FTCO - Fortitude Gold: The End Of The Golden Era Is Approaching

2023-04-03 17:29:07 ET

Summary

• Fortitude Gold Corporation produced 41,231 ounces of gold in 2022 and the net income stood at $14.7 million.
• In my view, the figures for 2023 are likely to look similar and the dividend will remain at $0.48 per share.
• However, probable high-grade reserves are down to below 40,000 ounces of gold and the grades at Golden Mile and County Lane are low.
• I’m concerned that AISC will increase substantially in 2024 or 2025, when the company transitions to the Golden Mile deposit.

Introduction

I've written three articles on Seeking Alpha about U.S. gold miner Fortitude Gold Corporation ( FTCO ). The latest was in November, when I said that Q3 financial results were disappointing and that the progress made on the exploration front seemed underwhelming.

In January, Fortitude Gold released an initial resource estimate for its County Line deposit, and I think that there are too few ounces in there to enable the company to extend the life of mine of the Isabella Pearl gold mine to 2028. Fortitude Gold also released its 2022 financial report on February 28, and in my view, it was a decent year for the company, as production reached 41,231 ounces of gold while net income came in at $14.7 million. However, proven and probable high-grade reserves were down to below 40,000 ounces of gold equivalent. Let's review.

Overview of the recent developments

In case you haven't read any of my previous articles about Fortitude Gold, here's a brief description of the business. The main asset of the company is the Isabella Pearl open pit heap leach gold mine, which is located in the state of Nevada and has an annual production of about 40,000 ounces of gold. The mine entered commercial production in 2019, and it had a proven and probable reserve of 50,800 ounces of gold equivalent at an average grade of 3.75 g/t as of December 2022. As you can see from the table below, proven reserves had a much higher grade, and the company also had a high-grade stockpile of around 8,300 ounces of gold equivalent on the Isabella Pearl heap leach pad at the end of 2022.

Looking at the 2022 production results, we can see that the average mined grade is very close to the average grade of the reserves. In 2022, Fortitude Gold exceeded its production target of 40,000 ounces of gold, although output was slightly below the level of the previous year. The targeted output for 2023 is 36,000 ounces to 40,000 ounces of gold.

The lower output in 2022 led to a small increase in all-in sustaining costs ((AISC)) as fixed costs were spread across more ounces. Still, the AICS of $725 per ounce of gold sold put Isabella Pearl among the lowest-cost gold mines in the world at the moment. The main reason behind the low unit costs is the high grade, as gold mines with reserves of above 2 g/t are rare these days.

Looking at the income statement , the gross margin decreased slightly as the realized average gold sales price was almost unchanged. The net income margin inched down from 21.8% to 19.7% as higher exploration expenses were offset by lower G&A expenses.

Net cash provided by operating activities came in at $28.6 million, and with $12 million going into capital expenses and $11.5 million into dividends, cash and cash equivalents rose by $5 million to $45 million as of December 2022. Over $9 million has been invested into the Golden Mile deposit as the company continued mine equipment and materials purchases in anticipation of a potential mine development decision. Looking at the exploration expenses, drilling was focused on several deposits located near the Isabella Pearl pit.

In January, Fortitude Gold announced a maiden initial resource estimate for the County Line deposit, and I think that the numbers were underwhelming. The deposit has measured and indicated resources of just 37,400 ounces of gold at an average grade of only 0.97 g/t. Considering the metallurgical gold recovery assumption used was 81%, you are looking at about 30,000 ounces of gold production at likely much lower margins as the grades are almost four times lower.

This is a red flag, considering the reserves at Isabella Pearl run out in 2024 and Fortitude Gold is aiming to extend the mine life to 2028 by putting the County Line and Golden Mile deposits into production in the near future.

The maiden resource estimate for Golden Mile was released in late 2021, and I think that the grade is almost as low - an average of 1.13 g/t per ounce for the indicated resources. While it's possible that a large share of the indicated and inferred resources could be converted into proven and probable reserves with more drilling and extend the mine life of Isabella Pearl to 2028, I expect the margins to be underwhelming due to the much lower grades.

Looking at what to expect for 2023, I think that revenues and net income should be similar to 2022 if gold prices remain unchanged as proven and probable reserves plus high-grade stockpiles stood at 59,100 ounces of gold equivalent as of December 2022. In my view, the dividend rate is likely to remain $0.48 per share and Fortitude plans to invest about $10.1 million of exploration activities at its properties (see page 8 here ). The estimated CAPEX for Golden Mile is about $28 million, which means there is about $19 million to go. The company revealed in its 2022 earnings call that it's working to modify its existing open pit permit depth to mine deeper by several more benches, and this has the potential to extend the mine life to 2025. However, I think that margins and net income are likely to decrease substantially after transitioning to Golden Mile and County Lane due to the significantly lower average grades.

So, how do you play this one? Well, opening a small short position seems like a viable idea as data from Fintel shows that the short borrow fee rate stands at 4.19% as of the time of writing. However, there are no call options available, considering Fortitude Gold is trading on the OTC market.

Looking at the risks for the bear case, I think there are two major ones. First, it's possible that Fortitude Gold finds a large zone of high-grade mineralization at Isabella Pearl or one of the nearby deposits, and this could significantly extend the portion of the mine life with low AISC. Second, gold prices have been rising in recent months as a result of global macroeconomic uncertainty and geopolitical risks, and this could provide a boost to the share price.

Investor takeaway

In my view, Fortitude Gold Corporation booked strong production and financial results for 2022. I think that the figures for 2023 are likely to look similar, but I'm concerned that AISC will increase substantially in 2024 or 2025 when the company transitions to Golden Mile as the grades there are significantly lower. In my view, this could result in a decrease or a suspension of dividend payments. That being said, the prices of commodities are notoriously volatile, and I consider short-selling companies in this space to be dangerous. In my view, risk-averse investors should avoid Fortitude Gold Corporation stock.

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