Chesapeake Gold: An Easy Way To Bet On Higher Gold Prices

Oct. 30, 2018 5:05 PM ETChesapeake Gold Corp. (CHPGF), CKG:CA6 Comments2 Likes
Don Durrett profile picture
Don Durrett
4.66K Followers

Summary

  • Highly leveraged to higher gold prices.
  • 18 million oz. gold project in Mexico.
  • Investors hate it today, but will like it as gold prices rise.

Stock Name

Symbol (US)

Type

Risk

Share Price (US)

FD Shares

FD Mkt Cap (10/20/2018)

Chesapeake Gold

CHPGF

Gold

Moderate

$1.48

50M

$74M

I normally don't consider project generator/exploration stocks to have a good risk/reward profile. However, there is one stock that has crashed to a level that makes it appealing. Chesapeake Gold (OTCQX:CHPGF) has an FD (fully-diluted) market cap of $74 million with a project that could produce $500 million in annual free cash flow at higher gold prices.

Investors currently hate this project because they refuse to value a company based on future gold prices. I, on the other hand, have no problem projecting out into the future. This project will require approximately $1,600 gold to get built. The reason why is because the after-tax IRR is only about 15% at $1,400 gold.

Long Term Investment

Not only do you have to wait for $1,600 gold, but you also have to wait for permitting, which will take 2-4 years. Then once permitting is completed, you will need to wait another 2 years for the mine to get built. Cash flow likely won't appear until around 2025. As you can see, this is a long-term investment.

Now for the good news. Their gold reserves in the ground are currently being valued at about $4 per oz. Investors will bid that up as gold prices rise. Thus, the odds of your investment doubling or tripling in value with higher gold prices is quite good.

There are two ways to look at Chesapeake Gold. One, as an excellent speculation stock to double or triple your money if gold prices rise. Or, as a long-term play to potentially make a high return if the mine is built. The risk is that gold prices do not reach $1,600 anytime soon.

As a gold stock mining investor, I always look at the various important data points that could raise red flags. I usually look at their properties first. I want to find companies that have a long-life mine along with either exploration potential or at least one pipeline project that can create future growth. For Chesapeake, they have such a large project that it really isn't necessary in this case.

Project Information

Metates has 18 million oz. of gold (.6 gpt), 500 million oz. of silver (15 gpt), and 4 billion lbs. of zinc. With gold production potentially reaching 600,000 oz. per year, this could be one of the most profitable gold mines in the world.

This project will be built in two phases. Phase 1 has a capex of approximately $2 billion. The problem is that the after-tax IRR for phase 1 is only 15% at $1,400 gold. The low IRR implies that this project will not get built until around $1,600 gold. Plus, it still needs permitting.

The grade and recovery rates are satisfactory. The grade isn't great at .6 gpt, but the recovery rate makes up for it at 85%. Also, they have a lot of silver, which as a 75% recovery rate. In fact, they plan to mine up to 20 million oz. of silver annually. That is going to create huge offsets to lower their cash costs.

The location is in Mexico, which is not high risk at this time. I consider it a good location, although not a great one.

They currently own 100% of the project.

Metates will have negative cash costs per oz. the first 4 years for gold production because of the offsets from silver and zinc. After year 4, cash costs will average about $650 per oz. for gold, although they could be lower if silver prices outperform gold. I consider $650 per oz. to be low cash costs and it will create huge cash flow at higher gold prices. It's possible, and perhaps likely, that these costs will increase by the time the mine is built.

They have a feasibility study from 2013 and an updated pre-feasibility study from 2016. They still need to do another feasibility study, plus permitting. They will need to raise some cash to complete this, but not much because they already have cash in the bank. If they are smart, they will let their “to be determined” partner fund most of these final development costs.

The capex is very high at around $2 billion for the first phase. With an after-tax IRR of 15% at $1,400 gold, no one will build or finance this large project until gold reaches at least $1,500 and probably $1,600. This high gold price requirement is the main reason their valuation is so low. Another reason, is the long wait until production, which will probably take another 6 or 7 years.

Management

The management team is very good at exploration, but has no plans to develop and operate this mine. The CEO said that he is looking for a partner to build the mine. The chance of them changing their mind and building this mine is highly unlikely.

I consider the management team to be investor friendly. They have been very patient with the low gold price situation for the last few years. I don't think they have waited this long to short change investors, although I could be wrong. Also, during this long wait, they have not diluted shares, which I think is a good sign for being shareholder focused. Another good sign is that management and the board own 12% of the shares. They have skin in the game.

Intangibles

Because of this long wait until production, this investment probably makes more sense to chase the 200% or 300% return if gold prices take off. The leverage to higher gold prices for Chesapeake is quite obvious.

I like their tight share structure, which is currently only 50 million fully-diluted shares. Management has done a good job keeping dilution down.

With a $74 million FD market cap, they are very cheap and offer a good entry point. They are trading near a 10 year low. Their balance sheet is pretty good, with $13 million in cash and no debt.

Conclusion

Now we get to the reason they are attractive. At $2,000 gold prices, they have a potential 1,000% return. Future cash flow would be around $160 million annually at 200,000 oz. annual production (using $1,200 per oz. all-in costs). This assumes they keep 30%.

Their projected future reserves would be 18 million oz. That translates into a current valuation of $4 per oz ($74 million / 18 million oz.). That is extremely low for a project in Mexico with $650 per oz. cash costs.

I project their future market cap growth to be 1,000% by comparing their current FD market cap ($74 million) to their future FD market cap ($800 million). Their future market cap is calculated using their future cash flow ($160 million) x 5.

I think this is a conservative future market cap valuation at $2,000 gold prices, although the unknowns of mine financing, mine hedging, mine streaming, and share dilution will bring down this valuation. For this reason, I use a 5x multiplier, which I think is realistic.

Is Chesapeake Gold highly undervalued? Yes, if you use higher gold prices for their future valuation. Using higher gold prices, their potential valuation could increase of 1,000% and future reserves are valued at $4.

This valuation assumes its upside potential will reach production of 200,000 oz. of gold at $2,000 gold prices. This valuation also assumes they will keep 30% of the project.

Note: You can check the data included in this analysis at Chesapeake Gold's website: Chesapeake Gold.

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.

This article was written by

Don Durrett profile picture
4.66K Followers
Author of How to Invest in Gold & Silver: A Complete Guide with a Focus on Mining Stocks. Expert on gold and silver mining stocks. Website: https://www.goldstockdata.com.Twitter: https://twitter.com/DonDurrettYoutube: https://t.co/TKA05E3Gsr?amp=1Instagram: https://www.instagram.com/dondurrett/Website: https://www.dondurrett.com
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Disclosure: I am/we are long CHPGF. 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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