This article is about Midas Gold (OTC:MDRPF). Midas Gold has a market capitalization of $120 million. It is currently in the process of bringing its large Idaho gold mine--Golden Meadows--into production.
Golden Meadows is a large property with 7 million ounces of gold at around 1.6 grams per tonne. It will be able to produce roughly 400,000 ounces annually for the first eight years of the mine's life. Because the company will mine lower grade ore afterwards this figure should go down to about 300,000 ounces, which is still a lot for a company valued at just $120 million.
If this is the case, then why aren't the shares trading at a higher valuation? There are two reasons for this. First, production is years away. We don't know how long it will take the company to bring the mine into production. It needs to complete a feasibility study, obtain its permits, raise capital, and then construct a very large mine. This will probably take four years, or three at the very least, and I would not be surprised if it took five years. A lot can happen in that time frame regarding the regulatory environment, even in a jurisdiction such as Idaho.
Second, the company estimates that it will need $880 million in order to build the project. Given the long period of time that investors must wait for cash flow, if the company simply dilutes shareholders in order to raise the capital it needs then the stock appears to be somewhat expensive. After all, if the company raises $880 through a secondary offering, then it would be worth $1 billion, and it would trade at roughly 6.7 times its estimated annual cash flow. Why wouldn't an investor simply opt to buy a gold mining company that already has production that trades at around this valuation (e.g. Timmins Gold (TGD))?
With these two caveats Midas Gold does not seem to be the bargain that it appears to be. However, there are two possibilities that give the shares explosive upside potential. The first is that the company may not have to dilute shareholders in order to raise the capital that it needs. If it is able to issue debt then the company's valuation to future cash flow ratio would be incredibly small, even if the company has to pay a high interest rate on this debt.
Second, the gold price can rise. This would lower the multiple of the company's valuation, including expected dilution, relative to its future cash flow. For instance, if the price of gold rises 30% to $1,750, the company's expected cash flow would roughly double. But in order for the company's valuation ($120 million) plus expected dilution ($880 million) to double, the company's valuation would have to rise to $1.12 billion, or nearly 10 times. Thus even if you believe that the company is overvalued relative to its future cash flow, you may still be able to justify buying the shares to participate in a revaluation of the stock like the one I describe.
Ultimately Midas Gold has a lot of upside potential, and it will provide investors with substantial leverage to the gold price without a significant amount of political risk. But unless you think the gold price will rise, Midas Gold seems to be primarily a bet on how it will fund its project. If it can issue debt for a sizeable portion of its capital needs then it is highly undervalued with gold at $1,340/ounce. If it has to issue stock to raise this capital then it is not worth the timeline risk at the current gold price.
Golden Meadows is located in Idaho.
It is a large property with 7 million ounces of resources at 1.6 grams per tonne. This is high grade for a surface mine, and so the company will have low production costs. The resource is so large that the company has divided it into geological regions: West End, Yellow Pine, and Hangar Flats.
(click to enlarge)
The gold at Yellow Pine is higher grade than it is at Hangar Flats and at West End, and so the company will be mining this area first
As I have stated Golden Meadows has roughly 7 million ounces of gold at 1.6 grams per tonne. Specifically it has:
- 4.2 million ounces of indicated resources at 1.68 grams per tonne
- 2.9 million ounces of inferred resources at 1.6 grams per tonne.
Since the company is mining at Yellow Pine first it is worth noting that this area has grades far closer to 2 grams per tonne.
The company also has some antimony:
- 108.5 million pounds of indicated resources at 0.06%
- 93 million pounds of inferred resources at 0.7%
Antimony is currently valued at just over $4/lb, and so the net value of the company's antimony is around $800 million, which is insignificant relative to the value of its gold. Thus the antimony will be used as a by-product to offset the cost of gold production.
Finally the company has a virtually negligible amount of silver.
The details of the company's resources are provided on the following table.
The company is going to mine around 7 million tonnes of ore annually at a grade of 1.8 grams per tonne. It will begin mining at Yellow Pine and, to a lesser extent, Hangar Flats for the first several years of the mine's life, and then switch to focusing on West End, which has lower grade gold. The following table details the company's production schedule.
At 7 million tonnes of ore mined annually, and about 1.8 grams of gold per ton as the mine's average grade, the mine should yield 400,000 ounces per year. This figure will decrease as the grade of the ore mined decreases, as West End has lower grade ore than Yellow Pine.
When mining commences, that is, when Midas Gold is focusing on mining Yellow Pine, Golden Meadows is expected to have cash costs of roughly $530/ounce without antimony and silver by-products, or $425 with antimony and silver by-products.
This is extremely low, and with other expenses such as taxes, mine repairs and exploration, it should cost the company around $800 to produce an ounce of gold net of by-products.
In calculating Midas Gold's future cash flow from Golden Meadows I am using very conservative estimates given that the company has yet to release a feasibility study and has no mineral reserves. Instead of 400,000 ounces of annual gold production I am dropping this figure 10% to 360,000 ounces. This is due to general uncertainty due to timeline risk, as well as the fact that the company sold a 1.7% gold royalty to Franco Nevada (FNV). I am also raising my estimated production costs from $800/ounce to $900/ounce. The following table estimates Midas Gold's cash flow at various gold prices with these assumptions in place.
|Gold Price||Cash Flow|
|$1,250/ounce||$126 million ($158.4 million at $1,340/ounce gold)|
Thus the company trades at roughly 4/5 of its projected annual cash flow at the current gold price. Of course we have to take into consideration the fact that the company needs to raise roughly $880 million in order to develop Golden Meadows. if it simply dilutes shareholders, thereby increasing the market capitalization to $1 billion, the company trades at roughly 6.7 times its estimated cash flow. If we don't use conservative metrics, and instead assume 393,000 ounces of annual production (400,000 minus 7,000 that goes to Franco-Nevada) and $800/ounce costs, then the company's cash flow would be $212.2 million at $1,340/ounce gold, and the price to cash flow multiple, assuming dilution, drops to 4.7. Given the fact that production probably won't commence for 3-4 years, I don't think the company is cheap using either scenario, although it becomes so at higher gold prices.
However there is a different valuation story if we assume that the company can raise a lot of the capital it needs through a debt offering. Let us assume that the company can raise half of the $880 million by issuing debt at an interest rate of 10%. It would then have an additional annual cost of $44 million in interest payments. In the conservative scenario where the company produces 360,000 ounces of gold, this would add an additional $122/ounce of gold produced, increasing costs to $1,022 (I will use $1,020 for simplicity's sake). The following table refigures the company's cash flow estimates in this scenario.
|Gold Price||Cash Flow|
|$1,250/ounce||$82.8 million ($115.2 million at $1,340/ounce gold)|
In this scenario, the company's market capitalization only increases to $560 million after dilution, and the company's price to cash flow multiple drops from 6.7 to 4.9, which is far more reasonable for a company that will not see cash flow for several years. If we do not use conservative estimates and use 393,000 ounces of production and $920/ounce costs, then at $1,340/ounce gold the company will have $165 million in cash flow, and a price to cash flow multiple of just 3.4
While we can look at other scenarios, from these two it becomes clear how important the company's source of capital is from an investment standpoint: this is why I say in the introduction that unless you believe the gold price will rise, a bet on Midas Gold is, to a great extent, a bet on its funding source.
A: The Price of Gold
The price of gold has fallen precipitously recently, and Midas Gold's share price will be highly correlated to the gold price. Thus so long as this downtrend remains intact, there is a reasonable possibility that the gold price will continue to fall in the short term.
The price seems to have found a bottom around $1,200, which suggests that the downtrend in gold may come to an end. Still, it is intact, and lower gold prices will be reflected in Midas Gold's share price.
B: Midas Gold's Capital Needs
I have already referenced Midas Gold's capital needs several times. The company needs an estimated $880 million in order to develop Golden Meadows and to bring it into production. the following table itemizes its expenses.
The company has the following options for raising this money:
- It can issue stock.
- It can issue debt.
- It can sell another royalty or a stream to a royalty or streaming company.
- It can find a joint venture partner.
- It can sell itself outright.
Given that the company's capital needs are more than seven times greater than its market capitalization, this might be an instance where an outright sale of the company is the best scenario, especially if the gold price remains depressed. However, if Midas Gold wants to remain its own company it will have to find the capital using the other options. Debt issuance is probably the best of these, but it will be difficult to find a lender of so much money without higher gold prices (in which case dilution is less punitive to existing shareholders). It may also have better luck finding a lender if it found a JV partner for 25% - 35% of the property. Ultimately the company has difficult choices ahead of it, and hopefully it can find willing lenders.
C: Timeline Risk
Golden Meadows will not be in production for several years, and there is ultimately more uncertainty as a result. Therefore, the company's future cash flow is worth less than it would be if it were to be realized sooner. However, the company's valuation should benefit as production approaches, and the likelihood that Golden Meadows will go into production increases.
D: Midas Gold's Size
Midas Gold only has one property. If it cannot mine at Golden Meadows, it is worth the $10 million in cash and equivalents it has on its balance sheet, which is more than a 90% discount to the current valuation.
Midas Gold has a lot of upside potential, but unless the gold price rises, a lot of it depends on its source of funding Golden Meadows. This observation, coupled with the fact that production and cash flow will not be realized for several years, make the stock speculative.
For some investors this sort of speculation may be appealing, as the company already has the resources it needs, and it has a plan in place for extracting these resources. Furthermore, it is operating in a low-risk jurisdiction. Thus the downside risk is not so much that there is no or little value at Golden Meadows. It's more that investors may not be properly compensated for their patience.
But the real potential in Midas Gold is the enormous leverage to the gold price it offers even before it has cash flow. Right now if we presume full dilution, the company is trading at $1 billion with potential cash flow of about $158 million. But if the gold price rises to $1,750 and Midas Gold triples in price, its potential fully diluted market capitalization would only be $1.24 billion relative to estimated cash flow of $306 million per year, and it would therefore be cheaper than it was. The gold price would rise 30%, the valuation relative to future cash flow would drop from 6.7 to 4, or about 40%, and yet the shares would triple.
As an investor you only need to expect one of these positive developments in order to find Midas Gold shares appealing.