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Summary

  • Rio Alto Mining Limited, caught in a general mining sell-off, is executing, building reserves, and significantly outperforming the competition.
  • As evidence of this, in Q1-2014, Rio Alto beat analysts EPS estimates by 75%.
  • Rio Alto provides a margin of safety with a strong balance sheet and very little debt.
  • Rio Alto is significantly undervalued and may have as much as 76% upside.

Declining gold prices and increased mining costs have led to declining revenues and earnings for the mining sector and a corresponding sell-off in the mining stocks. However, there is one company that has managed to excel in this difficult environment. Despite obvious execution by management, the stock price has declined 66% in the last two years, creating a substantial value.

Rio Alto Mining Limited (NYSE:RIOM) is a Canada-based resource company with a market capitalization of $344 million focused on gold and copper mining. Rio Alto's primary asset is the La Arena mine located in north central Peru. This area of Peru is home to some world-class gold mines including Barrick Gold's (NYSE:ABX) Lagunas Notre Mine and Newmont Mining's (NYSE:NEM) Yanacocha Mine both of which have yielded significant production.

Production for the Next 25 Years

Rio Alto estimates that La Arena contains 5.5 million total ounces of gold (1.7 million in oxide and 3.8 million in sulphide) and 3.7 billion total pounds of copper. Production began in 2012 and Rio Alto has projected 2014 gold production to be 220,000 ounces. At this rate of production, the La Arena Mine will produce gold reserves for the next 25 years (5,500,000 total ounces ÷ 220,000 ounces per year = 25 years of production).

Beating Analysts' Estimates & Growing Reserves

Rio Alto reported Q1-2014 results on May 9th, 2014. Analysts were expecting earnings-per-share of .04 and Rio Alto surprised to the upside with a 75% beat at .07 per share or $11.9 million. The La Arena Mine produced 53,463 ounces of gold which was ahead of projections (although the company reiterated its guidance at 220,000 total ounces for 2014).

In a recent resource update Rio Alto President & CEO, Alex Black, provided a bullish outlook for the remainder of 2014:

We are extremely happy with the result of our 2013 geological and metallurgical programs. Even after stacking 261,232 ounces in 2013, our Proven Reserves grew by 452,232 oz - accounting for depletion this represents a 51% increase over our year-end 2013 reserve, and this is in spite of using materially lower assumed gold prices. Our planned 2014 drill program has the potential to continue this resource and reserve growth... at La Arena

Outperforming the Competition

As mentioned earlier, both Barrick Gold and Newmont Mining are also operating in north central Peru in direct competition with Rio Alto. By market capitalization, Barrick and Newmont are two of the largest gold miners in the world with Barrick's market cap at $19 billion and Newmont's at nearly $12 billion. In fact, the only gold miner with a larger market cap than Barrick is Goldcorp (NYSE:GG) at $20 Billion. Yet, when you compare tiny Rio Alto to these mining heavyweights, it's Rio Alto that is executing and delivering fundamental knockout punches to the competition.

Forward

PE

Earnings

Growth

MarginROECashDebt
Rio Alto6.0947.3%31.13%13.54%33.8M3.49M
Newmont Mining16.78-68.2%21.98%-20.45%1.5B6.7B
Barrick Gold14.08-89.6%28.06%-52.14%2.67B13.1B
Gold Corp.24.11-68.3%10.91%-13.29%1.09B2.93B

A Great Value Proposition with Significant Upside

The average forward multiple for a gold mining stock is 15.91, while Rio Alto's forward multiple sits at a paltry 6.09. If we apply a 15.91 multiple to Rio Alto, using the average 2014 analyst earnings per share estimate of .31, we end up with a price target of $4.93 or 152.82% appreciation from today's price of $1.95 per share.

  • 15.91 multiple x .31 EPS = $4.93
  • Taking a conservative approach and discounting by 30%, we still end up with a price target of $3.45 or 76.92% appreciation from today's price of $1.95 per share.

Another way to examine a stock's value proposition is to examine the earnings growth that you get for the multiple you are paying. If the earnings growth is equal to the PE multiple, then the stock is fairly valued. However, if the earnings growth exceeds the PE multiple, then the stock is undervalued.

  • With Rio Alto you are paying 9.95x for 47.3% earnings growth; a significant value.

Rio Alto also provides a margin of safety with $33.8 million in cash on its balance sheet and only $3.49 million in debt. This strong balance sheet is in stark contrast to most other gold miners and it significantly reduces the possibility that Rio Alto will dilute shareholders with any debt offering or secondary to raise cash for exploration.

The Risk of Declining Gold Prices

Gold prices peaked at $1,883 per ounce in August 2011 and have since declined settling at just under $1,300 per ounce. This amounts to a 30% price reduction. Yet Rio Alto has managed to keep production costs low and this has led to quarterly outperformance. Even if gold prices continue to slide, with a low adjusted operating cost of $651 per ounce, and increasing reserves, Rio Alto is positioned for performance.

(click to enlarge)

Conclusion

Rio Alto Mining Limited is an undervalued gem in the out of favor mining sector. Management is executing and beating analysts' estimates and a strong balance sheet is providing a margin of safety for investors. A general sell-off in the mining sector has caused Rio Alto to be mispriced by the market. Investors could experience substantial gains in Rio Alto Mining Limited.

Source: Digging For Gold? Rio Alto Mining Is An Undervalued Gem