was recognized. Prior to the collapse of the Soviet Union in 1991, the mineral rights of the Pakrut gold deposit were owned by the State, and they were subsequently relinquished to the Republic of Tajikistan.
  
Since December 2003, the date Kryso obtained the Pakrut License from the Tajik Government to explore the property, the company has carried out drilling operations throughout the year using three diamond drill rigs, as well as undertaking significant underground adit development and surface excavations. During the 2007 drilling campaign, results of additional core drilling led to the first JORC-compliant resource estimate on Pakrut, which was produced by Snowden Mining Industry in March 2007.; This was followed by a second resource estimate produced by GeoLogix. The interim resource produced by GeoLogix at a 0.5 g/t Au cut off was 15.05 Mt at 2.18 g/t Au, which translates to in excess of one million oz to JORC compliant status resources, the majority of which is in the Measured & Indicated categories. To date Kryso has carried out around 12,000 metres of diamond core drilling, with all the gold grade samples being assayed at an externally accredited laboratory. In addition, the company has been developing over 600 metres of additional underground adit and drill chambers in the existing Soviet exploration adit.

Geology and Mineral Resources

Source: Kryso Resources

The Pakrut Ore Field consists of over twenty known ore occurrences, with a further fifty locations of gold-silver and polymetallic mineralization identified by the Soviets in the area. Of the twenty known ore occurrences, the Pakrut Gold Deposit, which is still open in three directions, is the most explored with a combined JORC resource of over one million ounces. In addition, there is a total of more than 3.6 million oz gold from other Soviet resources in the licence area; these consist of three mineralized systems within five  kilometres of the Pakrut gold deposit. These are the Eastern Pakrut gold prospect, the Sulfidnoye gold and silver prospect, the Rufigar prospects, and the Surmyanoye antimony and gold prospect.

The Soviet resource work on the Pakrut gold deposit was carried by the Southern Tajik Geological Expedition (STGE), classifying the resources at Pakrut into C2 and P1 categories. Officially, C2 category lies somewhere between Inferred and Indicated categories of the JORC code; however the Pakrut C2 resource is thought to be closer to Indicated than Inferred. P1 category is broadly similar to the Inferred category in the JORC code.

 

Pakrut Gold Deposit Pre-Feasibility Study Results

The basis for the Pakrut pre-feasibility study (PFS ) announced on February 13th this year was the November 2007 GeoLogix Resource estimate. This estimate indicated that sufficient gold resources exist to make a significant return on the required investment for opening and running a mine at Pakrut at forecasted metal prices. The PFS went further to assess the current viability of developing the Pakrut Gold deposit, by estimating that the direct capital cost of bringing the project into production is $65 million. Based on the interim GeoLogix resource estimate of over 1 million ounces of JORC compliant gold resources, the mine would have a minimum life of 6 years at 1.46Mt per annum. The PFS forecasts an average cash cost, including royalty, of $291 per oz, an estimated total net pre-tax cashflow of approximately $264 million, and a pre-tax NPV, and IRR using a 10% discount rate, of $157 million and 84.08% respectively.

The Pakrut Gold Deposit is located in a narrow steeped-sided valley, and hence the adverse topography makes the exploitation of the deposit solely by open pit economically non-viable. As a result the study has concluded that a combination of open pit and underground mining, for the deeper resources, will be needed to exploit the deposit. The first phase of mining operations (i.e. the first three years of the six year mine life) will concentrate more on open pit mining using a pit extending from the 2,190 metre level up to 2,590 metre level, which allows access to ore levels just below the river level. This pit is estimated to contain some 3.9 million tonnes of ore and some 13.5 million tonnes of waste at the assumed pit slope angles. The company is expected to process 3,000 tonnes per day (tpd) through open pit mining and 1,000 tpd through underground mining during the first three years, as the development of an open pit ready for full-scale production takes less time than that for the underground mine.

Gradually, the open pit throughput rate is expected to decline in the second half of the mine life, as the open pit will extract ore from levels between 2,190 metres and 2,350 metres, leaving significant amount of ore on deeper levels unexploited. These will be extracted through underground mining and consequently production rates of 2,000 to 4,000 tpd are expected in the second half of the life of the mine. The study estimates that the cash cost for production of gold, including royalties, ranges between $168/oz and $365/oz, or an average of US$291/oz over the life of the project.

The tailings storage facility is expected to be constructed from open pit waste material and it will be large enough to accommodate the tailings produced from production plus any additional resources subsequently brought into the mine plan. 

The company has contracted Scott Wilson Mining to complete a tailings storage facility and a number of designs have already been submitted to the company for review. In addition, the company has contracted Prime Resources (Pty) Ltd, a South African environmental consultancy to carry out an environmental study along with LLC Ziderer, a local environmental consultancy based in Dunshanbe.

In addition, the company is expected to upgrade part of the access road to Pakrut, especially part of the 50-kilometre dirt road from the village of Ramit along the Sardi-Mienna River valley to the project. In addition, relevant infrastructure and utilities are expected to be developed. Electrical power for the project is expected to be made available by connecting to the national grid at very competitive rates, while process water is expected to be extracted from the Pakrut River, which flows throughout the year. The company has employed and invested in the development of a skilled Tajik-based workforce but has relied on a number of expatriates for their skill and expertise in developing a mine at Pakrut.

Capital and Operating Costs

The company has considered three options for developing the Pakrut gold deposit. The most attractive is the simultaneous development of the open pit and underground mine with project start-up expected to be during 2010. The mine is expected to reach full output of 4,000 tonnes of ore milled per day for the first quarter of production. The direct capital cost for the existing life of the project is estimated to be $81 million. This comprises of $37 million for the construction of the plant and tailings storage facility, $15 million for infrastructure and utilities, $6 million for surface mining equipment and $20 million for underground mining equipment and contractor development. Included in the estimated capital cost is $3 million for project overheads, including engineering studies, project management and administration.

The study assumes an open pit mining cost of $1 per tonne, which is over 35% more than the budgeted open-pit operating cost for 2008 for a mine in the north of the country. For underground mining, the company will use the longhole stoping method, and hence the underground mining cost is estimated to be anything from $7/t to $14/t depending on geography and nature of the mining deposit. The PFS uses a conservative estimate of $12/t.

According to the PFS study, the most efficient way to extract gold from Pakrut is via a process of crushing and grinding followed by a gravity concentration process to recover free gold. A previous test work programme undertaken during Soviet times confirmed the suitability of the Pakrut ore to gravitational methods for extracting the gold with up to 75% of the gold responding to gravitation. The gravity-float concentrate process is expected to reduce the initial capital outlay and reduce the footprint of the plant required. The tailings from the gravity circuit will then be floated and the resultant flotation concentrate, along with the gravity concentrate, will be passed through the Gekko Intensive Leach Reactor (ILR), which will result in only a fraction of the ore being exposed to cyanide The company has estimated an overall 90% gold recovery, based on historical and preliminary test work conducted by Kryso.  The project is expected to process 1.46 Mt of ore per annum over a minimum life of six years. The overall processing cost for Pakrut is approximately $7.78 per tonne of ore milled, while the average total operating cost over the six year life, including royalties, is $20.38/t.

Based on the mine’s 4,000 tonnes of ore milled per day, the project is expected to produce around 100,000 oz Au per annum over a minimum six year life mine. The gold and silver ‘dore’ produced on site will be refined initially at the State Refinery Vostokredmet and, due to its non-recognised refinery status in world markets, it will then be exported to a London Bullion Dealers Association (LBDA) recognized refinery, where it will be assayed and sold at market prices. Evidently, the project is sensitive to gold price and capital expenditure. The gold price forecasts used in the study, which are based on the average predictions of seven major investment banking institutions, are as follows: $868.54 (2008), $876.83 (2009), $920.60 (2010), $1,033.50 (2011), $997.50 (2012) and $650 (2013-2015). Kryso’s own PFS sensitivity analysis has found the project to be economically marginal at a gold price of US$400/oz. Gold trades today at $970 oz.

Kryso’s stated objective is to develop and bring the Pakrut Gold Deposit into production during 2010, whilst continuing to explore the 63 square kilometres of the Pakrut Ore Field. Mineralization remains open to the north, north-east and east of the Pakrut Gold deposit where the presence of three mineralized systems within five kilometres of the Pakrut gold deposit provide further exploration upside for new discoveries of commercial gold deposits. The Rufigar prospects, the Eastern Pakrut gold prospect and the Sulfidnoye gold and silver prospect provide an exciting opportunity for Kryso to increase and upgrade the resource base at Pakrut and extend the mine life of the project. As we noted above, an extension to 10 years would have a massive impact on the NPV of the project.

We understand that the company is in the process of collating a vast amount of data on the Pakrut Licence area into a single database, with the aim of expanding the existing resource base and improve the status of these resources. The vast amount of data comes from extensive geological exploration work carried out during the Soviet Union era.

Strengths: The completion of the pre-feasibility study on the Pakrut Gold Deposit is a significant achievement for Kryso. This confirms that the project is economically viable and allows the company to follow a clear plan going forward in bringing the project into production. Admittedly, there is still a long way to go before this happens, with the construction and commissioning of an open pit and underground mine combination the most important phase of the project development. The company will use the pre-feasibility study as an interim report to the BFS which is currently underway. Upon completion, the company will negotiate project finance with suitable finance providers. The company has put together a team of project managers and plant construction and mining engineers that will take the project forward. Kryso has an experienced board with over 25 years operating and managing producing mines in Tajikistan from its two executive directors.

The price of gold and other precious metals is forecast to increase over the next couple of years. Already in 2008 the price of gold so far has reached the US$950/oz level as it is considered as a safe haven for investment and a strong medium for storage of value. The company stands to benefit if strong demand for gold continues well into the next decade, whilst the shortage of gold supply from in-demand gold producing mines and regions around the world has set the precedent that demand will outstrip supply.

Additionally, the project is located in the mineral-rich and complex area of the Hissaro-Alai zone situated on the southern slope of the Hissar ridge of central Tajikistan. The company has a number of exploration targets with potential to discover future ore deposits. The project is served by relatively good infrastructure, with access to electrical power and process water.    

Weaknesses: The political climate in Tajikistan and the wider region is clearly not a major plus point for Kryso. A change of government in Tajikistan or legislation in relation to how the country’s mineral resources are exploited by foreign investment companies could threaten the long-term viability of the project. So far the company has built a good relationship with the local authorities and views its presence in the Pakrut area as that of guests working with the local mining community to built a mine and bring the Pakrut Gold deposit into production. It is in the country’s interests to bring gold and other precious metals projects such as Pakrut, , into production in order to release the mineral wealth and benefit so benefit the country economically. During the duration of the project, the company has agreed to pay a 5% fixed royalty rate on gross revenue from precious metal sales. In addition, LLC Pakrut’s profit is subject to a 25% corporate income tax rate, after allowing for depreciation and amortization of capitalized development costs. 

Opportunities: LLC Pakrut, Kryso’s wholly owned subsidiary, owns 100% of the exploration and mining licence for the Pakrut Gold Deposit and has exploration rights over the 63 square kilometre Pakrut Ore field. At the Pakrut deposit itself, mineralization is still open in three directions and exploration is on-going. The wider area hosts many world-class mesothermal gold deposits within the Tien Shan Fold Belt and within the Pakrut area there are three known mineralized systems that need to be further explored. The upside potential of the company exploring and delineating further gold deposits in its licence area remains a strong and interesting proposition. The Hukas Nickel-Copper deposit, which is located South East of the Pakrut licence area offers additional exploration upside.

Dr Trevor Davenport, (aged 67), Non-executive Chairman
Dr Davenport has worked in the mining industry for over 35 years where he has been involved in mineral exploration and mining geology in over 17 countries both for mining companies and as an independent consultant. From 1994 to 1997 he was Chief Geologist and Exploration Manager for Nelson Gold Limited (subsequently renamed Nelson Resources Limited) in Tajikistan. In 1996 he was made a Director of Zeravshan Gold Company. His experience includes six years as Chief Exploration Geochemist for Bamagwato Concessions Ltd. in Botswana in its search for nickel/copper deposits.

Vassilios Carellas, (aged 34), Managing Director
Carellas is a qualified geologist from South Africa and has spent nine years working in the mining and exploration industry in Central Asia. He worked for Nelson Resources Limited, a company listed on the Toronto Stock Exchange, in various geological positions including as Chief Geologist. In 2002 he joined Gulf International Minerals Inc., a company listed on the Toronto Stock Exchange, as Chief Geologist and subsequently became its General Manager and Director for the subsidiary which operated Gulf’s mines in Tajikistan. He left Gulf in 2004 to establish Kryso.

Craig Brown, C.A., (aged 37), Finance Director
Brown is a Chartered Accountant from New Zealand. He has spent ten years working in the mining industry in Central Asia. Prior to working in Central Asia, Craig was a Chartered Accountant working in private practice in New Zealand. Brown worked for Nelson Resources Limited, from 1995 to 2001 in various positions ranging from Chief Accountant to Director of the Joint Venture Company that operated the Zeravshan gold mine. From 2001 to 2003 he was Chief Financial Officer for Gulf International Minerals Inc. and from 2003 to 2004 he worked part-time as a consultant to that company. He has been a director of several mining joint ventures in Central Asia. Brown is based in Dushanbe.

Abuali Ismatov, (aged 48), Executive Director
Ismatov is a prominent businessman in the Republic of Tajikistan. He graduated in 1981 from the Tajik Agricultural Institute with a diploma in Hydro Engineering and in 2001, completed his Masters in Finance and Economics from the Tajik State National University. Since 1992, Ismatov has been a founder and shareholder of several multi-national companies established in Tajikistan with foreign investment.

Andrew F de P Malim, (Aged 64), Non Executive Director
Malim has over thirty years experience in mining exploration and finance, and brings great value to the company given his vast experience as a board member to numerous public and private mining companies. He was a founding member of the award wining James Capel & Co. mining team in 1969, where he acted as a precious metals analyst and institutional salesman. In 1980, he founded the Lion Mining Group and over a 20 year period played an active role in mining fund management and the finance of numerous precious and base metal projects in North and South America, Asia and Africa.

Ferdinand Dippenaar (Aged 48), Non Executive Director
Dippenaar, a South African resident, has 25 years of mining industry experience, particularly in the gold sector, and has occupied a variety of senior roles. He is currently President, Chief Executive Officer(CEO) and Director of TSX-listed Great Basin Gold ('Great Basin'), Kryso's strategic partner and the owner of approximately 15% of its equity.

Kryso’s share capital consists of 79.239 million ordinary shares and 2.72 million share options and warrants outstanding. Those holding more than 3% of the current issued share capital are:

Simon Cawkwell, aka Evil Knievil, was a director of Kryso on flotation but resigned from the board shortly afterwards. We should note that Cawkwell also acts as a contributor to t1ps.com, the owner of GE&CR although he has not been involved in producing this report. The 27.07% held by directors is split equally among the three executive directors.

The company’s most recent results covered the six months to 30th June 2007 and showed an increased loss of $0.315 million, up from $0.104 million in the first half of 2006. The basic and diluted loss per share amounted to 0.47 cents per share, up from 0.19 cents. The increased loss was attributable to a decrease in foreign exchange gains during the period and an increase in corporate costs. During the period $0.991 million of site expenditure was capitalized, which included drilling, trenching and underground development work.

The financial position of the company reflected the continued exploration and development activity at its Pakrut prime asset. The company’s net asset base increased during the period to $10.637 million, up from $9.279 million 12 months previously. The company reported a net cash position of US$1.12 million at the period end. During the reporting period, the company continued its feasibility study and ongoing resource development programme at the Pakrut gold project and with initial exploration of the Hukas nickel-copper project. In October 2007 the company raised an additional £1.46 million in a placing at 11.5p.

This is a company which is likely to be loss making until 2010, but which could be generating free operational cashflow of $40 million per annum thereafter. The current market capitalisation is, on a fully diluted basis, less than £13 million which cannot discount the potential for future cashflows from Pakrut.

Our base case valuation of Kryso stems from a 6-year net present valuation model of the Pakrut gold project using a 10% discount factor. The parameters of the model assume a minimum life of 6 years processing 1.46 Mt of ore per annum with production start-up in the first quarter of production. A production of 4,000 tpd total from both the pit and underground mining was adopted in the model in line with the company’s pre-feasibility study.  2010 is set to be the first year of production for Pakrut with an estimated 130,000 oz gold per annum produced. In our model we have made an allowance for initial production delays, factoring a 100,000 oz gold for 2010, increasing to 130,000 p.a. in the following five years. Gold prices included in the model are consistent with the gold price (Au/oz) forecasts used in Kryso’s feasibility study, which are based on average predictions of seven major investment banking institutions. These are $868.54 (2008), $876.83 (2009), $920.60 (2010), $1,033.50 (2011), $997.50 (2012) and $650 (2013-2015). With gold now trading at $950 oz we believe our assumptions to be conservative. Our forecast of operating costs, using the average $291/oz produced estimated costs, come to $225.525 million over a 6-year life mine, whilst we estimate the company to incur about $5.6 million finance costs during the life of the mine.

We expect the company to finance the $65 million start-up capital requirement through a combination of equity/debt fundraising undertaken this year. In our model, we assume that the company raises $20 million in equity at around 20p per share, with the remaining $45 million being raised through debt. Our model expects the debt to be repaid within 3 years of operations, leaving substantial free cashflow in the region of $30-US$40 million per annum for the remainder of the six-year minimum mine life. Taking into consideration royalties on gross revenues of 5% and corporation tax of 25%, our net present value using a 10% discount factor for the Pakrut gold project based on the existing 1 million oz gold resource is $128.71 million or 49.5p per share on a fully diluted basis (around 133.24 million shares).   

The political sensitivities in Tajikistan and the wider region cause us to be cautious and as a result we apply an additional 25% risk factor to account for these uncertainties and that leaves a base case valuation of 37p on a fully diluted basis.

However it must be stressed that this is a base case valuation. We have attributed no value at this stage to the promising but very early stage Nickel-Copper deposit at Hukas. More critically we have also assumed only a six-year mine life at Pakrut. Mineralization remains open in three directions and there are numerous other prospects within the licence area. Thus it is perfectly plausible to believe that Pakrut could operate at the same level of output and with a similar cost structure but without the needs for significant additional capital expenditure for well in excess of six years. A longer mine life and/or increased output would have a material impact on our estimates of the NPV of this project.

We have prepared a separate model where we assumed that the company could increase its resource base to 1.5 million oz, a feasible prospect, given the deposit size indicated in the GeoLogix model, which has a mine life of some 12 years and an average daily mining rate of some 3,000 tpd. Our 10-year model, using similar assumptions to our six-year model of Pakrut, estimates a net present value of $192.18 million or 74p on a fully diluted basis and the 25% risk weighted valuation is $144.14 million or 55p per share on a fully diluted basis.

Whilst we continue to recognize that the company faces a number of hurdles before developing the Pakrut gold project into an asset ready to go into production, notably its ability to source additional finance, the completion of the PFS and the imminent completion of a BFS are important milestones for Kryso. At 14.25p, we initiate our coverage of Kryso Resources with a speculative buy recommendation and a base case target price of 37p.