|Shares Out. (in M):||107||P/E||0.0x||0.0x|
|Market Cap (in $M):||142||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||4||EBIT||0||100|
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Veris Gold (TSX: VG , Pink Sheets: YNGFF), formerly known as Yukon-Nevada Gold (YNG) and the subject of several prior VIC posts under that name, is a small cap US-Canadian gold mining firm that has undergone a sharp recent selloff after raising capital at a premium to current prices, with the stock being more than cut in half since November despite several positive fundamental developments including production and reserve growth, a significant decrease in cash operating costs, and the recent execution of several toll milling agreements that should deliver additional net cash cost savings going forward. After a brief recent rally, VG has now given up all of its gains in the sector-wide selloff and now trades near an all-time low, with attractive valuations to forward cash flows and to the value of its ore processing assets and gold reserves, and a deep discount to recent secondary offerings and insider buying.
In addition to more than 1.06 million ounces of proven and probable gold reserves at its 119 square mile Jerritt Canyon mining claim in Nevada, Veris owns an extensive complex of ore processing and roasting facilities adjacent to its Nevada mines, which has a reported replacement cost of over $1 billion USD. After protracted operating problems following a 2008 shutdown, the company has invested heavily in capital improvements (including $210 million in capex in 2012 alone), and is now finally beginning to show significant production and cost improvements that have not yet been recognized by the stock price. To take advantage of substantial unused processing capacity, the company has recently initiated a series of toll milling agreements with nearby third party mines that are expected to substantially lower Veris' net cash costs of gold production going forward.
Jerritt Canyon mines historically produced from 150,000 to 350,000 ounces of gold per year from 1990 through 2007, before operations were suspended by the EPA in 2008 due to excessive mercury emissions. The former management team was replaced, and after extensive investments in environmental remediation and facility upgrades, the company reached a consent decree with the EPA allowing mining to resume. Protracted technical and operating issues following the return to production made achieving target costs and production volumes much slower than anticipated, requiring several capital raises and severely pressuring the stock price. Following substantial investments in Veris by investors including Deutsche Bank and Eric Sprott, over $210 million of additional capital was deployed for plant and mine capital improvements in 2012 alone -- an amount which itself is now far in excess of Veris’ total market cap after the recent decline. Gold production has finally begun to increase significantly from 13,200 ounces in the first quarter of 2012 to 35,500 ounces and 31,700 ounces in the latest two quarters, and management is targeting annual production in the range of 175,000 to 185,000 ounces for 2013.
The company’s recently enhanced ore processing and roasting facilities now have significant unused capacity, which is projected to create operating leverage as ore extraction continues to ramp up with exploitation of the Starvation Canyon mine at the Jerritt Canyon property. Total permitted processing capacity of 6000 tons per day is still significantly in excess of the company’s 3300 tpd of internal requirements. Management has pointed to the potential for additional cash flows from toll milling performed on behalf of multiple nearby Nevada mining operations including Atna Resources, Klondex, Barrick, and Newmont, which are currently capacity constrained and accumulating stockpiles of unprocessed ore. With operating improvements at Jerritt Canyon, Veris’ cash costs per ounce have already declined from a prohibitive $1654 per ounce during the severe operational problems in Q1 2012 to $1038 in the latest quarter, before additional efficiencies from production at Starvation Canyon and before considering cash from toll milling. Management expects that after the effects of cash from toll milling agreements, net cash costs to Veris could reach $575 per ounce this year, and analysts have projected 2013 EBITDA in excess of $100 million. I'll attach a table showing the approximate sensitivity to a range of possible assumptions below:
|production (thousand oz)||net cash costs (USD/oz)||gold price (USD/oz)||OCF (USD thousands)|
Management and incentives
Although any forward projections about junior mining companies need to be taken with a generous grain of salt, management actions on behalf of their personal accounts may be somewhat more informative. Filings excavated from the cumbersome Canadian regulatory website http://sedi.ca reveal that multiple insiders bought over 80,000 shares on the open market during December, in addition to heavy buying in mid 2012 by multiple insiders including director and former CEO Bob Baldock. Veris Chairman Francois Marland owns an 8.8% block of common stock; together with this significant stock ownership by management, the 11% stakes of large shareholders Sprott and Deutsche Bank should bring added discipline to capital allocation going forward.
With recent exploration offsetting production, proven and probable reserves at Jerritt Canyon increased to 1.061 million ounces in the latest technical report, and total measured and indicated resource was 2.3 million ounces -- an attractive valuation on the $142 million market cap even before considering the value of ore processing assets. Veris additionally owns a mining complex at Ketza River in the Yukon Territory, purchased from a third party in 1997 after a prolonged period of low gold prices in the $200s made further operations uneconomic. Measured and indicated gold reserves at the site total 418,000 ounces. The company has begun the repermitting process but is currently not investing significant additional capital. With relatively little development risk and extensive infrastructure already in place, this property could be a source of significant free upside optionality to any recovery in gold prices; and an eventual sale to a third party could take advantage of the still very significant rise in gold prices since its initial 1997 purchase.
Analyzing the relative attractiveness of resource investments as an inflation hedge
Mining stocks overall have recently experienced a prolonged period of historically extreme underperformance, and have underperformed spot gold prices significantly on a relative basis even during the recent selloff. The chart below shows the XAU (Philadelphia Gold and Silver Index) relative to the spot price of gold, a ratio which now stands near an all time low. As John Hussman highlighted with a recent backtest on 35 years of data, the ratio of spot gold prices to the XAU has shown a strong inverse correlation with subsequent 4-year returns from gold stocks. Interestingly, the current ratio would be consistent with a predicted 4-year change in the XAU of more than +50%.
To the extent that much of this discount results from persistently lower investor tolerance for uncertainty and illiquidity following the credit crisis, exacerbated by capitulation of investors following the recent decline in spot gold, today’s very low relative valuations may signal a timely entry point for contrarian investors. However, one alternate explanation for the recent relative underperformance of miners would be that the market is anticipating that capital equipment and exploration costs may increase by more than the price of gold, justifying a much higher discount rate for junior miners. Investors considering natural resource stocks as an inflation hedge also need to consider the impact of inflation on future capital costs and development expenses that have not yet been incurred; particularly for early-stage exploration and development companies, future development and extraction of resources can benefit from inflation only to the extent that the relative increase in price of the resource being produced exceeds the increased price of future capital investments and operating costs needed to produce it.
In the case of Veris, the very high replacement costs of already completed investments in mining and processing infrastructure represent a significant hidden asset which could create disproportionate benefits for shareholders if either or both of gold prices and development costs increase in future. The ongoing devastation across the junior mining sector is now causing a lack of access to capital that is likely to curtail further investment in the kinds of large-scale roasting and processing facilities currently owned by VG. With nearby miners sitting on stockpiles of unprocessed ore and unwilling to invest in new processing capacity, VG's existing assets will be well positioned to create value for shareholders by providing a way for capital-constrained miners to generate much needed cash.
Veris stock now trades at a nearly 40% discount to its recently completed December secondary offering at $2.10, which when combined with growing cash flows from operations finally appears to have satisfied the need for further capital. Short selling as a hedge by holders of Veris warrants and convertible bonds may have exacerbated the recent share price decline. After considering the attractive valuations to forward cash flows and proven and probable gold reserves, the deep discount to replacement value of infrastructure assets, and recent insider buying above the current price, Veris stock appears an attractive way for contrarian value investors to add exposure to gold at advantageous prices. I have recently added VG and YNGFF shares near $1.30.
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