We’re nearing the end of the Q4 Earnings Season for the Gold Miners Index (GDX), and one of the first companies to report its results was Argonaut Gold (OTCPK:ARNGF). From an operational standpoint, the company had a solid year and beat its production guidance mid-point, but the massive capex increase at Magino has weighed on the stock. Meanwhile, Argonaut’s costs are rising rapidly, and as a low-grade, high-volume producer, it is less insulated than its peers from inflationary pressures. With the stock now more than 30% off its recent lows, I think there are more attractive bets elsewhere in the sector.
Argonaut Gold released its Q4 and FY2021 results last month, reporting quarterly production of ~61,900 gold-equivalent ounces [GEOs] and annual production of ~244,200 GEOs. This was a meaningful beat vs. the guidance mid-point of 230,000 GEOs, helped by a solid year from La Colorada both operationally and from an exploration standpoint. Unfortunately, this was overshadowed by a significant capex increase at Magino, with estimated costs up more than 50% vs. previous estimates. Let’s take a closer look below:
As shown in the chart above, Argonaut Gold had a solid finish to the year, producing just shy of 62,000 GEOs, a 9% increase from the year-ago period. The increase in production was driven by much higher production at La Colorada (~17,400 GEOs vs. ~14,500 GEOs) and Florida Canyon, offset by a slight dip in production at the El Castillo Complex. A significant increase in gold grades drove the higher production at La Colorada in Q4. Meanwhile, higher production at Florida Canyon was related to a production adjustment which also impacted costs in the period.
Given the strong finish to 2021, Argonaut posted record production of ~244,200 GEOs, a 20% increase from FY2021 levels. Based on the company’s expectation that it will pour its first gold at Magino by Q2 2023, the company has meaningful growth ahead, assuming it can secure its remaining financing to complete construction. As it stands, the expected shortfall for construction completion is north of $100 million, and the company recently announced gold price protection for the remainder of the Magino construction period (sold forward ~90,000 ounces at $1,916/oz) to help with potential future debt financing discussions.
Unfortunately, despite Argonaut beating its guidance mid-point, it was not immune from inflationary pressures, and the company saw a meaningful increase in costs in FY2021. As the chart below shows, Argonaut’s costs hit a new multi-year high in Q4 at $1,514/oz, though this was partially related to the production adjustment at Florida Canyon. Argonaut cited higher costs for consumables and reagents as reasons for the cost increases, which is evident in the 2022 guidance.
On a full-year basis, Argonaut’s all-in sustaining costs came in just 1% above its guidance mid-point at $1,311/oz, but costs are projected to increase substantially this year. This is based on its guidance mid-point of ~215,000 GEOs at $1,470/oz related to a higher strip ratio and lower grades at La Colorada, higher costs at El Castillo due to processing less oxide ore and more transitional/sulphidic ore. Of course, the other major impact is inflationary pressures, with most producers seeing cost creep due to higher diesel, labor, and consumables/reagents costs.
The chart below shows how Argonaut Gold’s all-in sustaining costs [AISC] have progressed relative to the industry average. As is clear, Argonaut was previously a low-cost producer in 2017 and 2018, but its costs have risen well above the industry average. In fact, they will rise 60% from FY2017 ($922/oz) to its FY2022 guidance mid-point ($1,475/oz), assuming the company cannot beat guidance. So, while Argonaut can credit itself with growing production, its margins continue to lag its peer group. This is evidenced by AISC margins declining from $528/oz to $480/oz on a year-over-year basis and set to dip to $425/oz, assuming an average gold price of $1,900/oz this year.
So, while some producers like Karora (OTCQX:KRRGF) are weathering the inflationary storm well, helped by nickel by-product credits and a higher-grade underground operation, Argonaut is in a worse position than its peer group, moving a lot of low-grade material at its operations. Obviously, a full year of contribution from Magino in 2024 (assuming it’s on time and budget) will help this trend. However, I still expect Argonaut’s costs to remain above the industry average in 2024, given that its other operations have elevated costs compared to the industry average.
Argonaut recently raised ~$41 million by selling ~20 million shares, pushing the company’s fully diluted share count closer to ~341 million shares. Based on a current share price of US$2.03, this gives the company a market cap of ~$692 million. Given that some advanced development-stage stories are trading at lower market caps currently, Argonaut remains reasonably valued relative to peers. This is especially true when its updated After-Tax NPV (5%) at Magino comes in at $522 million (75% of market cap) at a gold price of $1,700/oz without any value ascribed for expansion opportunities (underground, higher throughput).
However, while Argonaut could command a P/NAV multiple of 0.95 – 1.0x or better if it was a low-cost Tier-1 jurisdiction producer, I’m less confident that it can command this valuation with ~45% of production coming from a less favorable jurisdiction like Mexico. Meanwhile, although Argonaut states that it has a path to becoming a low-cost producer, I don’t see this being the case any time in the next four years. This is because even if Argonaut comes in near its cost estimates at $980/oz at Magino, I would still expect its consolidated all-in sustaining costs to be above $1,210/oz in FY2024/FY2025.
As the chart above shows, this is above the industry average and certainly not in “low-cost” producer territory. So, while I do see Argonaut as reasonably valued, I see a conservative fair value for the stock closer to US$2.35, translating to barely 15% upside from current levels, which is well below the 30% margin of safety I look for to start new positions. Obviously, a rising gold price could lift all boats and improve this fair value, but this is not a company-specific benefit. In fact, Argonaut actually has less to gain from higher gold prices, given that ~40% of its 2022 gold production is sold forward at $1,916/oz.
Moving to the technical picture, we can see that Argonaut has rallied sharply off support at US$1.55, but it’s now found itself in the upper portion of its expected trading range. Based on $0.13 in potential upside to resistance (US$2.16) and $0.48 in potential downside to support, this translates to an unfavorable reward/risk ratio of 0.27 to 1.0. Generally, I prefer at least a 5.0 to 1.0 reward/risk ratio when it comes to sector laggards, and this would require a dip below US$1.65. Therefore, I no longer see Argonaut near a low-risk buy point from a technical standpoint.
Argonaut is undergoing a very positive transformation with Magino’s first gold pour just a year away, and under previous circumstances, this could have easily pushed the stock to new highs above US$3.20 per share. However, the previous view that the stock would be a low-cost producer is off the table based on projects costs at Magino, and the stock is nearing short-term resistance. So, while Argonaut is reasonably valued, I think there are more attractive bets elsewhere in the sector. To summarize, I remain focused elsewhere, and I would view any rallies above US$2.43 before July as an opportunity to book some profits.