Torex Gold Stock: Additional Weakness Presents Buy Opportunity
It’s been a rollercoaster year for Gold Miners Index (GDX) investors, enjoying a strong first-quarter rally followed by a near-unprecedented decline to follow from a velocity perspective. This is because GDX has found itself down more than 40% in less than 100 trading days from its peak in April, which translates to an annualized decline of about 79%, enough to ward off the actions of some of the most hardened gold bulls.
The catalyst for the decline was continued margin compression due to inflationary pressures for many producers, exacerbated by a sudden drop in the price of gold. True to form, Torex Gold (OTCPK:TORXF) easily weathered the tough environment, being one of the few miners to report margin expansion in the second quarter. With the stock down 34% year-to-date despite its strong execution, I see it as a speculative buy at US$6.65.
Production & Sales
Torex released second-quarter results last month, reporting quarterly production of approximately 123,200 ounces, up 3% from the year-ago period. The increase in production was driven by higher throughput (~1.12 million tonnes) and higher head grades, with higher open pit grades more than offsetting slightly lower underground grades. That said, record mining rates offset lower underground grades in Q2, which were more than 10% higher than the previous record recorded in Q2 2021 (1,582 tonnes per day vs. 1,429 tonnes per day).
In remarks prepared by Torex, the company said it expects to maintain these record mining rates in the second half, and its long-term target is 2,000 tonnes per day. This sets the company up for a strong second half of the year and should allow it to exceed its fiscal 2022 mid-term production target of 450,000 ounces. The increase to a mining rate of 2,000 tonnes per day should be facilitated by the connection of Portal #3 and the possibility of longhole stoping in certain areas compared to its current cut and fill mining method. .
Moving on to sales, Torex sold approximately 123,400 ounces in the second quarter, an 11% increase over the prior year. Combined with a higher gold price ($1,865/oz vs. $1,816/oz), this resulted in a 14% increase in revenue to $235.0 million, while cash flows cash from operations amounted to $126.9 million. While some investors might worry about revenue and cash flow generation in the second half as the price of gold continues to decline, it should be noted that Torex hedged 30,000 ounces in the fourth quarter at $1,910. /oz, with around 110,000 ounces hedged in 2023 at $1,924/oz. .
While the lower gold price could put pressure on other miners’ margins, Torex will see a slight lag due to its proactive hedging. The company added these hedges to reduce risk from its period of increased capital spending with the construction of Media Luna underway. These hedges are expected to cover approximately 25% of gold production in 2023, with the possibility of extending its coverage until 2024. Given the strong generation of free cash flow during the period (74.0 million dollars), Torex ended the quarter with more than $306 million in cash, a 56% year-over-year increase (Q2 2021: $196 million).
Costs and margins
Turning to costs, the industry has seen a significant increase in costs over the past year, impacted by rising prices for labour, electricity, fuel and reagents. Torex was not immune, but the company delivered strong cost performance in the second quarter, with all-in sustaining costs of $911/oz. This was only a 2% increase over the prior year period, helped by higher sales volume and reduced cyanide consumption compared to last year. Torex noted that its underground mining costs were also helped by economies of scale due to the much higher mining rate.
This relatively marginal cost increase offset by a higher gold price allowed Torex to post higher margins compared to Q2 2021 levels, with AISC margins of $954/oz (Q2 2021: $919 /oz). Notably, these margins were well above the industry average AISC margin of approximately $600/oz in the second quarter of 2022, and Torex is in excellent shape to meet its fiscal 2022 cost guidance of $980/oz. at $1,030/oz. Given that Torex will not benefit from the hedges in Q3, we will likely see a shift to margin compression from Q3 2021 levels ($886/oz), impacted by the lower gold price. However, after the third quarter, Torex should be in better shape than its peers due to its hedges if the price of gold stays below $1,800/oz.
Media Luna Development
As operations continue to run smoothly given the relatively challenging environment (supply chain headwinds, labor shortages) in the industry, Torex is also making solid progress from from a development point of view. Witness the construction of Media Luna, 5% complete, and the Guajes tunnel advanced by 2.3 kilometers at the end of July. Equally important, Torex increased its total liquidity to $560 million with an increase in its revolving credit facility ($250 million from $150 million), giving the company additional flexibility to finance the project.
According to Torex, the company spent about $30 million on Media Luna in the second quarter and has about $840 million of capital remaining on the project. The current liquidity position of $560 million, combined with the expected cash flow for fiscal 2023 of approximately $220 million, should primarily cover required capital expenditures. It is important to note that the forecasted cash flow generation for fiscal 2023 assumes a lower average realized gold price of 1,725/oz in fiscal 2023. So unless we see a sustained collapse in the price of gold, Torex should be able to fund most of its remaining capital even with its current cash/credit facility and next year’s cash flow.
For those unfamiliar, Media Luna is expected to enter production in 2025 and is 7 kilometers from its current El Limon-Guajes mine. The asset offers increased copper and silver exposure and is expected to produce an average of approximately 374,000 gold equivalent ounces per year over the 12-year mine life. Notably, Torex will maintain its peak costs after transitioning to Media Luna, with AISC expected to be below $960/oz. As noted above, the Guajes Tunnel is now one-third complete on its way under the Balsas River to the Media Luna ore body.
Based on approximately 86 million fully diluted shares and a share price of $6.80, Torex trades at a market capitalization of approximately $585 million, a very cheap valuation for a mid-level producer. Even based on a more conservative estimated net asset value of around $1.20 billion based on $1,725/oz gold and $3.75/lb copper and $130 million corporate G&A , Torex is trading at 0.49x P/NAV. This is one of the lowest multiples in the industry, and it places limited value on the upside of exploration in a very promising set of lands.
These commodity price assumptions may seem less conservative at current prices, but it is important to note that these numbers extend to 2033. Therefore, one should take a relatively bearish view of gold and copper, the latter being a key raw material in recent years. trend towards electrification, to assume that prices will not average $1,725/oz and $3.75/lb at the bare minimum. In summary, Torex is trading at a steep discount to its fair value, even with very conservative assumptions, making it a steal if commodity prices return to their highs at some point over the next 18 months. .
While it’s hard to find a cheaper producer than Torex with an impeccable track record, the stock carries a higher risk given that it’s a single-asset producer in the state of Guerrero, in Mexico. While Torex hasn’t had any of the recent headaches that Equinox Gold (EQX) has endured at Los Filos (blockade), single asset producers are riskier given that any problems can be amplified. So while I have great confidence in the abilities of this team, we are in the midst of a critical mine-to-mine transition, which adds additional risk.
That said, I think a lot of that risk is already priced into the stock at 0.49x P/NAV and less than 3x cash flow estimates for FY2023. So for investors willing to Step out of the risk curve a bit, I see Torex as a speculative buy at US$6.65. Normally, I would avoid single-asset producers altogether. Still, this team has proven they can exceed their promises, turning Media Luna’s recent underperformance and execution concerns into a buying opportunity.