Is Timmins Gold a Worthy Investment?

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

Thus far, 2014 has been an excellent year for gold mining shares. The Market Vectors Gold Miner ETF is up nearly 6 percent whereas the Dow Jones Industrial Average is down 0.5 percent. As I expressed elsewhere, I believe there is excellent value in gold and that gold mining shares are excellent investment vehicles to leverage one’s exposure to gold.

However, not all miners are created equal. Many of them operate in risky countries such as South Africa or Argentina. Others have high debt loads to service, or high production costs. Finally, some simply aren’t growing. Investors in several gold mining companies would have done extremely poorly had they purchased shares in many of the companies that face these headwinds. Consequently, investors in gold mining shares need to be stock pickers.

Recently, I suggested that investors consider purchasing shares of Goldcorp (NYSE:GG), which is a company with solid growth, generally low production costs at its mines, a solid balance sheet, and very little exposure to political risk. All of these points combine to make Goldcorp a solid investment.

But one thing to be concerned about is Goldcorp’s size. A company with 2.6 million ounces of annual gold production simply cannot grow that fast, and more aggressive investors may want to consider something smaller with the same positive attributes. While there is safety in size and a diversified mine portfolio, there is explosive upside potential in a small company with just one (or maybe two) mines. This is why I like Timmins Gold (NYSE MKT:TGD).

Timmins Gold owns and operates the San Francisco property in Mexico. The company came out recently with a press release stating that it had surpassed production estimates at the San Francisco mine with nearly 35,000 ounces of production in the fourth quarter and more than 120,000 ounces of production for 2013. The annual figure represents a whopping 27 percent increase over 2012’s production figures.

This growth in production is matched by growth in resources, which is essential if the company wants to keep operating without depleting all of its in-ground gold. Just two months ago, the company reported an increase in resources. Mineral reserves, which are resources deemed economically feasible to mine, grew by 20 percent. Measured and indicated resources, which have a high probability of being economically feasible to mine, grew by 30 percent. Inferred resources, which have a reasonable probability of being economically feasible to mine, grew by a whopping 77 percent from the prior estimate from a couple years ago.

But despite this resource growth, management remains very conservative in its mine plan. Management’s San Francisco mine plan is designed for only about a third of the company’s resources, and the shares offer good value if we presume only this mine plan, thanks to consistent production and a reasonable all-in production cost of about $1,050 per ounce. Thus, in an optimistic scenario in which more resources are mined, we can project the mine’s value to be far greater than the current market capitalization of the company, which is just $189 million.

In addition to the San Francisco mine the company has several other exploration land packages throughout Mexico, which means the company can use its cash flow from operating the San Francisco mine in order to explore its other properties in order to find more resources. Thus there is a remote yet distinct possibility that Timmins Gold can be operating several gold mines in Mexico in the future, which, assuming a strong gold-price performance, could mean that the shares will trade at multiples of its current valuation.

Of course, with this reward potential comes risk. First, Timmins Gold only operates one mine, and should it be shut down for whatever reason most of the company’s value will evaporate.

Second, Mexico recently passed a 7.5 percent royalty on EBIDA for mining companies. This has done damage to the shares of the mining companies that do a lot of business in Mexico. While the damage to these share prices is probably overdone, we must keep in mind that this tax could indicate future tax increases. Since Timmins Gold operates only in Mexico, investors in the shares need to keep track of what Mexico’s senate is doing regarding mining legislation.

In order to mitigate these risks, investors should own shares in more than one small gold mining company. In particular, they should look at other companies that don’t operate in Mexico, so that if Mexico enacts another tax, their entire gold mining portfolios won’t be impacted.

Timmins Gold shares are up significantly — 17 percent – in the first couple of weeks of trading this year, as the gold price is higher and Timmins announced its positive production results from the fourth quarter of last year. At $1.31 per share, investors are getting a significant discount considering that the shares traded over $3 each in 2012 and at more than $2 per share the last time the gold price fell, in spring of last year.

These factors combine to make Timmins Gold an excellent investment opportunity.

Disclosure: Ben is long Timmins Gold and Goldcorp.

Don’t Miss: EIA Natural Gas Report: Week Influenced By Polar Vortex

 

More from The Cheat Sheet