It’s been a tough 13 months for the Gold Miners Index (GDX), with the ETF plunging more than 30% from its highs, dragging many high-quality producers down with it. A sanctuary during the carnage was Argonaut Gold (OTCPK:ARNGF), a company that mobilized during the carnage of March 2020 to make a nice additional acquisition and is currently working to bring its fourth mine online. While the investment thesis was unconvincing at the June highs, a 25% correction made the stock much more attractive, with Argonaut now trading at just 0.65x P/NAV. Given the company’s enviable organic growth profile and recent exploration success, I would view further weakness at US$1.95 as a low-risk buying opportunity.

Argonaut Gold just completed an incredible quarter, recording record production of approximately 63,700 gold equivalent ounces [GEOs], up 58% YoY (Q2 2019) thanks to the timely acquisition of Florida Canyon. This translated into significant cost improvement ($1,187/oz vs. $1,264/oz), with higher gold increasing revenue by 114% on a two-year basis. The highlight of the quarter, however, was the company’s strong exploration success at Magino and La Colorada, with the high-grade successes at La Colorada being the most surprising. These added to the investment thesis, given that La Colorada was previously a relatively average mine, only contributing around 15,000 GEO per quarter. Let’s take a closer look below:

With an average grade of around 0.58 grams per tonne of gold, La Colorada is not an asset that investors typically looked forward to for drill results, but that changed dramatically in April. During the late April exploration update, Argonaut reported an intersection of 21.3 meters at 44.6 grams of gold per tonne and 12.2 meters at 98.9 grams of gold per tonne , these two of the best intersections reported to date in the sector. Both holes were drilled below the El Creston pit, with several other holes like LCRC-556, LCRC-558 and LCRC-570 also intersecting very strong grades (3.71 to 3.92 grams per tonne gold) on significant widths. Notably, recent drilling has confirmed the existence of three distinct high-grade gold veins beneath the El Creston pit, with a scoring hole of 38.1 meters at 9.1 grams of gold per tonne.

Although the last three landmark intersections announced in September pale in comparison to the successful intersections reported in drill holes LCRC-562 and LCRC-592, they are still incredible results, confirming the presence of very high-grade gold. This is a potential game-changer for La Colorada, given that even “low-grade” holes on a relative basis are still nearly triple the average reserve grade at La Colorada, such as 35.1 meters of 1.4 grams of gold per tonne (LCRC-651), 24.4 meters of gold at 1.4 grams per tonne (LCRC-663) and 41.1 meters of gold at 1.4 grams per tonne (LCRC-667). This is a welcome surprise for Argonaut, with the potential for an underground mine below the El Creston pit and plans for a Phase 3 drilling program. Assuming these exceptional grades persist, we would see much higher annual production of La Colorada in an underground scenario, with a potential of more than 100,000 ounces per year.

Moving on to Magino, Argonaut also had a strong year from an exploration perspective, reporting two impressive interceptions in the southern zone. Drill hole MA-20-057 intersected 10 meters of 19 grams per tonne gold last year, more than 400 meters below surface, and drill hole MA-21-071 extended this mineralization further at depth, with 9.5 meters of 3.7 grams per tonne of gold. This is one of the deepest holes drilled in this section, confirming mineralization at over 700 meters depth.

Meanwhile, MA-21-070 confirmed the presence of mineralization in MA-12-424 (21 meters at 11 grams per tonne gold), with two intersections of 7.0 meters at 13.3 grams per tonne gold gold and 5.0 meters at 3.5 grams per tonne gold. Finally, as an infill hole to MA-20-057, MA-21-070 also reached 8.0 meters at 5.1 grams of gold per tonne. This is very encouraging, suggesting that the Magino project could have significant underground potential with high grades relative to the open pit reserve grade. In the Elbow Zone, results were also quite encouraging (shown above), with MA-21-065 intersecting 19 meters of 3.7 grams of gold per tonne down plunge from an intersection drilled in 2019, 14 meters from 9.6 grams of gold per ton. These new results increase confidence in a high-grade ore body well below the current reserve pit.

During the second quarter conference call, Argonaut noted that construction is on schedule, although currently slightly over budget. Based on the current schedule, Magino expects to pour its first gold by Q1 2023, which will put the asset on track to produce over 160,000 ounces of gold in 2024. This will boost major thumb to Argonaut’s production profile, with a potential production of over 375,000 ounces in fiscal year 2024. At a gold price of $1,725/oz, this would translate to annual revenue of approximately $640 million, an increase of more than 55% over fiscal year 2021 levels.

So what does the evaluation look like?

Based on an estimated FY2021 free cash flow of approximately $110 million, Argonaut is currently trading at a free cash flow yield of nearly 16%, based on its market capitalization of approximately $692 million (322 million shares fully diluted at $2.15 per share). On a price/sales basis, Argonaut is trading at just over 1.5x fiscal 2021 revenue estimates and just 1.0x fiscal 2024 revenue estimates, and that assumes a price of l $1725-$1750/oz gold, which I would say is conservative. Finally, on a P/NAV basis, Argonaut is trading at around 0.65x P/NAV after last week’s selloff, a very reasonable valuation relative to its updated peer group. Based on what I believe to be a fair value of 0.85x P/NAV once Magino pours its first gold, this indicates at least a 30% upside for Argonaut. It is important to note that this does not include the increase in this number of underground potential at La Colorada and the continued exploration success at Magino.

So, is stock a buy?

As seen in the technical image above, Argonaut Gold is one of the few miners that remains above its March lows and, after its recent weakness, is falling back towards a multi-year uptrend line near 1, US$95. This is the first critical level of support for the stock, and I would be surprised if we didn’t see strong buying support in this area should the weakness persist. If this level eventually fails, there is another strong support level just below it at $1.69. Considering the two support levels stacked below and the fact that the first level of resistance only comes in at US$2.83, I would consider any pullback towards the US$1.95 level as a low zone. risk to start a position or add to existing positions. From this level, the reward/risk pair would be quite favourable, with US$0.88 on the upside for resistance and only US$0.26 for major support.

With Argonaut Gold trading at just ~0.65x P/NAV and easily justifying a revaluation to 0.85x P/NAV once Magino pours its first gold, this pullback has significantly improved valuation. That doesn’t mean the stock can’t drop, as the fundamentals have apparently disappeared in the sector. However, this suggests that the valuation is ultimately compelling enough to put the stock back near the top of its shopping list in the mid-tier producer space. Currently I see a few names with more compelling reward/risk, so I’m not long Argonaut, but I might be looking to start a position if the stock drops below US$1.95.