RE:RE:Seeking Alpha article Thanks for the posts, guys.
Your points are well taken.
As for myself, I am placing a fairly close stop on my shares .
Good luck!
Goldguy
Below is the entire essay.
Gold & precious metals, macro, research analyst, deep value
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Summary
- Since I last recommended Timmins Gold the stock is up 42%, but the gold price is up just 3%.
- More importantly Sentry Investments -- the company's top shareholder -- has attempted to shake-up management by infiltrating the company's board in order to broker a deal.
- Given management's track record, this is not the best outcome for long-term shareholders, especially since it is a distraction.
- The stock is no longer a long-term bet on a quality management team; rather it is a stock driven by binary and short-term events, making the shares unappealing.
- With the stock trading above its NPV, and with the long-term investment thesis in question, the stock is far less appealing and should be sold by long-term investors.
An Overview of Timmins Gold
Timmins Gold (NYSEMKT:TGD) is currently mining and further developing its San Francisco Project in Sonora, Mexico. The company has been mining here since 2010 and it has grown production every single year since production commenced. Furthermore it has been a relatively low-cost producer, and as a result it didn't post losses or take write-downs on its reserves last year. In fact, the company has been growing its reserves and resources every single year.
As a growth company in the mining sector with low production costs, it seems like a quality company and one worth owning assuming that you are bullish on gold.
My Past Investment Theses
Last August I wrote an article in which I cited exactly these reasons for owning the stock. But in October, Mexico imposed an 8% royalty on gold mining, and in November Timmins updated its San Francisco mine plan. While the company cited an increase in reserves and resources, it also reported that its production costs would be notably higher than initially anticipated. This sent the stock plummeting to $1/share from nearly $2/share.
In January, with the stock trading at $1.35/share, I updated my bullish thesis, stating that I was slightly less optimistic given these developments, but that the decline in the share price led me to the conclusion that the market was essentially only assigning value to the San Francisco Project, and that the leverage to a rising gold price along with the company's exploration potential at both its San Francisco Project and on its other exploration projects throughout Mexico led me to continue to like the stock. I especially liked that management continued to develop its San Francisco resource, and it led me to the belief that management would continue to expand it and that it could produce more gold for longer than the mine plan suggested.
What Has Happened Since?
Since then the stock price has soared 42% back to nearly $2/share despite the fact that the gold price is only 3% higher. The driver, however, isn't necessarily a good one.
The company's largest shareholder -- Sentry Investments -- has begun to fight management for control of the company by nominating its own board representatives in lieu of the existing members. Sentry believes that management has not done a good job given that it has not allowed other companies to evaluate the company's assets, suggesting that it is not open to the idea of an acquisition.
Investors have therefore bid up shares in hopes that Sentry Investments will gain control over the company and that it will sell to an acquirer. It has so far succeeded in getting one member nominated to the soon-to-be 8-person board.
On the one hand, this is great if you've held the stock -- you've seen your position increase 42% in value. But the latest developments and the stock's increase have led me to become far less enthusiastic, and I think that investors should consider taking profits and look for opportunities elsewhere.
The "Sell" Thesis
There are two facets of the sell thesis. The first is valuation. As I suggested above, I felt the company was fairly valued at $1.35/share and $1,270/oz. gold, and that management's history of execution made the stock worth owning. Now at $1.92/share and $1,310/oz. gold I am not as bullish. As we will see below in my updated valuation analysis, the stock has about 18% downside on a DCF basis using an 8% discount rate.
Now this wouldn't be so bad. Again part of my enthusiasm for the company when it was "fairly" valued was the fact that management had done an excellent job of growing production, reserves, and resources.
But now management's leadership is in question, as Sentry Investments doesn't share my confidence in management and seemingly wants the company to explore other alternatives.
I think this is a bad idea given how successful management's strategy has been. While we have seen setbacks over the past couple of years with the falling gold price and rising production costs, Timmins' management has generally done an excellent job, and other than the fourth quarter the company has generated a profit throughout the bear market in gold. In short, I think management should be left alone given what it has accomplished, and while a buyout would be nice in the short term, I think a lot of that premium is built into the stock, and that a takeout bid might not be so enticing.
With this in mind, I want to take profits and wait for either:
- the valuation to come back down below the value of San Francisco's discounted cash flow.
- the battle between management and Sentry Investments to end.
In either of these events, I will certainly re-evaluate my position. But for now, the stock is overvalued on a DCF basis, and the one thing that would justify such a premium is in jeopardy.
An Updated Valuation Analysis of San Francisco
The San Francisco Project is currently slated to produce through 2022. According to the mine plan, the project is supposed to produce 121,000 ounces of gold this year and in 2015. This is supposed to rise slightly to 135,000 ounces per year through 2020 before slowing down to 130,000 in 2021 and down to 53,000 ounces in 2022.
However if we annualize this year's production, we get about 136,000 ounces, which is in line with the company's estimates through 2020. With this in mind, let us assume that the company produces 135,000 ounces per year from now through 2021 (we are adding 5,000 ounces of production to the company's 2021 figures for convenience and to give management the benefit of the doubt.). The following table shows production along with the company's estimated production costs before taxes.
| Year |
Production |
All In Costs |
| 2014 |
67,000 oz. |
$846/oz. |
| 2015 |
135,000 oz. |
$846/oz. |
| 2016 |
135,000 oz. |
$1,016/oz. |
| 2017 |
135,000 oz. |
$1,016/oz. |
| 2018 |
135,000 oz. |
$1,016/oz. |
| 2019 |
135,000 oz. |
$1,016/oz. |
| 2020 |
135,000 oz. |
$1,016/oz. |
| 2021 |
135,000 oz. |
$686/oz. |
| 2022 |
53,000 oz. |
$686/oz. |
With these figures, we get the following valuation estimates at various gold prices. Amounts are in millions of dollars.
| Discount Rate/Gold Price |
$1,200 |
$1,310 |
$1,420 |
| 8% |
$140 |
$197 |
$254 |
| 12% |
$123 |
$173 |
$224 |
Now if we assume that the company made $8 million in Q2 -- in line with Q1 -- and if we add the company's other non-mining assets and liabilities to these figures we add $18 million, giving us a valuation of roughly $215 million at the current gold price using an 8% discount rate.
Now we should keep in mind that the mine plan is relatively conservative with respect to the company's total reserves, which could add another 4 years of mining. Now assuming the company earns about $30 million a year assuming 4 more years of production (roughly in line with the company's current earnings power but lower considering that production costs are expected to rise starting in 2016) the NPV at $1,310/oz. gold and at 8% rises to about $250 million, or $268 million with the company's other non-mining assets thrown in.
Now that's about an 18% premium to the company's current $317 million valuation. Considering that the company has beaten production estimates, considering that the mine currently has an additional 3.5 million ounces of gold that hasn't yet been classified as reserves (meaning it hasn't been included in the mine plan or been deemed economical to mine), and considering management's track record for increasing production and resources (see the following charts), this premium seems to be justified, and perhaps even low.
(click to enlarge)
(Source: Timmins' Presentation)
(Source: Ibid)
Sentry's Involvement
However this premium is contingent upon management's freedom to do what it has done over the years, which is to create shareholder value. Unfortunately, as we have seen, Sentry Investments wants to interfere with that given that it doesn't believe that management is willing to explore all of its options and that this entails that management is not maximizing shareholder value.
Now given this track record of value creation, it seems to me that shareholders would be wise to leave management alone and not worry so much about the near-term 30% - 40% pop that could be realized in the event of an acquisition should Sentry get involved. In fact, as I have hinted already, the recent strength in Timmins' shares suggests that investors are pricing this in, and this could lead to disappointment once a deal is actually announced.
The odds of such a sequence of events (i.e. Sentry's board members "take over" and shop the company) has recently come down given the most recent development in the battle for the board: namely that Sentry will agree to support Timmins' board while it gets 1 seat on the now 8 (formerly 7) person board. However the odds are heightened since I last wrote about the company, and given the relative strength in Timmins' shares (see the following chart of Timmins shares in terms of the Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ)) I suspect that investors are still betting on a sale of the company.
(click to enlarge)
(Source: Stockcharts.com)
Conclusion
With the developments we have seen over the past several months, and given the rise in Timmins' shares, I am far less enthusiastic about the company, and I think that the stock should be sold in lieu of other gold investments. Investors have bid up the stock in the hopes that Sentry's increased involvement will lead to an event (presumably an acquisition) that will generate near-term value. But this is not a concrete investment thesis, and as I have emphasized I think this has largely been priced in, and that Timmins' valuation is close to a ceiling assuming the gold price remains flat.
What's worse, however, is that this has become a near-term catalyst story that is driven by binary events (e.g. "Will Sentry win board seats or not?", "Will Timmins Gold be acquired or not?"), and this radically shifts the appeal of the company from a long term value creation story driven by a management with a proven track record. Short term event-driven traders seem to be in charge now, and with this in mind I find it difficult to justify owning the stock now that it trades at a premium to its quantifiable assets.