Is It Time To Buy Alamos Gold?

|
About: Alamos Gold Inc (AGI)
by: Aitezaz Khan

Summary

Alamos Gold's third-quarter results missed on revenues and earnings.

AGI's income statement has been weak during the recent quarters.

Nevertheless, the balance sheet looks strong and AGI could leverage from expansion in production potential.

The prospective expansion of production potential would only happen in FY 2019 and therefore AGI is likely to remain flat during FY 2018.

Alamos Gold (AGI) is a Canadian intermediate gold producer that has four producing mines and six projects. The majority of its gold reserves are based in North America and even more so, in Canada (Figure-1); and helps the company conduct its operations in areas of low geopolitical risks.

Figure-1 (Source: September Presentation)

Thesis:

Over the past three years, AGI has reported favorable results in terms of increased gold output, gold reserves/resources, and a decline in mining costs. The company has also paid consistent semi-annual dividends and remains debt-free. Even though the company maintains a strong balance sheet, I do have some concerns about the company's recent financial performance particularly the sales and earnings' trend. A closer look at the numbers also indicates high-cost mining that is attributable to exhausting mines in Mexico. It logically follows that AGI will need to expand production potential from its existing Island Gold mine and the upcoming Turkish projects. This implies that in FY 2018 AGI will remain unimpressive. However, the stock would revive in FY 2019 and beyond as it unlocks increased gold production potential.

A quick overview of AGI's recent performance:

AGI has reported Q3 revenue of $146.7 MM that resulted in a ~14% increase Y/Y but failed to reach the revenue target of ~$155.67 MM. Besides, the company's EPS could not meet the consensus EPS of $0.01/share. During the past 3 years, AGI has managed to increase its gold output by ~30% (Figure-2) and I believe that it would keep expanding its production in FY 2019 (discussed in a later part of the article).

Figure-2 (Source: September Presentation)

Moreover, the company has also managed to reduce its AISC (read: All-in-Sustaining-Cost) by ~6% during the past 3 years (Figure-3). However, I believe AGI's average AISC is still a long way from being termed as low-cost.

Figure-3 (Source: September Presentation)

The company has 3 projects in Turkey that are risky but promise low-cost mining potential (discussed in a later part of the article).

On another positive note, AGI has reported a 67% increase in its proven and probable reserves during the past 3 years (Figure-4).

Figure-4 (Source: September Presentation)

Moreover, AGI had announced ~0.01/share semi-annual dividend, to continue the consistent payment of semi-annual dividends for the 18th time in a row. However, that dividend payment pertained to Q2 2018 and not the Q3.

Finally, the technical price chart (Figure-5) shows that AGI's price has formed a falling wedge pattern with resistance at ~$4.75. Theoretically, the stock should have found support near $4. But we have seen that AGI has already slid beyond those levels and is currently moving towards its 52-week lows ($3.74). Based on a purely technical analysis, one may assume that the stock should move up from here, but the discussion that follows indicates that AGI will remain shaky throughout the year; due to its weak fundamentals.

Figure-5 (Source: Finviz)

Financial performance analysis:

Sales: AGI’s sales trend during the past five quarters looks like a bell curve (Figure-6). From the period between Q3 2017 and Q3 2018, AGI’s sales stood at ~$128.8 MM, $161.7 MM, $173.1 MM, $168.9 MM and $146.7 MM respectively. Based on the sales trend, the next move (Q4 2018) may be even level. But that would depend on gold prices.

Gold prices have generally improved during the Q4, therefore, we may expect Q4 revenues to beat those in Q3.

Figure-6 [Prepared by Aitezaz Khan for Seeking Alpha]

Profitability: Another concern is the declining gross income reported in the preceding five quarters. AGI’s reported gross income for the said periods stood at ~$25.60 MM, $22.80 MM, $24.50 MM, $16.70 MM and $6.70 MM respectively. Then again, these numbers have declined significantly during the FY 2018 and I believe the decline is also attributable to increased costs during the last 5 quarters. Have a look at Figure-7 that illustrates how AGI’s AISC has increased over time.

Figure-7 [Prepared by Aitezaz Khan for Seeking Alpha]

AGI’s Island Gold mine was added in its portfolio when the company acquired Richmont Mines; back in 2017. As shown in Figure-8, this mine is currently the lowest-cost mine operated by AGI. Moreover, the company has completed Phase-I of its expansion that stretched the tonnage to ~1,100 tpd (read: tons per day). In my opinion, this should add favorably to the low-cost mining prospects.

Figure-8 (Source: September Presentation)

Earnings Per Share: AGI’s earnings/ (loss) per share during the past 5 quarters were $0.1, ($0.01), $0.0015, ($0.02) and $0.0185, respectively. The fact that AGI has been unable to report consistent earnings raises a question about its dividend payouts. As mentioned earlier, AGI has paid a semi-annual dividend for the 18th time in a row. Given the company’s increasing costs and declining profitability, such dividends are not supported by the company’s weak earnings that seem to have taken a roller coaster ride. It should be noted that AGI has ~390 MM shares outstanding and the recently announced DPS of $0.01 would imply the payment of ~$4 MM (390 X 0.01). This dividend is roughly 56% of the net income reported for Q3, but it won’t be a problem for the company given its cash and short-term investments of ~$230 MM as at the end of Q3.

Balance Sheet: AGI has a strong balance sheet of ~$3.33 B, out of which approximately 84% represents mineral property, plant and equipment. Apart from the mining properties, AGI maintains a healthy liquidity position (as discussed above). Moreover, AGI has zero debt and it could utilize the favorable cash balances for funding mine CAPEX. The only concern on the balance sheet is the ~$485 MM deferred taxes. It should be noted that most of them relate to the valuation of mining properties and therefore, would be amortized over a longer period. The overall position of the balance sheet looks solid.

AGI’s operational profile at a glance:

As shown in Figure-8, AGI has two operating mines in Canada and two in Mexico. The Canadian mines employ underground mining while the Mexican mines employ open-pit mining. Technically, underground mining operations are high-cost compared with open-pit, but in the case of AGI, I am surprised to see a reverse situation. Its open-pit Mexican mines have a considerably high cost compared with the underground Canadian mines. I believe the high AISC associated with the Mexican operations is attributable to aging mines. Consider the El Chanate mine (Mexico) which is depleting its resources and AGI is planning to cease mining operations therein (Figure-9). Mining costs at El Chanate stood at ~$1,200/oz (refer Figure-8) and I believe AGI would do well to get rid of this high-cost, low-production mine.

Figure-9 (Source: September Presentation)

Furthermore, I believe AGI’s existing mines do not have a cost low enough to compete effectively with other mid-tier gold miners. On that note, we should remember that AGI’s Q3 AISC stood at $1,048/oz while its year-to-date average AISC was ~$990/oz (as reported in November Presentation). In contrast, B2Gold’s AISC during the first nine months lied between the range of $780-830/oz.

Future outlook:

Now let’s consider the operational outlook of AGI in the future. So far I have discussed AGI’s operational and financial results up to Q3 2018, and the discussion indicates that AGI’s has delivered mediocre performance in the recent quarters. I see a few key factors that could change AGI's outlook going forward.

Island Gold mine: First, let’s consider the potential in AGI’s Island Gold mine. As mentioned earlier, this mine is the lowest cost mine in AGI’s portfolio of producing assets. Over the years, it has grown in terms of output, reserves, and resources (Figure-10). Going forward, we will see increased production from this low-cost mine due to the Phase-I expansion leading to increased ore processing capacity (as discussed earlier).

Figure-10 (Source: November Presentation)

Turkey projects: Next, I expect AGI to deliver low-cost mining once its Turkey projects start production. Note that AGI has 3 projects in Turkey namely Kirazli, Agi Dagi, and Camyurt and these projects are expected to have lower AISC than any of the existing mines run by AGI. Consider the numbers in Table-1 below:

Table-1 [Prepared by Aitezaz Khan for Seeking Alpha]

All the Turkish projects are in the permitting stage. Once AGI obtains the mining permits for these projects, it could safely conduct mining for at least a decade. This is so because the Turkish mining authorities provide a permit for a minimum of 10 years and these permits are further extendable for a period of 3 years. AGI plans to begin full-scale construction in the Kirazli project somewhere in H2 2018 and the project is expected to deliver initial production in about two years from now. This would be another catalyst that could positively impact AGI's share price in FY 2020. Furthermore, if we could find support from gold prices in 2019 then that would be another plus for the share price. But mining costs in Turkey would also be affected by the US$-Lira exchange rate. Let's discuss this factor in some detail:

As shown in Figure-11 the Turkish Lira has strengthened against the USD during the past month. Previously, $1 could buy ~6 Lira but now it can only buy ~5.30 Lira.

Figure-11 (Source: XE)

A stronger Lira against the USD would mean increased direct labor costs that are paid in Lira and reported in the USD. However, it could also have an indirect positive impact on mining costs. Consider the case for purchase cost of oil (in Turkish Lira). Due to strengthening Lira, oil prices in the country would go down and would put downward pressure on the inflation rate in the country. Consequently, there would be an overall improvement in the Turkish CPI (read: Consumer Price Index). This should discourage the mine workers from demanding higher wages on grounds of increased inflation in the country.[Note: The Turkish projects are expected to deliver production in at least 2 years from now, therefore the purpose of this discussion is not to evaluate the actual impact of exchange rate on mining costs; rather, it's only to explain the mechanics of how the exchange rate factors in].

Conclusion:

AGI is a mid-tier gold miner that is trading near the 52-week low price. Although the stock is technically well-positioned to go up from the current levels, the company has delivered average financial performance during the recent quarters, and that should restrain any sizeable growth in the short term.

As the preceding discussion indicates, AGI's share price is likely to remain flat during the remaining part of FY 2018. However, the real catalyst would be an increase in production during FY 2019 that would accrue from an expansion of its ore processing capacity at Island Gold mine in Canada. Going forward, the addition of Turkish projects into AGI's portfolio of producing mines should truly unlock low-cost mining for the company.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.