I want to thank Ryan O’Connor for telling me about Yukon-Nevada Gold Corp. He runs a great blog www.aboveaverageodds.com. I also want to thank Jared Levin of A. R. Schmeidler & Co., Inc. for contributing this idea to Ryan’s blog and speaking with me about the company when I was still learning about it.
http://www.aboveaverageodds.com/2010/08/03/investment-analysis-yukon-nevada-gold-yngff-pk/
Investment Thesis
Yukon-Nevada Gold Corporation is a gold explorer and producer. Most of its assets are located in the United States and Canada. The company was formed in June 2007 when two entities, YNG Resources, Ltd. (“YGC”) and Queenstake Resources, Ltd. (“Queenstake”), combined their operations. The purpose of this transaction was to combine YNG Resources’ exploration project, Ketza River (Canada), with Queenstake Resources’ production asset, Jerritt Canyon (Nevada, USA).
At first, the merger seemed successful because during the first two quarters (3rd and 4th of 2007) following the merger, the company was producing gold profitably. Then, by the first quarter of 2008, problems started to emerge. During this quarter, the company shut down its mining and processing operation in Jerritt Canyon to address infrastructure and safety concerns.
Within several months, production resumed only to be shut down again due to liquidity and environmental problems. The Nevada Department of Environmental Protection (NDEP) issued a “stop order” due to mercury emissions to the atmosphere. The situation became so severe that the company was 24 hours away from declaring Chapter 11 bankruptcy. The stock price went from $2 per share to 2 cents causing investors to lose almost their entire capital.
In early 2009, a group of European investors saved the company from declaring bankruptcy by providing it with an immediate cash injection. They also brought in Robert F. Baldock, 30-year veteran mining turnaround expert to get the company back on its feet. He immediately reduced the workforce and fired the old management team.
The following is a link to a video interview with Baldock in March 2010. In the video, he explains why he took the job and what he is doing to turn it around:
Since taking over, Baldock has done a tremendous job with his turnaround efforts. On September 22, 2010, Drew Clark, one of only two analysts covering this company, said an interview, “The company has already surpassed my estimated output rates for 2010 and has positioned itself to post strong production numbers for the remainder of 2010 and 2011. We are extremely encouraged by the progress made at Jerritt Canyon.” The positive turnaround efforts are already being reflected in the stock price which recovered significantly from its lowest point of 2 cents per share, but is still nowhere near to where it should already be by now and what it will be in the future.
Now, the company is in full environmental compliance and is operating and producing gold. It is now producing at an annualized rate of 150,000 ounces of gold per year. Baldock has a goal to increase production to nearly 1,000,000 ounces per year by 2015 as shown by the following illustration:
The following is a link to another video interview with Baldock on October 21, 2010, which provides a more updated picture of the turnaround process.
Valuation
Even though the stock price of Yukon-Nevada appreciated significantly from its lows, the company is still undervalued and the future price potential of its stock is tremendous. The company announced that it is currently producing gold at an annual rate of 150,000 ounces per year. This translates into the following cash flow calculation:
| Annual Production (In Ounces) | 150,000 | |
| Price of Gold | $1,300 | |
| Cash Costs | $600 | |
| Revenues (150,000 x $1,300) | 195,000,000 | |
| Mining and Processing Cost (150,000 x $600) | -90,000,000 | |
| Gross Profit | 105,000,000 | |
| G&A | 5,000,000 | |
| Exploration Cost | 5,000,000 | |
| Operating Cash Flow | 95,000,000 | |
| Number of Shares | 1,001,675,000 | |
| CF per Share | 0.09 | |
Assuming the price of gold is $1,300 per ounce and the cost to produce an ounce is $600, the operating cash flow comes out to be $95 million, which translates to $0.09 per share. Gold mining companies trade between 10 to 15 times the operating cash flow. Consequently, Yukon-Nevada should be trading between $0.90 and $1.35 per share very soon based on the current production level. But, as mentioned before, the company is in the process of increasing production, and when this happens, the stock price will move up much higher. In 2011, the targeted production is 250,000 ounces per year, and this will translate into the following cash flow calculation:
| Annual Production (In Ounces) | 250,000 | |
| Price of Gold | $1,300 | |
| Cash Costs | $600 | |
| Revenues (150,000 x $1,300) | 325,000,000 | |
| Mining and Processing Cost (150,000 x $600) | -150,000,000 | |
| Gross Profit | 175,000,000 | |
| G&A | 5,000,000 | |
| Exploration Cost | 5,000,000 | |
| Operating Cash Flow | 165,000,000 | |
| Number of Shares | 1,001,675,000 | |
| CF per Share | 0.16 | |
When the annual production of 250,000 ounces per year is achieved, the operating cash flow will be $165 million or $0.16 per share. Applying a multiple of 10 and 15 translates to a stock price of $1.60 and $2.40 per share.
The story gets even better as we look further into the future. By 2012, the company is planning to produce 400,000 ounces of gold per year and by 2015, 1 million ounces per year. If everything goes according to plan and the price of gold stays at $1,300 per ounce, we may be looking at a stock price of $10 per share. This is not outrageous. With the production of 1 million ounces of gold per year, this would translate into a market cap of $10 billion or about $10 per share.
While I realize that in order for the stock price to reach $10 per share, many things have to happen, I am not focusing on this number very much. Considering that we purchased shares between $0.69 and $0.74 per share, I will be very happy with a stock price of $1.40. Anything above that number would be a nice bonus.
Why Is Yukon-Nevada Still So Cheap
Anytime a stock price falls almost 100 percent like it did with Yukon-Nevada due to the fear of declaring Chapter 11 bankruptcy, it creates a long-lasting wound for investors. Many of them are still licking their wounds and are taking a “wait and see” approach. Meanwhile, more adventurous investors are choosing to invest ahead of them, getting a better price.
Catalysts
One of the reasons why I like this company so much is because there are a number of catalysts along the way that are likely to make the stock price move higher. When the company nearly went bankrupt, it lost its sell-side research coverage. Now that the turnaround is almost complete and the company is about to become a major gold producer, the analyst coverage is likely to be reinitiated, thereby increasing exposure. Also, the company is also about to release its NI 43-101 update, which is a way for Canadian companies to disclose information about mineral properties. The last time this type of update was done was in 2007 when the price of gold was $580 per ounce. Now, with the gold price above $1,000 per ounce, this will make a larger portion of mines economically feasible, thus increasing recoverable resources and reserves. Also, because the stock is trading at a low price per share, the company is considering doing a reverse-split and obtaining an Amex listing sometime in 2011. This would potentially allow the company to participate in gold ETFs and indexes, which would be very positive. The order and the exact timing of these catalysts is not precisely known, but if they do occur, they are likely to move the stock price higher.
Conclusion
The price of gold has been going up over the last several years. The investment community is divided as to whether the price of gold will keep going up. While I have no special insight into the future, I believe that gold is more likely to go higher than lower. How much higher? I have no idea but because of reasons such as future inflation and currency devaluation, the demand for gold is likely to stay high, maintaining its current price or pushing it higher. Investing in a turnaround gold miner such as Yukon-Nevada Gold Corp. offers one of the best ways to benefit from it.
Disclosure: I, or persons whose accounts I manage, own shares of Yukon-Nevada Gold Corporation (YNGFF). This report is not a solicitation to buy or sell securities. Neither Mariusz Skonieczny nor Classic Value Investors, LLC, is responsible for any losses resulting from purchasing or disposing shares of Yukon-Nevada Gold Corporation (YNGFF). You are advised to consult your financial advisor or conduct the due diligence yourself.
Good analysis as always Mariusz, but don’t you think that basing the valuation on current $1300 gold level is a bit risky? Gold has a very good chance of undergoing a correction which would change the numbers and show that YNGFF is fairly valued at current production levels (although still cheap compared to future production output).
You are absolutely right that if the price of gold goes down, then Yukon is fairly valued. However, because the production is likely to increase, it is still cheap based on the future production. I would not have bought a stabilized gold mining company because I have no idea where the gold price will be in the future.
Hi,
Why no income taxes in your cash flow analysis ?
150000*600 = 90,000,000??
I have been a shareholder in YNG since it was Queenstake. Fun ride.
You have an excellent writeup here – thanks.
One question- where did you get the valuation metric of 10x-15x cash flow? What size companies is that type of metric supposed to apply to…all producers?
I got the 10x – 15x cash flow by talking to people in the industry. And yes this is for producing companies. The smaller companies might trade in the lower range as they are viewed as more risky so the market is discounting them more.
The company announced today that it is issuing another 10M shares. How concerned are you about the constant share issuance and consequent dilution? Also, how necessary is this 18% discount incentive for warrant holders? If this company is producing and has some cash flow, why the equity raises instead of taking on some debt?
No surprise here. I knew they were going to do some type of equity financing. At this point, I don’t believe the company could get debt financing. The amount of equity dilution is nothing in comparison to the production increases we will get as a result of this financing.
I looked at this company recently. Unfortunately, you can’t depend on a steady state 150k. They are not even close to that, and that run rate was calculated of like a month of production.
They will probably meet their production goals at some point, but not on that timetable.
Different opinions make the market. You think one way and I think the other way. If you are right, you will not lose money and if I am right, I will make a killing and you will miss out. Only time will show. Thanks for your comment.
hi mariusz-
great blog. learning a bunch. two questions: are you concerned about future equity dilution? i believe the folks at above average odds were promised no further equity dilution by the management team and then equity dilution occurred subsequently. wonder if that points to an integrity issue on the part of management. i do get your point that they may be forced to go to the equity markets for financing – but wonder what the long term net effect of dilution will be for shareholders.
also, have you had a chance to speak with baldock or former employees to assess the probabilities of reaching the targets laid out the presentation?
beyond any of this, any risks you see that could jeopardize the upside? thx very much in advance.
Sorry it took me so long to answer you. I was moving and just got my internet connected and I saw this comment.
I am not concerned about equity dilution. The upside is so great that it won’t matter very much. I did not have a chance to speak with Baldock but I spoke with the investor relations guy many times.
Currently Yukon is working on a long term deal with Newmont. This thing should be signed within a few weeks. I believe this will be very positive for Yukon.
what are your thoughts on the earnings release a few days ago? to me, production ounces seemed a little lower than anticipated. also, any idea if the insiders are buying yngff at these levels? on another note, just bought and read your book. valuable read.
I am neutral on the results. The main thing is that when the management performs according to the plan, the proper results will follow and the stock price will go where it needs to go. For now we just have to be patient. They are having a conference call on Monday so hopefully we will get some positive news as far as the Newmont deal is concerned.
The company postponed today’s conference call indefinitely with no explanation…
Hi Mariusz,
Got into Yukon on original AAOI recommendation around .45. Watched it run into the .80s and now settle all the way back to .50. To what do you attribute the fairly steady drop from the highs and what do you make of the postponement of the earnings call? Any info would be appreciated.
The reason why the stock is down is because investors are simply stupid. However, they need a reason for their stupidity. Originally, Yukon told investors that they would need about $150 million for capex. Investors wanted the company to finance this from operations. As a result, they tried but because of the severe winter, they failed. Now they are moving to plan B which is raising money for this capex. Based on my conversation with the management, the financing will be in the form of debt, equity, and forward sales. This is the reason for the postponement. Now obviously raising equity is not a good thing because it dilutes shareholders. But once they have this $150 million, nothing will stop them anymore. All the issues are short term and they are fixable with money. So you spend $150 million to get about $2 billion of value. Not bad. This is how I see it but obviously sellers are panicking and selling like the company was going to go bankrupt tomorrow. In my personal opinion, they will be sorry very soon. But this doesn’t mean that the stock won’t go any lower. Nothing surprises me anymore.
Here is more info that can help you understand why the stock went down. Read the following release:
Luxembourg. Jean-Edgar de Trentinian, President of Orifer SA (“Orifer”) announces that Orifer intends to sell up to 140,400,000 Share Purchase Warrants of Yukon-Nevada Gold Corp. (“YNG”) from its control base. This sale will not result in a reduction of Orifer’s and Mr. de Trentinian’s direct and indirect shareholdings of 190,480,500 shares, representing 25.20% of the issued and outstanding share capital (755,816,679 shares) of YNG, but if completed will reduce the number of Orifer’s presently held warrants to zero. The securities will be distributed privately. The proposed commencement date of the sale is April 28, 2011.
Based on my conversation with Yukon, the exercise price is $0.32. The new buyer is required to exercise. This will bring about $45 million to the company which is good. But here is the bottom line. The new buyers are buying Yukon shares at $0.32 because they are required to do so and then they are probably turning around and selling it on the open market for a quick gain. Because their shares represent a huge part of all the shares outstanding, they are causing the stock to dive.
I liked the write-up and the subsequent comments. I’m a bit concerned about your tone though, on the last few. You sound somewhat emotional and that’s usually a mistake. This is not a call on the stock; just an observation. I know exactly how it feels. I liked Petrobank and it fell more than 20% in short order. (Devon Shire knows what I’m talking about, haha.)
That said, I’ve liked some of your picks in the past, notably ISCA. That was a good one.
Thanks,
Rommel
Rommel my “stupidity” comments have nothing to do with emotions here even though I am not happy with the decline. I believe that value investing is about taking advantage of stupid investors who chose to sell you something worth $1 for much much less. I just don’t like to sugarcoat things. I say it how I see it whether people think it is appropriate or not.
Dear investors what do you think about the current price of yukon I am quite lost with this stock since I read only positive news I don’t understand how it has lost so much in terms of market cap could anyone give me a small explanation
Geeshan
I think you hit the nail on the head. You don’t understand why it has lost so much in terms of market cap even though you only read positive news. Investors are panicking left and right. Who knows why someone is selling Yukon so hard. Maybe someone is forced to sell. I more than doubled my positions in Yukon over the last week.