DRDGF - Take A Chance On Bullish Gold Via K92 Mining

2023-09-08 12:35:36 ET

Summary

• K92 Mining Inc. receives a Strong Buy recommendation due to its strong positive correlation with gold and the expected rise in gold prices during the recession.
• The company is now even better positioned to take advantage of rising gold prices due to improved operational performance and an increased supply of precious metals.
• The stock is currently not expensive, but the share price may get even cheaper under the influence of the US Federal Reserve's tight monetary policy.

A Strong Buy Rating for K92 Mining Inc.

This analysis reiterates the Strong Buy recommendation on K92 Mining Inc. ( KNTNF ) ( KNT:CA ) shares, which was given in the previous analysis .

This stock will benefit from its strong positive correlation with gold, as analysts predict a rising price per ounce in response to the expected recession, which will reinforce the yellow metal's safe-haven characteristics.

The company is now much better positioned than in the previous analysis to benefit from rising gold prices. Due to the improvement in operational performance, the company can now actually expect an increasing supply of precious metals to the markets.

Given these interesting growth catalysts, the stock is currently not expensive. However, under the influence of the current monetary policy, which the US Federal Reserve wants to keep tight for a few more months, it can be expected that the share price will get even cheaper.

Gold, which doesn't like high yields, will have to take a break in price before rebounding once the recession starts, creating upward pressures for the share price of gold miner K92 Mining Inc. as well.

The Reason for Projecting a Strong Upside in the Gold Price

US-listed equities are currently at significant risk of a major sell-off that typically follows a shock to the business cycle, such as that experienced with the outbreak of the COVID-19 pandemic on March 20, 2020.

There is a potential for an economic recession in the US, and it is precisely the shock that threatens the economic cycle for the foreseeable future.

The risk of a sharp contraction in the US economy, which some economists (see this article on businessinsider.com and Yahoo Finance ) and industry experts (see Yahoo Finance ) have recently pointed out and which savvy investors have every right to fear, is being driven by the Fed's most aggressive interest rate policy since the 2008 financial crisis, which pushed inflation down from a 40-year high of 9.1% in June 2022 to 3.2% in July 2023.

With a recession looming, Friday's jobs report is prompting U.S. market participants who are keen on an earlier end to the Fed's rate hikes to have radically different expectations for the next economic cycle.

This trend emerges from what Keith Buchanan, a portfolio manager of Atlanta-based GLOBALT Investments, said last week in a statement to Reuters, reported by this Investing.com article as follows:

"The data makes the case for the Fed becoming more dovish as we head into the fall. If the end of tightening comes sooner than later, that could lead to a substantial rally in stocks."

The third consecutive month that the U.S. economy has added fewer than 200,000 U.S. nonfarm payroll jobs, as 187,000 U.S. jobs were added in August 2023, reports Trading Economics , is instead seen as the gradual easing of work market conditions that the U.S. central bank is waiting for to end its interest rate tightening.

The end of the rate hike policy may be approaching, but that doesn't mean rates will be cut the next day. In addition, it is unknown how long the US Federal Reserve intends to keep interest rates high in order to ensure that inflation definitely moves towards the 2% medium-term target. And that shouldn't inspire optimism in equity markets just yet, as higher interest rates bode poorly for the current value of stocks, especially growth stocks that were very popular during the recent bullish mood in the US stock market fueled by hype around AI software. Among other things, this technology has probably been around for years and has never received as much attention as it has in recent months.

In any case, the mere expectation of an end to monetary tightening is warmly welcomed, a sign that the US stock market may be underestimating what normally follows a sharp rate hike cycle, namely the economic recession.

So, should a recession occur, it would be a lightning bolt for US stock market participants, and the consequences could be truly devastating for less-experienced individual investors in US-listed equity portfolios.

Gold is the safe haven of choice to protect against the negative growth of the economic cycle, as it allows investors to offset the decline in the value of their portfolios due to the recession. Therefore, demand for gold as a safe-haven asset amid recessionary headwinds will be robust and gold prices are likely to rise in the coming months, according to this analysis.

Perhaps it is no coincidence that Trading Economics analysts are predicting a price of $2,033.46/oz. a year from now, the price is up 5.7% from the current $1,923.20/oz, but the forecast could be raised even more in the coming weeks as the likelihood of a recession increases.

K92 Mining Inc. Stock Valuation: The Opportunity for a Cheaper Price Could Be Just Around the Corner

To benefit from the next expected sharp rise in gold prices, investors should consider assets that, such as U.S.-listed gold stocks, typically correlate positively with changes in gold prices, and to a significant extent.

Therefore, investors may want to consider buying shares of Canadian producer K92 Mining Inc. ((KNTNF)) for its ability to closely monitor the price movements of gold bullion, and for the strong growth prospects this gold stock offers.

The positive momentum of this gold stock is driven by a company that appears to be doing well, both in terms of increasing production and costs better than expectations, as well as the progress of projects that will guarantee high gold-grade production in the future.

The chart below from Seeking Alpha, which shows the stock price of K92 Mining Inc. over the past 52 weeks, compared to gold futures (GCV2023), shows a strong positive correlation, as the yellow area below is always above zero, with a few exceptions.

KNTNF's stock price is not even high compared to the positive trend currently observed in the company's business and compared to the prospects, but there is a non-negligible chance that the stock could become even cheaper as the Fed plans to keep borrowing costs up at least until the end of 2023. Higher borrowing costs do not bode well for gold, as the cost of owning the precious metal rather than bonds, which are interest-bearing assets, increases. Under this effect, the shares of KNTNF may decline from current levels, and become cheaper.

The chart below from Seeking Alpha illustrates that at the time of writing, KNTNF stock was trading at interesting levels, as the stock price of $4.43 apiece is below its 100- and 50-day simple moving averages of $4.61 and $4.52 respectively, and significantly below the 200-day simple moving average line of $5.15.

Compared to the 52-week range of $3.93 to $6.63, the share price is closer to the lower bound (it is 12.7% above) than the upper bound (it is 50% below). The middle point of the 52-week range is $5.28.

On the Toronto Stock Exchange, under the KNT:CA symbol, shares were trading at CA$6.01 per unit as of this writing for a market cap of CA$1.42 billion. Shares are trading significantly below the 200-day simple moving average of CA$ 6.94, below the 100-day simple moving average of CA$ 6.16, and slightly below the 50-day simple moving average of CA$ 6.04.

Shares are significantly below the middle point of CA$ 7.06 of the 52-week range of CA$ 5.26 to CA$ 8.86. Additionally, the 14-day RSI's trend of 47.70 suggests that shares have plenty of room for downside in a high-interest rate environment, forming more attractive prices.

A lower price would allow for easier implementation of the strategy to gain exposure to the benefits that the gold market offers, especially a price per ounce that rises steadily but through cycles over the years, and with an eye on the next strong rally that may occur for the reasons mentioned above.

In fundamental terms, to assess the current attractiveness of KNTNF stock, this analysis compares the company's twelve-month enterprise value/EBITDA indicator with that of its peer group.

The metric is particularly useful for this purpose because it can provide a better idea than any other metric that attempts to measure the profitability of companies operating in capital-intensive industries, and gold mining is one of those industries.

In terms of the possibility of operating at an even more attractive price than the current level, there is also technically room for the stock to reach significantly lower levels.

According to Seeking Alpha , KNTNF 12-month EV/EBITDA is 13.47x (an improvement from the 5-year average of 15x) while the sector median is 8.96.

Within the most direct group of peers, K92 Mining Inc. ((KNTNF)) yields cheaper than IAMGOLD Corporation ( IAG ) 12-month EV/EBITDA 14.49x, and Coeur Mining, Inc. ( CDE ) 24.06x, but more expensive than DRDGOLD Limited ( DRD ) ( DRDGF ) 8.23x, according to Seeking Alpha .

The following chart from Seeking Alpha, which reports a 14-day Relative Strength Indicator of 47.31, suggests that the shares are not oversold or overbought but they are likely to move lower due to the Fed's stance. There's a lot of space underneath.

How K92 Mining Inc. Performs

K92 Mining Inc. is engaged in the production of not only gold, but also copper and silver, but the yellow metal is the main production at the Kainantu gold mine in the Eastern Highlands Province of Papua New Guinea, and production is expressed in ounces of gold equivalent. The production is located approximately 180 kilometers west-northwest of Lae (the second-largest city in Papua New Guinea).

Production is growing as 30,794 ounces of gold equivalent [AuEq] were produced in the second quarter of 2023 (gold representing 90% of total AuEq production), up 18% year over year and 43% sequentially.

The company reported second-quarter 2023 cash costs of $597 per ounce of gold and all-in sustaining costs [AISC] of $975 per ounce of gold which were significantly better than full-year guidance for cash costs in the range of $620 per ounce to $680 per ounce and AISC in the range of $1,180 per ounce to $1,300 per ounce.

Thanks to the strong metallurgical recovery of gold in the order of over 92%, the production is at a very opportune moment after the company has completed the expansion of the processing capacity of the facility, and the facility can now actually receive a larger amount of material at a higher processing rate than a year ago: +3% year-over-year increase in total processed ore to 1,236 tonnes per day in Q2 2023.

The production activities of the precious metal are also facilitated by the ongoing significant positive trend in the gold grade of mined material, if we consider that 9.23 grams of gold per ton of mineral now allows workers to extract a larger amount of material, approx. 12% increase year-over-year to 1,200 tonnes per day of mineral material in Q2-2023, without being concerned about taking on even more waste.

These are very important operational improvements that should send a strong signal for future production. It might be interesting for the investor to know whether they can continue or are only temporary.

This is not a temporary benefit, but rather due to an expansion of the flotation capacity, which is working so well that it is now believed that the processing plant can even go beyond the nominal production of 500,000 tons of mineral per year. So, it's about having reached a milestone of operational improvement that will have a long-term positive impact on the gold recovery rate, and thus on the production of gold equivalent ounces.

The results for the second quarter of 2023 showed that, in addition to the recovery rate, a high concentration of metals in the ore is essential to achieve higher gold equivalent production and put the balance sheet in a strong position to benefit from the positive trend in the gold price.

In this sense, investors can expect continuity of results as the exploration activities carried out by K92 Mining Inc., currently targeting the Kora and Judd deposits in the immediate vicinity of Kainantu, define a great potential for high-quality ore processing in the future. Kora is poised to deliver its first mined ore in the final quarter of this year as development activities are completed faster than originally planned.

The Financial Condition

Thanks to higher gold prices (up 5.7% y/y to $1,883/oz) and higher gold ounce equivalents sold (up 18.9% y/y to 28,141 oz), revenue rose 39% y/y to $51.8 million in Q2 2023, which resulted in a net profit of $8.8 million, or $0.04. per share, up 71% over Q2 2022.

The balance sheet appears solid to cover the outflow of funds to ensure ongoing operations as well as for exploration, evaluation, and development activities.

Cash and cash equivalents as of June 30, 2023, were nearly $96 million and there was no debt. The company managed to increase the amount of cash and equivalents by $6.9 million sequentially. Total capital expenditures were approximately $29 million in the second quarter of 2023, but operating activities generated $38.2 million in cash inflows.

The timely progress of exploration and development activities of mining projects depends on the ability to bring increasing amounts of production to the market in the hope that gold prices remain robust.

In terms of sales volumes, they will continue to benefit from the increased throughput of the production facility, which in turn positively affects the recovery rate, and from the high gold content per ton of mined ore.

As for the price of gold, this should be trading well above the realized price per ounce sold, which in the second quarter allowed K92 Mining Inc. to finance investments with internally generated resources and improve the cash balances.

Compared to the selling price of $1,883/oz that K92 Mining Inc. averaged by selling gold in Q2-2023, the price of the precious metal averaged $1,954.84/oz so far in Q3-2023 in the futures market, and analysts forecast the price per ounce to rise at least until next year.

On top of this, the 2,398oz gold concentrate and doré inventory as of June 30, 2023, could unlock a value of approximately $4.7 million if sold based on current gold prices.

If you scroll down this page of Seeking Alpha, you will find the Altman Z-Score index of 14.26, which indicates that the balance sheet of K92 Mining Inc. is in safe zones, which means there is no risk of solvency problems.

The Altman Z-Score measures the likelihood that a company will face bankruptcy problems. If the value is less than or equal to 1.8, the balance sheet is in distress zones, which means a high probability of bankruptcy within a few years. When the ratio is between 1.8 and 3, the balance sheet is in a gray area, which still implies a risk of bankruptcy, albeit moderate. While a score of 3 or higher means that the risk of financial insolvency is extremely low or non-existent.

Country Risk

The Sprott ESG Mining Risk Heatmap 2023 has assigned Papua New Guinea an average rank of 4.0, indicating a high risk of disruption to mineral activities in the country, but not due to reasons of political instability or social tensions in the country. Geopolitically, the country is close to the United States, as evidenced by the defense pact recently signed between the two countries, which, according to this article on theguardian.com, gives US forces access to the country's airports and ports in the Pacific, reflecting Washington's strategy to counter China's regional influence. Therefore, Papua New Guinea can only provide a favorable environment for the business activities of North American companies operating there. The problem is geophysical, as Papua New Guinea, like all other countries in the Southeast Asia region, is subject to seismic phenomena. To illustrate the country's propensity for seismic events, less than a year after the May 2022 earthquake, 200 km offshore in the Bismarck Sea, with a magnitude of 6.3 degrees on the Richter scale, as noted in the previous analysis , another major earthquake occurred on March 14, 2023. The magnitude 6.3 earthquake struck the coast of Papua New Guinea in the eastern part of the Momase region at a depth of 213 km, according to the information from earthquakelist.org website.

Conclusion

The price of gold is expected to turn sharply upward in the short term as its safe haven properties will come back strongly in fashion with the headwinds from the recession that should affect the cycle in a few months.

Among stocks that can thrive in a favorable gold price environment, K92 Mining Inc. is strongly positioned, as evidenced by its strong positive correlation with the yellow metal.

The identification with the price of the commodity is supported by strong operations that are now ready to achieve higher gold production, keeping costs under control and thus creating the conditions for generating cash flow to support further expansion.

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