Just over three months ago, I wrote on OceanaGold (OTCPK:OCANF), noting that investors would be wise to ignore the abnormally weak Q1 results and that any pullbacks below US$1.86 this summer would provide a decent buying opportunity. Since dropping below these levels in July, OceanaGold has rallied over 10% and outperformed its peer group, helped by a strong Q2 operational performance, even better financial results helped by the record gold price, and improved leverage ratios with net debt dropping to just ~$136 million as of the end of Q2. In this update, we’ll look at the Q2 results, recent developments, and whether the stock represents an attractive opportunity with it trading in the lower portion of its 2-year trading range.
All figures are in United States Dollars unless otherwise noted.
Q2 Production & Sales
OceanaGold released its Q2 results earlier this month, reporting quarterly gold production of ~130,100 ounces and copper production of ~3,400 tonnes. This represented a 16% increase in gold production from the year-ago period, benefiting from a better quarter at all of its operations on a year-over-year basis. The most significant increases were at Waihi (~14,800 ounces vs. ~8,200 ounces), Haile (~43,600 ounces vs. ~38,000 ounces), and Didipio ( ~32,200 ounces vs. ~29,300 ounces), with the higher output and a record average realized gold price ($1,967/oz vs. $1,856/oz), contributing to a significant increase in sales, cash flow, and free cash flow in the period. The result was that net debt dropped to a very modest figure at ~$136 million, down from Q1 2023 levels and the year-ago period (Q2 2022: ~$156 million).
Digging into the operations a little closer, we can see that Haile had a very solid quarter despite lower than planned grades at the Mill Zone, with higher throughput, grades, and recoveries helping the asset to report production of ~43,600 ounces in Q2. During the period, the plant processed ~903,000 tonnes at 1.82 grams per tonne of gold and 82.7% recoveries, a material improvement from ~895,000 tonnes at 1.67 grams per tonne of gold and 78.5% recoveries in Q2 2022. Just as importantly, development is progressing well at Horseshoe Underground [HSUG], with the company now just 80 meters from the 975 level, setting the asset up to deliver first underground ore to the mill at Haile in Q4. In addition, OceanaGold commission the water treatment plant expansion in the quarter, with it consistently treating over 2.5 million gallons of water per day.
Moving over to Didipio, production was higher at this high-margin asset as well, with gold production up 10% year-over-year to ~32,200 ounces, partially offset by a slight drop in copper production. Didipio’s higher output can be attributed to higher grades, which offset the slightly lower throughput (~1.02 million tonnes vs. ~1.06 million tonnes) vs. Q2 2022, helping the asset to report industry-leading AISC of $741/oz despite the impact of lower copper prices and fewer copper tonnes sold (~3,500 tonnes vs. ~3,700 tonnes). Of note in the prepared remarks was that the company is exploring the potential to increase underground mining rates at Didipio to “at least 2.0 million tonnes per annum” which would translate to a 25% increase from current levels and provide a lift in company-wide production from OceanaGold’s lowest-cost asset, translating to higher margins on a consolidated basis as well if implemented successfully.
Finally, the company’s Macraes Mine had a better quarter after the completion of repairs to the inlet trunnion of Mill #2 in Q1. This allowed the asset to benefit from higher throughput, with ~1.62 million tonnes processed at 0.93 grams per tonne of gold vs. ~1.14 million tonnes at 0.89 grams per tonne of gold in Q1 2023. The result was that Macraes reported more respectable all-in sustaining [AISC] of $1,287/oz in Q2 2023, down from $2,171/oz in Q1 2023. This has placed the company on track to meet its initial FY2023 guidance of 120,000 to 135,000 ounces despite the setback in Q1, with OceanaGold tracking well against its FY2023 company wide guidance of 460,000 to 510,000 ounces at $1,475/oz (cost guidance mid-point) with ~248,000 ounces produced year-to-date at $1,429/oz.
Finally, from a financial standpoint, OceanaGold reported its best quarter from a sales standpoint in years, with quarterly revenue of $301.0 million, up 31% from the year-ago period. This helped the company to report $161.7 million in operating cash flow and $72.3 million in free cash flow despite higher capital expenditures, a significant improvement from $8.8 million in the year-ago period. That said, we will see a pullback in free cash flow generation in Q3 given the softness in the gold price and the fact that Q3 is expected to be much softer than Q2 from a production standpoint.
Costs & Margins
Moving over to costs and margins, we saw a significant improvement in cost performance at Haile, with all-in sustaining costs [AISC] declining to $1,351/oz, down from $1,537/oz in Q1 and $1,432oz in the year-ago period. That said, this was primarily because of the benefit of delayed gold sales (~8,000 ounces), and all-in sustaining costs would have come in closer to $1,590/oz if not for the much higher sales relative to ounces produced in the period. In addition, we will see an increase in costs in the upcoming quarter, with Q3 expected to be the lowest production quarter of 2023 before the operation benefits from high-grade underground ore late in Q4. So, while H1 was quite solid at Haile, there’s no reason to expect a similar performance in H2 with production set to come in at the low end of guidance and be front-end weighted this year vs. most gold producers with back-end weighted production profiles.
Given the solid cost performance at Haile and Macraes, and the higher average realized gold price, OceanaGold was able to report margin expansion in Q2 2023, with AISC margins improving from $426/oz to $649/oz. Notably, this was achieved despite limited help from the copper price (realized price: $3.67/lb), and with no contribution from higher-grade HSUG ore, which is expected to average ~4.1 grams per tonne of gold in its first four years and spike the average feed grade at Haile from 2024 to 2027. So, while we will see softer margins in Q3, 2024 should be a better year from a margin standpoint, with company-wide AISC likely to come in closer to $1,400/oz. And as for commentary on inflation, OceanaGold noted that it’s seeing a benefit from lower diesel prices but with offsets from higher maintenance and labor costs, consistent with what other producers are reporting sector-wide.
Finally, as for overall company strategy, the company noted on its Conference Call that while it is always assessing inorganic growth opportunities with its development team, the company is confident in its organic growth profile which means it doesn’t need to lean on M&A to improve margins and production like some of its peers. This commentary is positive and should encourage investors and is certainly not an overstatement with solid exploration upside at Waihi (WKP), Haile (Horseshoe/Palomino) and Didipio (exceptional grades at depth below resource base), with this asset having further upside from excess mill capacity and the possibility to increase underground mining rates. So, when it comes to mid-tier producers with organic growth that don’t need to transact to improve their portfolio, OceanaGold is certainly unique which I see as an advantage given that major deals can weigh on share prices medium-term as we saw with Agnico Eagle (AEM) and Kirkland Lake, Fortuna Silver (FSM) and Roxgold among several other examples.
Based on ~724 million fully diluted shares and a share price of US$2.10, OceanaGold trades at a market cap of ~$1.52 billion and an enterprise value of ~$1.66 billion. This is a very reasonable valuation for a company set to grow into a diversified 550,000+ ounce gold producer once it sees the benefit of higher grades from HSUG, and there’s further upside to this figure if it can increase mining rates at Didipio Underground. The latter would allow for a higher average plant feed grade with better grades available underground, with the asset currently processing a mix of underground ore (~1.6 million tonnes per annum) and surface stockpiles. Plus, there’s further long-term upside to this production profile from the high-grade Wharekirauponga deposit north of Waihi, which is expected to deliver a Pre-Feasibility Study in 2024.
Using what I believe to be a fair multiple of 1.0x P/NAV and 7.0x FY2024 cash flow per share estimates and a 65/65 weighting (P/NAV 65%, P/CF 35%), I see a fair value for the stock of US$3.10. This points to a 47% upside from current levels, making OceanaGold one of the more undervalued producers in the mid-tier space. That said, I require a 40% discount to fair value to justify buying small-cap producers, and after applying this discount to an estimated fair value of US$3.07, OceanaGold’s ideal buy zone comes in at US$1.84 or lower. Hence, although the stock has a decent upside from current levels if it can execute successfully, I continue to see more attractive bets elsewhere in the sector trading at deeper discounts to fair value, with one example being B2Gold (BTG) which is also paying a ~5.2% dividend yield.
OceanaGold put together a solid Q2 report, helping it to bounce from its softer Q1 results because of one-time headwinds (crack in feed end trunnion of ball mill #2 and extreme weather at Waihi). This has placed the company in a position to deliver into its FY2023 guidance despite the lower than planned grades at the Mill Zone (Haile) in Q2, and the company will have an even better 2024 with the benefit of higher grade stope ore from HSUG. That said, Q3 2023 is expected to be much softer, which could lead to some margin compression sequentially (Q3 vs. Q2) and while the big picture remains positive, it’s possible we could see some short-term weakness if the gold price continues to hang out below $1,950/oz, translating to a much weaker quarter financially in Q3. Hence, while I would strongly consider buying OCANF below US$1.84 for a swing trade, I continue to see more attractive reward/risk setups elsewhere.
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