FTCO - Fortitude Gold Is About To Face A Lot Of Headwinds

2023-06-19 05:39:16 ET

Summary

• Fortitude Gold Corporation's first quarter 2023 results show strong mining momentum, but analysis confirms a Sell recommendation.
• The company's stock price is getting increasingly tied to market expectations for gold prices, and further rate hikes could cause the stock price to fall below the 200-day moving average.
• Best production and cost rates are over and the share price would need significant bullish sentiment on gold prices to stay up.

For Colorado-based gold producer Fortitude Gold Corporation (FTCO), this analysis believes that despite strong mining momentum in Q1 2023, there is no scope for the share price to rise significantly above current levels, confirming the Sell recommendation.

In the previous article , the Sell recommendation for this producer of gold in Nevada was based on a bearish gold price due to unfavorable macroeconomic conditions and declining production with the possibility of rising costs after a good start.

Subsequent to the initial sell recommendation, the company released financial and operating results for the first quarter of 2023 on May 8, which reported GAAP EPS of $0.26 on revenue of $21.54 million.

Based on the first quarter 2023 gold production of 11,487 ounces and full year 2023 production guidance range of 36,000 to 40,000 ounces, fewer ounces should be shipped in the coming quarters, and this does not pave the way for better financial results. This analysis also doesn't give gold prices a good chance of trading at levels that would offset the drop in production.

How Fortitude Gold Corporation Performed in the First Quarter

Fortitude Gold Corporation is producing gold from its Isabella Pearl Mine Project property, located in a traditionally favorable mining and exploration region of the state of Nevada. The Isabella Pearl Mine is a 9,777-acre property in Mineral County, Nevada, specifically on the Isabella Pearl mineralized trend.

In total, Fortitude Gold Corporation's Nevada Mining Unit consists of five gold properties in the Walker Lane Mineral Belt and one additional gold property in western Nevada. However, the Isabella Pearl Mine project is currently the only one in production. The mine started gold production in early 2019 with an estimated total mine life of 4½ years. As production nears the end of production, the company may be considering the possibility of recovering the precious metal from a number of other open-pit discoveries on Isabella Pearl's property.

The first quarter of 2023 was very positive as the business was able to generate monetary resources to pay further dividends, finance some mineral activity advancement, and ultimately add a couple of million US dollars to the cash position.

Now, the balance sheet shows a cash balance of $52.3 million at the end of the first quarter of 2023, an increase of $7.3 million from $45.05 million at the end of 2022.

The cash increase was realized despite the payment of dividends totaling approximately $2.9 million in the quarter (or a monthly dividend of $0.04 per common share), as there are currently no actual financial obligations to meet, and the gold mining business is fully financed from internally generated funds.

From an operational perspective, the plant is processing a much lower ore throughput (down 58.1% YoY to 106,475 tons in Q1 2023) but, as it was able to remove less waste tonnage from the mineral deposit, gold production was up 16.3% YoY to 11,487 ounces in the quarter.

Fortitude Gold Corporation has delivered the market with 11,639 ounces of gold equivalent at an average realized gold price of $1,889 (up 1.4% YoY), enduring total all-in sustaining cost [AISC] of $578 (up 31.8% YoY) per gold ounce sold.

The gold margin was $1,311 (average realized gold price of $1,889 per ounce less total AISC of $578 per gold ounce sold), an increase from $1,015 in the year-ago quarter.

This improvement may not be repeated as quarterly production is now expected to be approximately 9.505 ounces, which I believe will also result in a higher AISC going forward unless the price of gold peaks in the market. However, the latter is an event whose occurrence is assessed as low in this analysis.

A Challenging Outlook for Fortitude Gold Corporation

The stock price did not yield as many investors likely expected based on Q1 2023 results and now the company is going to produce even fewer ounces than it has done so far. So, there is no cause for optimism at this point.

As such, hopes are pinned almost entirely on the price of gold, whose volatility over the past two months has effectively prevented FTCO shares from taking an exciting course in the market.

A bullish gold would instead boost the stock price and allow for further improvement in the balance sheet provided, of course, that the rise in the gold price is of good intensity.

In order for this to happen, a strong interest in the precious metal as a safe haven must be rekindled on the market. But before a fresh wave of recession fears prompts investors to reconsider the metal as a safe haven from the related headwinds, more rate hikes are needed, which the US Federal Reserve actually foresees through the end of the year.

But an increase in the interest rate pushes up market demand for fixed-income securities at the expense of gold, which yields no returns other than the appreciation of the ounce.

The current inflationary picture, bolstered by the still resilient workforce, will prompt Fed governors to resume interest rate hikes after the pause at the June 14 meeting. Based on the logic set out above, this will cause the price of the ounce to trade downwards. As for the onset of recession effects, which are instead positive for the gold price, they will be delayed due to the timing of monetary policy transmission, assuming there will be a recession. In fact, it is not said that the economy will enter a recessionary phase of the cycle, this also needs to be taken into account based on what we have observed since the first-rate hike. The US economy is holding up very well despite ten rate hikes or one of the most aggressive monetary tightening policies ever undertaken by the Federal Reserve.

Fortitude Gold Corporation's balance sheet will certainly not benefit from a combination of an expected drop in gold prices due to the rate hike and lower gold production and maybe also higher operating costs.

The Stock Price

The combination of the above factors is not expected to have a positive effect on the share price. Rather, there is significant downside potential as a positive correlation between Fortitude Gold Corporation and the price of gold is gaining momentum.

As the chart below shows, the correlation coefficient [cc] has increased from 0.43 (affected by expectations of how gold will perform this month) to 0.56 (affected by expectations of how gold will perform two months from now).

0.43 is the value of the cc between FTCO stock and Gold Futures - June 2023 (GCQ3) while 0.56 (this is 30% higher and more indicative of a positive strong correlation between the two assets) is the value of the cc between Fortitude Gold Corporation and Gold Futures - August 2023 (GCQ3).

After a rapid rally in early 2023 fueled by a stunning improvement in gold production, the stock now appears more tied to market expectations for gold prices than it was a few weeks ago. It could also be a sign that the market has started pricing in lower production and possibly even higher operating costs in the upcoming quarters. This means that further rate hikes affecting the price of gold could cause the stock price to fall somewhere below the 200-day moving average.

Shares of Fortitude Gold Corporation were trading at $6.56 apiece as of this writing giving it a market cap of $157.99 million. The share price is below the 50-day simple moving average of $6.94, below the 100-day simple moving average of $6.71 but still above the 200-day simple moving average of $6.24.

Currently, the share price is above the middle point of $6.295 of the 52-week range of $5.22 to $7.37.

The Risk

The above stock price analysis downgrades a Sell rating on Fortitude Gold Corporation, in addition to the following considerations. Of course, there is a risk that this prediction will prove wrong, and the stock price will then start a rapid upward trend from the current level.

This essentially requires two things: a bullish gold price and higher, not lower, production levels than Q1 2023, but Isabella Pearl's property is nearing the end of the mine life.

Operations on the Isabella Pearl property can now rely solely on improved gold grades (3.83 grams of gold per ton of ore [g/t] in Q1 2023 versus 2.16 g/t in Q1 2022) as the volumes of ore to be processed are plummeting (106,475 tons in Q1 2023 versus 253,843 tons in Q1 2022).

As for the bullish commodity, let's say consistently priced above $2,000 an ounce, which could give Fortitude Gold Corporation's balance sheet a strong boost, investors should fear a deep recession coming as a result of the Fed tightening monetary policy.

But since policymakers resolved the debt-ceiling crisis, the economy is giving very different answers than the arrival of a negative cycle. Recently, the University of Michigan reported strong consumer optimism as its index rose sharply from 59.2 in May to 63.9 in June 2023, the highest reading in four months, says Trading Economics. Consumption makes up 70% of the US Gross Domestic Product.

In addition, economists seem to be assuming that a soft landing (i.e. higher interest rates but no recession) is becoming increasingly likely, rather than a recession this year.

Plus, the rate hikes implemented so far, while at no time so aggressive in the last 15 years, are proving to be very slow in transmitting their effects to consumption. Before they hit the economy, a very stubborn job market will ensure that in 2024 the economy should come out a little battered but not damaged.

A soft landing or modest economic slowdown is unlikely to generate headwinds that would prompt investors to hoard gold as a safe haven asset.

However, should a recession occur between 2023 and 2024, which cannot be ruled out, Fortitude Gold Corporation shares will likely have become cheaper than they are now due to the rate hikes. The key interest rate is now expected to stand at 5.6% this year, compared to the 5.1% forecast in March.

The Dividend

Finally, the company pays a monthly dividend of $0.04 per share, which pays out 0.48 US cents on an annualized basis. The company has approximately $50 million in cash on hand and 24.08 million shares outstanding resulting in a cash of $2.08 per share. This means that Fortitude Gold Corporation can continue to pay the monthly dividend for another 4.5 years.

However, to be even more rigorous, this period would need to be shortened because less and less cash will be brought in as Isabella Pearl nears completion. Furthermore, the company could use the existing cash to realize some additional potential that the portfolio of mineral assets of Fortitude Gold Corporation seems to harbor within the Walker Lane Mineral Belt, Nevada.

The company could also issue more equity, but that would result in shareholder dilution, or it could fall back on debt, but neither the high cost of borrowing nor the access credit requirements that banks are tightening in the wake of the US regional banking crisis encourage that funding channel.

With this in mind, the decision to hold the money invested in this stock in order to receive the monthly dividend exposes the value of the investment to the following factors:

• The possibility that the company will stop paying the dividend or reduce the payout, which I don't think is small.
• Headwinds for the share price as the Isabella mine nears the end of its 4.5-year operating life.
• Also, the risk that the stock will be worth significantly less than the current share price as the company gradually steps away from production and focuses more on exploration activities.
• A slim chance of a significant increase in the price of gold, which going forward the company needs to offset a drop in production.
• There is also a higher opportunity cost of not taking advantage of the great opportunity presented by gold price volatility through another mining company that could instead offer more certainty with many years of gold production ahead. The mining and exploration industry is teaming up with companies involved in the gold business, and gold's volatility is likely to offer increasingly more opportunities to exploit price fluctuations in an uncertain environment of geopolitical tensions and macroeconomic concerns.

Additionally, money is very valuable today due to the hawkish stance of the US Federal Reserve. As such, I would sell shares of Fortitude Gold Corporation and benefit from current stock prices, which represent more than 4.5 times the total dividend the company will pay over the next three years. By selling one FTCO share, you can free up about $6.5 and give on loan for three years at a 4.3% interest rate with a zero/very little risk investment. Instead of exposing the investment in FTCO to all the negative factors mentioned above.

Conclusion

This analysis supports a Sell recommendation for Fortitude Gold Corporation, as it appears that the best is already over in terms of production and costs.

If the Isabella Pearl Mine does not match the production rates and costs observed in the first quarter of 2023, the stock price would need significant bullish sentiment around the gold price to sustain.

Due to the state of the US economy, this analysis assumes that the market will be unable to hand out the price of gold, which Fortitude Gold Corporation would instead need to offset the deterioration in production prospects.

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