In an earlier article, we went over the true all-in costs to mine an ounce of gold in Q1FY13 and discussed one of the most important metrics to analyze the gold industry, the actual cost of mining an ounce of gold, which can help an investor figure out whether it is time to buy GLD and/or the gold miners. In that analysis, we used the FY2012 financials to calculate the combined results of publicly traded gold companies and come up with a true all-in industry average cost of production to mine each ounce of gold.
In this analysis we will calculate the real costs of production of Alamos Gold (AGI), a junior miner with operations in Turkey and Mexico. Alamos's major producing mine is the Mulatos mine in Mexico, and the company is developing two mines in northwest Turkey.
We will then use the real costs of production and the current expected and future gold price to come up with a valuation for the company. This will allow investors to gauge whether the current valuation is fair, and what the valuation should be at future gold prices.
Calculating the True Mining Cost of Gold - Our Methodology
In the previously mentioned article, we gave a thorough overview of the current way mining companies report their costs of production and why it is inaccurate and significantly underestimates total costs. Then we presented a more accurate methodology for investors to use to calculate the true costs of mining gold or silver. Please refer to that article for the details explaining this methodology, which is an important concept for all precious metals investors to understand.
Explanation of Our Metrics
Cost Per Gold-Equivalent Ounce - is the costs incurred for every payable gold-equivalent ounce. It is Revenues minus Net Income, which will give an investor total costs. We use payable gold and not produced gold, because payable gold is the gold that the miner actually keeps and is more reflective of their production. Miners also use payable gold and not produced gold when calculating their cash costs, so this is pretty standard.
We then add Derivative Gains (or minus Derivative Losses), which will give investors total costs without the effects of derivatives. Finally, we add Foreign Exchange Gains (or minus Foreign Exchange Losses) to remove the effects of foreign exchange on the company's costs.
Cost Per Gold-Equivalent Ounce Excluding Write-downs - is the above-mentioned "Cost per gold-equivalent ounce" minus Property/Investment Write-downs and Asset Sales. This provides investors with a metric that removes exceptional gains or losses due to write-downs and asset sales.
Cost Per Gold-Equivalent Ounce Excluding Write-downs and Adding Smelting and Refining Costs - is the above-mentioned "Cost per gold-equivalent ounce excluding write-downs" adding in smelting, refining and all other necessary pre-revenue costs. This is a new metric that we are now introducing to our true all-in cost series because it will more accurately measure all-in costs and allow comparisons between miners.
Most investors are unaware that many miners will remove smelting, refining, and other costs before reporting their total revenues figures and these pre-revenue costs are not reported in the income statement. The result of this is that it skews all-in costs higher for miners that refine themselves or include the costs in their income statement, while inaccurately showing lower costs for miners that remove it before reporting revenues.
A simple test can be done on any miner to see if there are any pre-revenue costs that are not reported in the income statement. Simply take payable production and multiply it by average realized sales price and this should come relatively close to the total revenues figure. If it gives you a number much higher than reported revenues then there are pre-revenue costs that are not being reported.
This line should alleviate these issues and allow comparisons on a fair basis.
Real Costs of Production for AGI - Q2FY13 and FY2012
Let us now use this methodology to take a look at AGI's results and come up with their average cost figures.
Observations for AGI Investors
True Cost Figures - Alamos Gold continues to show a stable, low all-in cost structure, though costs in Q2FY13 began to rise. True all-in costs for Q2FY13 were $1236 per gold ounce, which was an increase in both sequential and year-over-year basis. This rise in costs was especially interesting because compared to Q1FY13, where production numbers were similar, total all-in costs rose even as taxes dropped.
Even with the rising Q2 costs, AGI remains a solidly low-cost producer compared to the Q1FY13 numbers of competitors such as Yamana Gold (AUY) (costs just over $1300), Goldcorp (GG) (costs just under $1200), SilverCrest Mines (SVLC) (costs below $1100), Newmont Gold (NEM) (costs around $1300) Agnico-Eagle (AEM) (costs around $1400), and Barrick Gold (ABX) (costs around $1200).
One of the reasons for the higher true all-in costs was related to the lower grades being mined.
The 1.10 g/t AU grades experienced in the second quarter were lower than the 1.25 g/t AU grades from the first quarter. Both the all-in costs and grades are a situation that investors should keep a close eye on in the future because they will directly affect the profitability of the company.
Corporate Liquidity - Liquidity is very important for investors to monitor in this current low-price gold environment. AGI has a very strong financial position of $466 million in cash and cash equivalents and no debt. Even after their acquisition of Esperanza Resources that occurred after the quarter end, they should have plenty of cash to weather prices even lower than current gold prices without too much worry.
Production Numbers - AGI's second quarter production of 53,000 ounces of gold was up 10% year-over-year, and pretty much in-line with their Q1FY13 (though quite a ways off from their impressive Q4FY13 numbers). In addition, the 53,000 ounces of second quarter production keeps AGI on course to surpass its 2012 200,000 gold total.
Other Items - AGI management has shown that it is aggressively taking advantage of depressed prices for explorers and its own large cash position. The acquisition of Esperanza Resources, which we covered in an earlier piece, was a very strategic acquisition that netted AGI gold resources at approximately $26 per ounce. Additionally, the company bought out Orsa Ventures for a little over $3 million after the Esperanza buyout. We believe that these are very good moves by AGI management to use some of their cash to buy future gold production at a fraction of what it would have cost even six months ago.
Using the true all-in costs, expected future production, and the expected gold price investors can get an idea of what to expect for future EPS.
Let us now take a look at the earnings and use the true all-in costs to get a sense of future earnings.
Investors can see that AGI averaged true all-in costs of around $1156 per gold ounce for the first half of the year. The true all-in costs are a bit lower than the total company's costs would imply because we have subtracted foreign exchange losses of around $7 million for the first six months, which is done to make sure that all-in costs do not include gains or losses from highly volatile non-production related costs like foreign exchange and derivatives.
Management has stated that it expects to produce around 180,000 to 200,000 for FY2013, which seems very achievable based on first half's production numbers.
Based on these numbers we come up with the following valuation numbers for the company.
Extrapolated P/E is the Share Price divided by the Current quarter EPS * 4, which will give us the expected P/E based on the gold prices achieved during the quarter. This is much more relevant for gold companies because it ignores past gold prices and assumes the gold price at current levels when valuing the company.
As investors can see, the current valuation gives the company a P/E of around 53 - which is quite rich especially considering that those earnings were achieved with a gold price almost $100 above current levels. If the gold price rises $100 then the company will still be overvalued on a strict P/E ratio, especially since management does not expect to produce significantly more gold in the last six months of the year.
Let us now try and extrapolate P/E for Q3FY13 based on some very generous numbers. Assuming the company can bring down its true all-in costs to $1100 per ounce (significantly lower than Q2FY13 costs), an aggressive 53,000 ounces produced (which would put production ABOVE the high level of management estimates), and a gold price at current levels, we arrive at a Q3FY13 P/E of 39 per share at current prices. This is still very rich especially with such rosy assumptions - any reduction in ounces produced or an increase in all-in costs will bring that P/E much higher.
Finally, let's take a look at expected earnings using different gold prices using these assumptions.
Based on the current and expected valuations at different prices and the rosy assumptions for their production numbers and costs, it seems that AGI is quite overvalued at current levels. Even at a gold price $100 higher than the current price, we believe that the company will sport a P/E around 27 and it would take a gold price over $1500 per ounce to fairly value this company at the current stock price without significant production increases.
Conclusions for Investors
AGI has been one of the lowest cost gold miners in the industry and we recommended this company in the prior quarter to be a part of every gold investor's portfolio. We believe that Q2FY13 was a little bit of a letdown in terms of its all-in costs, and it is very important for investors to continue to monitor the company's costs in future quarters because it has a low-cost premium built into the share price - if costs continue to rise then a large amount of this premium will be lost.
We believe that AGI has some of the best management in the gold industry but at the current gold price the company is significantly overvalued. It would take a significant increase in the gold price or reduction in costs to justify even the current price, and though we hate to sell companies with excellent management, we believe investors can find much better valuations with other miners that have been beaten up a bit more and have not recovered to fair valuations.