Is It Time for Investors to Buy Alamos Gold?

Source: Thinkstock

Source: Thinkstock

So far, 2014 has been a very good year for gold and gold mining equities more generally.

  • The SPDR Gold Trust (NYSEARCA:GLD), which tracks the price of gold, is up nearly 7 percent year-to-date.
  • The Market Vectors Gold Miner ETF (NYSEARCA:GDX), which is comprised of the world’s largest gold miners, is up nearly 14 percent year-to-date.
  • The Market Vectors Junior Gold Miner ETF (NYSEARCA:GDXJ), which is comprised of smaller gold miners– usually companies with one or two mines — is up nearly 19 percent year-to-date.

However, not every gold miner has performed well. Alamos Gold (AGI) has fallen more than 17 percent year-to-date. The irony of this is that this was one of the better performing gold mining stocks in 2013. Alamos stood out as a company that was producing gold inexpensively. It was paying a dividend, it had a large cash position, and it had a pipeline of projects that would allow the company to expand production and keep its costs down. This is why investors were willing to pay well over $1 billion with production at just under 200,000 ounces.

All of this is still true except for the low costs. Alamos saw its effective cost of production soar in the fourth-quarter, and as a result, it actually reported a loss. This generated investor disappointment; wouldn’t you be upset if you paid a premium for one of the few gold miners that was able to make money in the downturn only to find that its costs have soared and that its profits are vanishing? Investors expressed this disappointment by selling off Alamos shares.

Now, however, might be a good time for contrarian investors to consider taking a position. While you might be hesitant to put your money in a quality gold mining stock that has risen 20 percent or 25 percent on the year, you may be more willing to buy a stock at a discount such as Alamos Gold.

Unfortunately, the company will likely not be able to bring costs back down to the extremely low levels we saw when the shares were in demand back in 2013. Still, the company predicts costs will come in at $1,000/ounce at the high end before taxes at its Mulatos mine. That means it can generate about $20 million in post-cash tax flow at $1,300/ounce gold.

Considering the company’s valuation of $1.2 billion, this seems to be way too high. However, we have to keep in mind the following. First, the company has $419 million in cash and equivalents, $453 million in working capital, and no debt. Thus, with the cash backed out the company’s estimated P/E drops from about 60 to about 40.

That’s still not enough to justify a position. We also have to consider that the company is going to be bringing a new mine into production — the Kirazli mine in Turkey. This project will add about 100,000 ounces of gold production, plus 600,000 ounces of silver production. Given the company’s large cash position it can easily afford the $165 million price tag, and it will bring its average production costs lower. Furthermore, Turkey’s corporate income tax is low at just 20 percent versus Mexico’s — where Mulatos is located — where the effective tax rate is over 35 percent thanks to the new mining royalty of 7.5 percent.

In addition to this near term project, the company is going to be developing its Agi Dagi Mine in Turkey. This mine’s production will approach 150,000 ounces per year for seven years, and it will go into production after the Kirazli mine starts production. The company will be able to afford the $326 million price tag to build the mine.

Finally, the company made a quality acquisition in 2013 of a Mexican mining company called Esperanza Resources. The Esperanza mine in Mexico is more valuable in the hands of a cash-rich and cash-flow positive company such as Alamos Gold than it was in the hands of Esperanza Resources, which was a company devoted to developing this mine. This project goes further out into the future, but it is expected to produce 100,000 ounces of gold per year at just $900/ounce before taxes.

So with this broader view of Alamos Gold’s portfolio, we find that the bulk of the company’s value has yet to be realized — it still has to develop a lot of its projects. Meanwhile, investors were spooked when the company reported a near term cost spike at its one producing mine out of an eventual four. Therefore, I think that long term investors may be presented with an opportunity here, especially if they are able to withstand market volatility and ignore the short term noise that might drive the stock price.

Shares appear to have made a double bottom recently and they are moving higher again. While I don’t think the company is on Easy Street just yet I think this is a good time for risk tolerant investors to become contrarians and take a small position in Alamos Gold.

Disclosure: Ben Kramer-Miller has no position in Alamos Gold or in the ETFs mentioned in this article.

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