Iamgold: Avoided The Carnage, Now I'm Buying

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About: IAMGOLD Corporation (IAG)
by: SomaBull
Summary

IAMGOLD has underperformed as expected due to issues at Westwood.

While there are still short-term challenges, there should be a turnaround in Q4.

There are other potential near-term bullish catalysts.

At an EV of just $1.1 billion, the risk/reward is compelling.

I haven't owned IAMGOLD (IAG) for well over a year as I had major concerns about their Westwood mine. IAG has three key operations: Essakane, Rosebel, and Westwood. Westwood was supposed to be a 200,000-ounce gold mine with AISC in the $800 per ounce range, but I have expressed my strong skepticism that the mine would ever achieve those targets as it's been dealing with seismicity issues over the last several years.

In March, the company announced the workforce at Westwood would be reduced by 32% as seismicity continues to hamper access to sections of the mine.

My summary investment thesis to subscribers at that time was as follows:

Shares of IAG continue to drastically underperform - mostly because of the dimming outlook for Westwood. I'm still avoiding the stock for now, but if it continues to decline, then IAG will eventually reach a point where Westwood has been fully priced in. There are several appealing aspects about IAG that could soon make it a buy, but it's best to let the market reset the stock price first.

IAG has declined by 55% over the last year compared to a decline of 5% for the NYSE Arca Gold BUGS Index (or HUI), and since March, IAG is down 23% vs. a decline of 2% for the HUI. IAG has reached a point where I finally see an opportunity on the long side. In this article, I will explain why and discuss those appealing aspects.

(Source: StockCharts.com)

Short-Term Challenges For IAMGOLD

  • The production forecast this year for Westwood is just 100,000-120,000 ounces of gold. Seismicity is occurring in higher grade areas of the mine, which is limiting access to the richer sections of the ore body. It's gotten to the point where IAMGOLD feels some areas of the mine are unsafe for its workers. With output at low levels, it will be much more difficult to drive down AISC. The workforce reduction will help rightsize the cost structure, but it won't solve the main problem. IAMGOLD needs to figure out how this deposit can be mined safely and profitably.
  • Essakane and Rosebel are also struggling with elevated AISC. This trio of mines (Essakane, Rosebel, and Westwood) averaged well over $1,000 per ounce all-in sustaining costs last quarter. Most companies in this sector have reduced AISC to under $1,000 per ounce; IAG is one of the highest cost producers in the industry at the moment.

(Source: IAMGOLD presentation)

  • While IAMGOLD has one of the best balance sheets in the sector, there has been a sharp decline in net cash over the last several quarters. Weak margins and heavy capital spend are resulting in excessive amounts of negative free cash flow. The net cash position has helped support the stock price in the past, but the recent deterioration is having a negative impact.

(Source: YCharts.com)

  • AISC might be even higher in Q2 and Q3 and negative free cash flow will likely continue, as if you look at what was spent in the first quarter vs. the budget for the year, IAMGOLD still has quite a bit of capex remaining. At Essakane, sustaining capex for the first quarter of 2019 was $10.2 million while the 2019 budget calls for $55 million in total for the year. At Rosebel, sustaining capital expenditures for the first quarter of 2019 were $11.1 million while non-sustaining capital expenditures were $9.2 million. The 2019 budget is $70 million in sustaining and $75 million in non-sustaining capital.

Much Improved Outlook By Q4

1. Saramacca Will Be Online

In 2017, IAG made a major discovery at their Rosebel mine. They found high-grade gold at Saramacca, which is located about 25 km from the Rosebel mill.

(Source: IAMGOLD presentation)

Grade is king in the mining sector, and Saramacca's reserve grade is almost double that of Rosebel. If you include the indicated ounces, the grade is even stronger.

(Source: IAMGOLD presentation)

IAMGOLD has been building a road from Saramacca to the Rosebel mill and Saramacca should start to produce in H2 2019 (likely Q4 to be conservative), with the full impact of production expected in 2020. Once Saramacca is online, AISC should improve in the short term. This operation also has the potential to be extremely low cost in future years (2022-2029) as that's when the average mill feed grade ramps up significantly.

(Source: IAMGOLD presentation)

2. Essakane Will See Slightly Better Grade In H2 And Further Optimization

Essakane is expected to see better grade in the second half of this year and the company has also been optimizing the operation in order to drive more cost improvements. Of the flagship assets, Essakane is the lowest cost and it could be under $1,000 per ounce AISC in H2 2019.

3. Improved Grades And Tonnage At Westwood As Year Progresses, With Q4 Being The Strongest

Q1 grade and tonnage at Westwood were disappointing because IAMGOLD was milling low-grade stockpiles to fill the mill - since they weren't able to access higher grade sections of the mine.

The tonnage is expected to increase about 30% in Q2/Q3 and then increase another 15% on top of that by Q4. Grade will increase as the year progresses as well, with grades being the strongest in the fourth quarter.

The operation will still just be limping along, but Q4 should be much improved compared to Q1.

Other Potential Near-Term Bullish Catalysts

  • Saramacca is an open pit deposit, but IAMGOLD is assessing whether it can be mined via an underground operation. They won't pick up all of the low-grade ore in this scenario, but the average mined grade will be even higher than what's currently modeled and there will be significantly less waste (the open pit strip ratio is very elevated). This will result in even lower costs. The rock conditions and geometry at Saramacca are extremely favorable for an underground mine operation. IAMGOLD is also being conservative with their assumptions when it comes to Saramacca. For example, they should be able to steepen the pit slopes for the open pit, which would positively impact the strip ratio. The company is anticipating having an internal study done later this year to determine the optimal way to mine the deposit. That study could be a bullish catalyst if improvements are shown.
  • IAG owns 95% of Rosebel and 66.5% of Saramacca, with the Government owning the remaining stakes. If IAG can increase its ownership in Saramacca and get it in line with Rosebel, then the company will participate even more in Saramacca's success. I believe the likelihood of this happening is high.
  • I exclude Westwood in my valuation model as I'm not convinced it will ever come close to reaching the output and AISC that the company originally forecasted. It's possible, though, this long-term outlook is too bearish. Agnico Eagle (AEM) has been successfully operating the LaRonde mine for over 30 years. LaRonde is adjacent to Westwood and has similar issues. Agnico even states on their website:

As the Company mines deeper at LaRonde, the risks of more frequent and larger seismic events increases. As a result, the Company is studying various design approaches to LaRonde 3. In addition, the Company continues to adjust the mining methods, ground support and protocols to address seismic activity in the deeper portions of the mine."

Recent commentary out of IAMGOLD addressed the similarities with LaRonde and how that can be applied to Westwood, as management of IAG stated that AEM has "multiple work areas so that they're able to anticipate where there could be problems and move to new zones, whereas we don't quite yet have that flexibility. We're working to build it."

(Source: IAMGOLD presentation)

If IAG can make this mine work - as say a 150,000-175,000 ounce operation at an AISC just under $1,000 - then that's much better than my expectations. Also, I don't know the level of interest (if any) that AEM has in Westwood, but Westwood is higher grade than LaRonde and also not as deep. Agnico's technical expertise could be applied here, and it seems now would be a good time for IAMGOLD to pursue a deal if there was interest. This would be a very bullish development, especially if it was a JV.

Valuation Has Become Much More Compelling

IAG is down 60-65% from its 2017 highs as the market cap has declined from $3.4 billion to $1.3 billion. Factoring in the net cash, the EV is just over $1 billion. The company did burn about $60 million in Q1, and as discussed above, there will likely be more cash burned in the next few quarters as they still have a hefty amount of capital spend remaining. I would look for net cash to be in the $175-200 million range by the end of Q3 before it stabilizes. Therefore, I would base valuation on that future net cash position in order to be conservative - or an EV of around $1.1 billion.

(Source: StockCharts.com)

IAMGOLD isn't a high margin producer and it doesn't own the best assets in the sector, but this is a company that produces over 800,000 ounces of gold per year and has one of the strongest balance sheets amongst its peers. Rosebel and Essakane are also long-life operations that have strong exploration potential. Saramacca will transform the Rosebel operation over the next several years and IAMGOLD is still actively exploring the Saramacca-Brokolonko trend.

Most of Westwood has now been priced in, which I was waiting for before I purchased the stock. There could be more negative news on the operation, but with gold on the move, the strong leverage IAG has to the price of the metal makes me more comfortable buying shares at these prices.

There are also improvements coming in Q4, and I expect cash flow to be much stronger by the fourth quarter.

Finally, IAMGOLD has many projects in its portfolio that also help support the current valuation.

At an EV of just $1.1 billion, the risk/reward is compelling.

In Summary

There have been clear red flags at Westwood for well over a year. The market has finally reset IAG lower as the issues have come to the surface and all investors and analysts are now seeing them. The irony is just as the market missed Westwood, it's missing the near-term catalysts that I believe will eventually drive IAG higher. This is a classic case of first buying when one should be selling, then selling when one should be buying.

Q2 and Q3 results could still be weak because of the capital spending that remains and the fact that these operations won't improve this quarter or the next one, but Q4 is expected to be the strongest of the year and that's when a turnaround will start taking place.

If gold wasn't moving higher, then I would likely be a little more patient with IAG and hold off buying (the best opportunity to purchase this stock might be after Q2 results are released). Though with gold now increasing in value and considering the leverage IAG has to the price of the metal, IAG could have already hit a bottom.

IAMGOLD is not in my top 10 and there are many gold and silver stocks I would purchase before IAG. But at these prices, I feel it warrants inclusion in a diversified gold and silver mining portfolio.

Disclosure: I am/we are long IAG. 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.