Canada-based Torex Gold Resources (OTCPK:TORXF) with a market cap of $1.1 billion is a compelling pick in metals stocks. It’s an exciting time for gold investors as for the first time since 2011, the market appears to be in a sustained uptrend since the break-out above $1,400 per ounce this year, which had acted as a major technical resistance level for the past decade.
Indeed, with a combination of growing global growth concerns, the Fed cutting rates for the first time since the financial crisis, and a number of ongoing geopolitical issues, we are bullish on gold and see more upside. It follows that the operating environment for gold miners has become favorable and Torex presents, what in our opinion, all the qualities of what makes a solid gold mining stock investment.
This is a company that controls quality assets, presents expanding production, has current profitability, with solid cash flow. Most importantly, we think shares of Torex at $13.00 have value following a near 20% pullback from recent highs. This article provides a recap of recent developments and our view on where the stock is headed next.
TORXF owns the 29,000 hectares Morelos Gold Property in an area of Mexico known as Guerrero Gold Belt. Within this property, the company operates the open gold pit deposit ‘El Limon-Guajes Mine,’ and the Media Luna Project, which is at an advanced stage of exploration. The company highlights that 75% of the property remains unexplored, representing future reserve growth potential.
(Source: Company IR)
The company is touting its proprietary integrated mining method called “Muckahi” as an industry-changing technology. From our understanding, the system is based on a “single lane” drill shaft conveyor compared to the industry standard of two lanes. The tunnels are intended to be built 4 times as steep and therefore a quarter the length of conventional systems leading to fewer processes from the stope to processing at lower costs.
The process is currently in testing at the Media Luna mine and the company sees progress in achieving its objectives. This system represents a potential upside catalyst for the stock even if it only partially achieves the objectives of a “30% reduction” in mining expenses. It’s possible the system and technical knowledge could be commercialized to other companies in the future.
(Source: Company IR)
Q2 Earnings Recap
The company reported its fiscal Q2 earnings back in August with net income of $10 million and GAAP EPS of $0.12 compared to a loss of $0.14 in Q2 2018. The story here is ramping production and higher levels of free cash flow leading to an expectation of deleveraging and growth opportunities. The improvement this year was driven by a 52% year over year increase in revenue on the quarter to $150.7 million, which beat expectations by $2.71 million. Torex produced a record amount of gold in the quarter at 113,645 ounces while benefiting from an average realized gold price of $1,314 per ounce in the quarter. The all-in sustaining costs per ounce of gold sold at $760 and total cash costs per ounce at $606 highlight the low-cost production value. The company generated $48.6 million in cash flow from operations in the quarter.
(Source: Company IR)
More recently the company provided an update on Q3 production, announcing a record 138,100 ounces of gold production representing a 21.5% increase to the Q2 figure. Looking ahead, the company is on track to reach previously guided full-year target of 430,000 ounces of gold sold (+/- 7%).
(Source: Company IR)
In terms of the balance sheet, Torex ended the quarter with $115.8 million in cash compared to $298.2 million in total debt. In the Q3 update, management noted that the total cash balance increased by $52 million in the quarter and total debt was reduced by over $36 million. Considering the numbers at the end of Q2, we estimate the company will end Q3 with approximately $268 million in total debt ($94.4 million in net-debt) compared to $240 million in EBITDA for the trailing twelve months from Q2. By this measure we calculate a current total debt to EBITDA leverage ratio of about 1.1x. Going forward, the company sees significantly higher cash flows from its El Limon Guajes mines as resulting in ongoing debt reduction.
(Source: Company IR)
Another development to note is that the company announced a “gold price protection program,” essentially hedging a portion of gold sales with a financial collar setting a floor price of $1,400 and ceiling price averaging $1,720 through August of next year. With the total amount hedged at 96,000 ounces representing approximately 22% of current full-year sales guidance, we view this as a relatively small program that does not significantly limit the upside in the stock price potential. Gold would need to rally 17.5% from the current level to exceed the average ceiling price for the year ahead, and at that point the stock would be benefiting from significantly more favorable conditions. To the downside, the floor price may slightly reduce volatility for the stock which improves the risk profile.
Torex Analysis and Forward-Looking Commentary
Torex came to our attention in the process of researching a different gold miner in Centerra Gold Inc. (OTCPK:CAGDF). Centerra included a slide in its latest investor presentation in which it highlighted its “compelling valuation;” the comparables data suggested that Torex may simply have a more compelling valuation. Between a price to NAVPS , price to cash flow per share, and price to full-year 2019 earnings estimates; Torex appears to be a value pick in the group.
(Source: Centerra Gold IR)
Indeed, given the current numbers, Torex’s valuation with a forward price-to-earnings ratio of 18x, price to free cash flow at 14.8x, and EV to EBITDA over the trailing twelve months at 5.6x overall appear reasonable. Keep in mind this is a company that just grew its gold production by 48% q/q in Q2.
Our intention here is not to be a cheerleader for the company. One of the obvious weaknesses that we highlight is the concentration of the business with only one operating mine which represents a risk to the investment thesis. While there is an expectation of deleveraging going forward, the gross balance sheet debt level remains elevated and is also a weakness for the stock. Larger and more diversified players may be a less risky play in the sector.
At the end of the day, Torex along with most other junior miners are going to need a continued move higher in the price of gold to maintain its bullish momentum. With that said, we think there are scenarios to support the price of gold irrespective of the next move in the broad stock market.
Clearly, the environment of deteriorating economic conditions and worsening global growth sentiment is bullish for gold, as precious metals are seen as a safe-haven from financial market volatility. Global policymakers in an effort to support growth would likely embark on a more aggressive easing cycle which has historically been positive for gold. On the other hand, there’s a scenario where policymakers including the Fed are successful in extending the economic cycle leading to a renaissance of growth expectations. We argue that this case is also bullish for gold as inflation expectations would necessarily rise rapidly from here, given currently low interest rates, and lead to demand pressures on the wider commodity pricing complex. Overall, the positive trend in the price of gold is supported by a number of fundamental tailwinds that should continue into 2020.
Junior gold miners have historically gotten a bad reputation in the market drawing parallels to the proverbial wild west of investing, given the number of highly speculative exploration-stage companies with ugly balance sheets and recurring losses. That’s definitely not the case here with Torex. This is a well-established company with quality assets and solid financial metrics.
Going forward, monitoring points include the ongoing deleveraging process and progress on the Muckahi system. We see the stock as reclaiming its recent high of the year at $16.00, representing 25% upside from the current level. To the downside, a break in gold under ~$1,350 would force us to a reassessment of the bullish thesis.
Disclosure: I am/we are long TORXF. 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.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Investing includes risks, including loss of principal.