Description

YNG is a gold miner selling at ~1/4 of its asset value offering a large margin of safety. The company is going through a turnaround and EBITDA should increase from -$37m in 2011 to $70-100m+ in 2012. Some other positives include the i) management recently buying stock, ii) a “review of strategic alternatives” announced in April 2012, and iii) YNG pursuing an Amex listing to increase liquidity. We believe YNG is clearly undervalued and the value will be realized either though a successful turnaround, or through a sale of the business (in an upside case, both the turnaround and the sale will come through).

Brief description

The company owns two main properties. The Jerritt Canyon property, which is 100% owned, has current reserve & resource of: 374,800 oz  proven; 686,000 oz probable; 1.03M oz measured, and 1.29m oz indicated. The property has mill engineered capacity of 6,000 tpd of which 4,320 tpd is currently permitted. The Ketza River property, which is also 100% owned, has 29,000 oz measured and 388,700 oz of indicated resources. YNG also owns a roasting facility, one of only three in Nevada and the surrounding region.

The value of the assets is 4x the current price

YNG has a total of 3.8m OZ of gold. If we value those as if YNG was an exploration company, we could probably get $30 per ounce, or $0.12/share. (At some point management was evaluating spinning off Ketza River. An analyst covering the company believed at the time that it could fetch $100m or $0.10/share. But let’s ignore this.) In addition, the Jerritt Canyon roasting facility is estimated to have a replacement value of ~$1bn, or $1.07 per share. In the hands of a larger, more efficient miner such as Newmont, these ounces can be worth significantly more per ounce (We have seen estimates as high as $200/OZ).

But can the roasting facility really be worth $1bn?

Currently, Yukon-Nevada Gold has the only permitted and operational roaster with spare capacity in the region. 6,000 tons/day engineered capacity roaster, plus 5,000 tons/day engineered capacity wet mill. It is one of only 3 roasters in Nevada and the surrounding region. The other two roasters are owned by Newmont and Barrick and both are running at full capacity. Roasting is currently the most economic method for processing refractory sulfide ore which is prolific in the region. Permitting of new roaster capacity in Nevada and the region is extremely difficult and time consuming due to environmental concerns. No new roasters have been permitted in the past 12 years and none are currently proposed or in feasibility stage.

Because Newmont and Barrick’s roasters are at capacity, both of these companies are using their roasters to process only the highest quality ore (0.40 to 0.50 ounces per ton) and are stockpiling the lower quality ore. For example, Newmont has 53 million tons of ore with a grade of less than 0.10 ounces per ton sitting idle. This is equivalent to about 5 million ounces of gold. At the current price of gold, this translates into more than $8 billion of revenue. If Newmont acquired Yukon-Nevada’s roaster, they could probably process their 53 million tons for $40 per ton or $2 billion, pocketing the remaining $6 billion. (This would be spread over many years).   

Why has the stock traded down?

The company has had operational issues since 2010 when it lost money on production during the fourth quarter of 2010, after the third quarter of 2010 had showed promising profitability. In 3Q2010, the stock gradually started to decline from $0.75 to today’s levels. It became clear that something was seriously wrong with the production process and that the processing plant was in immediate need of winterization and refurbishment. The CEO requested $100m of CapEx to be approved by the Board to renovate the plants, but the Board declined fearing significant dilution.  The management restarted production with the hope of producing enough cash to pay for the capital expenditures. Soon, it became obvious that this was a terrible mistake which could have been avoided from the beginning. The plant breakdowns created all sort of problems. Profitability disappeared. The hope for increased production was crushed. Liquidity became a problem. After the financing was put in place, management was supposed to finish the plan refurbishment by September 2011.

The turnaround is under way with EBITDA expected to improve from -$34m in 2011 to $70-100m+ in 2012

YNG eventually raised $179m in 3Q2011 from Deutsche Bank via a private placement, warrant exercises, and prepaid gold forward facility. Before Deutsche Bank went ahead with the deal, it hired SRK Consulting, a world class mining consulting firm, to examine Yukon-Nevada’s plant to determine if its production problems were solvable, which SRK did. Despite delays, the refurbishment was actually completed in January 2012.

After the refurbishment is complete, management is projecting production of 150,000oz in 2012 (and 200,000oz in 2013). At gold prices of $1,600 and cash production costs of $800, this translates in cash from mining operations of $120m. Cash SG&A is <$10m. 

The gold resource to reach this level of production is in place. Between the Smith mine and the SSX/Steer mine, the company is getting about 140,000oz/year. It also has stockpiled ~1b tons of ore at an average grade 0.07, which equates to ~70,000oz. The company is currently opening additional mines to ensure supply for its 2013 targets (keep in mind, the company has 3.8m oz in the ground).  

 The production volumes of Jerritt Canyon were around 300,000 OZ/year 1987-2003, declined gradually from 300,000 in 2003 to almost nothing in 2009 and bounced back in 2010 and 2011.

In order to understand why the company has been losing money and is about to turn the corner, it is useful to break the cost of sales into two components – the cost of mining and the cost of processing as shown below. The cost of mining is what it costs the company to get ore from the Smith and SSX/Steer Mines or from other sources such as buying ore from a third party. The cost of processing ore is the cost of running it through the roaster.

In the first three quarters of 2010, when the company sourced ore from the Smith mine at average cost of ~$95/ton, its cost of mining was $425/oz. The high cost of mining later on is due to significant amount of ore being purchased from Newmont. (And Newmont was continuing to charge YNG more per ton as the price of gold kept increasing).

In 2012, YNG stopped buying from Newmont and is sourcing 100% internally. The company has indicated that internally sourced tonnage from the Smith mine costs ~$140/ton (and come down to $80-90 after YNG stops using a 3^rd party mining company in 1H2012). An yield of 0.24 oz/ton, this translates into mining  costs of $600/oz. At $90/ton, the implied mining cost per ton should be $383.  The cost per ton from the SSX/Steer mine is $85/ton, or $500/oz.

A key to the production costs is utilization. The fixed proportion of the processing costs are 80%+ so low production volumes contributed to high costs per oz. The high processing costs have also been exacerbated by breakdowns, other stoppages and high operating costs of the roasting facility historically. After the completion of the refurbishment, these issues should decline significantly.

In 3Q2010, when the facility was running at 1,000 tons per day, the processing costs were $735. After the refurbishment and increasing the production to 4,000 tons/day as planned, processing costs should come down. YNG indicated verbally that the roaster will be able to process ore for $40 per ton. If we use a grade of 0.15 ounces per ton, this translates into $266 per ounce.

So all-in cash cost per oz. should be $800-900. This should translate into $100-140m of EBITDA at production levels of 150,000-200,000 oz./year (those are the company projected volumes for 2012 and 2013). These levels of production volume are still significantly below the 1992-2003 levels of ~300,000 oz./year.

Recent events

In April 2012, YNG announced a strategic review which may include a sale, business combination, joint venture, merger, acquisition, strategic investment or other alternatives identified by the Company or the Financial Advisors that will serve to maximize shareholder value.

On June 3, 2012, YNG’s CEO Bob Baldock resigned. The COO, who executed the restructuring program, is likely run the business going forward

On June 18, 2012, YNG announced that it reached a steady state production and positive cash flow (104,000 oz./year run rate). YNG said that at these levels of production it is “generating positive cash flow from operations as well as covering the maintenance capital required to continue to operate the facility effectively going forward “. Management reiterated the 140,000-150,000 oz. target for 2012.

Management/insiders have been buying stock. CEO, COO and others have acquired $500K+ of stock in recent months.

Catalysts

Until a few months ago, the main catalyst was the expected improvement in the earnings. Given that the refurbishment is complete, the company is already producing at their target run-rate.

The recently announced “strategic alternatives” review could bring further upside if the business is fixed and sold. If the turnaround does not work for some reason, a sale should still generate sufficient profit from current levels given the substantial asset value.

Risks

-          Execution risk, further delays to achieving 150-200K oz/year, though significantly smaller after the refurbishment completed and positive cash flow reached

-          Execution issues will be accompanies with a further need for cash, which in turn may result in more dilution

-          Price of gold

Catalyst

Until a few months ago, the main catalyst was the expected improvement in the earnings. Given that the refurbishment is complete, the company is already producing at their target run-rate.

The recently announced “strategic alternatives” review could bring further upside if the business is fixed and sold. If the fixing does not work, a sale should still generate sufficient profit from current levels given the substantial asset value.