Argonaut Gold Inc

TSX:AR

Earnings Call Transcript 2019-Q1

[Operator]

Good morning. My name is Marianna, and I will be your conference operator today. At this time, I would like to welcome everyone to Argonaut's Q1 Results Conference Call and webcast. [Operator Instructions] Thank you. Mr. Pete Dougherty, President and CEO of Argonaut Gold, you may begin your conference.

[Peter C. Dougherty, President, CEO & Director]

Thank you, Marianna, and welcome, everyone to Argonaut Gold's Q1 Financial and Operating Results Conference Call and webcast. With me today, I have Bill Zisch, our COO; Dave Ponczoch, our CFO; and Dan Symons, our Vice President of Investor Relations. This morning we will provide an overview of the quarter, and then take a deeper dive into some of the financial and operating highlights. Toward the end of the presentation, we would also like to spend some time looking ahead to the balance of this year and beyond. I am excited today. I believe that we had a tremendous year last year, capped off with a record fourth quarter production of 51,000 ounces. This year is even starting off better, and we have the opportunity to not only deliver on a solid 200,000 ounces a year production profile but also the opportunity to advance our development projects significantly this year.The big takeaways from our call today should be as follows: One, we have added $12 million of free cash flow during Q1. We had another record quarter of production and our second consecutive quarter of over 50,000 ounces of gold being produced. When annualized, this achieves our 200,000 ounce plus run rate. We continue to derisk our development asset portfolio and could be in a strong position with all 3 projects by the end of 2019. Please turn to the next slide, slide #2. Forward-looking information. During this presentation, we will be making forward-looking statements based on our best knowledge as of today. Please note that we cannot predict the future with a 100% accuracy. But we'll do our best based upon the information we have today. Please turn to the next slide, Slide #3. Q1 2019 and recent highlights. With another record quarter of production and our second consecutive quarter of over 50,000 ounces produced, we generated $11.7 million in free cash flow. We made good progress on our short term initiatives with leach pad construction progressing as planned at both El Castillo, San Agustin and starting of leach pad construction at La Colorada. We are on schedule and on budget with respects to the expansion at San Agustin from the current 20,000 tonne per day run rate to a 30,000 tonne per day run rate in the second half of the year. Looking our longer term initiatives and derisking of our development assets, we made significant progress at both Magino and San Antonio during Q1. At Magino, we received both our federal and provincial EAs during the first quarter. This unlocks the pathway for those projects. We also signed a community agreement with the Batchewana First Nation during the quarter. At our Cerro del Gallo project, we are on track to deliver a pre-feasibility study by the end of the year and are excited by what we are seeing. Please turn to the next slide, Slide #4. Recent CSR highlights. I want to take a moment before we dive into the financial and operating statistics for the quarter and recognize our continued commitment to social responsibility. We received our ESR recognition or recognition from the Mexican government that Argonaut continues to be a socially responsible company. This is our seventh consecutive year of this recognition and speaks to our key values of health and safety, our people, our environment and our communities where we operate. Some of the highlights during the quarter include the following: We celebrated International Women's Day with the support of Claudia Pavlovich, the Sonoran state governor at our La Colorada mine. To note, this was the first time that Claudia had been to an actual mine, something that we are very proud of and we represent well at Our La Colorada operation. We continued with our six year of free medical and medicine program at the communities surrounding the San Antonio project in the state of Baja California Sur. Over the six-year program working with the local doctor, more than 6000 medications have been delivered and more than 4900 medical consultants -- consultations have been provided. We held a ceremony in Ste. Sault Marie with the Canadian government and some members of our local communities to recognize the positive decision on our federal EA for the Magino project. And we also held a signing ceremony with the Batchewana First Nation after executing a community agreement with respects to the Magino project as well.Please turn to the next slide, Slide #5. Financial performance. It was a record quarter for production for Argonaut with over 54,000 ounces of gold being produced. We now have had back to back quarters of over 50,000 ounces being produced, which should provide the market the confidence that our 200,000 ounce plus annualized run rate is achievable and is here. And the most -- and most importantly, the bank account doesn't lie. We added about $12 million of net cash to the bank account during Q1. I'll now pass the call over to Bill Zisch, our Chief Operating Officer, who will walk through our operational highlights from Q1. Bill?

[William M. Zisch, Chief Operating Officer]

Thanks, Pete, and good morning, all. As Pete mentioned, we had our second consecutive quarter of record production and our second consecutive quarter of over 50,000 ounces of production. The biggest change this quarter versus Q1 2018 was at our El Castillo mine, where we saw the benefit of the expansion we made during 2018 to the west crushing circuit to drive higher throughput. Costs were higher, when compared to Q1 2018. At La Colorada, we had waste stripping to catch up from the period where we were not blasting in the pit during 2018 and did most of this during Q1. This led to a higher strip ratio and also times where we were waste bound with limited access to available ore. However, we are pretty much caught up on this now and should see improvements going forward. Also at San Agustin, we realized a higher strip ratio at 0.8:1 versus the 0.2:1 we saw during Q1 2018. Cost were higher in Q1, and we expect Costa trend lower during the remainder of 2019. I will walk through this with you on the next slide. Please turn to Slide 7. With respect to all-in sustaining cost, we made a change in how we report this number starting in Q1 2019. Historically, leach pad expansion costs were in expansion capital, and towards the end of 2018, the World Gold Council provided amended guidance of what cost they recommend be captured in a all-in sustaining cost. We now include heap leach pad expansion in our sustaining capital and therefore, it is included in our all-in sustaining cost calculation. To be clear, this doesn't change the cash to the bottom line. It is merely a reallocation of capital from expansionary to sustaining. Since we typically try and build our required leach pad during the first half of each year to avoid earthworks during the Q3 rainy season, our all-in sustaining cost is higher in the first half of 2019 versus the second half of 2019. We are confident that cost will trend lower during the balance of 2019. When we look at our key consumables, cost are significantly higher than a year ago. However, this is trending in the right direction for us with key consumables down 12% versus Q4 2018. We expect higher grades and a lower strip ratio at La Colorada for the balance of this year. We also expect a lower strip ratio at San Agustin for the balance of this year. Also important to note, when we think about the El Castillo complex, we expect a higher proportion of production from El Castillo during the first half of the year and a higher proportion of production from San Agustin during the second half of the year as throughput at San Agustin ramps up following the expansion to 30,000 tonnes per day. As San Agustin is our lowest cost operation, this will move cost lower on a consolidated basis. I'll now turn the call back to Pete. I'll be happy to answer questions during the Q&A portion of the call.

[Peter C. Dougherty, President, CEO & Director]

Thank you, Bill. If we can all turn to Slide #8. Q1 2019 capital spending and cash flow. On Slide 8, you can see that our -- you can see our cash flow reconciliation. During the first quarter, we invested $16 million into capital, with the largest portion of this coming at our San Agustin mine for the ongoing expansion from 20,000 tonnes a day to 30,000 tonnes per day. As you probably saw from our press release, we are making good headway with the leach pad nearly almost complete and erection of the crushing circuit expansion well underway. Please turn to Slide #9. Slide #9, 2019 guidance reiterated. We maintain our guidance of 200,000 to 215,000 gold equivalent ounces at a cash cost between $775 to $875 an ounce and all-in sustaining cost of $975 to $1075 per ounce. It is important to note that because we typically do the bulk of our leach pad expansion and construction during the first half of the year to avoid building during the rainy season, this means that our all-in sustaining costs will be higher during the first half of the year as leach pad construction is well underway and is considered a sustaining cost item for calculations. We are on target so far with our capital estimate for 2019 of $50 million to $60 million to be spent, with approximately 30% of this capital being spent during Q1 or $16 million. Please turn to the next slide. Slide #10, investing to the future, 2019 growth capital. We are tracking well with each of our key initiative growth investments thus far this year. At the San Agustin expansion from 20,000 to 30,000 tonnes per day, we are approximately 75% complete, which is on schedule and on budget and should be completed by the end of the second quarter. We'll see our throughput rate pick up during the third quarter and should start to see that production benefit Bill talked about during the fourth quarter and beyond. So we're making the investment today for future production enhancements. At Magino, we received both the federal and provincial EAs approval during this quarter. With the EA complete, it really opens the door for the other remaining permits, and we will continue to progress this project and progress on those permits. We are on track to deliver a pre-feasibility study at our Cerro del Gallo project before the end of 2019. We should also have feedback on our environmental permits at Cerro de Gallo and San Antonio we expect by the end of the year. Please turn to the next slide. Slide #11, achieving our objectives and delivering value, 3 year production outlook. We challenged ourself in 2017 to increase our production by 65% by the year 2019. And after 2 consecutive quarters of over 50,000 ounces of gold, we are at that annualized run rate of over 200,000 ounces per annum. It's interesting to see what this could potentially do for us on the next slide. Please Turn to Slide #12. Rerate potential. This is what gets me excited. On this graph, you can see a cluster of companies in the 100,000 to 150,000-ounce annualized production range. That's where we were as Argonaut back in 2017 and before. And you could also see the corresponding enterprise values associated with this company.As you move up the scale, you will see companies that are producing in a 200,000 plus thousand ounce cluster. We have been working to move Argonaut towards this next level where companies are valued at a higher level. And we saw a pretty clear gap between this 100,000 and 150,000 ounce a year producing companies to the 200,000 plus ounce a year valuations. Currently, we are being valued as a smaller producer. But as we continue to show the market that we are achieving these higher levels of production as we have for the last two quarters, we believe there is a strong potential to close this value gap. And that's what gets me excited. Please turn to the next slide, Slide #13. Development assets provide optionality. On top of a rerate, we would expect as we deliver on the 200,000 ounces this year, we have the potential to unlock further value in our development assets, which I would argue at this time are currently free optionality for our shareholders in the stock today. Our market capitalization has been sitting at roughly USD 250 million. Of the 8 analysts covering Argonaut, the consensus value of the operating mines and development assets sits closer to $450 million or roughly a $2 million gap in the current -- from where the current market value is today. That gap we simply want to close. If we take a look at the analyst consensus value for the operating assets at our cash net of debt, we get nearly $300 million of value or an additional $50 million that we are not receiving in the market today. That speaks to our opportunity right now, short-term. And then when you consider the value of these 3 development assets based on the most recent technical reports -- and I caution you that the Cerro del Gallo value was not produced by Argonaut. And we will be publishing a technical report with economics later this year. But looking at those assets, we have the potential to lock -- unlock over $600 million of additional value in the company. This gap between the analyst consensus value and the most recent technical reports value for the development assets can be explained as follows: The value for San Antonio is simply binary, either you have it on or you have it off. Since we currently do not have the necessary permits to move forward on this project, it is currently off in many of the analyst expectations. However, we expect to hear more on this project later in this year, which could drive considerable value creation at this project. At our Cerro del Gallo project, we have taken credit for much of the past work that had been projected by the previous owners and do not account for this previously announced mineral reserves or resources in Argonaut's consolidated reserve and resource statements. However, when we publish this pre-feasibility study later this year, we will be able to account for not only the reserves and resources but as well detail our view of the economics surrounding this project, which could potentially drive yet another rerate within our shares. And at the Magino project, analysts are close to value -- are close to valuing this project at roughly 50% of its value. This is done by taking this project from an economic per ounce basis versus a net asset valuation. This really makes sense since we have been open that we are unlikely to move this project forward without a joint venture partner due to the initial capital requirement. Some analysts, as I have said, value this at 50% in their models assuming a 50/50 JV at the future time. The bottom line here is that there are catalysts within this company that could drive rerates for our shares in 2019. Simply executing and delivering on that 200,000 plus ounces of production from our existing operations could create a value gap that we could close. Secondly, if we have positive news on San Antonio permitting process, this could be a massive improvement for the company. Once we publish the Cerro del Gallo feasibility study and technical report and start accounting for this asset in the portfolio, I believe we're going to see a natural rise in our reserves, our resources and in value that can be brought to the table on this project. And if we find a suitable JV partner for Magino, there could be another unlock of value for the company. Please turn to the next slide, slide #14. Summary of investment case. Argonaut is well known for maintaining a strong balance sheet throughout the market cycles, which provides stability and fuels growth. We have $28 million in cash, with $14 million drawn on our revolver and an additional $24 million in value added tax receivables that we constantly are replenishing and bringing back into the company. We have proven that we can add cash to the balance sheet from our strong operating track record of profitable production despite the fact that our mines are low grade in nature as was demonstrated here in the first quarter with $12 million of net cash being added to the balance sheet. With close to 8 million ounces of measured and indicated resources, we provide tremendous leverage to a rising gold price environment, as we continue to de risk these development assets, we could see even more value in the market for these assets. And it's important to note that during December, when we saw the gold price rise, Argonaut was one of the top performing companies going up nearly 30% during that time frame. And importantly, we have a track record that is unmatched with 9 years of production and proven production of over 1 million ounces at a average cash cost of nearly $730 per ounce. Please turn to Slide #15. Slide #15, our focus. While we must always make sure we are executing day in and day out no matter what challenges we may encounter, we must also remain focused on our goals and objectives. Our focus as a company is threefold: rebuild our balance sheet, which we did in the first quarter by adding $12 million worth of free cash flow; derisk our development assets and -- as we have shown by advancing not only the Magino project, the San Antonio and the Cerro del Gallo project, all moving them forward; and then to continue to deliver on our new production run rate and meet our 3-year 65% growth rate as a company with over 200,000 ounces of production this year, which would be another record for the company. I'd like to thank you all as this concludes the formal presentation portion of today's call. Myself and Bill as well as Dave and Dan are here to take any questions that you may have. We will now turn the time back over to Marianna for a brief question-and-answer session. Marianna?

[Operator]

[Operator Instructions] You have a question from the line of Craig Stanley with Eight Capital.

[Craig Philip Stanley, Principal & Precious Metals Analyst]

Looking forward to hopefully a higher gold price soon. Just a quick question. San Antonio. So you're hoping to maybe get some news by the end of the year? What would that news exactly be? Would it be the actual approval of the EA?

[David A. Ponczoch, CFO & Corporate Secretary]

Well, Craig, just to tell where we're at, we actually announced during the first quarter that we've actually submitted the environmental permit on that project. We also completed a voluntary, what I would consider a voluntary, what they consider a consultation meeting or an opportunity where people can come and ask questions about this permitting process that we are under, we concluded that during the first quarter with the help of the regulators who run that process down in Mexico. So it is kind of a prescriptive process that you go through at this point in time, that first meeting, which is the first hurdle to overcome, has been concluded. And we saw good support at that meeting for the company and the project. And now we'll look forward to the questions that may come out from the regulators at this point in time. But it could take anywhere from another 6 to 9 months before we'll hear on the permits on this project.

[Craig Philip Stanley, Principal & Precious Metals Analyst]

Okay. And then at Cerro del Gallo, you mentioned you're into Phase II of the metallurgical test work. Is there anything else that you have to do to get all the information required for the pre-feas?

[David A. Ponczoch, CFO & Corporate Secretary]

Well, in order to complete a pre-feasibility, we've already gone through, as you heard last year, relogged, redrilled some work for metallurgical, and we concluded the first round of metallurgical. Now we're into refining the metallurgical to look at how we can better optimize the project a little better. We have also looked at our first pass or phase of costing on this project, we'll have to tighten those numbers up a little bit better with some actual defined bids from people before we would come out with a full pre-feasibility study. So those are the kind of things that we are under, so it's more of a fine tweaking at this stage. But we think we have a project that looks exciting.I'm happy to say that the work that we had seen before by the people at Primero was substantiated by a lot of our work. They had talked about a project that held roughly around 80 million tonnes in total measured indicated in inferred material. And we see a project that contains roughly about a 0.6 grams, that's somewhere around that, that would -- we'd be able to pull into a mine plan. So that work, what they had done, we have been able to substantiate that. The metallurgical work that they had done, we've been able to substantiate some of their recoveries. So now it's a matter of refining and getting ourselves to a point where we can actually release something there. It takes about 3 months for the experts to write the report, so we'll have that requirement going on over the next quarter or so, and then they will be writing the reports to go along with that. We've also submitted the permits on that project as well. So we're advancing that quite rapidly right now today.

[Operator]

And your next question comes from Ryan Hanley with Laurentian Bank.

[Ryan Hanley, Mining Analyst of Institutional Equity Research]

Pete, maybe just a quick financial one for you. I'm just kind of going through the cash flow statement here, and I noticed that you got a big inventory gain, a little bit over $10 million or so. Can you maybe provide a bit more color on that?

[Peter C. Dougherty, President, CEO & Director]

Right. I'll turn this actually over to Dave Ponczoch, our CFO. But it's related to our pad inventory. So Dave?

[David A. Ponczoch, CFO & Corporate Secretary]

Yes. So in first quarter, we -- with the production, we drew down the inventory. And essentially, that's -- that was helpful for us in generating cash flow. And so it's something that we're focused on as a company. We look at whatever we can from a production standpoint to generate free cash flow. And so that was one of the initiatives that was started and we're continuing to work on.

[Ryan Hanley, Mining Analyst of Institutional Equity Research]

Okay. Perfect. And maybe just one more sort of in the same area. I know that there's a couple of different items that impacted cost in the quarter, one of them being a little bit maybe higher on some of the consumables. I think Pete, when we talked on the last quarterly call, you had kind of mentioned that you'd maybe baked in a little bit of conservatism into your guidance to account for that. Now that we're into May here, how are you seeing consumable cost tracking over -- sorry, relative to what you had baked into your guidance there?

[Peter C. Dougherty, President, CEO & Director]

Okay. I'll turn this over to Bill, obviously, since he does operations. But clearly, we had baked in some higher cost when we had built our original budgets, and Bill talked about the impact of stripping et cetera that really drove a lot of these costs. But we have seen some increases in our consumable cost. And he'll talk a bit about that.

[William M. Zisch, Chief Operating Officer]

Yes. We have seen some inflation on some of the consumables, but the major thing that we had included in the forecast and in the guidance was an increase in the application rate of our lime and cyanide. We had taken that up significantly. We have now seen, through efforts, that we have been working on material-type characterization and chemistry of the pad, and we have been able to reduce that by about 30% on the lime side and reduce cyanide as well. So we do now think we will see some improvement on the cost from consumption of these consumables like lime and cyanide.

[Operator]

Your next question comes from Tom Gallo with Canaccord Genuity.

[Thomas Gallo, Associate Analyst]

Just a question on the stripping at San Agustin. You mentioned you were waste bound in a few areas and that the strip ratio got up to 0.8. Do we see that trending back down towards normal? Or is there going to be a couple quarters of higher than expected strip?

[Peter C. Dougherty, President, CEO & Director]

Yes. Tom, thank you for being on this morning. I'll turn that over to Bill. Obviously, he's here. And we should hear from him first and foremost. Okay? Bill?

[William M. Zisch, Chief Operating Officer]

Yes. As I mentioned the strip ratio at San Agustin was the one that we said had gone higher, not necessary to the point of waste bound, being waste bound was over at La Colorada. But the strip at San Agustin was higher than we had expected during Q1, that's just kind of the -- what we saw in the model. And as we work through the plan, we do expect to see that coming back in line with our original forecast later on throughout the year.

[Thomas Gallo, Associate Analyst]

Okay. So for Q2, just to step back towards the model, and then H2 kind of back to normal basically? Is that a fair assessment?

[William M. Zisch, Chief Operating Officer]

Yes. Tom, that's about what we anticipate, that we'd be -- we would be kind of returning back to that planned levels.

[Operator]

There are no further questions at this time. I will now turn the call back over to the presenters.

[Peter C. Dougherty, President, CEO & Director]

Well, thank you all for attending this morning, and thank you, Mariana, for running this conference call for us. I'm excited where we are with Argonaut today. We had another fantastic quarter record. We have been advancing these development projects, and I'm excited to where we'll be here by the end of the year with significant progress made at all 3 of the -- of those projects. As many of you have shared concerns over the costs, we do as well. And we are seeing some improvements already starting to turn here in the second quarter for us. So as we look forward to the remainder of this year, we look forward to speaking to you in August about our Q2 and the improvements we've been able to achieve during the second quarter of the year. And thank you again for your support. And all, have a good day.