Yesterday morning I decided to take a sizable new position Gold Resource Corp (NYSEMKT:GORO) on the news that they had decided to go ahead with the development of their El Aguila mine in Mexico and that they anticipate production by mid 2008. The company noted that they expect to produce 70k ounces of gold in the first year, 90k in the second, and 100k in the third year. GORO did not mention their expected silver production, but given that silver has been found along with gold in their exploratory drilling, there will definitely be some significant silver production as well.
Given the production estimates, we can calculate that at gold prices of $650/oz, revenues should be around $169 million over the first three years of the production of the mine. Given that the company stated production costs at about $100/oz, gross profits over the first three years would be at least $140 million, not including the production of silver. Yet, even at $3.20 per share, the company has a market cap of only $90 million.
Additionally, the company expects to operate the mine for longer than three years, and my own belief is that gold prices are headed solidly over $700/oz in the near future. This provides upside leverage above and beyond what appears to me to be an already undervalued situation. Over the longer term, the company has 3 other properties that have yet to be explored in Mexico, and the company intends to make progress in exploring at least one of them in 2007.
Now, it is worth noting that the company is going to have to raise additional capital through dilution in order to fund the construction of a processing mill on the site. However, the company already has a solid balance sheet with $7 million in cash and no debt, and dilution would probably only amount to about 10 to 15% of the total value of the company. Even if we account for a $15 million dollar capital raise, the company still appears to be undervalued. I will throw together a rudimentary analysis below to summarize what I think is an appropriate valuation for the company. Unfortunately, I am a bit too busy to put together a more detailed analysis at the moment, but this should suffice.
Using current gold prices of $680, a silver price of $14:
Gold revenues= 260k oz, worth about $177 million
Silver revenues= 200k oz, worth about $3 million
Total revs= $200 million
Cost of production= $100/oz of gold=$26 million
Gross profits= $154 million
Expected SGA=8 million per year, $24 million
Operating income=$130 million
Tax expense (assuming 35% tax rate, and $6 million in NOL’s)=43 million
Net income=$87 million
Present value of this net income (assuming a risk free interest rate of 6%, and a period of 4 years): 87/(1.06)^4 = $69 million
Fully diluted market cap (assumes share count of 34 million): approximately $109 million
Market cap plus expected dilution for mill: $124 million.
Therefore, given the present value of future earnings, the stock is essentially trading at a P/E of 1.8. Obviously, this is all very speculative because the earnings are not yet in the bag and there is still significant risk here because the company has yet to secure a long term revenue stream. However, a P/E of less than 2 seems radically undervalued, even considering the risks.
Given the lessened uncertainty surrounding the company after yesterday’s news, I would expect the stock to move higher. It will still be given a low P/E, but something around 4 or 5 seems more appropriate. As more information is revealed about reserves and the funding process, the P/E will continue to rise to a more normal level, and the company should be given a boost by rising gold prices as well.
I bought shares in several trades between $3.01 and $3.20, resulting in a basis of about $3.14. I believe the stock has $4+ upside from here, especially if we are given reserve estimates for the El Aguila project.
GORO 1-yr chart
Disclosure: Author holds a position in GORO.OB