Gold mining companies focus strategically – The Critical Investor

The gold price closed at a record high in March; a disciplined, cautious and consistent approach to acquisitions can bode well for gold stocks. Monthly gold market and economic insights from Imaru Casanova, portfolio manager, with her unique perspective on mining.

Gold prices reach new record highs

After several failed attempts over the past three years, gold finally managed to break the August 2020 high of $2,075 per ounce. This time the breakout was decisive and the gold price closed at a new record high every week in March. The strong price rise took gold to a close of $2,229.87 per ounce on March 28, a monthly gain of no less than 9.08% ($185.56 per ounce). Gold continued to reach new highs in the first few days of April. While COMEX gold open positions and net long positions increased in March, the physical gold exchange traded fund continued to decline after a few days of net inflows.

We’ve highlighted the widening valuation gap between gold and gold stocks. In March, gold stocks finally showed their leverage on the gold price. This could mark the start of a long-awaited trend reversal for gold mining stocks. After years of underperformance against the precious metal, the NYSE Arca Gold Miners Index (GDMNTR)1 and the MVIS Global Juniors Gold Miners Index (MVGDXJTR)2 significantly outperformed gold in March.

What now?

We believe that gold may have the potential to trade at a higher price level in 2024 – above the $2,000 per ounce level. In recent years, strong price gains, like gold’s last month, have often been followed by periods of consolidation around an established, higher level, with the precious metal moving sideways until a new catalyst emerges to push prices even higher. The return of investment demand, as evidenced by inflows into global physical gold ETFs, could be that catalyst in our view, with the potential to push gold above $2,500 per ounce.

For mining companies, it’s about more than just the gold price…

Historically, a rising gold price environment has been associated with strong returns from gold stocks. The outperformers in the sector must also demonstrate that they are fundamentally positioned and have a sound strategy that will translate higher gold prices into better cash flow and higher returns, which will drive growth. Organic growth is not easy in the gold sector. Finding new gold deposits, or defining/expanding existing ones, is a difficult, lengthy and capital-intensive process. Most large and medium-sized companies struggle to simply replace their annual production. To significantly expand their depleted reserves and resource base, companies generally must acquire other companies or acquire assets. The more advanced a project is, the higher its valuation and the faster the company can achieve growth.

But acquiring the right projects is not easy either. Companies must achieve an acceptable balance between the price paid and the level of risk associated with the project, and they must demonstrate to the markets that they are able to achieve attractive returns. There have been many bad buyouts in previous gold bull markets, as companies rushed to increase production at any cost. Gold stocks were punished for it, companies learned from it, and today the sector leaders are disciplined and cautious buyers.

Alamos + Argonaut: A blueprint for transactions

Last month, Alamos Gold announced that it had entered into a definitive agreement to acquire all of the issued and outstanding shares of Argonaut Gold. There are several aspects of this transaction that are worth highlighting:

• Alamos has a good track record in the field of acquisitions. Today, the consensus view is that the net present value of acquired assets far exceeds the acquisition cost, demonstrating value creation. The market rewarded that successful transaction history with a 7% share price increase on the day the deal was announced (March 27), despite it being an all-share deal that resulted in the issuance of shares representing approximately 5% of the company’s market capitalization company represented.
• Alamos expects to realize immediate synergies through the use of shared infrastructure, which, combined with operational, procurement and tax savings, should result in more than $515 million in synergies.

Alamos: demonstrating healthy value creation through thoughtful acquisition

Acquisition savings and synergies

1 Synergies pre-tax and undiscounted over the life of the mine; the discounted after-tax value of the synergies is $250 million

Estimated NPV and FCF per project

Source: Alamos Gold. Data as of March 2024.

1 Based on analyst consensus on net present value (NPV).

2 Cumulative Free Cash Flow (FCF) generated since acquisition as of Q4 2023. Please refer to the cautionary note on non-GAAP measures and additional GAAP measures

3 Acquisition costs based on the value of Richmont Mines at closing ($627 million), net of $58 million in cash on the balance sheet. The repurchases of royalties and NPIs totaled €71 million

• The proposed transaction involves the transfer of Argonaut’s non-core assets to existing shareholders as a newly established junior gold producer. Existing Alamos shareholders do not have to worry about integrating these assets into Alamos’ portfolio.
• Under the proposed transaction, Alamos will acquire Argonaut’s Magino mine, which is adjacent to the Island Gold mine in Ontario, Canada, making this combination very logical. The integration of these two operations is therefore significantly less risky and will create one of the largest and cheapest gold mines in Canada.
• With the addition of Magino, Alamos’ assets in Canada will represent more than 85% of the company’s consensus net asset value, potentially leading to higher valuation multiples for the company reflecting an improved geopolitical risk profile.
• The Magino mine reached commercial production in November 2023, so the acquired investment provides Alamos with immediate production (and cash flow) growth, with an estimated mine life of 19 years and the potential for mine life extension from a large mineral resource.

Disciplined and consistent approach

Alamos management has carefully executed the process to achieve this growth. It has been in a position to make acquisitions for some time, given its strong balance sheet and cash flow generation. However, they were patient and chose to deploy capital to enlarge and expand the existing mines until the right opportunity arose. This acquisition has proven to be a bull’s eye. A logical move, as shown by the above points. Alamos must once again show the markets that it can get the promised value from this combination. This disciplined and consistent approach has earned the company a high rating relative to its peers and could lead to continued above-average performance.