2022 was a tough year for most junior and mid-cap gold producers, and several names turned in lifeless performances while others suffered a worse fate, like Pure Gold (PGM.V/LRTNF), Great Panther (GPR.TSX/GPLDF), and Aurcana (AUN.V/AUNFF) who have had to stop operations at their mines due to a lack of profitability and or balance sheet weakness. However, while there was one name in the laggard group that underperformed all year due to a massive capex over-run and significant share dilution that followed, it actually managed to put together a strong finish to the year, outperforming the Gold Juniors Index (GDXJ) with a 24% return in Q4, a 300 basis point outperformance vs. GDXJ. This stock was Argonaut Gold (AR.TSX/ARNGF) and this outperformance was certainly justified.
In fact, not only does the company have a company-builder in its new CEO, Richard Young (who delivered consistent sector outperformance as CEO of Teranga Gold), but it has begun to monetize non-core assets and has received a respectable price for these assets considering the only minor improvement in sentiment sector-wide. Richard Young's fresh set of eyes could help the company to take a closer look at the portfolio to optimize it for cash flow generation (vs. focusing on the total number of ounces produced), and I would expect Argonaut under his leadership to take a closer look at the scale-up potential of Magino, which was long forgotten with sentiment for the stock in the gutter the past year. The result is that I expect we'll see a very different Argonaut by Q4 2023, with the potential for further monetization of non-core assets and a conceptual for growing its Tier-1 production profile by examining the possibility of a larger operation at Magino. Let's take a closer look below:
Recent Developments
Argonaut Gold had a very rough first three quarters of the year, with a significant capex blowout at its Magino Project, an avalanche of share dilution to address this funding gap (434 million shares at C$0.45), and a tough time at some of its more marginal mines with inflationary pressures and a weaker gold price pinching profitability. However, there was also some solid news reported along the way. The problem is that this the good news tends to be ignored when a stock is in a violent bear market and when sentiment is at its worst levels in years, with all eyes on the balance sheet and most investors focused solely on the negatives. One of these positive developments was the appointment of Chuck Hennessey as VP Canadian Operations (Mine General Manager at Mount Milligan, Rainy River, and Detour Gold, and VP of Operations BC for Centerra), which should help with a smooth commissioning and ramp-up for Magino. The other was the continued positive drill results coming out of the underground at Magino, with Argonaut reporting the following:
- 11.0 meters at 8.83 grams per tonne gold, and 3.5 meters at 7.2 grams per tonne gold (Elbow Zone)
- 3.0 meters at 11.6 grams per tonne gold, and 4.0 meters at 7.3 grams per tonne gold (Central Zone),
- 13.0 meters at 7.4 grams per tonne gold (#42 Zone)
- 8.0 meters at 15.0 grams per tonne gold (South S3), 9.8 meters at 5.5 grams per tonne gold (South S3), and 15.5 meters at 4.5 grams per tonne gold (South S1)
These exceptional intercepts continue to point to a large mineralized system down-dip of the current open-pit resource base at Magino, and I would expect a resource in the next 12 months with nearly 150,000 meters drilled and better spacing to try and better inform the underground opportunity here. For those unfamiliar, the company has identified six areas of interest (Elbow, Central, Scotland, #42, Sandy, and South Zones), with drill density highest at the Elbow and Central Zones. In terms of the size of this opportunity, Argonaut noted that it sees the potential for 1.8 to 2.5 million tonnes of material at 6.0 to 7.0 grams per tonne of gold at solely the upper portion of the Central and Elbow Zones. The low end of this exploration target (1.8 million tonnes at 6.0 grams per tonne of gold) represents ~350,000 ounces. However, this entirely ignores any potential below the 550-meter level below the surface and the discovery of new zones (which can be seen in the above image to the left of the Central and Elbow Zone), which could ultimately translate to an underground resource of 1.50+ million ounces of gold once it's better defined with another few years of additional drilling.
(Source: Company Presentation)
So, why does this matter to Argonaut Gold, an open-pit producer focused on a 10,000-tonne-per-day operation?
As regularly discussed by the company, the 10,000-tonne per day operation was pursued to allow for reasonable upfront costs and to allow Argonaut to independently build this asset, which was certainly the right move given that a larger footprint in an inflationary environment could have been even more of a disaster for the company. However, Magino is permitted to operate at 35,000 tonnes per day, and the company has noted that it is working on studies looking at expanding the processing facility to 20,000 tonnes per day which could reduce costs materially as the asset would benefit from economies of scale. However, given the exceptional grades being hit beneath the Magino Pit, another opportunity could be to complete a more modest plant expansion and send some incremental feed from the underground to the plant to spike the average feed grade. To date, we don't have a resource or a scoping study to give an idea of what this potential could be, but with two distinct potential mining areas being identified below the Magino Pit, this opportunity is becoming quite exciting with very mineable widths (4.0+ meters), and a little extra tonnage can go a long way at these grades for a relatively small operation like Magino.
(Source: Company Website)
It's quite premature to try and put numbers or economics around this operation, given that we don't have a resource in place yet. However, if we assume that Magino were to look at a 1,600-tonne-per-day underground operation with an average diluted grade of 5.40 grams per tonne of gold and a 93% recovery rate, this would translate to ~94,000 ounces per annum of incremental production. If we add this to Magino's 117,000-ounce life of mine production profile, this would translate to 211,000 ounces per annum, but this would still utilize just one-third of permitted capacity (~12,000 tonnes per day vs. 35,000 tonnes per day). So, even with a very modest underground operation that could be exploited relatively early in the mine life to boost production, this would be a game-changer for Magino and allow for a significant increase in annual cash flow. Hence, I would argue that an estimated After-Tax NPV (5%) of ~$400 million for Magino ($1,725/oz gold) is quite conservative when there are significant open-pit ounces outside the current mine plan (including ~540,000 inferred ounces at a 0.30 gram per tonne cut-off), and an underground opportunity that isn't reflected in the recent Technical Report either.
(Source: Company Technical Report)
Some investors might argue that this is too conceptual in nature to consider, and I would agree, which is why I have not provided any value for this opportunity in Argonaut's valuation. That said, it's important to note that Magino was an underground operation (1988-1992) before its planned transition to open-pit mining (Q2 2023), with the production of ~803,000 tonnes at 4.43 grams per tonne of gold, or ~114,000 ounces of gold. Production halted in 1992 due to elevated operating costs combined with a low gold price (~$340/oz), with the operation further impacted by excess dilution within longhole stopes that affected grades. However, with the gold price 450% higher and likely heading above $1,950/oz by the time an underground opportunity would be pursued (post-2025), there is a lot of value in ~$330/tonne ore just beneath an open pit, which assumes a 5.4 gram per tonne diluted grade. It's also worth pointing out that the Island Gold Mine to the east and Eagle River Mine to the southwest continued to get better at depth, suggesting that there could considerable additional resource potential below the 1,200-meter level at Magino.
To summarize, while I wouldn't rely on these numbers as they're very conceptual given that it's near impossible to get a decent idea of what the underground opportunity is here with simply an exploration target to work with and wide drilling spacing in most zones to date, Magino ultimately looks like it has two paths (incremental underground feed or major plant expansion) to becoming a 220,000+ ounce per annum asset. This would likely lead to a material re-rating in the stock if either of these scenarios were green-lighted, especially given that this opportunity would be attacked with cash flow now that Magino is nearing its first pour, not dilution like its most recent step-up in production. Finally, the team has an ambitious CEO at the helm who has been scooping up shares at breakneck speed since joining (2.0 million shares purchased at successively higher prices), suggesting that he might have a much larger vision for this asset/company vs. the Argonaut of today and is certainly confident in the potential to turn this company around.
(Source: SEDI Insider Filings)
Valuation
Based on 846 million fully-diluted shares and a share price of US$0.38, Argonaut trades at a market cap of $321 million, which is a dirt-cheap valuation for a future 350,000-ounce plus per annum producer. In fact, I see a fair value for Magino of $400 million at a $1,725/oz gold price which at a 0.80x P/NAV multiple already covers off the current market cap ($320 million), and it doesn't take into account any boost in NPV (5%) from potentially scaling up this operation to be a 220,000-ounce per annum asset, with the opportunity to increase this further given considerable permitted capacity. Hence, regardless of what one's opinion is on the weaker gold price and higher oil prices (vs. 2020 levels) which could continue to weigh on profitability at its highest-cost operations, it's worth noting that investors are getting the rest of these assets for free. This includes three small mines in Mexico (El Castillo, San Agustin, La Colorada) and a small-scale producing asset in Nevada (Florida Canyon), plus its Cerro Del Gallo Project, which it could also look at monetizing given that it's not getting any value for this asset currently (which appeared to be the case with Ana Paula and San Antonio as well).
Even if we assign just ~$350 million in value for the rest of its portfolio (three mines in Mexico and one in Nevada), which I would consider to be brutally conservative, and combine this with a conservative $320 million valuation for Magino and a conservative $70 million for Cerro Del Gallo, we arrive at a fair value of $740 million. After subtracting out estimated corporate G&A ($170 million) and dividing by 846 million fully-diluted shares, this translates to a fair value of US$0.67 [C$0.88] or an 77% upside from current levels. However, it's important to note that this price target places a very conservative valuation on its current operating portfolio; it assumes no long-term upside in the gold price ($1,725/oz gold price assumption), and it doesn't give any credit to what a Magino expansion could do for this asset's value. It also doesn't factor in any expansion in its P/NAV multiple due to having an all-star CEO at the helm, as investors envision what Young could do with this portfolio considering what was accomplished at Teranga. Hence, I would consider this 12-month price target to be a base case target.
Summary
Despite Argonaut Gold's recent share-price recovery, 2022 was certainly a year to forget, with the stock shedding 78% of its value and plunging to new 10-year lows. However, with a productive Q4 with contingent financing in place and a new CEO in place, I expect 2023 to be a much better year, with the potential to claw back a portion of 2022's losses, given the more favorable outlook. Just as importantly, we already appear to be seeing a more favorable shift in sentiment which means that good news should be embraced, and any margin compression at higher-cost assets can be looked over with Argonaut just one year away from commercial production, adding a ~140,000-ounce per annum asset with sub $975/oz AISC in its first five years. To summarize, I see Argonaut as a solid buy-the-dip candidate; I remain long with an average cost of C$0.37, and I would expect any sharp pullbacks in the stock to provide add-on opportunities.
Disclosure: I am long AR.TSX
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. This article is provided for informational purposes only and is not intended to be investment advice of any kind. The author is not sponsored by any company discussed in the article, nor has he ever been compensated by any company discussed in the article. Given the volatility in the precious metals sector, position sizing is critical, so when buying small-cap precious metals stocks, position sizes should be limited to 5% or less of one's portfolio.
