CA - Torex Gold: Another Solid Quarter

2023-05-02 11:16:30 ET

Summary

• Torex Gold continues to be one of the best performers in the precious metals space, up 42% year-to-date and over 180% from its Q3 2022 lows.
• This outperformance can be attributed to a period of lagging its peers significantly despite solid progress and strong operational execution, with the stock now playing significant catch-up.
• However, this rally has left Torex trading at a premium P/NAV multiple, and while exploration success points to continued resource growth, the stock is no longer cheap and is extended short-term.
• Hence, I continue to see the stock as a high-risk way to get precious metals exposure at current prices, and I don't see any way to justify paying up for the stock here above US$16.50.

Just over three months ago, I wrote on Torex Gold ( TORXF ), noting that the stock's rally above US$13.70 looked to be providing an opportunity to take some profits with the stock the most extended it had been in years and massively outperforming its peer group. This turned out to be a very poor call, with the stock defying gravity, marching another 20% higher and settling above the US$15.00 level on the back of a strong bid under the gold price. However, while this outperformance has been a welcome change of character after two years of sluggish returns, Torex is no longer cheap. In addition, it's the most overbought it's been in years. Let's take a look below.

Q1 Production & Sales

Torex Gold released its Q1 results last month, reporting quarterly gold production of ~122,900 ounces, a 9% increase from the year-ago period. This solid performance was driven by record underground mining rates, record throughput which beat the prior record set in Q2 2017 by a hair, and significantly higher grades. In fact, processed grades were up 17% year-over-year to 3.50 grams per tonne of gold, which combined with record throughput has left Torex tracking at ~27.3% of its annual guidance midpoint, continuing the company's track record of under-promising and over-delivering.

Digging into the results a little closer, we can see that El Limon Guajes [ELG] Underground was the star performer yet again, enjoying record mining rates of 1,738 tonnes per day, translating to ~160,000 tonnes for the quarter. This was up over 35% from the year-ago period, which should translate to a robust Q1 report for Torex given the combination of ~10% higher ounces sold (~118,500 ounces) and a slightly higher average realized gold price. And while the results from ELG Underground are very encouraging with yet another new quarterly record (previous record of 1,685 tonnes per day set in Q4 2022), the company remains confident to achieve 1,800 tonne per day underground mining rates by year-end, providing an increasing feed of high-grade ore to the plant.

Just as importantly, while operations continue to perform well at ELG, Torex reaffirmed that Media Luna remains on schedule and tracking to budget. As it stands, Torex hopes to achieve the breakthrough of the Guajes Tunnel in Q1 2024, with the company successfully crossing under the Balsas River that separates its ELG Mine and its future Media Luna operations, and the tunnel advanced to ~3,900 meters as of the end of Q1. As for the South Portal Lower on the Media Luna side, the company's most recent update noted that the company is currently developing the main spiral ramp and there are eight active headings in development between South Portal Upper and South Portal Lower.

While the successful execution to date here isn't surprising given Torex's excellence in other areas of its business (operational performance, safety performance), it's certainly encouraging to see the company continuing to track to plan. This is because the successful transition of mining at Media Luna vs. its current ELG Mine is critical to the investment thesis here, with this mine expected to make up the bulk of mill feed once the ELG Open Pits are exhausted by 2026. And while the operational performance has certainly been impressive, Torex has been regularly topping the charts from an exploration standpoint, releasing some of the best drill results sector-wide with gram-meter intercepts that rival even some of the largest producers.

Recent Developments

As for recent developments, the first positive one is the gold price, which continues to make higher lows, with the potential for it to average $1,900/oz this year, a ~6% increase from its average price in 2022. Previously, I had noted that Torex was up against tough comps because of rising operating costs in 2023, and while it had put together phenomenal 2022 results, we were likely to see margin compression this year. However, with the company hedging 30% of its 2023 production at ~$1,945/oz and the company looking like it will benefit from an average realized gold price on its remaining ounces of ~$1,900/oz, the company may evade margin compression due to help from the gold price.

Torex reported an AISC margin of $801/oz in FY2022 and, assuming an average realized gold price of $1,930/oz and FY2023 AISC of $1,105/oz (midpoint of guidance), we could see a 3% improvement in margins year-over-year despite rising costs due to continued inflationary pressures, higher capitalized stripping and the construction of a 8.7 MW solar plant.

The other benefit of the higher gold price is that Torex should be able to maintain strong liquidity during this capex-heavy growth phase for the company, with the company in a position to generate upwards of $300 million in operating cash flow this year based on a $1,925/oz gold price. This is just as important to the investment thesis, given that the previous risk was that things could get a little messy with a ~$880 million project being built if the gold price continued to hang out below $1,650/oz, where it briefly traded in Q3 2022. As it stands, Torex had net cash of ~$370 million at year-end and ~$620 million in liquidity, more than enough to complete Media Luna construction when combined with ongoing cash flow from operations.

Finally, as for the most recent positive development, Torex has been knocking it out of the park from an exploration standpoint, with the company consistently releasing impressive results from ELG Underground, and now also reporting solid results from Media Luna and EPO with $20 million dedicated to drilling its Media Luna cluster this year. Regarding the most recent drill results, Torex reported high-grade intercepts at EPO (directly northwest of Media Luna) that included the following hits:

• 32.9 meters at 18.9 grams per tonne of gold-equivalent
• 4.3 meters at 107.7 grams per tonne of gold-equivalent
• 35.1 meters at 10.8 grams per tonne of gold-equivalent
• 42.0 meters at 7.3 grams per tonne of gold equivalent
• 17.2 meters of 16.4 grams per tonne of gold-equivalent

These results are exceptional, with the bulk of them being infill intercepts, and Torex noted they are showing similar thicknesses at slightly better grades than previous drilling at EPO. However, the company also saw success stepping out to the south and west of EPO, with mineralization extended 200 meters to the west and 250 meters to the south. This should lead to continued growth in resources at EPO and this deposit is looking like it could provide meaningful high-grade feed that could displace lower-grade stockpiles post-2027. Torex's drill map is shown below, and as we can see, the step-out hits are quite significant, with very solid grades (drill-holes ML-22-927 and ML-22-920A).

As for its Media Luna deposit, the results here have been so impressive that they are stealing EPO's thunder a little, with some world-class infill intercepts that include 28.4 meters at 46.08 grams per tonne of gold, 58.08 meters at 17.08 grams per tonne of gold, and 26.39 meters at 21.39 grams per tonne of gold. While not true widths, the grades on these highlight intercepts are well above the reserve grade of 4.54 grams per tonne gold-equivalent. Plus, Media Luna has also seen exploration success aside from infill drilling, with multiple thick mid-grade and high-grade intercepts outside of the current resource boundary, including a highlight hole of 25.43 meters at 8.00 grams per tonne gold-equivalent.

So, why is this important?

Per the current mine plan, Torex expects to rely heavily on stockpiles post-2025 in addition to Media Luna ore, but there appeared to be the potential to extend ELG Underground into the late 2020s even with higher mining rates given exploration success. However, with continued exploration success at Media Luna (infill & step-out) and EPO as well, it's possible that Torex may not only see slightly higher grades at Media Luna and a possible mine life extension, but we could also see Torex take advantage of excess mill capacity, with 2,000+ tonnes per day set to be available later this decade. Even assuming a conservative grade of 4.3 grams per tonne gold-equivalent from EPO and a contribution of 1,500 tonnes per day, this could add ~65,000 GEOs per annum to the production profile.

Valuation & Technical Picture

Based on ~87 million fully diluted shares and a share price of US$16.60, Torex trades at a market cap of ~$1.44 billion, well above the ~$800 million market cap it traded at last January when I highlighted the stock as one of the most attractively valued names sector-wide . And while this valuation is very reasonable from a cash flow standpoint (~4.5x FY2023 cash flow estimates of $3.70) and it continues to see exploration success across its Morelos Property, it is looking fully valued from a P/NAV standpoint with it trading above 1.0x P/NAV based on an estimated net asset value of ~$1.37 billion. Given that Torex operates out of a less favorable jurisdiction in Mexico (Guerrero State) and Mexican mining laws are becoming harsher, it's difficult to justify the current valuation.

Using what I believe to be a more conservative multiple of 0.85x P/NAV given Torex's status as a single-asset gold producer operating in a less favorable jurisdiction, I see a fair value for the stock of US$1.19 billion or US$13.70 per share. This suggests zero upside from current levels for the stock from a P/NAV standpoint and limited upside from a cash flow standpoint (using a multiple similar to its 10-year average). So, regardless of what valuation metric one uses, I don't see any way to justify paying up for Torex, and I see this rally above US$16.60 as an opportunity to book additional profits. This is corroborated by the technical picture, which shows Torex hugging resistance at US$16.75 and remaining short-term overbought.

Summary

Torex has continued to be one of the most consistent producers operationally and is one of the few single-asset producers with sub $1,100/oz AISC and a near Tier-1 scale asset. That said, I continue to see a low likelihood of a takeover given that the company operates in a less favorable jurisdiction, and especially at current levels. This suggests that the premium valuation is hard to justify even if the company is clearly enjoying exploration success and should see another year of strong resource growth, with no real catalysts except a higher gold price to push the stock higher, which is not a company-specific catalyst.

So, given this outperformance and with the stock having a less favorable reward/risk ratio as it hugs resistance, I see this as an opportunity to book additional profits and I continue to see far more attractive bets elsewhere in the sector.

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