MUX - McEwen Mining: Further Margin Compression In Q2

2023-08-18 16:22:43 ET

Summary

• McEwen Mining Inc.'s Q2 results were weaker than expected, with high costs and disappointing performance at Gold Bar and San Jose (49%).
• Fortunately, the company's H2 outlook is more positive, with expected improvements in grades and or throughput at all three assets.
• In this update, I'll look at whether McEwen Mining has a shot at meeting guidance which it's tracking far behind & if it's in a buy zone after a steep correction.

Roughly three weeks ago, I wrote on McEwen Mining Inc. ( MUX ), noting that the recent MARA Project sale at a lower price than I expected could weigh on sentiment for the stock (valuation underpinned by Los Azules interest) and that a weak quarter at San Jose (49% interest) may weigh on Q2 results. Unfortunately, McEwen Mining's Q2 results were even weaker than I expected, with Gold Bar's all-in sustaining costs spiking above $2,500/oz, Fox milling lower grades than I expected, and San Jose coming in as expected (pre-reported) with sharply lower grades year-over-year and $1,800/oz plus AISC. In this update, we'll look at whether the correction has run its course and if the stock is offering enough margin of safety to consider it for investment.

All figures are in United States Dollars unless otherwise noted.

Q2 Production & Sales

McEwen Mining released its Q2 results earlier this month, reporting quarterly production of ~35,700 gold-equivalent ounces [GEOs], a 1% decline from the year-ago period. The dip in production was despite lapping easy year-over-year comps, with Gold Bar contributing just ~5,100 GEOs in the year-ago period, the asset's worst quarter in three years. That said, this was partially because of slower than planned recovery rates in the period, and while Hochschild ( HCHDF ) had another sub-par quarter at San Jose (McEwen Mining has a 49% interest), the Fox Complex had a solid quarter, reporting throughput of 1,248 tonnes per day, a meaningful increase from the year-ago period (~114,000 tonnes processed in Q2 2023 vs. ~104,000 tonnes in Q2 2022).

Based on the company's H1 performance (~66,100 GEOs produced year-to-date), meeting full-year guidance of 150,000 to 170,000 GEOs might look like a difficult task, and delivering at or above the mid-point is looking even more challenging. That said, its Gold Bar Mine in Nevada should benefit from higher grades and improved recoveries in H2, its Fox Complex should see similar or better throughput at higher grades, and San Jose should also enjoy better silver grades in H2 according to Hochschild. So, if we assume H2 production of ~27,000 ounces at Gold Bar, ~38,000 ounces at San Jose, and that Black Fox can produce ~28,000 ounces (1,285 tonnes per day, 4.15 grams per tonne of gold, 88.5% recovery rates), this should push the company just below the mid-point of its guidance range (~160,000 GEOs).

Costs & Margins

Moving over to costs and margins, McEwen Mining's costs remained miles above the industry average, with Gold Bar reporting all-in sustaining costs [AISC] of $2,585/oz (affected by lower grades, slower recoveries, and elevated sustaining capital), while Fox Complex costs came in at $1,371/oz. These costs were up ~22% and ~6% vs. the year-ago period, and the 22% increase in Gold Bar's costs was up against easy comps, lapping a 30% increase in the previous year (AISC Q2 2021: $1,619/oz ---> AISC Q2 2022: $2,108/oz). This was certainly a disappointment and resulted in consolidated all-in sustaining costs of $1,912/oz for McEwen Mining. And while McEwen Mining noted that costs would decrease in H2 at Gold Bar, this is not much of an accomplishment when its costs are currently sitting over 90% above the industry average ($2,585/oz vs. ~$1,360/oz).

Fortunately, Black Fox performed a little better than I expected, but the asset benefited from weaker energy prices, which partially offset the high single digit labor costs and near double-digit materials inflation discussed in its Conference Call . However, we've since seen a tick-up in energy prices which could affect both of its operations, making it more difficult to deliver into guidance. So, while I would expect improved cost performance in H2 at the Fox Complex, Gold Bar's costs are likely to come in at or above $1,650/oz for the year even if it meets guidance ($1,680/oz). And with the gold price sitting at ~$1,900/oz, this continues to be a marginal asset struggling to generate any mine site free cash flow, making it difficult to assign any real value to this asset.

Finally, Hochschild's San Jose Mine fared little better in the period, reporting all-in sustaining costs of $1,811/oz in Q2 and $1,980/oz year-to-date. These costs are miles above AISC guidance of $1,550/oz, making this another asset that it's tough to assign much value to given its razor-thin margins. And this is especially true given its relatively short reserve life (~2 years) despite using some of the highest metals price assumptions sector-wide ($1,800/oz, $26.00/oz silver). The result was that McEwen Mining reported revenue of $34.4 million from its operations and an adjusted net loss of $14.5 million despite the record gold price, as well as AISC margins at its 100% owned operations of ~$40/oz.

Recent Developments

As for recent developments, the company reported a PEA on its Los Azules Project in late Q2, with an After-Tax NPV (8%) of $1.93 billion to $2.66 billion for its base case and alternative case assumptions, highlighting a 3.4-year payback in the alternative case, a 27-32 year mine life across both cases, and life of mine average production of ~123,000 to ~146,000 tonnes of copper. Although an impressive study and positive for McEwen Mining, which owns 51.9% of McEwen Copper, this is a project that is still several years from production, and the sale of the MARA Project for ~$475 million to Glencore ( GLCNF ) which is much larger (~300,000+ copper-equivalent tonnes in first five years), higher-grade, and also in Argentina with similar upfront capital suggests that it's hard to assign more than $300 million in value to McEwen Mining's interest in Los Azules. And even if we assign $200 million for the rest of its portfolio, this places a fair value on MUX of US$500 million [US$9.80 per share].

Summary

McEwen Mining had a mediocre Q2 with improved performance at Fox offset by another disappointing quarter at Gold Bar and San Jose (49%), where all-in sustaining costs spiked to $2,585/oz and $1,811/oz, respectively. Fortunately, the company is expected a better second half at all three assets with higher silver grades at San Jose, higher grades and a lower strip at Gold Bar, and higher throughput and grades at Fox. This should help the company deliver into its guidance range of 150,000 to 170,000 GEOs, but meeting the mid-point of 160,000 GEOs looks like it could be a tough feat even with the grade outperformance in H2.

That said, McEwen Mining Inc. still doesn't offer the margin of safety I'm looking for (minimum 40% discount to fair value for junior producers) vs. an estimated fair value , which would require a pullback below US$5.90. So, while the story has improved from last year with a better balance sheet and lower interest expense aided by McEwen Copper sales, I continue to see more attractive bets elsewhere.

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