Summary
Argonaut Gold's first-half revenues climbed 18%, but an inventory write-down pushed profits back into the negative territory.
The company made 180% more operating cash flow in the first half of 2015, leading to $16 million in free cash flow.
We expect free cash flow to rise in 2016 as Argonaut Gold expects capital spending to decrease by 60%.
It expects to release an updated pre-feasibility study for the Magino gold project at year-end.
Argonaut Gold (OTCPK:ARNGF) is a Canadian gold producer operating the El Castillo and La Colorada mines in Mexico. It also owns three development projects in the Americas that could add significant cash flow growth once in production. Argonaut Gold's revenue for the first half of the year rose 18% on the back of higher production and sales volume. The decrease in gold prices has cut into revenue and profits as expected, but the restructuring of operations has helped achieve lower operating costs and widen cash margins.
Argonaut Gold generated 180% more operating cash flow in the first half of the year, leading to $16 million in free cash flow after subtracting capital expenditure. Free cash flow has remained positive for three consecutive quarters. We expect free cash flow to rise in 2016 as Argonaut Gold estimates capital spending to decrease by 60% to $15 million. The stock price has performed poorly mainly because of the increasing negative sentiment in the gold market. It currently trades well below book value of $4.90 per share.
Profits slips back to negative territory
Argonaut Gold saw second quarter revenue rise by six percent to $43.5 million on higher aggregate production and gold sales at the company's El Castillo and La Colorada gold mines in Mexico. El Castillo produced gold at a steady rate of 21,624 gold equivalent ounces, whereas La Colorada significantly rose production by 67% to 14,905 gold equivalent ounces because of increased gold ounces delivered to the leach pad. The table below displays production and sales performances at the two gold mines for the first two quarters of 2015, compared to the same period in 2014.
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Six months ended June 30, 2015
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Production (ounces)
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Sales (ounces)
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El Castillo
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46,467 (+7%)
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44,973 (+3%)
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La Colorada
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33,315 (+88%)
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33,992 (+87%)
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Total
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79,784 (+30%)
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78,965 (+28%)
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Net income for the second quarter slipped to a $10.5 million ($0.07/share) loss after recording a $13.6 million non-cash write-down on the value of El Castillo's leach pad inventory. This compared to a gain of $1.5 million ($0.01/share) in the first quarter of 2015, and a gain of $2 million ($0.01/share) in the same period in 2014. The double-digit loss accounts for the inventory write-down, an increase in deferred tax expense of $1.1 million and of course, the continuous decline in the selling price of gold weighing on top-line growth.
Excluding one-time items such as the inventory write-down, adjusted earnings for the second quarter were at a loss of $0.1 million, compared to a gain of $1.9 million a year ago. When looking at the company's year-to-date financials, revenues climbed 18% to $94.5 million as total gold sales jumped 28% as illustrated in the table above. Net earnings for the first half were at a loss of $9 million ($0.06/share), compared to a gain of $1.5 million ($0.01/share) a year earlier. Adjusted earnings for the first half fell by 43% to $2.7 million ($0.02/share).
Argonaut Gold estimates to produce 135,000 to 145,000 gold equivalent ounces at a cash cost of $700 to $750 per ounce this year.
Operating cash flows are improving at a fast pace
Argonaut Gold has restructured its business operations with layoffs at El Castillo and La Colorada and contract re-negotiations with suppliers to achieve lower operating costs. The weakening of the Mexican peso is a tailwind on items such as wages. However, when it comes to purchasing supplies such as cyanide, fuel and repair parts, the net impact of a lower peso is quite the opposite, according to Argonaut Gold's president and CEO, Pete Dougherty. This is because the company buys the supplies from the U.S. in U.S. dollars.
The decrease in gold prices have sliced cash margins significantly in the gold industry since the beginning of the bear market after gold fell from its all-time highs in 2011. Lower gold prices have added pressure on company balance sheets, particularly debt-laden miners with high-cost mining operations. Just this year, the steep decline in gold has led miners to file for Chapter 11 bankruptcy, for example Midway Gold (NYSEMKT:MDW), Allied Nevada Gold (NYSEMKT:ANV), and most recently, Santa Fe Gold (OTCPK:SFEGQ).
Argonaut Gold is relatively low-cost with year-to-date all-in sustaining costs of $895 an ounce, down 6% from the same period in 2014. We think the company's mining operations should produce positive operating cash flow assuming gold prices were to drop below $1,000 an ounce. Goldman Sachs and Morgan Stanley suspect the yellow metal to fall below $1,000 an ounce, with the U.S. central bank raising interest rates as the main catalyst. The U.S. Fed will decide today (September 17) whether or not to raise rates.
An increase in interest rates would directly affect the investment appeal of gold, as the metal pays no dividend or interest. This means investors would be more inclined to invest cash in yield-bearing assets such as U.S. bonds and equity. In our view, Argonaut Gold has a strong balance sheet that couldweather another leg down in the gold market, with $43.7 million in cash, and minimal long-term debt of $2.5 million maturing in 2016. Its two gold mines are also adding cash to the balance sheet.
For the first half of the year, Argonaut Gold produced $38.2 million in operating cash flow (after changes in non-cash working capital). That is an increase of 180% when compared to same period a year ago. We calculate the company made $16 million in free cash flow in the first half after subtracting capital expenditure incurred during the period.
Argonaut Gold has so far incurred 60% or $22 million of the budgeted capital expenditures for this year, with the remaining 40% or $15 million to spend in the second half of 2015. This year's capital spending primarily accounts for deferred stripping and leach pad construction at the El Castillo and La Colorada gold mines.
The company completed the construction of the heap leach pad at El Castillo ahead of schedule. At La Colorada, the company finished developing the first phase of the heap leach pad 6. The second phase should be completed in the fourth quarter of 2015.
Capital spending in the second half of the year should be lower, and therefore free up cash flow. Argonaut Gold has produced positive free cash flow for the past three quarters. We expect free cash flow to rise in 2016 as Argonaut Gold expects capital spending to decrease by 60% to $15 million.
Adding to the company's growth profile are three low-cost gold projects, two in Mexico and the other in Canada. The two Mexican gold projects, San Agustin and San Antonio, could double the size of current operations to 270,000 to 365,000 ounces of gold with a combined investment of $151 million. Argonaut Gold has submitted permits for the San Agustin project, and we expect the company to make a construction decision by the end of the year. It will cost $67 million to build the mine. San Agustin will be an extension of the El Castillo complex, which should allow for capital and operational synergies.
On the other hand, the San Antonio project will cost roughly $84 million to build. Argonaut Gold is currently evaluating the project and finding ways to advance discussions with newly elected officials taking office. The project has previously run into problems with Mexican authorities. An update in the third quarter should clarify the project's standing. The third project is Magino, the company's sole operation in Canada. We expect an updated mineral resource and pre-feasibility study for the project by the year end. It will include this year's drill results and new economic assessment.
Magino will cost approximately $356 million to build based on an economic assessment released in 2013. It currently supports a low net present value (NPV) and internal rate of return (IRR) at today's gold price. We think deferring the construction of Magino makes sense until gold prices recover, and focus on bringing the two Mexican projects on line. Magino is Argonaut Gold's bet to achieving its long-term goal of producing 500,000 ounces of gold on an annual basis. However, bank financing is not there for Magino, especially at such a low after-tax NPV and IRR numbers in the current gold environment
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Gold Price US$/oz Sensitivity
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After-Tax NPV5% (US$M)
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After-Tax IRR
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$1,620
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$479
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33.50%
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$1,490
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$381
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28.20%
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$1,400
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$313
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24.30%
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$1,300
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$237
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19.90%
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$1,000
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-$5.3
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4.60%
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Table 2: Magino project sensitivity analysis
The stock price has performed poorly, falling 45% year to date. We think the market heavily discounts the value of the company's asset base because of the negative sentiment in the gold market. Argonaut Gold is relatively low-cost with a solid balance sheet and asset base. Its operations should generate positive operating cash flow even if gold prices fall below $1,000 an ounce as suspected by Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS). Argonaut Gold currently trades well below the book value of $4.90 (C$6.00) per share and provides a long-term 'buy and hold' opportunity.
Argonaut provides a unique opportunity. We are an established producer generating real cash growth. We have a strong balance sheet with $44 million in cash and minimal debt. We have three very attractive growth projects towards the future. Our valuation shows that no value is basically being attributed to those development assets," Mr. Dougherty said to investors in a recent earnings call.