Dundee Precious Metals: Is There More Upside?

source: http://www.flickr.com/photos/ahorcado/

Source: http://www.flickr.com/photos/ahorcado/

Last Friday, shares of Dundee Precious Metals (MKTS:DPMLF.PK) soared more than 13 percent after reporting its fourth-quarter and 2013 earnings figures. The bottom line number was in-line with analyst expectations. The company earned $19.2 million in the fourth-quarter and $22.5 million for the full-year.

The reason for the sharp price increase was likely the fact that the company didn’t disappoint. The company had reported that it was anticipating weak production figures coming out of its Kapan poly-metalic mine in Armenia. The Kapan mine saw a decrease in the amount of ore mined from 138,000 tonnes to just 96,000 tonnes, and this resulted in a decline in the amount of gold sold from 7,000 ounces to 5,500 ounces.

While this is seemingly not a large decline for a company that produces over 100,000 ounces of gold on an annual basis (thanks to production at its Chelopech mine in Bulgaria) the result was that production costs soared for the quarter. Cash-costs at Kapan net of copper, silver, and zinc by-products ran up to $1,255/ounce of gold produced compared to just $778/ounce a year earlier. This means that the mine could barely turn an operating profit in the fourth-quarter, and given other expenses such as exploration and SG&A, the mine probably lost money.

Nevertheless, the quarter showed a lot of promising signs. First, the weakness we saw at Kapan means that there is substantial room for improvement. Not only can the company process more ore, but it can mine higher grade ore. The ore mined at Kapan in the fourth-quarter contained 2 grams of gold per tonne. Meanwhile, the resource has an average of 2.4 grams of gold per tonne. This suggests that the mine can be up to 20 percent more efficient, excluding whatever the company does on an operational basis.

Second, the net results for the quarter demonstrated the company’s overall strength in its earnings power. Despite the operational issues at Kapan, and despite the fact that the gold price was substantially lower in the fourth-quarter of 2013 than it was in the fourth-quarter of 2012, the company was able to grow its earnings from $14.7 million to $19.2 million. If the company can grow its earnings given the aforementioned headwinds, it stands to reason that it can grow its earnings at an even faster pace in a strong metals price and operating environment. Given that the company has just a $635 million valuation, and given that $19.2 million annualizes out to $76.8 million, Dundee Precious Metals stands out as a rapidly growing company trading at an effective single digit P/E.

With these points in mind, I think the shares have additional upside.  However, investors should probably wait for a pull-back, seeing as the shares are already up 80 percent on the year. Furthermore, investors should be aware of the fact that the company operates mines in Bulgaria and Armenia. Mining companies operating in countries in the former Soviet bloc have heightened risk in that it might have difficulty getting mining permits or it might be subjected to punitive taxes and hostility from a public that doesn’t want its natural resources owned by western investors.

As a result of these overhanging risks, I would expect that Dundee Precious Metals will trade at a discount to its peers operating in the Western Hemisphere. Nevertheless, so long as the company continues to execute, it is worth considering at the current valuation.

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