VITFF - Victoria Gold Is Still Learning To Walk

Summary

• 2022 is looking like another year to forget for Victoria Gold shareholders.
• Operations at the Eagle mine disappointed, again, and free cash flow generation remained elusive for the first three quarters.
• Near-term catalysts are unlikely to change the bearish sentiment around this gold miner.

Rewind to the end of 2021. Victoria Gold ( VITFF ) had just completed the first full year of commercial production at its Eagle gold mine in the Yukon, overcoming plenty of teething problems, yet the company remained upbeat about its future. It had produced 164Koz of gold, somewhat short of the guidance issued at the start of the year, and certainly short of the 200Koz nameplate production capacity of the new mine. Nevertheless, confidence was high and bars were raised:

The Company has initiated ‘ Project 250 ’ aimed at increasing the average annual gold production of the Eagle Gold Mine toward 250,000 ounces of gold during 2023 ( source ).

This scribe hadn't bought the exuberance at the time, calling SELL on the company. Here is how the share price has fared since then.

And here is what the CEO Mr John McConnell had to say only nine months later when queried about Project 250 in the Q3/2022 earnings call :

The first step is to get to steady state [of] 200,000 ounces per year. So we're going to learn to walk before we run, so to speak.

The quip about "learning to walk" paints a rather accurate picture of the past year. Victoria Gold has staggered from quarter to quarter yet again, trying to find its stride in an admittedly challenging environment. The company had started the year cautiously guiding for 165,000-190,000 ounces of gold production, well below the 218,000 ounces documented in the current mine plan. This was a resoundingly conservative target; it was a target to be beaten. Yet again, the company had to withdraw guidance following the failure of the overland conveyor in late September, losing roughly 15,000 ounces of production during the three weeks it took to repair the equipment. Keep in mind that the Eagle mine is a cold climate heap leach operation with highly cyclical gold production. Gold output is typically low in Q1 and Q2, and peaks in Q3 and Q4. Having to suspend stacking in the second half of the year is painful and the chart below shows the damage: the latest Q3 bar disappointingly registered well below the Q3/21 print.

This lower-than-expected production in Q3 was accompanied by higher-than-expected costs thanks to the ubiquitous cost inflation, and lack of scale thanks to the production shortfall. When pressed during the earnings call, McConnell explained that cost inflation was caused by all the usual factors, compounded by difficulties to recruit enough mine workers and the resulting necessity to resort to more expensive contractors.

Rising costs put pressure on the margins leaving little to no room for free cash flow generation. The chart below shows the effects on the balance sheet, especially the increase in total debt during Q3 whereas the plan was to repay a good chunk of this debt in the second half of the year. Fortunately, the company restructured this debt early in 2022 and has been shuffling funds from the revolver into the term loan. But all this restructuring can't hide the fact that Victoria Gold has gone backward with its plan to reduce debt during the first three quarters of 2022.

Looking Ahead

Unfortunately, shareholders have little reason for optimism regarding the immediate future in our view. Reduced stacking rates due to the conveyor failure in Q3 will most likely impact gold output in Q4, and we don't expect quarterly Q4 production to exceed 50,000 ounces. And if this expectation holds true, then total 2022 production will come in below 2021 production -- at significantly higher costs. Last year Victoria Gold reported annual production on January 6, and if the company sticks to a similar release schedule this year, then we should get clarity on Q4 production in just a few days.

Furthermore, the company is working on an updated technical report with a revised mine plan for the Eagle mine scheduled for release in Q2/23. It's probably a safe bet to expect the revised mine plan to be based on more conservative inputs than the current mine plan, resulting in reductions of annual production and higher costs as the experiences of the past couple of years find their way into the calculations. Furthermore, the current mine plan predicts a noticeable production dip in 2023, followed by two more years of mining relatively high grades, and challenges thereafter as grades drop by 20+% towards 0.6g/t. It will be interesting to see how Victoria Gold navigates the 2023 dip in the updated mine plan, and it will be interesting to see if the company can find a way to optimize the remaining high-grade ore. Overall, we expect the revised mine plan to result in a reduced NPV when compared to the NPV derived from the current mine plan.

And there is one bright spot among the gloom. The company released a maiden resource estimate for the Raven discovery some 15km to the East of the Eagle mine. 1.07M ounces at 1.67g/t is a very encouraging result after just three seasons of drilling. To put this into perspective, the reserve grade of the operating Eagle mine is 0.65g/t. If upcoming metallurgical studies confirm the mineralization to be amenable to heap leaching, then blending ore from the Raven deposit with ore from ongoing operations could indeed change the game for Victoria Gold as it would lift head grades in the later years of the mine plan, and add to the mine life.

The current resource estimate for the Raven deposit is based on 18,000m of drilling. In 2022 the company has drilled additional 25,000m at Raven that will be incorporated into an updated resource scheduled for Q2/23. We would expect this update to exhibit some resource growth, but also an increase in resource confidence which will be required for these ounces to be eligible for inclusion in future mine plans.

Summary & Investment Thesis

The first three quarters of 2022 didn't work out as planned, and this time around the storyline about teething problems at a newly commissioned mine was no longer palatable for the market. Victoria Gold's share price under-performed peers by a 35% margin throughout 2022 as illustrated by the share price chart at the start of this post.

The company carried C$256M in total debt on its balance sheet at the end of Q3/22, and C$62M of this debt was due within one year, while Victoria Gold has been struggling to generate free cash flow in 2022. Even if operations finally improve, it will still take several years to pay down this debt. The current reserve base supports nine more years of mining operations at the Eagle mine and we wonder how much value will be left for shareholders once the company has repaid its debt.

The market capitalization computes to C$520M at a C$8.00 share price at the time of writing. This valuation is generous in our view, and already seems to signal expectations of operational improvements as well as mine life extensions. We are less optimistic, and see catalysts favoring the downside in the near-term: Q4/22 results are unlikely to turn the tide, and the first two quarters of 2023 will deliver the typical subdued output for a cold climate heap leach operation. Furthermore, we see downside risks when the updated mine plan will be released in Q1.

Risks clearly beat potential rewards at this point, and we call SELL on Victoria Gold.

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