It was a mixed Q1 earnings season for the Gold Miners Index (GDX), with increased absenteeism impacting production levels and costs. Whatever the case, Torex’s (OTCPK:TORXF) operational excellence has proven its worth continued and stands at about 24.7% of forecast year-to-date, although Q1 was the bottom for production. Unfortunately, this operating performance was overshadowed by higher than expected capital estimates at Media Luna and difficult rock conditions at the South Portal Lower. With a market cap of under $750 million, Torex remains undervalued. Nevertheless, with several other high-quality producers on the shelves, I see better opportunities elsewhere for the time being.
Torex Gold released its Q1 results last month and reported quarterly production of ~112,400 ounces at all-in sustaining costs [AISC] from $1,034/oz. This was a solid performance given the underperforming operating results of many manufacturers amid ongoing labor shortages, exacerbated by COVID-19-related exclusions. Based on this solid performance, the Company is on track to meet its fiscal 2022 cost guidance ($980/oz to $1,030/oz) and exceed its mid-year production guidance. Let’s take a closer look below:
As shown in the chart below, Torex saw production fall 13% year over year, which could disappoint investors just reading the headlines. This was related to lower ore grades and slightly low year-on-year recoveries, with underground grades below 6.0 grams per tonne gold compared to difficult year-on-year comparisons of ~7.5 grams per tonne gold Q1 2021. However, it is important to note that production is expected to increase throughout the year as grades improve and although production was lower compared to Q1 2021 this was in line with plans.
Assuming an average quarterly production rate of 116,000 ounces for the remainder of the year, Torex will exceed its mid-point production guidance of 455,000 ounces (~460,000 ounces vs. 455,000 ounces) and be reasonably positioned to meet its cost guidance. This is consistent with the company’s performance over the past few years, which deserves an A grade given the headwinds. In fact, Torex CEO Jody Kuzenko has not only managed to hit targets from a production and cost perspective with remarkable consistency, but has also held some of the best safety records in the industry, with the company being 1 year LTI free in April.
Costs & Margins
Turning to costs and margins, Torex had a higher cost quarter in the first quarter, with AISC at $1,034/oz, up from $854/oz in the year-ago period, up 21%. However, this was largely due to much lower sales over the period, with gold sales 4% below production (~108,000 ounces vs. ~112,400 ounces) and hitting difficult year-on-year comparisons from a phenomenal first quarter of 2021 at a note’s standpoint. However, while costs were higher, those costs are in line with projections and I estimate Torex’s AISC ($1,010/oz) is expected to be 15% below the FY2022 industry average of $1,190/oz.
Looking at the margins above, they also eased over the period but came in around 45%, reflecting some support from a higher average realized gold price ($1,876/oz). Similar to costs, margins were well above industry average and should improve over the year due to higher grades, partially offset by slightly higher cyanide consumption per tonne milled compared to a favorable Q1 (2.73 kilograms per tonne milled). Assuming Torex reports all-in-sustaining costs of $1,005/oz in Q2, we will see another quarter of slight margin declines, with AISC margins likely compared to nearly $870/oz in Q2 2022 $919/oz Gold prices started Q2 strong, its performance fizzled out over the quarter.
Looking at Torex’s financial results, revenue of $207.7 million was down 10% year-on-year as lower ounces sold were offset by a higher average realized gold price ($1,876/oz vs. $1,778/oz). As we look to Q2, we should see a return to higher year-on-year earnings with similar ounces sold but slight year-on-year comparison prices due to the weak gold price in Q2 2021. However, free cash flow for the quarter and for the Expected to remain negative for the remainder of the year unless gold prices rise significantly.
The weaker free cash flow profile in the first quarter was due to royalties and profit sharing payments which combined with lower ounces sold resulted in a cash outflow of $19.1 million in the first quarter (Q1 2021: cash inflow of $9.3 million). On an annual basis, Torex is increasing Media Luna development spending and plans to switch production from El Limon-Guajes to Media Luna in 2024. While this move to a negative free cash flow yield may be disappointing, it’s important to note that Torex will once again become a cash flow machine in 2025 once Media Luna is in commercial production. This is based on projected production of ~405,000 ounces gold equivalent in 2025 at AISC below $1,025/oz.
It is worth noting that although production will be slightly below 2022 levels once mining transitions to Media Luna (after 2024), there is a long-term opportunity to sustain the mill with ore from ELG Underground and the nearby EPO deposit to fill. Assuming Torex can recover 2,000 tonnes of excess material per day we could see a nice increase in annual production which would result in over 70,000 ounces depending on grades mined. So, while not yet confirmed, there is a path to long-term production of over 400,000 GEOs per year (production will fall sharply in 2027).
Finally, once development of Media Luna is complete in 2025, Torex may also consider a diversification acquisition that will allow the company to relinquish its status as a single asset producer, much like Orla Mining (ORLA) did last week. This would be a significant improvement to the investment thesis as while Torex has a high valuation and high operational/safety performance, single asset producers are trading at much lower multiples, particularly if their sole operation is in a less favorable jurisdiction. Ideally, if the company went down this route, it would enter a Tier 1 jurisdiction (Canada, US) or a cheaper mining state in Mexico.
Media Luna progress
Last but not least, Torex has seen improved development rates in the Guajes Tunnel, which has advanced more than 1.9 kilometers. However, this was partially overshadowed by an acknowledgment that development rates in the South Portal Lower were not quite as planned. To date, progress is only ~600 meters, at an annual rate of advance of less than 2.5 meters per day versus a budgeted rate of 4.5+ meters per day. This isn’t a big deal, but will be a key metric to watch going forward.
On the sourcing side and financing, the company is working to secure long lead time items and the hope is that given the global supply chain headwinds there will be no issues. Meanwhile, from a financial perspective, Torex sits on approximately $240 million in cash and approximately $390 million in liquidity ($150 million undrawn revolving credit facility) and intends to raise between $250 million and $300 Millions of dollars in debt to ensure it has sufficient capital Fund Media Luna Bau. If gold prices cooperated and climbed back above $2,000/oz, it would certainly help Torex maintain a stronger balance sheet during the build period.
Review & Technical Image
Based on Torex’s 85 million shares outstanding and a share price of $9.20, the stock currently trades at a market cap of approximately $782 million. This is a very reasonable valuation for a 400,000 ounce per year producer and is well below my estimated Torex NAV of ~$1.28 billion, which translates to a P/NAV multiple of just under 0.65. However, Torex is a riskier bet than most other producers because it’s a single-asset producer in a Tier 2 jurisdiction that’s in the process of transitioning from one mine to another. So I believe that part of this discount is justified.
Based on what I believe to be a more conservative multiple of 0.90x P/NAV, I see a fair value for the stock at $13.55. While this suggests 47% upside potential from current levels, I prefer to build in a minimum 35% safety margin for single asset producers to justify starting new positions. After applying a 35% discount to fair value, Torex’s updated low-risk buy zones are slightly below current levels at $8.80. That doesn’t mean the stock needs to go lower, but if I were to buy the stock, I would be most interested in a pullback below the $9.15 support (see below).
Torex Gold continues to be one of the best run producers from an operational perspective, consistently meeting its targets and having an excellent safety record. However, this is a single asset producer in a less favorable jurisdiction at a time when there are a handful of producers to choose from that are also on the store shelf. Therefore, while I think this is a great story, I continue to see safer bets elsewhere in the industry. However, if I were to open a position in the stock, I would view any dip below $8.85 as a low-risk buying opportunity.