2023-04-06 13:49:20 ET
Summary
- K92 Mining has been one of the weakest performers this year, trading in negative territory year-to-date vs. a strong return for the Gold Miners Index.
- The underperformance can be partially attributed to unplanned maintenance in Q1 that could impact its ability to deliver into the upper end of FY2023 guidance.
- However, while K92 Mining missed its guidance midpoint in FY2022 and could have a softer H1-2023, we continue to see positive developments under the surface.
- So, with a top-5 growth profile sector-wide, the potential for $1,200/oz plus AISC margins post-2025 and this being a budding exploration story, I would view sharp pullbacks as buying opportunities.
The Q4 Earnings Season for the Gold Miners Index ( GDX ) is finally over and it was a disappointing earnings season overall. Not only did several companies miss production guidance, but delivery against cost guidance was pitiful, with many gold producers forced to move the goalposts (guidance range) entirely. In fairness, the misses on costs were related to stickier than expected inflationary pressures and some miners had tougher years due to supply chain headwinds. The result was that average AISC margins shrunk to ~$510/oz for the year, and have declined over 30% from FY2020 levels despite a higher gold price.
Unfortunately, K92 Mining ( OTCQX:KNTNF ) was one name that came up short of guidance in the small-cap space, with FY2022 production of ~122,800 ounces coming in 4% shy of its guidance midpoint at 127,500 ounces. That said, the company delivered below the low end of cost guidance for the year ($890/oz to $970/oz), helped by a strong H2 performance and slightly less sustaining capital spent than intended due to supply chain headwinds. Plus, while production may have come in a little light, key operating metrics continue to trend in the right direction, with development tracking ahead of budget, record tonnes mined, and throughput well above nameplate capacity. Let's dig into the FY2022 results and 2023 outlook below.
Q4 & FY2022 Production & Sales
K92 Mining released its Q4 and FY2022 results last month, reporting quarterly production of ~35,500 gold-equivalent ounces [GEOs]. The strong finish to the year helped K92 Mining to deliver into its FY2022 guidance range of 115,000 to 140,000 GEOs, but as noted, the company came in shy of the midpoint. However, while the absolute production figure might have come in shy of estimates, K92 Mining has been executing near flawlessly, which may not have been obvious from the headline results (production miss and higher costs year-over-year). This included record tonnes of material mined in Q4 (~287,500 tonnes), record tonnes processed (~121,700 tonnes), and development rates also hitting a record of 2,221 meters to finish the year (beating the previous quarterly record by 17%).
Based on the solid development rates achieved, K92 Mining's twin incline #2 and #3 had advanced 1,843 meters and 1,811 meters, respectively, de-risking the company's growth plans, with the twin incline sized for up to 5 million tonnes per annum with conveyors to more than deliver required tonnes for Stage 4. Meanwhile, the plant continues to outperform expectations, with daily throughput records hit on February 26th, February 28th, March 3rd and March 11th of 1,726 tonnes, 1,773 tonnes, 1,802 tonnes, and 1,815 tonnes, respectively. Even using the first daily record on an annualized basis (1,726 tonnes per day), this is well above the Stage 2A Expansion run rate of 1,370 tonnes per day, and would translate to ~630,000 tonnes annualized, over 20% above Stage 2A Expansion capacity of 500,000 tonnes per annum.
Given the strong Q4 production and despite a weak average realized gold price, K92 Mining reported record revenue of $62.0 million, up 15% year-over-year and trouncing its prior record. However, we should see several new financial records broken in H2 2023 if the gold price continues to cooperate, with K92 Mining set to produce ~40,000 GEOs in Q3 and Q4 2023 with an average realized gold price above $1,850/oz. On a full-year basis, K92 Mining also broke its prior record for annual revenue, with FY2022 revenue of $188.2 million, a 22% increase year-over-year. And while inflationary pressures with no help from the gold price put a dent in margins, K92 Mining still generated $73.1 million in operating cash flow and finished the year with $110 million in net cash.
Assuming an average realized gold price of $1,900/oz in FY2023, we should see a slight increase in cash flow despite the higher cost profile, though free cash flow will be deep in negative territory due to increased spending on growth capital after approving its Stage 3 and Stage 4 expansions late last year. However, once completed, K92 Mining could generate upwards of $200 million in free cash flow per annum at gold prices below spot levels. This leaves the stock trading at a very attractive ~15% FY2025 free cash flow yield, which assumes a gold price below spot levels.
Costs & Margins
Moving over to costs and margins, K92 Mining reported all-in sustaining costs of $870/oz in Q4, translating to AISC margins of $782/oz, well above the industry average but down sharply on a year-over-year basis (Q4 2021: $1,035/oz). The lower margins were partially related to the weaker average realized gold price, and a significant increase in sustaining capital year-over-year, with sustaining capital increasing up ~190% year-over-year to $10.8 million. On a full-year basis, K92 Mining also reported margin compression, with AISC up 1% year-over-year to $864/oz, and AISC margins declining to $847/oz (FY2021: $856/oz). Similar to Q4, this was related to significantly higher sustaining capital and the impact of inflationary pressures, offset by increased ounces sold.
For most producers, we should see a very strong Q1 given that the recent gold price strength should erase the impact of inflationary pressures that have added approximately $260/oz to costs since FY2022. However, with catch-up spending in 2023 and higher capex related to the Stage 3/Stage 4 expansions, K92 Mining is expected to see a significant increase in operating costs this year, with guidance set at 120,000 to 140,000 ounces with AISC of $1,240/oz at the mid-point. Previously, I noted that this would lead to significant margin compression year-over-year if the gold price didn't cooperate, but it has begun to move higher since my last update, which will help to offset some of the higher costs expected this year. If we assume an average gold price of $1,900/oz and AISC of $1,255/oz, this would translate to FY 2023 AISC margins of $645/oz.
While this near-term margin compression is certainly not ideal, and I would expect AISC closer to $1,260/oz for the year following the two unplanned maintenance events in Q1 that impacted Q1 production, it's important to note that AISC margins should improve materially from H1 2022 to H2 2022. Plus, 2024 should be an entirely different year as production starts to increase materially, allowing the operation to benefit from economies of scale. Hence, although K92 Mining will see its costs come in near the industry average in FY2023 and suffer margin compression, this won't last long, and the company could see AISC margins more than double in 2026 vs. FY2023 levels once its Stage 4 Expansion is complete (1.7 million tonnes per annum vs. 500,000 tonnes per annum currently).
So, what's the medium-term opportunity here?
Today, K92 Mining may look expensive as a ~$1.40 billion market cap producer with a single asset and a sub 150,000-ounce production profile, giving it a similar market cap to names like Iamgold ( IAG ) but with one-third the production profile. However, as stated in past updates, K92 Mining is one of the only juniors with an asset with Tier-1 potential (10 years of mine life, ~500,000 ounces per annum, and costs in the low-end of the cost curve). The other single-asset producer with a Tier-1 profile trades at a $3.0+ billion market cap in Ecuador, Lundin Gold ( OTCQX:LUGDF ). Obviously, a re-rating to this valuation isn't guaranteed, but K92 Mining's Kainantu Mine would actually be higher-margin than Fruta del Norte if the team executes successfully, so I don't think a long-term valuation of $2.5+ billion is unreasonable.
Given that the Stage 4 Expansion requires relatively modest capex ($187 million in growth capital) and K92 Mining is well-funded ($110 million in net cash), K92 Mining can easily self-fund this growth without any share dilution, suggesting that we will see significant growth in cash flow, net asset value, and production per share. So, if the right valuation for this company once in Stage 4 production is $2.5+ billion and it's able to close some of the ~$1.6 billion valuation gap with Lundin Gold currently, this could be a US$10.00 stock post-2024 based on ~246 million fully diluted shares. Let's see whether investors are getting this growth at a reasonable price today:
Valuation
Based on ~243 million fully diluted shares and a share price of US$5.70, K92 Mining trades at a market cap of ~$1.39 billion, and an enterprise value of US$1.28 billion. If we compare this figure to an estimated fair value of ~$1.80 billion at $1,800/oz gold ($200 million assigned to exploration upside), this leaves K92 Mining trading at just 0.77x P/NAV, a very reasonable valuation for a company that could become one of the highest margin gold producers sector-wide in 2025. Using what I believe to be a fair multiple of 1.10x P/NAV to reflect its strong resource growth to date and significant exploration upside, I see a fair value of US$8.10. This translates to a 42% upside from current levels, making K92 Mining one of the more attractive names from a relative value standpoint.
So, is the stock a Buy?
I typically prefer buying at a 33-40% discount to fair value for small-cap names, and using the lower end of this range, the ideal buy zone for K92 Mining would come in at US$5.40 or lower. Obviously, there's no guarantee that the stock pulls back this sharply if the strong bid under the gold price continues. Still, this is where I believe investors would have a meaningful margin of safety and the stock would also drop back towards a key support area where buyers stepped in immediately to soak up any shares during February and early March. So, while I am not long the stock yet, I am keeping a closer eye on it as it approaches support in this area.
Summary
K92 Mining has underperformed other producers this year and has struggled to sustain any rallies over the past two years, which might frustrate some investors. However, the underperformance shouldn't be that surprising following a 1600% run from its 2018 lows, with stocks often needing time to digest their gains following a move of this magnitude. Besides, the lack of upside progress in the share price has had little to do with the company's execution to date, which has been near flawless except for minor hiccups out of the company's control. So, with a top-5 growth profile sector-wide, the potential for $1,200/oz plus AISC margins post-2025 and this being a top-5 exploration story among small-cap producers, I would view sharp pullbacks as buying opportunities.
For further details see:
K92 Mining: A Solid Buy-The-Dip Candidate