2023 has been a great year for investors thus far, with several asset classes enjoying double-digit year-to-date percentage gains, including the Nasdaq 100 Index (QQQ).
While it may be lagging short-term after a strong November and December, the strongest performance has come from the Gold Miners Index (GDX), which outperformed the Nasdaq 100 by more than 3500 basis points in 2022, and is up 46% off its Q3 2022 lows.
Following this strong rally in the GDX and a surge in optimism among investors, some consolidation or a deeper pullback would not be surprising.
However, it’s worth building a watchlist of undervalued now to prepare for sharp pullbacks, assuming these stocks retreat into a low-risk buy zone.
In this update, we’ll look at two gold names still trading at deep discounts to fair value and highlight their low-risk buy zones:
Argonaut Gold (ARNGF)
Argonaut Gold (ARNGF) is a gold producer with a market cap of $430 million and was a name I highlighted in November as one to keep a very close eye on, and I stated the following:
To summarize, this pullback in the stock has provided a fire sale, and I don’t recall the last time I saw sentiment this bad for a producer in years.
Since that update, the stock has soared by more than 60% and is one of the top-performing gold producers by a wide margin.
This is partially attributed to the strong recovery in the gold price that has placed a relentless bid on gold miners but also due to several positive developments.
The major one worth discussing is the appointment of a new Chief Executive Officer, Richard Young, who is well known for transforming Teranga Gold from a junior producer into a $2.0 billion miner before its eventual takeover in late 2020.
This recent development is a huge upgrade to the investment thesis, given that Young is a very competent company builder with a wealth of experience in the sector (30+ years), beginning with Barrick Gold (GOLD) in 1991.
Most importantly though, this transition occurs during a pivotal period for Argonaut Gold as the company is barely two months away from its first gold pour at its Magino Project in Ontario, Canada.
As discussed in my previous update, Magino is a game-changer for the company, given that it will catapult Argonaut from a 250,000-ounce producer to a 370,000 to 400,000-ounce per annum producer, with Magino’s costs set to be well below its current cost profile.
Assuming production comes in as expected (150,000+ ounces per annum at sub $1,000/oz all-in-sustaining costs at Magino in the first five years), we would see Argonaut’s consolidated costs drop from ~$1,600/oz to below $1,375/oz, a significant improvement.
However, with Richard Young on board, I would imagine that the plan could be to divest one or two higher-cost assets and look at expanding production at Magino post-2026.
This would result in a slightly smaller producer but boasting costs more in line with the industry average and with more production coming from Tier-1 jurisdictions (Nevada, Ontario).
For now, it’s still early to speculate, but with ARNGF on track to report $0.28+ in cash flow per share in FY2024, the stock trades at less than 2.0x cash flow, which is far too cheap for a producer of its scale.
This is especially true given that construction is more than 90% complete at Magino, and we often see a re-rating in miners once they move out of a capex-heavy period and into a period where it’s generating significant free cash flow.
So, based on what I believe to be a conservative multiple of 3.0x and FY2024 cash flow per share estimates of $0.28, I see a fair value of $0.84 for its 18-month target price.
That said, when it comes to small-cap producers, I prefer a minimum 45% discount to fair value to justify starting new positions to ensure a meaningful margin of safety.
In the case of Argonaut, this would require a pullback below US$0.46 to place the stock in a low-risk buy zone. In summary, while I am bullish on the stock longer term, I am neutral short-term and waiting for a deeper pullback to add to my position.
Sandstorm Gold Royalties (SAND)
Sandstorm Gold Royalties (SAND) is a $1.6 billion company in the precious metals space. It earns most of its revenue from gold, silver, and copper, with ~90% of its revenue from gold and silver.
The company is unique because it is not a gold producer but a royalty/streaming company, offering superior diversification for investors relative to producers (which typically have fewer than eight producing assets).
These companies also boast higher margins, allowing them to command premium multiples relative to gold producers, with 15-35% operating margins in most cases.
For those unfamiliar with the business model, royalty/streaming companies finance developers and producers in the gold and silver space, giving them capital upfront to build or expand their assets. In exchange, Sandstorm receives either a royalty on the asset over its mine life or a stream on the asset, meaning that Sandstorm has a right to buy a percentage of metal produced at a fixed cost well below the current spot price of gold/silver.
The result is that Sandstorm reported 70% - 80% gross margins over the past five years, with operating margins averaging 34% the past three years despite its relatively small scale (~95,000 gold-equivalent ounces in FY2023).
While there are several royalty/streaming companies to choose from, Sandstorm differentiates itself from its peers, given that it has one of the highest-growth rates sector-wide. This is based on its soft guidance to grow annual attributable production from 82,000 ounces in FY2022 to ~140,000 ounces in FY2025, translating to a 70% growth rate.
If successful, annual cash flow would soar from ~$110 million to ~$190 million, translating to cash flow per share of $0.63 based on ~300 million shares.
Using what I believe to be a conservative multiple of 18x cash flow (given that it is more diversified than most of its peers but has some production coming from less favorable jurisdictions), I see a long-term fair value for Sandstorm of $11.30 (110% upside from current levels).
However, this assumes metals prices remain below $1,850/oz gold and $24.00/oz silver in FY2025.
In a more bullish scenario for metals prices, SAND could generate $0.75 per share in cash in FY2025, translating to a fair value of $13.50.
So, why has the stock underperformed its peers?
With a weaker balance sheet than its peer group ($300+ million in net debt) and the fact that the company just diluted shareholders in its financing in Q4 of last year, the stock is out of favor, and understandably so after the financing came as a major surprise.
Meanwhile, given its higher debt position, Sandstorm may struggle to add new royalties/streams this year because it is laser-focused on reducing its debt load.
However, if we look ahead to 2024/2025, there’s a lot to like here, and Sandstorm is trading at a significant discount to its historical multiple. To summarize, I would view any further weakness in the stock below $5.10 as a buying opportunity.
Several names in the gold sector are now closer to fairly valued after a ~50% rally in the GDX.
However, Sandstorm and Argonaut are two names that continue to trade at attractive valuations with large safety margins.
While I don’t see either stock as a buy this second, I do see them as two of the more undervalued names sector-wide, and I would view pullbacks below $5.10 (Sandstorm) and $0.46 (Argonaut) as buying opportunities.
Disclosure: I am long SAND, ARNGF
Disclaimer: This article is the opinion of the contributor themselves. Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information in this writing. Given the volatility in the precious metals sector, position sizing is critical, so when buying small-cap precious metals stocks, position sizes should be limited to 5% or less of one's portfolio.