2023-04-25 04:45:29 ET
Summary
- Wesdome Mines was one of the worst-performing precious metals stocks in 2022, down 39% vs. a 15% decline in the Gold Juniors Index.
- The significant share price decline was attributed to a kitchen sink year with everything that could go wrong having gone wrong, combined with little help from the gold price.
- Fortunately, 2023 is off to a better start & the violent decline in the stock has put a dent in sentiment, making this one of the better turnaround stories sector-wide.
- That said, I don't see enough margin of safety baked into the stock following its recent rally, so I remain focused on more attractive opportunities elsewhere in the sector for now.
2022 was a year to forget for investors in the Gold Juniors Index ( GDXJ ), with several producers seeing 20% plus share price declines and margin compression felt across the sector. However, perhaps the most disappointing performance of the year was from Wesdome Mines ( OTCQX:WDOFF ) which started the year by hitting a new all-time high before finding itself in the midst of a ~60% drawdown to finish 2022. This violent decline that continued into this year torpedoed sentiment in the stock to its worst levels that I've seen it in years, and Wesdome briefly traded at a 30% discount to net asset value. In this update, we'll look at what went wrong and why there are reasons to be optimistic about the company's future:
All figures are in United States Dollars unless otherwise noted with a USD/CAD exchange rate of 1.33/1.00.
A Rough Year
While some companies had kitchen sink quarters in 2022 with a litany of issues experienced sector-wide that included supply chain headwinds, inflationary pressures and labor tightness, Wesdome took it on the chin multiples in a kitchen sink year. This was evidenced by issues at both of its mines, which included:
- hoist rope manufacturing defect (Eagle River)
- negative grade reconciliation (Eagle River)
- leach tank failure (Eagle River)
- delayed receipt of mobile equipment (Kiena)
- delayed receipt of mechanized bolters (Kiena)
- delayed commissioning of paste fill plant (Kiena)
- unscheduled downtime related to the underground crusher (Kiena)
- unplanned absenteeism (COVID-19 related)
While the issues at Eagle River impacted productivity and resulted in significantly lower production year-over-year (~80,000 ounces from ~99,100 ounces), the real hit was at Kiena which was six months schedule on commercial production and nearly 12 months behind on ramp development because of the delayed receipt of critical items, entirely out of the company's control. And while this led to a significant miss on FY2022 production (~110,800 ounces vs. initial guidance of 160,000 to 180,000 ounces), the limited progress regarding Kiena development has set Wesdome up for a disappointing 2023 as well, with head grades expected to come in at 3.7 to 4.7 grams per tonne of gold for the year, well below the average grade of 11.9 grams per tonne of gold in the 2021 PFS.
Kiena Deep - 3D View Looking West & Ramp Development (Company Presentation)
Some investors might be alarmed by this FY2023 guidance (30,000 to 40,000 ounces at grades over 50% below the reserve grade), but it's important to note that this is not a case of negative grade reconciliation or the ounces not being there, it's just the impact of being significantly behind on development and only having access to lower grades areas and previously mined areas with significantly fewer ounces per vertical meter (118, 120, 121 zones). However, Wesdome will see production improve materially when it accesses the 123, 125, 127, and 129 zones, with these zones averaging ~2,040 ounces per vertical meter. And while development is ahead of schedule, the mining method of overhand long-hole stoping means it's mining in a bottom-up fashion and isn't seeing the immediate benefits of the development progress.
In regards to Wesdome's 2022 results which were impacted by sector-wide inflationary pressures and the unexpected issues noted earlier, the financial performance was abysmal. Operating cash flow declined 50% year-over-year, we saw a free cash outflow of ~$67.7 million, and Wesdome drew ~$41.0 million on its revolving credit facility, plus it sold ~1.59 million shares at US$6.16 as part of its $75 million ATM established in Q4. This ended a multi-year track record of no equity issuance, which was previously a major differentiator under CEO Duncan Middlemiss, in a sector where small-cap and mid-cap producers often rely on significant share dilution for growth. Meanwhile, all-in sustaining costs [AISC] soared to $1,552/oz (FY2021: $1,123/oz) for the year and AISC margins plunged by ~62% to $252/oz from $672/oz in FY2021.
Wesdome Mines - Quarterly AISC (Company Filings, Author's Chart) Wesdome Mines - Quarterly Gold Sales, Revenue & Operating Cash Flow (Company Filings, Author's Chart)
These results certainly don't inspire much confidence and if investors were disgusted with the 2022 results, the 2023 guidance midpoint of ~120,000 ounces at all-in sustaining costs of $1,710/oz likely didn't alleviate any concerns. However, following the massive miss in FY2022, I would argue that the company had no choice but to guide conservatively to ensure it doesn't lose further confidence from investors. Plus, at least based on the preliminary Q1 results released earlier this month, there's reason to believe that Wesdome should be able to beat guidance. Let's take a closer look:
A Better Start To 2023
Wesdome released its Q1 2023 production results earlier this month, reporting quarterly production of ~28,400 ounces, placing Wesdome at ~23.7% of its FY2023 guidance midpoint despite production expected to be back-end weighted. At Kiena, grades came in above the guided FY2023 range at 5.9 grams per tonne of gold with ~42,300 tonnes processed (~7,900 ounces produced), and at Eagle River (Wesdome's legacy operation), the company processed ~48,100 ounces at an average grade of 13.5 grams per tonne of gold, translating to production of ~20,200 ounces.
Wesdome - Quarterly Production by Mine (Company Filings, Author's Chart)
In the company's prepared remarks, there was reason to be optimistic, with the company noting that grades are reconciling positively at the Falcon Zone, a welcome development vs. last year's negative grade reconciliation that was one factor in the guidance miss. Meanwhile, the paste fill plant at Kiena is performing well with reduced dilution and improved stope cycle times, and development is tracking ahead of schedule which is also welcome given how far the mine is behind on development due to supply chain headwinds experienced last year.
Given the decent start to the year, I see a high likelihood of Wesdome beating its guidance midpoint of 120,000 ounces and assuming the weakness in the Canadian Dollar persists, we should see all-in sustaining costs come in below $1,650/oz. Undoubtedly, paying a ~$900 million valuation for a ~120,000-ounce producer with ~$1,650/oz all-in sustaining costs is a hard sell, and this isn't a cheap valuation by any means if this were the best things were going to get. However, as noted previously, this is expected to be a peak year for costs and trough year for production for Wesdome in the 2021-2030 period, and there's no reason to judge a company with two very solid assets with industry-leading grades based on its worst year.
Looking ahead to 2024, I would expect production to rise to ~170,000 ounces at sub $1,150/oz AISC. And I would expect FY2025 to see further improvement to ~190,000 ounces at sub $1,050/oz AISC, with the potential for Wesdome to generate upwards of $100 million in free cash flow. Plus, it's important to note that while Kiena is a 100,000-ounce per annum asset at sub $950/oz AISC even when incorporating inflationary pressures, this is an asset with considerable permitted capacity (2,000 tonnes per day) double what's contemplated in its mine plan, and grades appear to be just as rich at depth with new discoveries in the Footwall, South Limb, and Hanging Wall Basalt zones. This points to the opportunity for increased ounces per vertical meter, lower unit costs, and just as importantly, rock quality is more favorable within the basalt which should translate to improved development rates.
As for the opportunity outside of the Kiena A Zone, the recently drilled Presqu'ile Zone (2 kilometers west of Kiena) has shown promising results and is shallower than the Kiena Deep A Zone, suggesting it could be accessed by ramp and provide a future ore feed for the Kiena Plant. While it's very early to speculate, there looks to be the possibility to add an incremental ~37,000 ounces per annum from the Presqu'ile Zone based on a mining rate of 600 tonnes per day, an average grade of 5.6 grams per tonne of gold, and a 95% recovery rate. This would be an attractive sweetener for the plant which has idle capacity and could help Kiena to maintain a 125,000-ounce plus production profile long-term vs. peak production above 100,000 ounces.
Finally, it's worth noting that while Kiena's NPV (5%) comes in at less than $300 million ($1,800/oz gold) when incorporating inflationary pressures, the 2021 PFS envisioned the cessation of mining in 2028 with no upside from a throughput standpoint and no benefit of increased ounces per vertical meter. However, with continuity established at Presqu'ile, a higher gold price, the potential for increased ounces per vertical meter and the exploration success to date that suggests a mine life that could easily extend to 2033 or later, I see this NPV (5%) figure as quite stale, with the true value for Kiena being upwards of $450 million, especially if gold prices can remain above $1,900/oz.
A Potential Takeover Target?
One reason I started a position in Wesdome in late January was that it looked like it could be a takeover target for other miners in the region, such as Eldorado Gold ( EGO ) that has shown its interest in acquiring land in the Abitibi region previously QMX Gold , plus Agnico Eagle ( AEM ) which had just added ~20,000 tonnes per annum of excess attributable mill capacity (post-2027) at Canadian Malartic by acquiring the other half of the asset. While I didn't see high-grade A Zone material as the likely feed for the Canadian Malartic Mill given that this was not a high-tonnage operation and the Kiena Plant had sufficient capacity, it looked like a possibility that Agnico might want to lock up ~7,000 hectares of land with exploration potential (Presqu'ile and several past producing mines) sandwiched between two of its operations (Goldex and Malartic), and just east of its legacy operation which also has excess capacity, LaRonde.
However, we've since learned that material from Amalgamated Kirkland appears to be earmarked for the LaRonde Complex, and while it looked like it could be tough to find material to use all of the Malartic Mill's excess capacity (~40,000 tonnes per day), several assets look like they could take care of most of this capacity. These include Upper Beaver (5,000+ tonnes per day), Wasamac (exploring potential for 9,000 tonnes per day), the possibility of a second shaft (~10,000 tonnes per day), plus lower-grade material from assets like Camflo and LTA. So, with Upper Beaver looking like a potential feed source and the possibility of higher mine production (9,000 tonnes per day vs. 7,000 tonnes per day) from Wasamac sent to Malartic vs. a stand-alone plant near Rouyn-Noranda, I'm not sure that Agnico would make a move for Wesdome.
Meanwhile, regarding Eldorado Gold, investors have finally been graced with a green-light at Skouries, a massive project that Eldorado plans to fund on its own vs. taking on a partner. While this won't add Tier-1 jurisdictional exposure, it will bring with it significant margin expansion and this should keep Eldorado busy until at least 2025. Finally, Wesdome's assets would be a decent fit for a company like Alamos Gold ( AGI ) given that they would improve Alamos' average grade and both mines are in Tier-1 jurisdictions with one in Ontario where it already operates. However, Alamos has been busy with bolt-on acquisitions at Island Gold (Manitou, Trillium), it recently received its Lynn Lake permits, and its potential to increase reserves looks solid at Mulatos, suggesting any major M&A is a low priority for growth.
Alamos Gold - Manitou Gold Acquisition (Company Presentation)
To summarize, I see the likelihood of a takeover by these companies as lower than I did in January, and it's not clear who a potential suitor would be outside of these companies given that these appear to be the most likely suitors. Besides, the price for Wesdome (current price + a material premium) isn't nearly as compelling as it was three months ago. Hence, I don't see the takeover angle as a bonus to the investment thesis, which it was in January when it seemed like we could see a company take advantage of the share price weakness to make a move, especially with the benefit of Wesdome's shares potentially being further pressured by its ATM.
Valuation
Based on ~146 million fully diluted shares and a share price of US$6.15, Wesdome trades at a market cap of ~$900 million. This leaves the company trading at a discount to its estimated net asset value of ~$1.02 billion, which deviates from the past couple of years when the stock consistently traded at a premium to net asset value. The compression in the stock's multiple can be attributed to the disappointing 2022 operating results which dented investors' confidence, plus the establishment of an At-The-Market Equity program [ATM] which has made it more difficult to forecast the outstanding shares.
Fortunately, the recent strength in the gold price should alleviate short-term cash flow issues and reduce the probability of any significant issuances under its ATM. In addition, and while selling shares is not preferable at any price, the stock has rallied sharply off its lows so the company is at least getting more value per share sold if it makes some minor share sales under its ATM to improve its balance sheet. Given that it's hard to forecast the gold price, I believe it's best to model 150 million fully diluted shares to be conservative or ~3% share dilution this year until the company gets into much better grades at Kiena.
Using what I believe to be a fair multiple of 1.10x P/NAV (ultra high-grade assets in Tier-1 jurisdictions with solid exploration upside), I see a fair value for Wesdome of ~$1.14 billion [US$7.60 per share]. This translates to a 23% upside from current levels, suggesting decent short-term upside if Wesdome can get itself out of the penalty box and further long-term upside if it can beef up its production profile with material from Presqu'ile Zone and take advantage of excess mill capacity. That said, and while Wesdome remains very reasonably valued, I prefer a minimum 40% discount to fair value to justify starting new positions. And after applying this discount, Wesdome's low-risk buy zones comes in at US$4.60 or lower.
Technical Picture
As for the technical picture, Wesdome has rallied sharply off its January lows and has now found itself in the upper portion of its support/resistance range, with lower resistance at US$6.80 and no strong support until US$4.55. This doesn't mean that the stock can't go higher, but the reward/risk setup is nowhere as favorable as it was when I started a position in the stock in late January at US$4.60, and the current reward/risk ratio is 0.41 to 1.0 when measuring from the current share price. This corroborates the view that Wesdome is not in a low-risk buy zone and suggests that patience is the best course of action.
Summary
2022 was a year to forget for Wesdome investors and 2023 isn't expected to be much better with the company guiding for production of 120,000 ounces at all-in sustaining costs of $1,710/oz (guidance mid-point). However, there are two points worth noting. The first is that guidance looks to be conservative especially given the decent start to the year, with a decent likelihood that Wesdome delivers into the upper end of production guidance (122,000+ ounces). Secondly, 2023 is a transition year for the company and while Kiena's performance won't be anything to write home about this year, this is an asset capable of producing 100,000+ ounces per annum even without utilizing excess processing capacity.
Given the low expectations after a brutal year in 2022 and the fact that Wesdome has an asset base that supports ~200,000 ounces per annum, I don't see any reason to put much weight into the uninspiring 2023 ahead with negative free cash flow and the potential for minor share dilution. Instead, investors should be focused on the long-term potential here, which is a return to a premium multiple assuming successful execution at Kiena and significant free cash flow generation in FY2025. That said, and while Wesdome is a solid turnaround story, I see more attractive opportunities elsewhere currently, with Wesdome trading significantly above its low-risk buy zone following its recent rally.
For further details see:
Wesdome Mines: A Better H2 Ahead