Argonaut Gold (OTCPK:ARNGF) missed the initial production and cost guidance from Q4 2018 and most of the guidance which was revised a couple of times during the year as the below figures illustrates. The stock has consequently been punished, excessively in my view.
Management is rightly questioned when this happens, but the stock price has gone down to levels where I think the downside is very limited for the patient investor.
The company produced 186,615 gold equivalent ounces in 2019, which by itself wouldn't have terrible given that production still increased by 21,498 GEO in 2018. However, when costs disappoint at the same time as production undershoots, the impact on All-in Sustaining Cost becomes very pronounced.
Figure 3 - Source: YCharts
The market seems to have overlooked that the price of gold has effectively offset the higher costs and is attributing a very low value to the later stage development assets with a combined NPV above $700M, at a $1,500/oz gold price.
The current stock price is C$1.59, together with the prevailing exchange rate, latest share and financials information give us a market cap of $221.8M and an enterprise value of $193.0M.
Figure 4 - Source: Quarterly Reports & Price Data
Caution is certainly warranted when it comes to guidance given the recent misses. During 2019 the company produced 186,615 gold equivalent ounces with an adjusted cash cost of $923/oz and an adjusted AISC of $1,181/oz. I use adjusted numbers as the write downs are assumed to be non-recurring costs.
However, the company is not looking to stretch production in 2020, but rather focus on cost efficient production. So, a reversion in costs is not an aggressive assumption in my view.
Figure 5 - Source: Q4 2019 Conference Call Presentation
Let's use the production and cost guidance for 2020 in a few scenarios to illustrate the current valuation. We will only be looking at the producing assets in this section and a few of the inputs require some additional comments.
Cash Cost and All-in Sustaining Costs are not standard IFRS measures and there will often be smaller deviations to how they are applied.
AISC relates to the cost of maintaining production and is comparable to operating profits, but the biggest difference is that maintenance capex is used instead depreciation, depletion and amortization.
I have assumed that general & admin and exploration expenses are the same as 2019 numbers. I have assumed inventory write downs, value change on derivatives, and other income to be zero as they fluctuate from positive to negative during the quarters.
Regardless on the assumptions we use, we get a very attractive valuation. EV to EBITDA is between 1.55 and 3.00 for the above scenarios. Enterprise value to All-in Sustaining Profit is between 2.09 and 5.51.
Figure 7 - Source: YCharts
The stock is presently trading at a very attractive level, when comparing the 2020 estimates to history, extremely so for the Mid-Point and Bull-Case scenarios.
It is worth highlighting that the price of gold is presently well above the price used for the Conservative scenario. If we use a gold price of $1,650/oz, the lowest point of the production guidance and highest points in cost guidance, EV to EBITDA is only 1.94 and EV to All-in Sustaining Profit is 2.76.
Magino is an extremely attractive asset, with a feasibility study in place and some environmental permits. The project is consequently at a relatively late stage of the development cycle. Note the NPV of $519M at a gold price of $1,500/oz. However, the company likely needs a partner to move the project forward in the near term given the initial capital cost of $321M.
Figure 8 - Source: January 2020 Corporate Presentation
Argonaut will be running a drill program at Magino during 2020 at a deeper level, which has the potential to increase the value of the asset, provided the veins from neighbouring assets continues.
Figure 9 - Source: Q4 2019 Conference Call Presentation
The company just released a pre-feasibility study of Cerro Del Gallo as well, which is smaller in size. The initial capital is a more manageable $134M with an NPV of 175M given a $1,350/oz gold price and $16.75/oz silver price. The NPV is naturally significantly higher given the current gold price which can be seen in the below sensitivity analysis from the report.
I expect Magino will be of higher priority for the company to move forward due to the later stage, more attractive location, and size.
Figure 10 - Source: Cerro Del Gado Pre-Feasibility Report
San Antonio was written down completely in the Q4 2019 given a denied environmental permit, so I wouldn't add a high probability that the project moves forward. However, a write down is a conservative approach and Argonaut will continue to with the permitting process.
Figure 11 - Source: 2018 Annual Report
2019 was not a great year for Argonaut, the company had production issues which resulted in missed guidance, there was a write down of both inventory and the San Antonio project.
The valuation has now gone to such an extremely attractive level, that the company doesn't need to outperform for there to be significant upside from current price. We simply need to see cost revert toward historical levels.
Figure 12 - Source: Quarterly Reports
Argonaut has also locked in the realized gold price between $1,450/oz on the downside and $1,672/oz to $1,816/oz on the upside for portion of production over the next two and half years. This also offers some downside protection if we see a significant sell-off in the price of gold.
Figure 13 - Source: Q4 2019 Financial Report
I was pleased with the communication from the Q4 2019 conference call, which emphasized the focus on generating cash flows and optimizing the development assets. There is always a concern that mistakes will compound, and the company would take on significant leverage or re-finance to rush the larger development projects. That does not appear to be the case for Argonaut.
We can also see the target price from analysts covering the stock is well above the current stock price and the target price has been raised during the last 30 days.
Figure 14 - Source: MarketBeat
Given the very low enterprise value of C$193M and the NPV of Magino specifically, Argonaut also has the potential to be an acquisition target. I don't use this as for the base case when estimating the value of a company, but it is an interesting consideration though. One point which makes this more relevant to Canadian operators is that Argonaut sits on operating loss carryfowards, not reflected on the balance sheet.
Figure 15 - Source: Q4 2019 Financial Report
If one is looking for a stock to take part in the current bull-run, with a high beta to the price of gold, this is likely not the stock for you.
However, unless the company manages to destroy a significant portion of the value of the producing and development assets, this stock price offers a very attractive risk-reward. Patience is likely required though and I have just started to build a position.
I see several scenarios where Argonaut is up 100% over the coming 12-18 months, but I think a lot of things will have to go wrong at the same time for this to be a losing investment, which at least fits my definition of great risk reward.
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I enjoy my anonymity, where I write under the name Bang For The Buck. I hold a BSc and MSc in Financial Economics, but most of my value-based investment knowledge comes from independent learning where I am a perpetual student. I primarily focus on turnaround stories, with attractive valuations, in cyclical industries. I have a significant portion of my portfolio exposed to the precious metals industry due to current monetary and fiscal policies.
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