If you like to invest in high upside potential stocks, then Paramount Gold Nevada (PZG) is worth a look. They meet most of the criteria (discussed below) that I look for when analyzing a gold mining stock for large returns. There are several key criteria that I look at, although it usually comes down to risk/reward and upside potential. I especially focus on future cash flow potential versus their current market cap.
Share Price (US)
FD Mkt Cap 9/16/2017
Paramount Gold Nevada
Paramount Gold Nevada has a market cap that is a bit lower than where I like to buy stocks. I prefer to get them in what I call the sweet spot, with a fully diluted market cap between $50 million and $150 million. Once a stock reaches the $50 million level, the risk reduces because investors have recognized its value. Conversely, once a stock exceeds $150 million, the upside potential begins to diminish.
This range of $50 to $150 million does not apply to all miners. Sometimes, a company displays extraordinary value before it reaches $50 million or long after it exceeds $150 million. This is the case for Paramount Gold Nevada. I expect them to rise to this level soon. I have assessed them as moderate risk and am confident this stock is heading higher. I'm surprised that it is being ignored by investors and do not expect that to last.
This sweet spot range is where you will find late-stage development projects, near-term producers, or mid-tier producers. What you are really investing in are emerging mid-tier producers. Most mid-tier producers are valued over $100 million, so buying in this range is catching an early mid-tier producer. These are the companies that can grow quickly. At this valuation, most of these companies will only have one producing mine, or their first mine under development. Thus, you are getting in early, which is smart. One thing I have learned is that you usually don't make your big money on a company's first mine, but its second and third.
Paramount Gold Nevada is developing their first mine, but the value of this stock is really in their second project called Sleeper. Not only is Sleeper their game changer, but it defines this stock, which is a sleeper. It is one of my favorite unknown stocks.
Whereas the risk is substantial for junior gold and silver mining stocks, the upside is also substantial. My current focus is on both undervalued producers and companies with solid projects that are advancing toward production. My range is wider than $50 to $150 million market cap, but if a company falls into that sweet spot, I am more likely to buy it.
One key to buying a stock before it reaches this sweet spot range is risk. If you can identify when the market is undervaluing the risk of a company, then that is when you buy. A company like Paramount Gold Nevada has much lower risk than most stocks with similar valuations. The big reason why is Sleeper, which is worth a lot more than their current market cap.
As much as I like Paramount Gold Nevada, I consider all junior development companies as speculation stocks, because you can never know if they will make it into production. There are no sure things. If they have trouble with financing, or if the geology is analyzed incorrectly, e.g. Rubicon Minerals (RBYCF), or if any number of issues arises, these stocks can drop like a rock. Also, management is crucial and can disappoint investors with poor decisions and bad execution. Lastly, quality projects tend to get taken out by larger companies, which generally do not have the upside potential that I prefer.
Now is a good time to look for undervalued companies with growth potential. If we are at the beginning of another gold bull run that will see new highs above the 2011 level of $1,935 (see historical prices), then it would be wise to buy the potential winners now and get in early.
My investing style is to focus on potential future cash flow in conjunction with higher gold prices. For instance, what is the future value of XYZ gold stock if it develops a 3 million oz project and produces 200,000 oz annually at $2,000 gold? If you do a quick and dirty analysis using potential future cash flow, you get the following:
200,000 oz x $500 (estimated cash flow per oz using all-in costs of $1500 per oz) = $100 million in annual cash flow.
If you multiply that by 10, you get a $1 billion estimated valuation.
Note that some companies were valued at 30x cash flow during the last mania in stocks in 1980 and a 10x cash flow valuation is quite common today for strong mining companies. A conservative method is to use 5x cash flow to value a company. However, my expectation is that we should see 10x cash flow valuations as gold prices rise and companies obtain much more healthy balance sheets.
It's amazing how valuable a mining company could become at higher gold prices when it owns large profitable projects. There are many development stocks today with solid projects that are valued unbelievably cheap. Not all of them will be successful in building their mines, so it is a crapshoot picking the winners early. The smart play is to watch these stocks and see which ones are going to get financing. Of course, the longer you wait, the higher your entry price will be, and many will no longer be available at low valuations.
The most ideal risk/reward stock is an undervalued, or near-term producer that is both permitted and financed to build its first project. Paramount Gold Nevada is neither of these, so that adds some risk. However, it should reach this criteria soon on its first project.
The only way you can understand the risk of a stock is to do your own due diligence. Below, I will go step by step and show you what to look for when analyzing a mining stock. However, even with this data in hand, you should do your own due diligence to confirm what I have written.
Even if you think you know a stock intimately, the data will change. If there is one constant in the story of a stock, it is change. And stocks with high risk, it seems like the data changes more frequently. Whereas a major or a strong mid-tier producer can survive a data change without much impact, a junior can drop in value a significant percentage on small changes. The volatility can be stunning, and sometimes juniors do not survive these changes.
Here are my two most important rules to limit your risk exposure:
1) Only invest in a company that has the goods. Make sure that your company has at least one very good project. In other words, do not chase drill results (and if you do, then do it rarely). Exploration should be the icing on the cake, and not the cake.
2) Do not invest more than 1% of your portfolio's cost-basis into a single high-risk stock. Thus, if your total invested dollars is $100,000, then your max is $1,000 for a high-risk stock. You can break this 1% rule, but do it rarely.
This 1% rule may seem too low, but you have to stay humble and acknowledge the high risk with mining stocks. If you think the stock is low risk, then you can triple this total to a maximum of 3%. For any single stock, except mutual funds or ETFs, I would not exceed 3%. Remember, this rule only applies to your costs basis. If a stock that you own increases in value, that does not apply to this rule.
You may be thinking that you could end up with 50 or more stocks. Perhaps, but this won't happen if you buy bullion and/or ETFs as a foundation. With bullion, mutual funds, and ETFs, you can go over the 3% limit.
The following analysis is based on data from my website.
Paramount Gold Nevada. (Analysis on 8/16/2017).
Paramount Gold Nevada is developing two gold projects with 7.5 million oz. It is a new company that was a spinout of Paramount Gold & Silver in 2015, which sold their San Miguel project. That left them with the Sleeper project in Nevada. Sleeper is very large with about 6.5 million oz of gold equivalent (including silver). It has 5.8 million oz (.35 gpt) of gold and 35 million oz of silver (3 gpt). The problem is that it is low grade and the recovery rates will be low for both. The economics are not great, at about 20% after-tax IRR at $1300 gold. The capex is $175 million to produce 80,000 oz annually, but production will increase. This project won't get financed until $1400 gold.
Instead of waiting for higher gold prices to build Sleeper, they acquired Grassy Mountain in Oregon. It is a 1 million oz (.6 gpt) open pit and 600,000 oz (5 gpt) underground project. The cash costs are projected to be low at around $600 per oz. They are currently working on the PFS (pre-feasibility), which is due in Q1 2018. They are giving guidance for permitting in 2018 and are targeting 2020 for production. The capex for the PEA was $120 million, but they think it can be reduced. The after-tax IRR is projected to be 25% at $1300 gold. This project looks good and seems to be progressing.
Their FD market cap is only $29 million, giving them huge upside potential. Their future reserves are valued at about $5 per oz. Once investors realize what they have, it should quickly double in value. Insiders own about 40%, which should be enough to prevent a hostile takeover. Usually stocks this cheap with large resources get taken out. Let's hope that doesn't happen.
The 3 Ps
Do they have a flagship project? Yes, Sleeper has 6.5 million oz (gold equivalent, including silver).
Do they have a pipeline of projects for growth? Yes, Sleeper.
Do they have the exploration potential to expand resources? Yes, Sleeper has significant exploration potential.
Is the grade and recovery rate satisfactory? Grassy Mountain is only
.6 gpt, but cash costs are only $600 per oz. Sleeper is only .35 gpt, but is economic at $1300 gold.
Is the location satisfactory? Grassy Mountain is in Oregon. Sleeper is in Nevada. Both are satisfactory.
Do they own it? Yes, 100%.
Do you consider it a strong management team? This is perhaps my biggest concern and the biggest risk with this stock. The CEO has not built a mine before, but is confident he can pull it off. They do have an experienced board.
Is it an exploration or production team? Both.
Do they have experience? The CEO has significant operations experience.
Do they have a track record for building mines? First mine for Paramount Gold Nevada.
Are they investor friendly and not always diluting? Yes, they have done a good job containing share dilution.
Is the team large enough to build a mine? Yes.
Have you listened to a CEO interview? I read one of his recent interviews. He was lucid on their plans with good guidance and clarity. I think he is committed to becoming a mining producer.
Are they cash-focused? So far they have kept debt low, which is currently zero.
How much stock does management own? 7% fully diluted.
Do the website and company presentation provide adequate guidance and details? Yes.
What are the resources? 1.6 million oz of gold at Grassy Mountain (1 million oz open pit at .6 gpt and 500,000 oz underground at 5 gpt). 6.5 million oz open pit at .35 gpt at Sleeper.
Long life mine? Yes. 12+ years for both projects.
What are the current/estimated cash costs and all-in costs per oz? From the PEA: $600 cash costs per oz. My estimated all-in cost (free cash flow) is $1000 per oz for Grassy Mountain and $1200 per oz for Sleeper.
What documentation has been released for first mine (Preliminary Economic Assessment, Pre-feasibility Study, Feasibility Study)? PEA. A pre-feasibility study is due in 2018 for Grassy Mountain.
What is the capex for its first mine? $120 million for Grassy Mountain.
What is the after-tax IRR for first mine? 25% at $1300 gold for Grassy Mountain. 20% at $1300 gold for Sleeper.
Can its first mine be financed? Should not be a problem at $1300 gold. Won't be as easy at $1200 gold.
How will its first mine be financed (debt, equity, streaming)?
To be determined. Perhaps half debt and half equity.
Is it highly diluted? No, it has 20 million fully-diluted shares.
Timeline Risk (time frame until production)
Production scheduled for 2020, but could slip to 2021. This is mostly why it is so cheap. As it gets closer to production, the share price will rise.
Market Cap Size
$28 million. Below the sweet spot, but I don't think the risk is significant because of their large resources.
Is this a good entry point? Yes, likely 5+ bagger if Grassy Mountain gets built.
What is its cash/debt situation? $4 million in cash and no debt. (check Seeking Alpha).
Insiders (42%): Mgt 2%, FCMI Financial and Seabridge Gold 25%, HNW 15%. Note: Mgt owns 7% fully diluted, counting their options.
What is its potential future market cap growth rate at $2,000 gold? 5,600% at 200,000 oz (see below).
What is its potential future free cash flow at $2,000 gold? $160 million annually at 200,000 oz (200,000 x $800). (This assumes all-in costs are $1200 per oz).
What are its future reserves valued at today? $4.65 per oz at 6 million oz ($28 million/6 million oz).
Future market cap growth calculation
Current Market Cap: $28 Million.
Potential Future Market Cap: 200,000 oz x $800 = $160 million annual cash flow x 10 = $1.6 billion
Compare the two values and you get a 5,600% increase.
Is Paramount Gold Nevada highly undervalued? Yes, with a potential increase of 5,600% and future reserves valued at $4.65, it is highly undervalued.
This valuation assumes they will reach 200,000 oz of annual production, all-in costs will be $1200, and future gold prices will reach $2000.
Note: You can check the data included in this analysis at Treasury Metals website and www.paramountnevada.com.
Disclosure: I am/we are long PZG.
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.
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