Richmont Mines - A Long-Term Buying Opportunity

| About: Richmont Mines, (RIC)

Summary

In May, Richmont Mines released its new expansion plan of the Island Gold mine. In my opinion, this plan is a game changer for the company.

The expansion plan is founded on four pillars: higher capacity of the Island Gold mill, higher mineral resources, higher gold grades and lower costs of production.

According to my estimates, the upgraded Island Gold mine is worth C$484M.

In my opinion, the value of the main company's assets is above the current market capitalization of Richmont shares, therefore the company presents a long-term buying opportunity.

Richmont Mines (NYSEMKT:RIC) is a mid-tier gold producer operating two mines in Canada. Most recently, the company released its Preliminary Economic Assessment for its flagship property, the Island Gold mine. In my opinion, this PEA is a game changer, transitioning the company into a solid, high production and low-cost league of mining companies. Strangely, this transition was totally ignored by precious metals investors. In this article, I am trying to fill this gap.

Introduction

Now Richmont runs two mines: Island Gold in Ontario and Beaufor in Quebec. Of these two operations, it is the Island Gold mine that is the flagship property. In 2016, Island Gold delivered 83.3 thousand ounces of gold while Beaufor produced only 19.6 thousand ounces. What is more, the flagship operation is a low-cost one - for example, in 1Q 2017, the mine was producing gold at the cash cost of C$668 per ounce and the all-in sustaining cash cost (AISC) of C$848 per ounce of gold. On the other hand, the Beaufor mine was a high-cost operation producing its gold at the cash cost of C$1,265 per ounce and AISC of C$1,580 per ounce of gold.

Interestingly, over the years, the Island Gold mine was just a typical mine. After starting its operations (2007), the annual production was generally stable (between 35 and 50 thousand ounces of gold), but in 2015, the company initiated a very ambitious expansion program and the production rapidly jumped up since that time (look at the green arrow depicting a transition period):

Chart 1

Source: Simple Digressions

Island Gold

In 2015, the company started the Island Gold expansion program aiming at increasing mineral resources, upgrading the processing plant and lowering production costs. For example, look at the chart below. It shows the history of the Island Gold mineral reserves, starting from 2008:

Chart 2

Source: Simple Digressions

It can be easily spotted that since 2015 the company has been very successful in expanding the mineral base at Island Gold. Let me give a short description of the property.

Description of the property

As the picture below indicates, Island Gold is located in the so-called Michipicoten Greenstone Belt, where a few notable mining companies operate or operated in the past (for example, Wesdome Gold (OTC:WDOFF) with its excellent Eagle River mine):

Picture 1

Source: Richmont Mines

Gold mineralization occurs mainly in three zones:

  1. Lochalsh - this part of the property has been mined out.
  2. Island - the part of the property where current mining operations are carried out.
  3. Goudreau - an area of potential expansion (this year Richmont is conducting an exploration program here).

Now, the company's strategy is to go deeper and deeper at the Island zone. The current expansion program is focused on the ore lying at a depth of 400-1,000 meters below the surface. Simply, deeper means higher grade:

Table 1

Source: Richmont (slide 37)

Note: The first mining horizon ends at a depth of 635 meters, the second at 740m, the third at 860m and the fourth at 1,000m below the surface

As the table shows, the gold grades are increasing along with depth. The only exception is the fourth horizon where reserves are grading 8.74 grams of gold per ton of ore. However, the main part of this horizon consists of inferred resources (part of them is included in the current expansion PEA) grading 15.22 grams of gold per ton of ore, which is a very high grade. The problem is that inferred resources are the riskiest resources a mining company discloses in its mineral estimates. In other words, due to insufficient exploration, the inferred resources may prove to be uneconomic. However, according to the PEA, the company is going to start mining in the fourth horizon not earlier than in 2021, so there is a lot of time to do additional drilling and convert inferred resources into reserves.

Expansion plan

In 2015 and 2016, the company radically increased its project capital spending at the Island Gold property (C$35.5M and C$54.7M, respectively). This money was spent on extensive exploration, upgrading the processing plant and development (construction of a new mine at a depth of 400-1,000 meters below the surface).

However, the first concept was to go deeper and expand the processing facility (MILL) to 900 tons of ore per day (from the previous 800 tons per day). Then, in 2016, the bull market in gold had started and Richmont decided to prepare a more ambitious study on the Island Gold with the mill being upgraded to process 1,100 tons per day.

The difference between the two studies (the 800 and 1,100 tons per day) is huge and, in my opinion, the currently realized variant is a game changer for the company. The chart below shows gold production under these two expansion plans:

Chart 3

Source: Simple Digressions

I am sure that the difference is obvious:

  • Under the first scenario (800 TPD), the total production stands at 465 thousand ounces of gold; the average annual production is 77 thousand ounces and the mine life is 6 years.
  • Under the second scenario (1,100 TPD), the company should produce 964 thousand ounces of gold over the mine life of 8 years; the average annual production is 121 thousand ounces of gold.

Further, the chart below shows the actual and planned capital expenditures under the 1,100 TPD scenario:

Chart 4

Source: Simple Digressions

I guess the company has a very good message for its shareholders - the highest capital spending (C$79M, the green line on the chart above) was reported in 2016, and over the coming years, Richmont is going to spend less and less on Island Gold.

The expansion of the processing plant (primary costs: adding new ball mill and extension of the mill building) is going to end in 2018 and will cost C$15.7M. As a result, since 2019 the upgraded Island Gold mine should be processing more than 400 thousand tons of ore per year and delivering 128 thousand ounces of gold in annual production, on average.

Costs of production

In 2016, the Island Gold mine was producing gold at the cash cost of C$215 per ton of ore (mining and processing costs). According to the 1,100 TPD PEA, the upgraded mine should be producing gold at the average cost of C$157 per ton of ore (27.0% below the current cost). For better comparison, below I have plotted historical and planned cash costs and all-in sustaining cash costs (AISC) of production, calculated on a-per-ounce basis:

Chart 5

Source: Simple Digressions

As the chart shows, the upgraded mine should be a very low-cost gold producer. For example, at the current price of gold of C$1,658 per ounce, the Island Gold should be delivering free cash flow of C$823 per ounce of gold, on average (the current gold price less AISC). In other words, the upgraded Island Gold mine should be a very safe operation - gold prices would have to go down to C$835 per ounce (US$625) to make this operation uneconomic.

Valuation of the Island Gold

Now, the most interesting thing - the value of the upgraded Island Gold mine. To find this value, I used the company's data presented in the section "Financial Analysis" (PEA presentation, slides 60-64). Additionally, I made one small adjustment - instead of the price of gold of C$1,700 per ounce I applied the current gold price of C$1,658 per ounce. Here are the results:

Table 2

Source: Simple Digressions

As the table shows, the net present value of the project is C$483.5M (applying a discount rate of 5%). Interestingly, although the project presents good value, the first major positive effects will be seen in 2021 (the red ellipse on the chart below):

Chart 6

Source: Simple Digressions

In other words, the Island Gold is quite a unique mining project. Generally, mining companies do everything to generate high cash flow at the initial stage of any mining project. Then, over the years, the cash flow generated by a typical project goes down. Richmont is different. Due to the specific mining sequence, the highest cash flow will be delivered not at the initial stage of the project but later. The highest-grade ore will be mined in 2021 and later, when the company operates in the third and fourth mining horizon (refer to Table 1). Additionally, in 2021 and later on, the capital spending should be very low (Chart 4). Hence, high net cash flow in 2021 and later.

I think that this fact may be a sort of a negative surprise for investors:

Island Gold is an excellent property, but the first major, positive effects are to be seen in 2021

Richmont's share price action is similar to the broad precious metals stock market.

For me, it does not matter, but for some investors, it definitely matters so the current price action of Richmont shares looks as follows:

Chart 6

Source: Simple Digressions

The charts show the price action of Richmont shares compared to the broad precious metals stock market, represented by the VanEck Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ). Simply put, despite the positives I discussed in the sections above, in the current bull cycle in gold, Richmont shares have done nothing special. As the two red lines on the lower panel of the chart indicate, since the beginning of 2016 (the beginning of the current cycle), there was generally no difference between Richmont and GDXJ share prices action.

What is the value of Richmont shares?

As of June 16, 2017, Richmont shares were trading at C$10.0 a share, so the company's market capitalization was C$632.4M. Additionally, at the end of 1Q 2017, the company was holding cash of C$75.2M and debt of C$10.4M.

In my opinion, the main assets of the company are Island Gold and cash. What is the value of these assets? Well, it is a simple calculation. According to my estimates, at current gold prices, the Island Gold mine is worth C$483.5M (refer to the section "Valuation of the Island Gold"). Adding cash to that figure (C$75.2M) and subtracting the debt of C$10.4M, I arrive at the value of C$548.3M. So the final equation looks as follows:

Equation 1

The difference is minus C$84.1M and it means that an investor acquiring all shares outstanding would have overpaid (the value of the assets acquired is below the company's market capitalization).

However, apart from the Island Gold mine and cash, Richmont owns a few assets that were not included into this calculation:

  • The additional extension of the Island Gold operation.
  • The Beaufor mine.
  • The Camflo mill.
  • The Wasamac property.
  • A few other exploration properties.

In my opinion, the Wasamac property and other exploration properties do not show any relevant value today, so they are excluded from my discussion.

The other assets are very interesting. Let me discuss them:

Extension of the Island Gold operation

At the end of 2016, the mineral resources of the Island Gold mine were estimated at 1,839.4 thousand ounces of gold, of which:

  • Mineral reserves accounted for 40.9% (752.2 thousand ounces).
  • Measured and indicated resources accounted for 5.0% (91.4 thousand ounces).
  • Inferred resources accounted for 54.1% (995.7 thousand ounces).

To remind my readers, only 926 thousand ounces of gold are included in the 1,100 TPD PEA, so there is plenty of gold left for the future expansion. Of course, all this gold is classified as inferred resources, so the company has to convert this risky material into a more viable one. However, history tells that Richmont geologists are experienced, successful guys, so the conversion of inferred mineral resources into reserves seems to be a question of time only. Additionally, the Island Gold (at a depth below 1,000 meters) and the adjacent mineralized zones (especially the Goudreau zone) are prospective deposits and a future gold discovery is in the cards. If that is the case, another ambitious expansion plan would have added additional great value to the company.

Beaufor mine

Over the years, the Beaufor mine became dominated by the Island Gold mine:

Chart 7

Source: Simple Digressions

Chart 7 shows the Beaufor/Island Gold production ratio (defined as the Beaufor gold production divided by the Island Gold production). It is easy to spot that now the Beaufor mine is a marginal operation. For example, in 2016, Beaufor produced 19.6 thousand ounces of gold while the Island Gold mine delivered 83.3 thousand ounces of gold (so the ratio was 0.23), but in 2008, the Beaufor mine produced 32.9 thousand ounces of gold and Island Gold delivered only 38.0 thousand ounces (the ratio of 0.87).

What is more, last year the quality of the Beaufor mine deteriorated very much. Production costs went up significantly (for example, AISC went up from C$1,212 per ounce of gold in 2015 to C$1,854 per ounce in 2016) and Beaufor became an uneconomic operation.

This year the company's management wants to revive the Beaufor mine. The all-in sustaining cash cost of production should stand at C$1,590, so the mine is going to generate free cash flow at current gold prices (C$1,658 per ounce). In 1Q 2017, AISC was C$1,580, so it looks like everything is going well at Beaufor and the main takeaway is this:

Free cash flow generated by Beaufor means that this operation adds value to the company.

Camflo mill

The Camflo mill has a capacity of 1,200 tons of ore per day. The mill processes the ore coming from the Beaufor mine, but due to the fact that this mine uses only 25% of its nominal capacity, it is possible to offer toll processing for the mining companies operating nearby. In my opinion, the toll processing should add value to the company improving the right side of Equation 1.

Risk factor

As I discussed above, apart from mineral reserves, part of the 1,100 TPD mine plan comprises inferred resources. To remind my readers, according to the Canadian Institute of Mining (CIM):

An 'Inferred Mineral Resource' is that part of a Mineral Resource for which quantity and grade or quality can be estimated on the basis of geological evidence and limited sampling and reasonably assumed, but not verified, geological and grade continuity. The estimate is based on limited information and sampling gathered through appropriate techniques from locations such as outcrops, trenches, pits, workings and drill holes.

In other words, inferred resources do not have demonstrated economic viability. It means that part of the deposit located in the fourth horizon of the Island Gold mine (where the inferred resources are located) is more risky than the other parts of the deposit. However, in my opinion, it is just a theoretical risk - the company has plenty of time to convert the inferred resources into reserves (mining operations in the fourth horizon will start not earlier than in 2021).

Summary

In my opinion, the 1,100 TPD expansion plan of the Island Gold mine is a game changer for Richmont:

  • The average annual production should amount to 121 thousand ounces of gold over the mine life of 8 years (according to the previous 800 TPD expansion plan, the annual production was to stand at 77 thousand ounces over the mine life of 6 years).
  • With the average AISC of C$835 per ounce, the upgraded mine is going to be a very low-cost producer of gold.
  • Low cost of production means that Island Gold has a very wide economic moat (gold prices would have to go down to around US$630 to make this mine uneconomic).
  • Under the current expansion plan, the Island Gold should produce 926 thousand ounces of gold over its mine life. However, the total Island Gold's mineral resources are estimated at 1,839 thousand ounces, nearly twice as many as the current mine is going to produce. In other words, the Island Gold mine has huge upside potential (it may double in size relatively easy).
  • According to my calculations, the current well-defined assets (Island Gold and cash) are worth C$548M. This figure is slightly below the current market capitalization of C$632M, but it does not take into account such items as, for example: the Beaufor mine, the Camflo mill and a possible additional expansion of the Island Gold. In other words, Richmont shares seem to be undervalued now.

Despite these positives, investors seem to ignore Richmont and its ambitious Island Gold expansion plan. I discussed this issue in the section "Valuation of the Island Gold" - due to a specific mining sequence at Island Gold, the first major positive effects should be visible in 2021. For many investors, it is a long time (maybe too long), so they probably have chosen to stay away from these shares. However, I believe that from the long-term perspective, Richmont presents a very interesting buying opportunity now.

Disclosure: I am/we are long GDXJ.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I hold a long position in gold futures.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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