Gold Resource Corp: Commercial Production Pending At Isabella Pearl

Summary

• Management is shareholder-focused as exemplified by low dilution, a strong balance sheet, consistent annual profitability, and dividends since 2010.
• Latest results include first contributions from the Isabella Pearl project in Nevada.
• Pending commercial production at Isabella Pearl could be a catalyst to drive the stock higher.
• Isabella Pearl makes GORO a multi-operation miner with producing assets in Nevada and Mexico.
• Risks forinvestors relate to mine life, contractor concerns, commodity prices, and a tradingdisconnect between GORO and its peers.

Introduction:

Gold Resource Corp (NYSE:GORO) is a junior miner headquartered in Colorado with operations in Oaxaca, Mexico and Nevada. In the second quarter, the Isabella Pearl project in Nevada produced its first gold, and in the coming months it is expected to reach commercial output. Historically, the Mexican unit has generated GORO’s revenues with nearly half coming from gold and silver, and the rest coming from zinc, lead, and copper. Going forward, Isabella Pearl is expected to more than double the organization’s gold ounces and shift the entity to more of a precious metal miner.

Here at Contra the Heard, the stock was purchased at $3.86 in December 2018. Since then the shares have traded at a high of near $5.00 and a low of under $3.00. Unlike the Junior Gold Miner’s ETF (NYSE:GDXJ), GORO has not rallied with precious metal prices. This disconnect with peers and commodity prices could be cause for concern. Nevertheless, the fundamentals look strong and reaching commercial production is often a meaningful de-risking event and can serve as a catalyst for driving valuations higher.

The Thesis: A Shareholder Focused Enterprise:

The name attracted our interest years ago for a variety of reasons. The balance sheet, for example, had low debt, a healthy net cash position, and limited shareholder dilution. Since production began in 2010, the share count has only grown from 50 to 63 million shares. This low dilution is impressive given the multi-year commodity bear market and the construction costs associated with Isabella Pearl.

The corporate strategy, which focused on profitability and low operating costs over growth for the sake of growth, has also paid off. The enterprise has generated an annual profit since 2011, and has paid a dividend since 2010. Although the dividend is a sliver of what it was in 2012 (i.e. $0.02 versus $0.69), the fact it pays a distribution at all is unusual for a junior miner, especially one operating during a resource downturn.

Source: Morningstar’s Key Stats page on GORO

The location and nature of its deposits was another plus. Unlike some miners, Gold Resource Corp has low all-in sustaining costs per ounce, owns 100% of their properties, and appears to have promising exploration potential. Oaxaca, MX and Nevada are also mining friendly jurisdictions, with high quality mineralization and long mining histories.

Though we liked many aspects of the story and had watched it for years, we only purchased shares in December 2018. This was partly because the company was operating mines only in Oaxaca, and this dependence on one set of assets presented investors with higher risk versus a multi-operation miner. By December 2018, the Nevada expansion was nearing completion, which reduced the risk profile. Not only did Isabella Pearl de-risk the enterprise, but bringing a new mine online is often a catalyst. This was the thesis for owning Alacer Gold Corp (OTCPK:ALIAF), for example, which has moved sharply since the Alacer team completed its Çöpler sulphide expansion project. (Those of you who are interested can read more about Alacer, the Çöpler project, and Contra’s position in it here). Finally, the valuations in December 2018 looked reasonable. Like many mining companies between 2015 and 2018, GORO had traded at a discount to our estimate of net asset value. This said, we were happy waiting to see if other valuations, including price to sales, cash flow, EV/EBITDA, and EV/EBIT, would fall too. In late 2018, that is exactly what happened, and Gold Resource Corp ended up in the portfolio.

Latest Results, Outlook, & Catalysts:

Last quarter was the first time revenues were generated from the Nevada unit. This important milestone was overshadowed, however, by a slight miss versus analyst estimates, lower year-over-year comparisons, and construction delays due to contractor issues associated with Isabella Pearl’s absorption, desorption, and refining plant. Despite the setbacks, the executive team sounded optimistic regarding the construction delays, and expects the plant to be finished by the end of the third quarter. Management anticipates announcing commercial output at Isabella Pearl soon, at which point they intend to boost GORO’s 2019 guidance.

Source: August 6, 2019 Presentation Slides

In the years ahead, Gold Resource Corp anticipates its new mine will more than double total gold ounces. Once it’s at full steam, the capex focus will shift to exploration and development around the organization’s existing processing infrastructure in Mexico and Nevada. The goal is to increase the company’s reserves, mine-life, and develop its most promising deposits into new mines. While there appear to be many promising exploration projects, including East Camp Douglas in Nevada, it is far too soon to get excited. In 2020 and beyond, the corporation could also grow its dividends, which could serve as an additional catalyst for the stock. In the past cycle the policy was to spend a third of revenues on taxes, a third on capex, and a third on dividends. It is unclear if this will be the policy going forward, but it’s something to watch for.

Risks:

There are, of course, risks potential investors must consider. The outfit’s mine life, for example, is under five years, which is at the low end of the spectrum. By contrast, Contra’s investment in Alacer is at the other end of the spectrum and has a mine life over 20 years. Top brass knows this of course, which is why they want to focus on exploration and hopefully grow their reserves in the process.

Source: Gold Resource Corp’s 2018 10-K, page 45.

Although the issue should be resolved quickly, the recent absorption, desorption, and refining plant delays at Isabella Pearl exemplified concerns regarding the use and cost of contractors at the mine. In 2018, the company signed a two-year contract mining agreement regarding Isabella Pearl for $30.9 million. On the fourth quarter 2018 conference call, analysts asked questions regarding the price tag. In response, chief executive officer Jason Reid noted that after two years GORO can bring the mining operations in-house if the contractor fails to meet expectations, and that they have experience with in-house operations in Mexico. Still, the price tag seems high compared to potential output or doing the work themselves, contractor issues are common in the industry, and the recent hiccup with the absorption, desorption, and refining plant raises warning flags. Investors should watch this plant development closely to see if it is addressed in the third quarter as expected. Over the longer term, keeping an eye on the proficiency of the mining contractor may be key.

Commodity price volatility is another risk. Not only do investors need to consider the price of gold and silver, but they must also keep an eye on zinc, which accounted for 37% of 2018 revenues, as well as lead and copper which represented 20% of 2018 sales. Those percentages are set to decline now that Isabella Pearl is online, but material portions of revenue will still come from base metals.

Another issue is the before-mentioned disconnect between GORO’s year-to-date performance versus other junior miners and the price of gold, silver, etc. Though there are potential catalysts in its near-term future and the fundamentals are strong, the market is not stupid. It’s possible we missed something important, have overvalued the company, or have erred in our evaluation of its prospects. Buyer beware.

Conclusion:

Gold Resource Corp is a junior miner with properties in Oaxaca, Mexico and Nevada. In the second quarter, the new Isabella Pearl mine produced its first gold, and in the coming months it is expected to reach commercial production. This milestone should de-risk the venture, result in an improved 2019 outlook, and serve as a catalyst to drive GORO’s ticker price higher. This said, the shares are stuck in a funk despite the rally in precious metals and the Junior Gold Miner’s ETF. Concerns regarding the mine life, recent construction delays, and the use of contractors at Isabella Pearl may explain this disconnect. Still, the fundamentals appear strong, and the organization is shareholder-focused as demonstrated by low dilution, a strong balance sheet, consistent annual profitability, and dividends since 2010. In the years ahead gold production should more than double due to Isabella Pearl’s contribution, and there is potential for dividend increases as exploration activity attempts to unearth promising deposits for future mine development.

Disclaimer:

The opinions expressed – imperfect and often subject to change – are not intended nor should be taken as advice or guidance. Contra the Heard Investment Newsletter is not an investment advisor or financial advisor. Contra the Heard Investment Newsletter provides research, it does not advise. The information enclosed in this article is deemed to be accurate and reliable, but is not guaranteed by the author.

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.

Analyst’s Disclosure: I am/we are long GORO, ALIAF. 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.