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David Goguen: Finding Real Value in the Ground
Source: George Mack of The Gold Report (2/2/11)
PI Financial Institutional Sales VP David Goguen sees real potential for share price appreciation in select mining companies with expandable resources. Through their quantitative research report Select Golds, Dave's team, including Associate Brodie Dunlop, are focused on Latin American explorers and producers while searching the globe for companies moving through the industry lifecycle. In this Gold Report exclusive, Dave and Brodie share a few mining plays that offer real opportunity to leverage the power of value.
David Goguen: I think it's a combination of both of those things. It will be defined differently depending what category you're examining. In the case of advanced explorers, it could be a rapidly growing resource where the full scale and potential are not yet fully recognized in the marketplace. For emerging producers, value will be found very classically in that time period when the company is two-thirds of the way through a project build and not generating a lot of catalyst-rich news. That results in a bit of a sleepy period when oftentimes we see the share price drift to levels that represent very good value.
TGR: Gold has pulled back a bit. Are you currently telling your clientele this is a good time to buy gold mining stocks?
DG: Absolutely. We feel the gold price is going to be very well supported above the $1,100/oz. level, and we feel that the margins being afforded to gold producers in this $1,200–$1,300 gold environment have not been properly reflected in the valuations for these companies. There's still a sense that the gold price isn't sustainable at these levels, so there's a hesitation in the valuations being afforded to these junior producers. Therefore, they're trading at 3x–5x cash flow when, in fact, higher valuations are merited. These juniors are generating strong cash flow.
TGR: If gold did go down to that $1,100 support level, could the producers still maintain earnings growth to satisfy investors?
DG: Given the average cash cost of the eight junior producers we track is $478 an ounce, it would leave a very healthy margin on which to generate free operating cash flow.
TGR: Would it support quarter-over-quarter or year-over-year growth?
DG: In the instance of these junior producers, they're still ramping up production, so you're getting unit volumes that, in most cases, are growing quarter over quarter. Whether we're delivering 50% more production into a $1,300 or $1,100 gold price, I don't think it's going to make a tremendous amount of difference. It's still going to have a positive impact on the bottom line and result in growing cash balances that can be plowed back into production expansion or the development of new projects.
TGR: Your initial stock screen is enterprise value (EV) divided by ounces in the ground (EV/Oz. Au) as estimated by the NI 43-101 resource estimates. Where do you go from that point?
DG: Certainly in the junior producer category, in addition to the EV/Oz. Au, we're going to be looking at cash costs and operating margins, and we're going to be looking at price to cash flow.
TGR: I imagine that the multiple of EV per ounces in the ground is most important in the advanced explorers and less important as you come up the scale to emerging and junior producers.
DG: I would agree with that in large part, certainly in the case of the junior producers. Not all ounces in the ground have the same economic impact. Different ounces have different margins depending on mining methodology, grade or extraction costs. So, from a financial modeling point of view and company valuation standpoint, the differences in those ounces and the methodologies to extract them are going to have an impact on valuation.
In the advanced explorers' category, I think the economics and engineering are less defined; it's more about developing as large an in situ resource as possible. There'll be differences in the valuations that the market ascribes to these companies; but, generally speaking, we're looking to provide a primary screen that will highlight undervalued and overvalued in situ ounces in advanced explorers.
TGR: Does a company have to reach a certain level of development in its most advanced project before it becomes interesting to you or relevant to your investment strategy?
DG: We believe that being early in situations is critical to the ultimate investment return we're going to achieve for our clients. So, if we see 500,000 ounces (Koz.) in the ground growing to 1.5–2 million ounces (Moz.), we'll start presenting that situation to our clients in the belief that the geology and execution capabilities of management will be sufficient to bring it up to size.
TGR: Under what level does the EV per ounce have to be for you to look at it as a great value play?
DG: Well, I don't think we can look at that particular metric in isolation. We have to look at it in the context of the grade and style of the resource. But certainly, we're going to be attentive to anything that's below $50/oz. and we're going to question and look to justify valuations above $200/oz. in enterprise value.
TGR: So, if you were going to pay $200/oz. it would have to be relatively easy to get out of the ground?
DG: Certainly, and that's the case with both Andean Resources Ltd. (TSX:AND, ASX:AND) and Extorre Gold Mines Ltd. (TSX:XG; Fkft:E1R; OTCQX:EXGMF). They're trading at north of $200 in EV/oz., but in these instances the market is telling us the grade is there, that these will be high-margin ounces and that the geology will continue to deliver additional ounces into an expanding total resource.
TGR: Tell us about some of the companies you like.
DG: Sure. Timmins Gold Corp. (TSX.V:TMM) represents a successful emerging producer that has transitioned to a bona fide junior producer. The company is now producing north of 20 Koz. gold per quarter at a cash cost of approximately $450/oz. It's trading at what we feel is an attractive valuation. Timmins continues to expand production at its San Francisco mine in Sonora, Mexico and it continues to expand both the resource and mine life. We believe Timmins is underfollowed and isn't properly valued to reflect gold prices north of $1,000.
TGR: The stock's up 74% over the past 52 weeks with a $300 million market cap—large enough to be bought by funds but not so small the shares are unmarketable.
DG: Excellent point; we're aware of that sweet spot in the marketplace. Market liquidity is a critical criteria for large resource investors. It's a sweet spot for investors in the junior gold sector as companies with market caps exceeding $300 million tend to draw a broader audience of institutional investors.
Timmins is continuing to pursue the acquisition of Capital Gold Corp. (TSX:CGC; NYSE.A:CGC; Fkft:CGU). Capital Gold has the El Chanate deposit, which is approximately 60–70 km. north of Timmins' San Francisco mine. The operations are fairly similar from a mine process perspective. Both are open-pit, low-grade heap-leach deposits that source a number of people and engineering services and consumables from Hermosillo, Mexico. So, we would envision some operating and personnel synergies being generated from the marriage of the two companies. Collectively, that would represent production of around 180–200 Koz. per year with a market cap in the $600M range. We believe that a merger would result in a revaluation of the combined company and would likely attract larger resource investors compelled by the operational diversity, improved liquidity and access to capital market funding.
TGR: How about another company.
DG: Also in Mexico, in the Sierra Madre gold-silver belt, is Kimber Resources Inc (TSX:KBR, NYSE.A:KBX). On our valuation table, Kimber trades at under $50/oz. in the ground. It recently completed a preliminary economic assessment (PEA) on the Carmen and Veta Minitas deposits at Monterde that define a potential low-cost, long-life gold/silver producer profiled at 62 Koz. gold and 1.85 Moz. silver production per year for over 13 years. Through a combination of underground and open-pit mining, the operation would produce gold at a sub-$250/oz. cash cost, assuming silver as a byproduct credit.
The company has initiated a 30,000-meter drill program, which is targeted toward up grading the classification of near-surface mineralization and to test for mineralization down dip and along strike of the known zones. Additionally, the program is going to target a number of satellite gold and silver showings within a 3 km. radius of the main ore body. So, we think Kimber has a lot of potential in that it's trading at roughly one-third of its net asset value (NAV). The 30,000-meter program will likely add to its resource and highlight the long life potential at Monterde. Kimber in our opinion typifies the single asset, junior gold company that will likely attract M&A interest from any growth-oriented intermediate gold producer.
DG: Almaden Minerals Ltd. (TSX:AMM; NYSE:AAU) is a very strong explorer in eastern Mexico. The company is headed by Chairman Duane Poliquin and CEO Morgan Poliquin. Almaden is one of the few true project generators out there. Morgan spent 2000 hours in a Hughes 500 helicopter landing on intrusives along the eastern seaboard of Mexico sampling and age-dating rocks that lead to much of the ground that is the company's exploration portfolio today. These are large land positions generated from a macro view of the geology that runs from Arizona down into Central America.
Drilling of specific targets is already yielding strong results. At Ixtaca, in Puebla State, Mexico, the company has a low-sulphidation epithermal gold discovery that's characterized by both very high-grade veins and lower-grade mineralization over broad intervals. The company is a dozen holes into the project so far. It's a bona fide discovery that the market is beginning to appreciate. The deposit model here would be similar to Aurelian Resources Inc.'s (TSX:ARU) Fruta del Norte that was taken up by Kinross Gold Corp. (TSX:K; NYSE:KGC) via a friendly business combination. Drilling will continue with 2 to 3 drill rigs starting in the middle of February.
Additionally, Almaden owns the Caballo Blanco high sulphidation gold system in Vera Cruz, Mexico. At Caballo Blanco, Goldgroup Mining Inc. (TSX:GGA) is earning in a 70% interest in the project. Goldgroup is presently conducting a 30,000-meter, $8M-dollar drill program to expand on a known resource and to test an area of 5 km. by 4 km. of classic epithermal alteration. A highlight hole from previous drilling intersected 94.5 meters at 2.09 g/t Au. Almaden has a carried 30% interest until Goldgroup delivers a bankable feasibility study.
So, there's plenty of potential in Almaden; it's still early days in the exploration process, so we look for some exciting news from Almaden in the first quarter of 2011.
TGR: That project has generated some great results, but the stock is up over 235% over the past 52 weeks. And you feel like it has more room to go?
DG: Yes. We recognize the potential of this kind of system, which could deliver a high-grade, long-life, low-cost asset if the initial discovery continues to play out as this deposit model has been known to do.
TGR: What other companies do you like?
DG: We like B2Gold Corp. (TSX:BTO; OTCQX:BGLPF), a new junior producer with 120 Koz. of production in Nicaragua at a cash cost of $540/oz. The company has a cash position approaching $50 million and aggressive drill programs around both of its existing mines—La Libertad and El Limon. There is also interesting exploration going on at its Cebollati gold project in Uruguay. At Cebollati, B2Gold has just commenced a 5,000m drill program that will follow up on some promising trenches reported in late 2010. Soil sampling, trenching and geophysics are supportive of a large multimillion gold target.
TGR: B2Gold is unhedged, debt free and has improved its cash cost by $131/oz. So, is the company for a more conservative investor?
DG: I think B2Gold represents one of the best examples of a junior producer in the junior gold space. It has a strong management team capable of both discovering and building through its exploration and development teams. It also has strong access to capital markets through the executive team with a demonstrable track record of success. B2Gold has strong production growth coupled with a solid pipeline of exploration potential.
TGR: What did you want to mention next?
DG: Sulliden Gold Corp. (TSX:SUE; OTCQX:SDDDF) is exploring on the Shahuindo gold project located in northern Peru. Peru is the largest gold producer in the Americas. This year Sulliden has a very aggressive 70,000-meter drill program, which is one of the largest drill programs that we know of any junior company we follow. That program will continue on last year's work, which we believe resulted in a possible doubling of its existing 1.8 Moz. gold resource. The company has had a discovery cost per ounce of less than $6.00.
The geology here is really permissive to rapid resource growth. This year's drilling will have the objective of defining additional ounces along strike and also to test some parallel structures that have seen limited drilling from previous operators but yielded encouraging results that have not been followed up on until now. Management will also be testing for sulphide mineralization below the oxide mineralization at surface. Classically, high sulphidation gold systems like Shahuindo have sulphide tonnage below the oxides that can be 1–3 times that of the oxide tonnage. Shahuindo may evolve into the 5 Moz. gold resource category of large gold deposits not yet controlled by a major.
TGR: I noted that in mid-December, Sulliden announced an accelerated expiration initiative for the warrants. I was thinking that that was a very bullish sign by management.
DG: Well, certainly it's a strong signal for the marketplace the company believes its 70,000-meter program is going to deliver a lot of new ounces and certainly be accretive from a total resource standpoint. The acceleration of the outstanding warrants represents an opportunity to bring in additional capital for previously incurred dilution. So, this basically represents the market endorsing the acceleration of the exploration program and providing Sulliden with the capital to work that program.
Brodie Dunlop: Sandspring Resources Ltd.'s (TSX.V:SSP) Toroparu gold/copper deposit in Guyana, South America, continues to profile well on our Select Golds report, trading at under $50/oz. They've had a very successful 2010 where they managed to more than double the size of their current resource through 57,000 meters of drilling. Coming into 2011, the most important catalyst for the company will be the scoping study that is due out mid-year. That study is going to provide the market with a bit of clarity on the economic viability of their ounces.
The most important information that's going to come out of this study is how they intend to recover the gold and copper, and what the cost of the recovery process are going to be. There are still a lot of untested targets on that property that will continue to be drilled.
DG: Another name that we like in that category here in North America is West Kirkland Mining Inc. (TSX.V:WKM), which was founded by CEO Mike Jones and CFO Frank Hallam . They have an outstanding track record of success. As an example, they were most recently associated with Timmins West Mining that was taken out by Lake Shore Gold Corp. (TSX:LSG) for $440 million. There's a similar corporate strategy at West Kirkland of tying up and exploring on land positions along some of the historic major structures within greenstone belts. In this instance it's in the Kirkland Lake area where they have tied up a more than 80-sq. km. land position through both staking and acquisitions.
The second aspect of the West Kirkland story is a large and increasing land position in northeastern Nevada where they have entered into a joint venture agreement with Fronteer Gold Inc. (TSX:FRG; NYSE.A:FRG) on 11 properties. We expect that market interest in Kirkland will heighten in anticipation of drilling at both projects in Kirkland and Nevada over the next several months.
DG: Philippine Metals Inc. (TSX.V:PHI; OTCQX:PHIXF) is another explorer that we think represents very good value. It has a tiny market cap of under $15 million and is an early entrant into the Philippines, an increasingly hot country in the geological and exploration worlds. It's got a tremendous geology both for gold and copper gold.
The company has three projects on which it is presently exploring and also has a large copper-gold target in the Malitao property. The company looks forward to getting its exploration permit on this property and to commencing on a drill program that has been designed and is ready to go. The company also benefits from a strong board of directors and strong local representation. One of the early entrants, it is focused on making additional acquisitions to capitalize on its presence in the Philippines.
TGR: Is this ideal for a small hedge fund perhaps, because it has a small market cap?
DG: I think Philippine Metals represents a lot of potential share price appreciation through exploration success. It is certainly of a market cap size that success at the drill bit is should be quickly reflected in success in the share price.
TGR: Is there another one?
DG: Looking at other areas of favorable geology, another company that we quite like and that is undertaking two exploration programs right now is Edgewater Exploration Ltd. (TSX.V:EDW). Edgewater has the Enchi Gold Project in southwest Ghana in West Africa. Enchi was acquired from Red Back Mining (which was acquired by Kinross in September 2010). The Enchi geology is analogous to Kinross's Chirano Gold mine and has been subject to over 40,000 meters of drilling, which was effective in identifying several strong gold zones that are presently the subject of a newly initiated drill program.
At Enchi, a soil-sampling program has yielded several anomalous gold trends, the largest of these gold in soil anomalies is located in the southeastern section of the gridded area and measures 4.2 km. in length and averages 0.5 km. in width. Edgewater will be targeting these new gold trends with drilling starting immediately.
In addition to Enchi, Edgewater owns the Corcoesto gold project in Spain. Edgewater is conducting a multi-rig 12,000m drill program to strengthen and expand an existing resource. Recent results include 10.72 g/t Au over 17.0 meters and is the best grade-X thickness interval on the project to date and is indicative of managements growing understanding of the mineralization at Corcoesto. We expect the next several months to be exploration news rich for Edgewater.
TGR: Thank you, Dave and Brodie.
David Goguen, CFA, vice president, Institutional Sales, has been focused on the mining sector at PI Financial for 13 years. David has 18 years of investment experience servicing institutional and private client portfolios.
David earned a BA in economics from Carleton University and holds the Chartered Financial Analyst designation. Brodie Dunlop, associate, Institutional Sales, joined PI Financial's Institutional Sales desk in 2009. His primary focus is on the resource sector. Brodie earned a BA from the University of Concordia and studied finance and accounting at the University of British Columbia. Brodie services Canadian, U.S. and international clients.
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1.) George Mack conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2.)The following companies mentioned in the interview are sponsors of The Gold Report: Extorre, Timmins, Capital Gold Corp., B2Gold, Sulliden, Sandspring and Philippine Metals.
3.) David Goguen: I personally and/or my family own shares of the following companies mentioned in this interview: Almaden Minerals, Kimber Resources, Philippine Metals and West Kirkland Mining. I personally and/or my family am paid by the following companies mentioned in this interview: None.
4.) Brodie Dunlop: I personally and/or my family own shares of the following companies mentioned in this interview: West Kirkland Mining and Kimber Resources. I personally and/or my family am paid by the following companies mentioned in this interview: None.