The price of gold fell over 25 percent in 2013, and this dragged down the prices of most gold miners. But despite this gold price weakness, investors still bid up the price of Klondex Mine (or, KLNDF) shares by roughly 30 percent. This is a phenomenal performance, and even those investors who aren’t so bullish on the price of gold — as well as those investors who are searching for deep discounts in the gold mining space — should wonder what the company did that merited such a performance.
This performance is even more counter-intuitive when we consider that toward the end of the year, the company made two moves that are seemingly bearish: it reduced its gold resource estimate and it issued stock. Despite this, I think Klondex Mines has one of the most compelling stories in the gold mining space, and investors can still find value in the company’s shares even at the current price of $1.58/share.
What makes Klondex Mines so compelling?
Klondex Mines owns a significant amount of exploration land in Nevada. The company is focused on one of these — the Fire Creek project, which it expects to bring into production sometime this year. This should be a low-cost mine that will almost certainly be profitable even in a depressed gold price environment.
Late last year, the company refigured its resource estimate for the Fire Creek property. Prior to the reconfiguration it the company had between 1.4 million ounces and 2 million ounces of gold. With the new configuration, the property has just over 700,000 ounces of gold. Despite the reduction, this is actually an improvement. Management decided that it would be better to define the resource focusing only on highly profitable gold, and as a result, the grade of the ore more than doubled from less than 10 grams of gold per tonne to over 20 grams of gold per tonne. This means that the company’s direct production cost (or, cash cost) per ounce of gold should be significantly lower than initially thought. In fact, the company should be one of the lowest cost gold producers in the world with ore grades this high.
Management showed enthusiasm for the potential of this new resource estimate. Markus Aarino, a Seeking Alpha contributor, pointed out that insiders purchased over half a million shares of the company in November. Not only that, but shortly thereafter management bought a land package with a mill nearby the Fire Creek property from Newmont Mining (NYSE:NEM). While the company will end up issuing shares and debt to finance this deal, it demonstrates management’s intent to begin production at Fire Creek very soon. Not only that, but now that the company has a milling facility we know its capacity for processing ore, and we can therefore estimate its production at a minimum of 100,000 ounces per year minimally.
This is excellent news, because 100,000 ounces of low-cost gold can produce a lot of cash-flow for a company that is valued at just $165 million (note that this valuation assumes that the company will issue stock in order to fund the mill purchase from Newmont). For example, if the company can generate $400/ounce of gold, then it will see $40 million in free cash-flow for at least the next 6 years, which means that Klondex shares are still undervalued despite last year’s strong performance.
Furthermore, the share offer leverage to the gold price. Using our current example and assuming today’s $1,250/ounce gold price, if the gold price rises to $1,450, then cash-flow rises to $60 million per year — a 50 percent increase.
In addition to the upcoming production plans for Fire Creek, Klondex Mines has plans to expand its resource base at Fire Creek and at its other Nevada exploration properties. This gives investors cost-free upside potential.
As we can see, there is strong justification for Klondex Mines’ strong 2013 performance even in the face of lower gold prices. While many companies were writing down assets and having trouble raising much needed capital, Klondex moved ahead meaningfully with its flagship project, and it is consequently positioned to generate a lot of cash-flow for investors over the next few years even in a weak gold price environment. Therefore, I think the shares can still be purchased today, and I think that they are a screaming buy on any pullback.
Disclosure: I am long Klondex Mines.