Gold Resource Corporation: Digging Into The Q1 Results

Summary

• Gold Resource Corporation reported its Q1 results this week, with quarterly gold production of just over 10,000 ounces.
• Unfortunately, due to mine shutdowns in Mexico, the company has seen mining at their Oaxaca Mining Unit suspended since April 1st, which makes up the bulk of the company's production.
• To make matters worse, treatment charges for zinc have continued their ascent this year with zinc prices declining further, translating to significantly higher costs at Oaxaca.
• Based on the company continuing to be a mediocre junior producer with volatile margins due to the base metal component, I continue to see much better opportunities elsewhere in the sector.

We're now more than one-third through the Q1 earnings season for the Gold Miners Index (GDX), and we continue to see very mixed results with some mines partially shut down and pulling guidance and others relatively unaffected. Gold Resource Corporation (NYSE:GORO) is in the former group, unfortunately, as the company's Oaxaca Mining Unit [OMU] has now been shut down for nearly six weeks, with the closure expected to extend until May 30th. This should be a significant drag on Q2 for Gold Resource Corporation, and it comes after a feeble Q1 performance on the cost side for the company.

While costs are likely to decline for FY-2020, all-in sustaining costs [AISC] are currently tracking more than 70% above FY-2019 levels of $727/oz, with Q1 AISC coming in at $1,260/oz. Based on volatile costs due to the company's base metal component and what's likely to mark a very weak H1 2020 for Gold Resource Corporation, I continue to see the stock as an Avoid in favor of higher-margin producers in Tier-1 jurisdictions.

(Source: ElkoDaily.com)

Gold Resource Corporation released its Q1 2020 earnings results last week, and it was a tough start to the year operationally, to say the least. The company reported just over 10,100 ounces of gold production in the quarter, which is relatively in line with guidance, but all-in sustaining costs soared to industry-lagging levels above $1,200/oz. To complicate things further, the company tapped its At-The-Market-Offering [ATM] to raise close to $12 million, which led to some further dilution in the company's shares. This dilution of a few million shares has given the company a share count of over 70 million, a very respectable figure for a gold producer, but a slight hit to valuation, given the higher share count. Let's take a closer look at the quarter below:

(Source: YCharts.com)

Beginning with the Nevada Mining Unit [NMU], gold production came in at 3,755 ounces for the quarter, which was nearly 30% below Q4 levels as the company continues to mine the lower-grade Isabella Zone, on the way to hitting the deeper higher-grade Pearl Zone ore. All-in sustaining costs for the quarter also jumped significantly sequentially, from $1,096/oz to $1,330/oz. It's worth noting that this is more or less in line with the plan at Isabella Pearl, which was to generate some very minor cash flow while working through the Isabella ore, and then reaping the rewards once the Pearl Zone is accessible. The company noted in their call that they believe they've finally hit the Pearl Zone ore as CEO Jason Reid pointed out:

"But to put this in perspective, we’ve mined about one half of 1% of the Pearl deposit. That’s basically $1 million worth of a $300 million value in the ground. So we are just at the very top of the Pearl ore body. And again, 80% of the ore in the Isabella Pearl deposit is in the Pearl. And what’s really exciting, and that’s why I led off with it in the conference call is we’re re-reaching it now and we’re seeing it and it actually is exceeding our expectations."

- CEO Jason Reid, Q1 Conference Call

(Source: Company Presentation)

This is positive news as we should see the first glimpse of Pearl Zone ore in the Q2 results assuming Nevada mining is not materially affected by shutdowns. Based on this, not only should we see a significant jump in ounces produced at NMU quarterly by Q3, but we should also see costs come down given the much higher-grade ore at the Pearl Zone. Therefore, while this was an extremely underwhelming quarter at NMU, I believe the worst is behind us, and it's onwards and upwards from here.

As we can see in the chart below, the company was expecting gold production of 27,000 ounces in FY-2020 from NMU, and we're clearly tracking well below this at just 3,700 ounces in Q1. However, it would not be surprising to see 12,000-plus ounces produced in the back half of the year once the Pearl Zone is available to mine. This suggests that this 27,000-ounce target might not be as far off as it looks. Let's move over to the Oaxaca Mining Unit below in Mexico:

(Source: Company Presentation)

Unfortunately, the Oaxaca Mining Unit also had a very weak Q1. Despite production coming in at reasonable levels with 6,500 gold ounces produced, we saw a massive jump in costs due to higher treatment charges for zinc. As Jason Reid noted in the Q1 call, these costs have sky-rocketed and are up over 700% from FY-2018 levels, and a mix of lower zinc prices and higher treatment charges has been a massive drag on margins at the OMU.

All-in sustaining costs for the quarter came in at $1,229/oz for Q1, a 52% jump from the same period last year, and it's likely going to be a weak year at the OMU going forward. This is because the company signs a yearly contract for treatment costs and is now locked in for these exorbitant treatment charges for FY-2020. Therefore, even if treatment charges do come down to more reasonable levels during the year, Gold Resource Corporation won't benefit from this until FY-2021. The company has noted that they are working to avoid mining high-zinc areas in the meantime, and are hoping that gold (GLD) price strength can offset some of this.

(Source: Company News Release)

(Source: BusinessInsider.com)

Unfortunately, however, the mine shutdown has made things even worse as the Mexican government ordered that all non-essential businesses be shut down on April 1st. This shutdown is scheduled to extend through to the end of May, suggesting that Q2 will be extremely weak for the Oaxaca Mining Unit, given that there will be a ramp-up period even when mining activities do restart. Therefore, the combination of high treatment charges, higher costs to re-open the mine, and a complete lack of production are likely to make for an ugly Q2 as well. This means that even if the company can benefit from higher gold prices and see costs come down at Isabella Pearl in Nevada, the OMU is going to drag on margins significantly, given that the bulk of the company's production (60%) is coming from this mine.

(Source: Author's Chart)

As we can see from the chart above, this jump in costs has had an enormous effect on the company temporarily from a valuation standpoint. This is because Gold Resource Corporation has dropped from a rank of 10th last year to a rank of 46th currently out of 53 miners. This drop in the company's ranking has moved the company from an industry leader on the cost side to a massive industry-laggard unless costs can come down significantly.

While I don't think that the company will finish the year with AISC near $1,260/oz where we sit currently, it's looking like it will be challenging to get AISC down below $1,100/oz on a consolidated basis for FY-2020. This is likely to lead to a contraction in the company's multiple it deserves, given the much lower margins. Therefore, with OMU pretty much guaranteed to have a weak year given the higher treatment costs that have been locked in, it's all eyes on Isabella Pearl in Nevada to help bring costs lower. Let's take a look at the company's earnings trend below:

(Source: YCharts.com, Author's Chart)

As we can see from Gold Resource Corp.'s earnings trend, the company continues to see relatively flat earnings growth, with annual earnings per share [EPS] trading in a range of $0.06 to $0.20 since FY-2015. While FY-2020 annual EPS is expected to jump by over 60% from $0.09 to $0.16 based on estimates, it's worth noting that this is still below FY-2017 levels, and the company is up against a very easy comp year-over-year given the 40% drop in annual EPS last year. Therefore, this 77% growth this year can be discounted as it's only gaining back what was lost in the previous year.

If we look out to FY-2021, estimates are calling for $0.17 in annual EPS, only minor growth and no real improvement in earnings despite the higher gold price. Therefore, for investors looking for leverage to the gold price, Gold Resource Corporation isn't the best option out there. Besides, the company is currently trading at 25 times forward earnings above $4.15 per share. This is a reasonable valuation for a cost leader, but we've seen the company shift to a cost laggard due to the treatment charge headwinds. Therefore, it's hard to argue that Gold Resource Corporation is cheap here above $4.15 per share.

(Source: TC2000.com)

Based on significant technical resistance overhead near $5.40 per share, a challenging year for the company on the cost side, and very volatile costs in general compared to peers due to the base metal component, I see Gold Resource Corporation as an Avoid above $4.15 per share. The stock could undoubtedly bounce back sharply and even head back above $5.00 if the gold price remains above $1,750/oz. Still, there are more than a dozen better opportunities in the mining sector elsewhere with better leverage to the gold price and more predictable earnings growth. Therefore, I would view any rallies to the $5.30 level as selling opportunities, and I am personally focusing on higher-margin producers in Tier-1 jurisdictions.

Analyst’s Disclosure: I am/we are long GLD. 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.

Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.