- Torex Gold released its updated Reserves & Resource statement last week, reporting a sharp decline in El Limon Guajes reserves relative to FY2019 levels.
- This decrease in reserves occurred despite an increase in the company's average realized gold price to $1,400/oz, which is one of the higher metals prices assumptions in the industry.
- However, at a valuation of barely 6x FY2020 free cash flow, I believe most of this decline in reserves is priced in.
- At current levels, I see Torex as a Hold, but I would view any pullbacks below US$12.40 as low-risk buying opportunities.
The Q4 Earnings Season for the Gold Miners Index (GDX) is finally coming to an end, which means that many miners are busy reporting their year-end Reserves & Resource statements. The most recent name to update its reserves is Torex Gold (OTCPK:TORXF), and unfortunately, the report was a little underwhelming. This is because we did not see much reserve replacement at all year-over-year, despite the fact that Torex increased its metals price assumption to $1,400/oz. The good news is that at barely 6x FY2020 free cash flow, the company's lower reserves are priced in. At current levels, I see Torex as a Hold, but I would view any pullbacks below US$12.40 as low-risk buying opportunities.
Torex Gold released its FY2020 Reserves & Resource statement last week and reported year-end reserves of ~1.92 million ounces at El Limon Guajes [ELG], a decrease of 15% year-over-year. On a reserve-ounce basis, this translated to a decrease of 335,000 ounces year-over-year, attributed to processing 487,000 ounces of gold (GLD) in a significant year for production for Torex. The company managed to offset some of this depletion from mining with 93,000 ounces added from an infill drilling program and 54,000 ounces added by using a lower cut-off grade, as a result of a higher metals price assumption in the FY2020 reserve report ($1,400/oz vs. $1,200/oz). Let's take a closer look below:
As shown above, Torex Gold saw a material decrease in reserves in FY2020, with reserve inventory and gold grades down 15% and 4%, respectively. Fortunately, Torex has 630,000 ounces of gold at an average grade of 4.08 grams per tonne gold in the inferred category. This could add another ~300,000 ounces of reserves to the mine plan assuming a 50% conversion rate. Based on the current reserve base (open-pit and underground) and assuming a ~450,000 production profile, which is consistent with FY2021 levels, we have a relatively short mine life of 4.3 years, or closer to 5 years if we assume a chunk of inferred resources get pulled into the mine plan through future resource conversion.
Normally, a sub-5-year mine life would be quite alarming, especially when we consider that Torex raised its gold price used to calculate reserves from $1,200/oz to $1,400/oz. This metals price assumption is above the industry average of ~$1,275/oz, which translated to the company lowering its cut-off grade from 3.1 grams per tonne gold (FY2019: 3.7 grams per tonne gold) on underground material and 0.80 grams per tonne gold vs. 0.90 grams per tonne gold on open-pit material. However, it's important to note that Torex is sitting on a mountain of resources at its neighboring Media Luna [ML] Project, where the company has a total of 6.47 million gold-equivalent ounces [GEOs], with 2.24 million of these GEOs in the indicated category.
The plan is to continue processing ELG mineral reserves for the next four years until the anticipated start of production at ML in Q1 2024. The current reserve life suggests that this shouldn't be an issue with just over 4 years of reserves. The company's Portal 3 to El Limon Underground is projected to arrive below the current Sub Sill and El Limon orebodies later this year, which will kill two birds with one stone. Not only will it allow Torex to shorten its haul distances by 50%, but it will also allow the company to offer a new platform to explore underground.
Obviously, there is some risk to relying on a project in the Preliminary Economic Assessment [PEA] stage for future production past 2024, and Media Luna is only in the PEA stage currently with its most recent technical report completed in 2018. The PEA highlighted a 10+ year mine life based on inferred & indicated resources with an average production profile of ~391,000 GEOs per annum at industry-leading costs of $619/oz. However, if we use solely indicated resource ounces, this mine life drops to just barely five years, which would exhaust production at Torex's Morelos property by 2030. We should get a better idea of what this production profile actually looks like with a Feasibility Study for ML in Q1 of next year, as well as an updated life of mine plan.
If we make a couple of conservative assumptions, though, one could argue that a 5-year mine life at Media Luna is probably on the low end. This is because Media Luna has 2.24 million ounces of higher confidence indicated resources and 4.23 million ounces of inferred resources. If we assume that Torex converts only 35% of this inferred resource base into reserves, we should see a reserve base of at least ~3.7 million GEOs. Based on the ~391,000-ounce production profile, this would translate to a more than 9-year mine life or extending production well into the 2030s from a 2024 start to production. This calculation is based on 40% of 4.23 million GEOs (1.48 million GEOs) and 2.24 million ounces of indicated resources summed together to give us 3.72 million GEOs.
There are certainly many assumptions here regarding future production at Morelos, but the recent infill drill results out of the project are arguably some of the best results drilled to date in the sector outside of intercepts from Roxgold's (OTCQX:ROGFF) Koula deposit. These infill holes drilled by Torex suggest that the average resource grade at ML (5.00~ grams per tonne gold-equivalent) might actually be on the low-end, with a few highlight holes as follows:
- 13.66 meters of 12.73 grams per tonne gold-equivalent
- 13.18 meters of 8.72 grams per tonne-gold equivalent
- 22.47 meters of 9.84 grams per tonne gold-equivalent
- 5.24 meters of 48.33 grams per tonne gold-equivalent
- 14.59 meters of 22.05 grams per tonne gold-equivalent
- 13.68 meters of 13.11 grams per tonne gold-equivalent
- 21.46 meters of 9.51 grams per tonne gold-equivalent
- 16.57 meters of 10.60 grams per tonne gold-equivalent
- 25.47 meters of 7.11 grams per tonne gold-equivalent
- 16.17 meters of 8.31 grams per tonne gold-equivalent
- 13.22 meters of 10.38 grams per tonne gold-equivalent
- 15.84 meters of 8.05 grams per tonne gold-equivalent
- 22.95 meters of 27.21 grams per tonne gold-equivalent
Notably, five of these holes came in at above 200 gram-meters and are outlined in bold, with the average hole coming in well above the Media Luna resource grade of roughly 5.0~ grams per tonne gold-equivalent. We will need to see what the Media Luna FS looks like in Q1 2022, but I would be surprised if the company didn't prove up at least 2.5 million ounces of reserves at least a 6-year mine life.
While the reserve update was a little disappointing with minimal reserve replacement, it's worth noting that it was a very tough year for Mexican miners, and Torex is sitting on a world-class resource base at Media Luna and could certainly add additional reserves at ELG and surrounding areas of the Morelos property if it steps up its exploration program. The company has the option to start drilling much more aggressively with all of its debt now paid down and over $200 million in cash, and I would prefer to see excess cash flow earmarked for Media Luna development (~$490 million) and a more aggressive drill program vs. returning capital to shareholders through a dividend. There is nothing wrong with a dividend, but with a relatively short mine life at ELG, and the need for a smooth transition to production at ML in 2024, I believe the focus should be on building the balance sheet and increasing the number of drills working on regional targets.
So, is Torex Gold a compelling buy at current levels?
While I don't love Torex's single-asset status in a Tier-2 jurisdiction like Mexico, and I'm not elated with the relatively low reserve life and risks of relying on a PEA for production past 2024, I believe a lot of the risk is priced in here. This is because Torex is sitting at an enterprise value of ~$900 million, translating to the stock trading at less than 6x free cash flow. It's important to note that a good chunk of this free cash flow will have to go to Media Luna development with a shortfall of roughly ~$280 million currently, but this still gives Torex a pretty reasonable valuation. At US$13.50 per share with less than 40% to my fair value of US$18.00, I do not see the stock as a Buy. However, if the stock were to dip to US$12.40, I would view this as a low-risk buying opportunity, where the stock would have closer to 50% upside to what I believe to be fair value.
Torex Gold reported a disappointing reserve update, but with ML in the wings and a strong balance sheet, the company has the ability to drill out this property aggressively with no further major commitments other than ML development. Ideally, I would prefer to see Torex keep cash on the balance sheet or use cash for drilling and ML development vs. paying out a dividend to provide more visibility into future production. However, regardless of what the company decides to do with its cash, the valuation remains reasonable at roughly 5.5x FY2020 free cash flow. Therefore, if we see further weakness in Q2 and a dip below US$12.40, I may look to start a new position in the stock.
This article was written by
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.
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