Now looks like a good time to reappraise Serabi Gold (SRB:AIM) at 5.12p before it returns to the spotlight amid the prospect of positive cashflow. The Brazil-based miner is finally reopening its Palito gold mine, closed in 2008 after changes to the extraction method caused financial problems.

There is significant upside potential for earnings since Serabi is well placed to be a regional consolidator. There are lots of small high-grade prospects nearby that could act as feed to Palito’s processing plant, which has lots of spare capacity to fill. The £23.3 million cap has already acquired one very high-grade site called Sao Chico and numerous prospects within Palito’s existing licence area could be future sources of gold.

House broker Peel Hunt’s 10p price target implies the shares could almost double in value. Its valuation model assumes a long-term gold price of $1,300 per ounce, compared to the spot price of $1,285 at the time of writing. Helpfully, the broker also published price target alterations in the summer to show sensitivities to different gold prices. At $1,200 per ounce, it says Serabi is worth 7.3p per share. Should gold surge to $1,500 per ounce, a level last seen in April, then its price target goes to 12.5p.

Serabi quotes a $739 per ounce cash cost of mining. That does not include all the outflow of cash required to run its operations including office expenses and money to keep Palito in production. The ‘all-in’ cost of mining is $900 to $920 per ounce, says finance director Clive Line. That implies Serabi should make a profit even if the gold price falls from its present level.

The processing plant will start commissioning before the end of this year. This is the stage at which Serabi will make any slight adjustments to make sure equipment is working before full production gets underway in the new year. That will coincide with the construction of a cyanidation circuit that Serabi hopes will increase gold recovery rates by 1,000 basis points.

Line admits cash has been tight within the business. Serabi had not budgeted for the acquisition of Sao Chico’s owner, Kenai, this year when it raised $25 million in January. That deal came with a $2.7 million loan facility to Kenai for exploration work. Line says he is looking at ways to put in a new working capital facility to ensure Palito starts smoothly. We expect 40.5% shareholder Fratelli, a Chile-based private investment firm, will help out.

Execution and financial risks remain but the upside potential is too attractive to ignore.

Swot analysis

STRENGTHS

• Good knowledge of ore body

• Wealthy financial backers

• Big exploration upside

WEAKNESSES

• Working capital needs

• Mine re-start risk

• Waning investor interest in Brazil

OPPORTUNITIES

• Buy nearby gold assets

• Expand production

• Lower output costs

THREATS

• Processing plant problems

• Gold price volatility

• Lack of exploration funds