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Nov 20

A Rick Rule Example: Aurizon Mines

“Top mining companies are finally generating dramatically higher profit margin. Free cash flow is now “gushing” and will double in the next year as huge capital investments by the majors pay off.

That quote comes from a recent interview with investor Rick Rule.

The observation that gold equities are undervalued has been coming from a number of fronts of late. Donald Coxe, David Einhorn, heck even Cramer was touting gold stocks a few months ago before his favorite, Agnico Eage, ran into stability issues at Goldex and scared Cramer silly. Rick Rule said the following recently about the attractiveness of gold equities:

“There have only been two times in the past ten years when, from our own calculations, gold and silver equities were attractively priced relative to the metal, that being 2001 and 2008. We are back strongly in that territory.

I believe if current gold and silver prices hold up, and I believe they are actually going to increase, that we are going to see a rather dramatic jump higher in the prices of select gold and silver equities on a go-forward basis.

The point, made best by Rule but also by others, is that gold miners are finally in the business of making money, not just producing gold. A case and point of Rule’s comments: Aurizon Mines.

Here is a company that gets no respect from the market. The company can release an excellent quarter, as they did two weeks ago, and the market will yawn. If the price of gold falls a few bucks on any given day, the stock will crater 3% or more. You’d think the company was some sort of fly-by-night chop shop given the way the market treats their paper. Yet nothing could be further from the truth.

Below is Aurizon’s free cash flow and cash on hand on a quarterly basis. Free cash flow is cash flow from operations less capital expenditures. Keep in mind that at its current price of $5.80, Aurizon has a market capitalization of $940M and no debt.

The free cash is allowing the company to grow its cash on hand significantly every quarter.

As the above figure points out, about 20% of Aurizon’s market cap is in the form of cash on the balance sheet. The enterprise value of the company is only $740M after subtracting this cash. Annualizing the last four quarters, the company is trading at about 9x its free cash flow generated. That would be using an average gold price of about $1500/oz.

If you annualize the third quarter, where the realized gold price for Aurizon was $1695/oz, the company is generating $104M in free cash a year. This puts the companyvaluation at a little less than 7.5x free cash flow.

It is important to recognize that what I am talking about here is free cash flow. This is different then the metric that is often touted by the mining analysts in their evaluations. They focus on the operating cash flow, which ignores any capital expenditures a company has. I’ve chosen to look at free cash because:

As I pointed out last week in my comparison between Jaguar Mining and Aurizon, companies generating similar amounts of operating cash flow can have drastically different expenditures required to maintain that level of cash flow.
Free cash is what ultimately goes to the bottom line and increases the cash position of the company.

If I was going to look at cash flow from operations for Aurizon, here is what I would find. In the estimates below I have removed the exploration expense to get a true picture of cash flow from operations. Exploration expense is a tricky beast, because a company can choose to expense or capitalize the cost, which can work to obscure comparisons. I prefer to leave it out when talking about operating cash flow (though I left it in when we talk about free cash).

In the last four quarters Aurizon generated $111M of operating cash flow (6.6x)
Third quarter annualized operating cash flow was $136M (5.4x)

On either metric the equity is cheap.

So Aurizon is cheap on a basis of four quarter trailing gold prices (~$1500/oz) and certainly on the basis of current gold prices $1700/oz. I am certain that if you did the same analysis for other gold companies you would draw similar conclusions. Some would come out astoundingly cheap. OceanaGold comes to mind as a gold producer priced particularly inefficiently.

The next step I want to focus on is how Aurizon looks on a NAV basis. Cash flow is the metric to evaluate current profitability, but to fully appreciate all the assets of the company, and the productive life of those assets, you have to look beyond the current cash flow and into the expected cash generated in the future. But I will leave that for a later post.

Nov 16

Bad Timing

Sometimes your timing is so bad that you have to wonder if there is some intervention!

Shandong Gold Group Co., parent of China’s second-largest gold producer by market value, made a $785 million offer to buy Jaguar Mining Inc. (JAG), two people familiar with the deal said.

Shandong bid $9.30 for every Jaguar share, said the people, who asked not to be identified because of the information is confidential. That’s 73 percent more than Jaguar’s closing price of $5.39 yesterday in New York. The company has 84.4 million shares issued, according to data compiled by Bloomberg.

Full story here.

Nov 14

1 Comment

Atna Releases Q3 and Moves Ahead in a Big Way

I had been waiting to post more on Atna until I finished the analysis of Pinson I have been working on, but today Atna released their 3rd quarter results today and they were strong. I bought some more stock on the results, and I wanted to post a summary of what the quarter was like and why things are looking good for the company.

Atna’s one operating mine, the Briggs mine in Nevada sold 9,700oz of gold. This was 2,000 oz more than Q2. Production has been increasing steadily for 3 quarters now.

Cash costs as stated on the income statement were stable the last two quarters, albeit still fairly high, at $924/oz of gold sold (Atna calculates costs based on produced gold and also subtracts silver credits so the cash flow number that will come out with the MD&A will vary somewhat from my estimate).

What is most impressive about the quarter is the cash generation of Briggs. The Briggs mine produced $7.4M of operating cash flow. Below is the corporate cash flow generation of the company.

The cash generation of the company is going to go a long ways to financing the development of Pinson. Capex spent in the quarter jumped substantially, suggesting that Atna has already moved ahead with starting mine development.

Even with the expenditures the company ended the quarter with a cash position of $10.5M

Atna is in the enviable position of having a stable producing mine that is throwing off enough free cash to fund the development of their star project, Pinson. I’ll write more about Pinson shortly, but even ignoring that eventual production, the Briggs mine is now producing at a rate of almost 40,000 oz per year. The company has a market cap of a little over $100M and with debt only $120M (see financial structure below). A 40,000 oz producer trading at $100M is a reasonable deal in its own right.

If you add Pinson to the mix, not even to mention the potential of a 3rd mine in a few years at Reward, you have the makings of a very cheap stock. Given the growth prospects of the company, if you believe in a rising or even stable price of gold, you have to like what you see.

Nov 13

Week 19: Liquidating Jaguar, Adding to Atna, Aurizon

Last week was another good week for my portfolio. I tend to perform well in sideways markets. In down markets, especially those like we’ve had recently where the correlation of all asset classes go to one, I tend to underperform on an individual equity basis, because the stocks I own are for the most part small caps and commodity stocks, and they get hit harder than the broader market. I’m trying to mitigate that with my currently high cash position, and it has done its job and dampened the effect.

I would, however, like to reduce my cash position at some point, as it is har d to make money when so much of it is doing nothing. To do that though I would have to see some sort of light at the end of the European tunnel, and that is not likely forthcoming.

The only significant portfolio change I made last week was to sell my position in Jaguar Mining, and using the subsequent cash to increase in my positions in both Aurizon Mines and Atna Resources. There will be more to come on both Atna and Aurizon in a future post. I see Atna in particular as a interesting and soemwhat unique situation. Atna recently received 100% interest in the Pinson deposit. This is a game-changer for the company, and one that is not even close to being priced into the stock price. Because Pinson does not have a full feasibility study complete, or even a PEA, investors are not aware of the economics of this high grade underground project. But more on this later. For now though I want to spend a few minutes talking about Jaguar Mining. Since I have written about the company fairly extensively, I think its worthwhile to review why I have now chosen to go the path of full liquidation.

I can point to a number of reasons for getting out of Jaguar Mining. At the top of that list is the company’s inability to generate free cashflow, even though the gold price has risen some 40% over the past 9 months. The way that Jaguar has managed to match any increases in operating cash flow with correpsonding increases in capital outlays is uncanny.

Let’s compare this to another holding of mine, Aurizon Mines.

Aurizon, on the other hand, has done exactly what you’d expect a company to do in a rising gold price environment. They have generated a great deal of cash. The cash position of Aurizon has increased almost $40M since the beginning of the year. Jaguar’s cash position, on the other hand, has actually decreased if you remove the effect of the convertible denbenture issued in the first quarter.

Of the two companies, the one that you would have to say is in a better position for expansion would be Aurizon. But never a management team to be daunted by lack of available funds, Jaguar said in a separate press release that they are going forward with the development of the Gurupi project.

At the beginning of the year Jaguar provided a longer term outlook of what to expect from the company. I’ve provided one of the tables from this outlook below. Pay particular attention to the requirements of Gurupi (which as the table indicates was supposed to start development this year, by the way), an estimate that one analyst on the conference call referred to as outdated and not in the “that number is too high” kind of way.

Jaguar is going to be forced to raise a lot more capital to fund Gurupi.

On top of that, Jaguar plans to refinance their outstanding debentures with senior debt. Between the Gurupi financing and the convertible refinancing Jaguar is looking at a bond offering of $400M+. This seems like a bit of a heroic expectation for a company that is struggling to produce any free cash flow at record high gold prices.

Another analyst on the call pointed out that the market might not be quite as responsive to new debt from the company as Jaguar management seems to think it might be. Quite reasonably, the analyst referred to the existing debentures, which the market is currently valuing at a 13% interest rate. He speculated that the market is suggesting that Jaguar debt would take a 15-17% coupon.

Management said that the offer sheets they had received were in the 9-11% range. Forgetting for a minute that 9-11% interest rates are extremely high, you have to be a bit suspicious of the company’s ability to raise money at this level when there are debentures outstanding that carry the upside conversion option, at a 20-40% discount.

I could go on.

I bought Jaguar because in the low $4’s it was a undervalued NAV play. The projects, if you tally up the value of each, are worth around $6-$7 per share, and maybe more at $1800 gold. But at $6 per share, which is about the average price that I unloaded my position at, that NAV story is replaced by a cashflow story that to be quite frank about it, just isn’t there.

I’ll stick with Aurizon, with Atna, and with the big boys like Newmont and Barrick.