We’ve seen a strong start to Q2 for the Gold Miners Index (GDX), which has been a welcome change for investors after a violent 8-month correction that shaved nearly 35% off the ETF. However, while some investors might think they’re late to the party after this strong start to the quarter, this couldn’t be further from the truth. In fact, there are a few names in the sector that are still trading at deep discounts to their peers and P/E ratios or per ounce values that are well below their historical levels.
In this article, we’ll look at the most undervalued producer, the most undervalued royalty company, and one of the most undervalued explorers to showcase where investors can still find value in the precious metals space after last week’s rally.
While many names are up more than 15% off their lows and are now only trade at moderate discounts to their historical ratios, Kirkland Lake Gold (KL), Wheaton Precious Metals (WPM), and Gold Standard Ventures (GSV) are three names that stand out among their peers. The first company is one of the highest-margin producers in the sector that’s trading for less than 10x earnings. The second company is a royalty company with massive growth and exposure to silver (SLV). The final company is a Nevada-based explorer with an exciting project that could become a takeover target. Let’s take a closer look at all three companies below:
Beginning with Kirkland Lake Gold, the stock has had a rough 18 months, with the company previously being an industry leader but falling out of favor after the massive acquisition of Detour Gold. This shift in sentiment has seen the stock plunged more than 45% from its highs at $57.00 per share, where the company had a market cap of over $15BB. For investors that sat through this massive decline, it’s certainly been a bumpy ride.
However, for investors new to the story, this violent correction looks like an exceptional buying opportunity. This is because KL not only operates out of the safest jurisdictions globally (Australia & Canada), but it has some of the highest margins in the sector, with FY2021 cost guidance of $810/oz, translating to 50% all-in sustaining cost margins even at a gold price of $1,620/oz. Despite these high margins, KL is trading at a P/E ratio of 9.3 at a share price of $35.00.
(Source: YCharts.com, Author’s Chart)
Often, I am wary of buying companies with P/E ratios below 10 because this discount is often in place for a reason. However, in KL’s case, I believe the significant discount is due to sentiment. Investors used to triple-digit share-price performance, and an extremely high growth story has moved on to greener pastures. Still, with KL set to produce over 1.4MM ounces of gold with over $900 in profit per ounce in FY2021, and up to 1.6MM ounces of gold in FY2024 at a similar profit per ounce, the stock is a cash-flow machine.
This is evidenced by the company generating over ~$730MM in free cash flow in FY2020 and having estimates of $1.1BB in free cash flow in FY2021. At an enterprise value of barely $8BB, this translates to a 13% free cash flow yield and a P/E ratio closer to 8 when we subtract out KL’s $4.00 per share in cash.
Any time a previous leader is available at a discounted level like this, it provides a very low-risk entry into the story. The bonus with KL is that it’s paying a 2.20% dividend yield with a payout ratio of less than 20%. So, for long-term investors, a forward yield of 4.00% is possible with future dividend growth. Given the discounted valuation and sentiment that’s the worst it’s been in years for the stock, I see the stock as a Strong Buy at current levels with FY2021 annual EPS estimates of $3.75 and FY2022 annual EPS estimates of $3.89. Even using a conservative earnings multiple of 14, this translates to a fair value of $52.50 per share.
(Source: Company Filings, Author’s Chart)
The next name on the list is Wheaton Precious Metals, a royalty/streaming company that focuses on providing financing for metals companies, and in turn, receives a stream or royalty on their metal produced over the mine life. Given the higher metals prices we’ve seen over the past year, the company has seen significant growth in revenue and margins, with gross margins soaring to 77% in Q3 2020 and coming in above 75% in Q4 2020. This significant growth in both revenue and margins and several new deals completed in the past year has bolstered the company’s earnings trend considerably, with annual EPS doubling in FY2020 from $0.54 to $1.14. However, the growth isn’t over yet.
(Source: YCharts.com, Author’s Chart)
As shown above, WPM’s annual EPS estimates for FY2021 are sitting at $1.56, with FY2022 estimates of $1.66. This would translate to more than 45% growth in annual EPS over the next two years ($1.66 vs. $1.14), and the FY2022 annual EPS estimates are looking conservative if silver prices can stay above $25.00/oz.
At a share price of $41.00, the stock might look expensive initially, but it’s important to note that WPM could be an 80% gross margin business with a silver price above $25.00/oz. Generally, companies with these margins trade at between 35-50x earnings and as high as 60x – 80x earnings in the tech space, which is not as cyclical as mining. Even if we assume a multiple in the lower end of this range at 36, this translates to a fair value for WPM of $56.16, translating to more than 30% upside from current levels.
Like KL, WPM also pays investors to wait, with a 1.00% dividend yield with room to grow. So, if we do see weakness in Q2, I would view dips below $39.00 as low-risk buying opportunities.
The final name on the list is quite under the radar and has also been out of favor before a recent significant shake-up of management. This company is Gold Standard Ventures, a Nevada-based explorer that’s focused on its Railroad Project in the #1 ranked mining jurisdiction globally.
Recently, the company saw a new CEO and several new executives come in to breathe new life into the project; after the previous management made a few missteps and eroded investors’ confidence. Given the 80% decline from the stock’s 2016 highs, GSV is now valued at just $200MM, which is a dirt-cheap valuation for a company sitting on more than 3 million ounces of gold resources in the best mining jurisdiction in the world.
Based on current studies, GSV is capable of producing up to ~140,000 gold-equivalent ounces per year from its project over a more than 10-year mine life, at all-in sustaining costs of below $750/oz. These industry-leading costs and reasonable production profile suggest that the stock might be a takeover target for a mid-tier producer looking to grow its production.
In terms of the valuation, I believe GSV should be able to prove up 3.2 million ounces at Railroad-Pinion, and I see a fair value for these ounces of $95.00, given that we’ve seen M&A well above the $100.00 level in the past in Nevada. This translates to a fair value of $304MM, or closer to $0.85 per share based on 358MM shares outstanding. It’s important to note that this is a small company and a much riskier bet, but with more than 50% upside to fair value and takeover target potential, it looks like a solid name to keep an eye on after this recent pullback to $0.58.
While KL, GSV, and WPM have little in common with different business models, they all share one common trait: significant undervaluation. So, for investors looking for value in the space and takeover targets in KL and GSV’s case, I believe these are three names to consider. As noted, KL and GSV are both on buy ratings at current levels with an upside of more than 50% to their fair value, while WPM would hit a buy rating below $39.00.
Disclosure: I am long GLD, KL
Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
GDX shares were trading at $34.60 per share on Thursday morning, up $0.67 (+1.97%). Year-to-date, GDX has declined -3.94%, versus a 9.37% rise in the benchmark S&P 500 index during the same period.
About the Author: Taylor Dart
Taylor has over a decade of investing experience, with a special focus on the precious metals sector. In addition to working with ETFDailyNews, he is a prominent writer on Seeking Alpha. Learn more about Taylor’s background, along with links to his most recent articles. More...
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