OceanaGold: Valuation No Longer Attractive (OTCMKTS:OCANF)

Just over four months ago, I wrote on OceanaGold (OTCPK:OCANF), noting that while the stock remained reasonably valued at US$1.82, I saw better opportunities elsewhere in the sector. Since August, the stock is up just 18%, which has significantly lagged behind some of my favorite ideas like Agnico Eagle (AEM) and Argonaut Gold (OTCPK:ARNGF), and this isn’t surprising given OceanaGold’s (“Oceana”) tough Q3 performance. Not only did production come in below my estimates, but costs rose sharply, impacted by inflationary pressures, lower by-product credits, and lower grades at its primary operations.

In some cases, underperformance can be a reason to jump into a stock, and this was certainly the case a month ago when Argonaut Gold was hovering near C$0.35 per share at less than 0.50x P/NAV, where I started a new position in the stock. However, while OceanaGold has underperformed since August, it isn’t cheap, trading at a premium to net asset value, and it has little justification for this premium multiple, even if its story is improving. So, while we have seen positive recent developments and the company has a stronger Q4 and 2023 on deck, I don’t see any reason to pay up for the stock at US$2.15.

Q3 Results

OceanaGold released its Q3 results in November, reporting quarterly production of ~105,000 ounces, representing a sharp increase in production from the year-ago period (Q3 2021: ~79,200 ounces). However, this was largely due to easy comps with the benefit of its Didipio Mine coming back online following an extended shutdown. Besides, while the company’s production was up, costs soared more than 29% year-over-year ($1,554/oz vs. $1,200/oz). This was related to inflationary pressures, which included higher labor and reagent costs at Haile and higher energy costs at Didipio, combined with much lower grades at its primary operations (Haile, Macraes). Let’s take a closer look below:

As shown in the chart above, Macraes had another tough quarter in Q3, with similar throughput year-over-year, but with relatively low grades (0.83 grams per tonne gold vs. 0.73 grams per tonne gold) and lower recoveries in the period. Oceana noted that this was related to record rains that impacted productivity, and recovery rates were affected by a higher proportion of carbonaceous material from Deepdell Phase 4. The result was that the operation produced just ~29,400 ounces in Q3 at industry-lagging mine-site AISC of $1,924/oz, leading to an AISC margin of [-] $192/oz in the period.

Moving over to Haile in South Carolina, it was a decent quarter for the mine operationally despite the planned lower grades with ~36,500 ounces produced, and the receipt of critical permits for Haile Underground was a significant milestone and positive development. However, higher capital costs and inflationary pressures related to labor, reagents, and mechanical parts combined with fewer ounces sold led to a sharp increase in AISC, which came in just shy of peak costs recorded in Q3 2020. This was a major drag on consolidated costs, given that this is its largest operation, more than offsetting the much lower costs at the re-started Didipio Mine ($913/oz AISC).

Finally, Didipio had a solid quarter with ~25,400 ounces of gold produced and ~3,600 tonnes of copper. Still, with a lower copper price and fewer tonnes of copper produced sequentially, by-product credits were down in the period. The result was that costs spiked above $900/oz when combined with higher energy costs (increased electricity tariffs), partially offsetting the benefit of a weaker currency. So, with Didipio’s costs up sharply and its two primary operations posting AISC of $1,550/oz plus, it’s not surprising that OceanaGold’s costs were up sharply in the period, and this led to a significant hit to margins. In fact, AISC margins fell more than 75% year-over-year to $145/oz, impacted further by the weaker gold price.

Recent Developments & Forward Outlook

The good news is that OceanaGold is expecting a better finish to the year and does expect to deliver into its FY2022 guidance of 445,000 ounces to 495,000 ounces despite a disappointing Q3 at Macraes. Meanwhile, its smallest Waihi Mine is finally hitting its stride, helping to pull costs down at this asset. However, the most important news is that underground development has begun at the company’s flagship Haile Mine and this is expected to be a totally different mine with the benefit of much higher grades going to the mill, similar to the transformation underway at New Gold’s (NGD) Rainy River. The major impediment to this robust future at Haile was getting key permits, which were received in Q4 as a nice early Christmas present.

As the chart above shows, Haile is expected to see a significant increase in gold production per annum once mining heads underground. The company remains confident that it will send its first underground ore to the mill by the end of this year. While this won’t translate to much lower costs in the near term due to elevated spending on pre-stripping and underground work, we should see a material improvement in costs post-2023 for the remainder of the decade. That said, the AISC highlighted in the updated Q1 2022 mine plan are likely on the ambitious side, given that they didn’t adequately capture worse-than-expected inflationary pressures.

Looking at the above chart, we can see that Haile Underground combined with Didipio will significantly turn around OceanaGold, with production set to increase to ~600,000 ounces in FY2024 at sub $1,125/oz all-in-sustaining costs. This is a massive improvement from ~460,000 ounces in FY2022 at an estimated AISC of $1,420/oz and should help the company get more market respect. Meanwhile, cash flow from Didipio should help the company to improve its balance sheet, with net debt already down sharply year-over-year to $174 million (Q3 2021: ~$250 million). To summarize, the turnaround story is clearly intact. Let’s see if the valuation justifies a new position in the stock.

Valuation & Technical Picture

Based on ~719 million shares and a share price of US$2.14, Oceana trades at a market cap of ~$1.54 billion (enterprise value of US$1.71 billion). Normally, I would argue that this is a very cheap valuation for a 500,000-ounce producer, but the major difference in Oceana’s case is its cost profile. While most mid-tier or larger producers are producing gold at sub $1,270/oz AISC, Oceana’s FY2022 will be above $1,400/oz and will remain above the industry average in 2023. Plus, while they will decline in FY2024, the previous outlook of a $1,075/oz AISC mid-point looks far too ambitious. So, with Oceana being a medium-cost producer with one operation in a less favorable jurisdiction (Philippines), I don’t see any reason it should trade at a premium to its peers.

However, following this recent rally, Oceana is trading at a moderate premium from a P/NAV standpoint, sitting at a market cap of ~$1.54 billion vs. an estimated net asset value of ~$1.33 billion, which adjusts for an estimated $350 million in corporate G&A, its current net debt, and adds $100 million in exploration upside for WKP (Waihi growth opportunity) and Haile Underground. This leaves Oceana trading at ~1.15x P/NAV, which is not a cheap valuation by any means and is in line with where Agnico Eagle (AEM) currently trades. Agnico has a larger scale (3.7+ million ounces), better costs (sub $1,000/oz AISC), and a much more robust pipeline than OceanaGold. Hence, the premium makes little sense to me.

Moving to the technical picture, OCANF has strong resistance overhead at US$2.64 and no strong support until US$1.58, and the stock is currently trading slightly above the mid-point of its expected support/resistance range. If we measure from the current share price of US$2.14, this translates to a reward/risk ratio of 0.89 to 1.0, well below the 6.0 to 1.0 reward/risk ratio that I prefer to justify starting new positions in small-cap producers. So, with the stock trading above 1.0x P/NAV and significantly above its next support level, I don’t see any way to justify chasing the stock here. In fact, I would view rallies above US$2.40 before March as an opportunity to book some profits.

Summary

OceanaGold is set to deliver into its FY2022 output guidance, but costs have disappointed this year and are on track to come near the already upwardly revised cost guidance mid-point ($1,375/oz – $1,425/oz). Fortunately, 2023 will be a much better year for the company, but I expect to see a decline in annual free cash flow with an expensive year ahead at Haile. In fact, even if the company reports $50 million in free cash flow in FY2023, it’s still trading at barely a 3.0% free cash flow yield, which is far too low for a volatile cyclical stock. To summarize, I continue to see more attractive bets elsewhere in the sector and remain focused on those companies trading at a deep discount to NAV, like Argonaut Gold (OTCPK:ARNGF).

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