DPMLF - Dundee Precious Metals: A Strong Start To The Year

2023-05-09 12:25:42 ET

Summary

• Dundee Precious Metals has been a top performer this year, with shares up more than 50% up-to-date.
• This outperformance is justified by the extreme undervaluation that I first flagged in November 2022.
• The company has recently reported strong Q1 2023 results, confirming its industry-leading margins and operational excellence.
• Given the positive exploration results at ?oka Rakita and Tierras Coloradas, and the possibility of getting full approval for Loma Larga, Dundee has a meaningful growth pipeline, plus the balance sheet to finance it.
• Significant value remains even at current share prices.

Introduction

Dundee Precious Metals (DPM:CA) (DPMLF), a Canadian intermediate gold miner with producing assets in Bulgaria (Chelopech and Ada Tepe), a smelter operation in Namibia (Tsumeb), and undeveloped projects in Serbia (Timok) and Ecuador (Loma Larga), has recently outperformed most other comparable gold miners. Its shares are up 56% year-to-date and over 62% since my initial recommendation in November 2022.

This strong performance is certainly a result of a more bullish outlook for gold, as the Fed appears close to pausing interest rate hikes. However, many gold miners are still far away from their all-time highs. Even with gold near record levels, the sometimes unappreciated fact is that most producers saw their margins reduce in 2022, because of the increase in production costs on the back of inflationary pressures. The new industry average for AISC is around $1200 per ounce, up more than 20% compared to 2020. As a result, the VanEck Vectors Gold Miners ETF ( GDX ) is still 22% below its summer 2020 peak. Despite the disappointing performance of gold miners in aggregate, however, the sector continues to offer significant alpha via individual stocks. Dundee has in fact reached new all-time highs in 2023, the consequence of solid operational performance, combined with industry-leading margins and an exciting growth pipeline.

Q1 2023 results

In the first quarter of the year, Dundee reported production of 69 thousand ounces of gold and 7.2 million pounds of copper, which correspond, respectively, to around 23.6% and 22.1% of the guidance's midpoint. While slightly lagging with respect to guidance, it should be noted that production is weighted towards the second half of the year.

Looking in more detail at each asset, Chelopech had a strong start, with 35,000 ounces of gold and 7.2 million pounds of copper. Copper production was slightly below expectations due to lower grades, but still on track to achieve guidance. Chelopech is a mature asset, but Dundee has consistently been able to increase its life of mine via several brownfield exploration programs. In March 2023, the company released a mineral reserve update, extending Chelopech's life of mine to 2031. Exploration activities continue via the drilling campaign at Stetipetka and on the Ibraveni exploration license.

Ada Tepe was the clear outperformer. The mine produced a near-record 33 thousand ounces of gold, at an AISC of only $486 per ounce, below the low end of the guidance range. The company updated its life of mine plan in January 2023. Ada Tepe is now expected to average 90.5 thousand ounces per year over the next 4 years, compared with 73.5 thousand ounces according to the 2020 mine plan, a 23% improvement. While Ada Tepe has a short life of mine, exploration efforts continue, especially at the Surnak and Kupel prospects. Given that the asset has consistently beaten expectations since 2019, it seems likely that Dundee might further extend its life of mine in the future.

At Tsumeb, Dundee has been implementing several cost optimization programs. Cash cost per tonne of complex concentrate smelted came down to $392 per tonne, a 11.5% decrease quarter-on-quarter. Volume smelted was around 50 thousand tonnes, up 19.6% quarter-on-quarter, but lagging full-year guidance of 200 to 230 thousand tonnes, because of unplanned maintenance.

AISC was at $872 per ounce, well below the majority of other gold producers, but significantly above the range of $700 to $860 per ounce that the company guided for. The explanation is that AISC include expenses related to stock compensation. Because of the strong stock performance, marking to market such expenses resulted in a roughly 100$ per ounce cost increase.

In terms of cash flow metrics, cash from operations was $75 million, and free cash flow was $65 million. The company ended the quarter with a cash balance of $473 million. In addition, at the beginning of the year, the company also held investments in Sabina Gold & Silver, which was acquired by B2Gold. All B2Gold shares obtained by Dundee as a result of the acquisition were sold for total cash consideration of $56.5 million in April. This transaction is not yet accounted for in Q1 results. Dundee's war chest is therefore likely close to $530 million, making its total EV below $1 billion. Despite the recent rally, the company thus remains significantly undervalued, with a FCF / EV ratio below 5.

With continued strong cash generation and abundant liquidity at hand, there is no concern about the health of the balance sheet. It is natural however to wonder what the company is going to do with all the liquidity at its disposal. Dundee has a quarterly dividend policy in place, which is certainly sustainable, but not particularly generous. It is equivalent to a roughly 2.1% yield, or 24% of free cash flow based on last quarter's results. There is for sure a wide space to ramp up capital returns. Management is likely aware of that, which is why in February 2023 it announced the decision to supplement dividend returns via a new buyback program for up to $100 million over a 12-year period (equivalent to around 7% of the current market capitalization). It has since repurchased around 1.3 million shares, for a total value of approximately $8.3 million. This is for now quite disappointing, and I am surprised that the buyback program has not been used even more aggressively. However, such consideration should be tempered by the fact that the share price has recently been on a tear. In addition, Dundee is going to put the cash to work in the near future, given its exciting growth pipeline, especially following the recent intercepts at ?oka Rakita and Tierras Coloradas.

Loma Larga

There is nothing significant to report concerning the Loma Larga project, where all drilling activities are still stopped while the company waits for the outcome of the appeal process related to the decision on the constitutional protective action. An updated feasibility study is planned to be released by the end of the year.

Loma Larga is a high-quality copper-gold underground project in Ecuador, with P&P reserves of 2.2 million ounces of gold and 88 million pounds of copper. It has a similar geology to Chelopech. This is an advantage considering that Dundee could leverage its significant operating expertise in Bulgaria to optimize the project beyond the initial planning. Based on the feasibility study , the economics of the project seem robust. With an average annual production of 170 thousand ounces and a life of mine of 12 years, Loma Larga would have an internal rate of return of 31% and an NPV 5% of $520 million.

Unfortunately, the project has been plagued by all kinds of delays due to the opposition of the local communities, despite the strong support from government bodies. Dundee is therefore still waiting to obtain its environmental license. In the meantime, it has been working on an investor protection agreement to submit to the government of Ecuador. The agreement is substantially complete and is going through the approvals of the various ministries.

Until the end of last year, Loma Larga represented the only significant growth opportunity for Dundee. This fact weighed heavily on the valuation, in particular considering that the Bulgarian assets have a less than stellar life of mine. However, Dundee has recently reported some of the best intercepts in the sector, significantly expanding its future growth options.

?oka Rakita and Tierras Coloradas

In January , the company announced some very high grade intercepts at its ?oka Rakita prospect, in Serbia. These intercepts were: 4 0 metres at 63.46 g/t Au (!) , 71 metres at 3.46 g/t Au, and 65 metres at 13.4 g/t Au (including 38 metres at 19.43 g/t Au and 9 metres at 11.05 g/ Au).

It is still very early days, but ?oka Rakita could be developed as a new standalone asset. Based on the data so far, the deposit appears to be high grade, initial metallurgical results were positive, and the project still has considerable upside.

For this year, Dundee has planned a 40 thousand meter infill and extensional drilling program. The company is targeting a maiden mineral resource estimate by the end of the year. We still don't know much, but management has stated during the conference call that the strategy is to advance the project as fast as possible, especially given the difficulties encountered with Loma Larga which, however, remains the priority because of its more advanced stage.

In February , the company also announced some positive results from its 2,700-meter drilling program at the Tierras Coloradas concession. This program was designed to test a series of previously identified low sulphidation epithermal veins. It confirmed the presence of 2 high-grade vein systems that remain open in multiple directions. A further 10,000-meter drilling program is planned for the second half of the year. Tierras Coloradas could potentially become a further new asset in the company's portfolio, with infrastructure synergies with Loma Larga, since it is located approximately 200 kilometers south of it.

Conclusions

I consider Dundee a top-quality, long-term holding in my portfolio, and I still see value in the current share price, especially if gold continues to hold above the $2000 per ounce level. There is significant future upside via exploration, based on the recent results at ?oka Rakita in Serbia as well as Tierras Coloradas in Ecuador. The company also has another undeveloped world-class asset with its Loma Larga project which, if fully permitted and put into production, would almost double current gold volumes. Nonetheless, because of the recent rally, I don't see sufficient margin of safety at the current price of around CAD 10 per share, but I would consider any selloff as an opportunity to further accumulate.

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