OceanaGold: A Path To Growth With Margin Expansion (OTCMKTS:OCANF)

The Q4/FY2022 Earnings Season for the Gold Miners Index (GDX) is nearing its end, and it was a disappointing year overall. While several companies delivered on production, several producers missed cost guidance. And many by a country mile, like Equinox Gold (EQX) and SSR Mining (SSRM). This was mostly because of stickier-than-expected inflationary pressures, COVID-19 related exclusions in H1-2022, supply chain headwinds, and labor tightness, with extreme weather bouts in some jurisdictions. The result was that sector-wide all-in-sustaining costs (AISC) soared 15% to ~$1,300/oz, a few companies ceased operations as net losses piled up, and on a two-year basis (FY2022 vs. FY2020), AISC margins compressed by 30% to just ~$500/oz.

Unfortunately, OceanaGold (OTCPK:OCANF) was one of those that missed cost guidance by a significant amount. It initially guided for ~470,000 ounces of gold and 13,000 tonnes of copper with $1,325/oz AISC at the mid-point and while it beat on output, costs came in well above the mid-point and top end of guidance at $1,407/oz. Although this was partially due to factors outside of its control, 2023 hasn’t started off much better, and we’ll see another high-cost year based on FY2023 guidance of ~485,000 ounces at $1,475/oz using the mid-point of guidance. Let’s take a closer look at the results below:

All figures are in United States Dollars unless otherwise noted.

Q4 & FY2022 Results

OceanaGold released its Q4 and FY2022 results last month, reporting quarterly production of ~120,900 ounces of gold and annual production of ~472,200 ounces. The latter represented a 30% increase from the year-ago period, helped by a full year of production from Didipio (~113,200 ounces vs. ~14,900 ounces), an increase in production from Waihi (~39,100 ounces vs. ~27,700 ounces), and a 10% increase in output from Macraes (~143,700 ounces vs. ~130,300 ounces) despite a challenging year. Unfortunately, while production was higher, costs came in much higher as well, impacted by sector-wide inflationary pressures. On a full-year basis, cash costs soared to $869/oz (FY2021: $740/oz) and AISC increased to $1,407/oz (FY2021: $1,247/oz), and this trend isn’t expected to improve in 2023.

Looking at the operations in a little more detail, Q4 was the strongest quarter of the year for Macraes and also a solid quarter for Didipio, with the two assets combining for just over 68,000 ounces. This was helped by a solid quarter out of Haile with ~836,000 tonnes processed at an average grade of 1.86 grams per tonne gold, helping the asset to finish the year well ahead of guidance (155,000 ounces at $1,550/oz mid-point), producing ~176,200 ounces at all-in sustaining costs of $1,425/oz. Unfortunately, the solid performance from its top two assets (Didipio and Haile) was offset by a tough year at Waihi, where production came in at ~39,100 ounces at $2,174/oz AISC, a massive miss vs. expectations of ~63,000 ounces at $1,425/oz based on the guidance mid-point.

While the inclement weather at Macraes (record rainfall in July) and poor grade reconciliation early in 2022 at Martha Underground led to misses for both assets and much higher costs, the high-margin Didipio operation in the Philippines saved the year, with ~113,200 ounces of gold produced at $637/oz AISC, more than 50% below the industry average. Although the contribution at much higher margins wasn’t able to pull costs within the initial guidance range for FY2022 ($1,325/oz to $1,375/oz), it did help to make the year a little more respectable despite a tough Q4 for Haile (extreme weather in December) and a late shipment at Didipio (~4,400 ounces of gold). So, while cost performance was disappointing, OceanaGold made the best out of a tough year, especially with inflationary pressures being stickier than hoped.

In terms of the big picture, the major news for OceanaGold and its Haile Mine was the receipt of its Supplemental Environmental Impact Statement Record of Decision and permit under Section 404 of the Clean Water Act, providing a green-light for the development and operation of Haile Underground and marking the completion of the state permitting process. The higher grades from Horseshoe Underground will pull down unit costs in 2024 through 2028 and provide a material boost to overall production, and 400 meters of the underground decline has already been completed, with OceanaGold aiming to deliver first underground ore to the mill by year-end. Notably, while 2024-2028 will be favorably impacted by Haile Underground ore, exploration success suggests the potential for several years of additional high-grade feed (Palomino & Horseshoe Extension).

The other positive development for OceanaGold in 2022 was exploration success at WKP, which sits just 10 kilometers of its Waihi Mine in New Zealand. OceanaGold noted in its most recent update that it expects to complete additional drilling to support a Pre-Feasibility Study in early 2024, and its aim is to increase its indicated resource base to 1.1 million ounces of gold, up from ~640,000 ounces at 13.5 grams per tonne of gold currently, with an additional 700,000 ounces at 9.5 grams per tonne of gold in the inferred category. As shown, WKP remains open in multiple directions, and while it will be several years before it starts contributing, this is an incredible resource to have especially near a mill for a company of OceanaGold’s size. To put these grades in perspective, even with a 20% decline in grades to be conservative (dilution), WKP would be a top-10 mine by grade if in operation today.

Financial Results & 2023 Outlook

Looking at costs and margins, AISC margins plunged to just $167/oz in Q4, impacted by a lower average realized gold price and a spike in AISC to $1,602/oz. This was related to slightly lower than planned sales volumes (delayed shipment), a weaker copper price and increased sustaining capital at Didipio. On a full-year basis, AISC margins fell to $406/oz from $574/oz, impacted by a slightly lower average realized gold price ($1,813/oz vs. $1,821/oz), inflationary pressures and headwinds from weather at multiple operations. As noted earlier, the two drags on performance were Macraes and Waihi, where costs were well above the industry average ($1,510/oz and $2,174/oz, respectively).

Fortunately, despite the higher-cost year, OceanaGold was able to pay down debt (net debt down from $238 million to $170 million) and it generated nearly $60 million in free cash flow. This was helped by the cash cow in the Philippines, Didipio, which is finally back online and contributing and it was despite the impact to free cash flow from delayed gold sales that got pushed into January. The negative news is that OceanaGold will see higher costs this year based on guidance, and the 2023 outlook came in uglier than I expected (128,000 ounces at $1,675/oz) due to a 15,000 ounce negative impact related to a crack in the feed end trunnion of one of the asset’s two ball mills that was identified during a plant shutdown.

That said, the company clearly is seeing a tailwind from stronger copper and gold prices, which could help to somewhat offset higher capital spend this year which would otherwise weigh on free cash flow generation.

2023 isn’t expected to be a year to write home about with OceanaGold guiding for ~485,000 ounces at all-in sustaining costs of $1,475/oz on a consolidated basis, but the future for the company is much brighter once it gets past this year. This is based on guidance of ~575,000 ounces at $1,375/oz AISC in FY2024 and a goal of 600,000 ounces at $1,175/oz AISC in FY2025, with the primary contributor being higher grades and reduced material handling at its largest Haile Mine and improved unit costs at Waihi/Macraes. Assuming the company delivers on this goal, costs would go from ~12% above the industry average in FY2023 to 10% below the industry average in FY2025, an impressive feat that should help the stock to command a higher multiple. Let’s look at OceanaGold’s valuation and technical picture:

Valuation & Technical Picture

Based on ~719 million shares and a share price of US$2.19, Oceana stock trades at a market cap of ~$1.57 billion and an enterprise value of US$1.74 billion. Although the stock trades at a very reasonable valuation from a cash-flow standpoint, sitting at just ~3.8x cash flow FY2023 cash flow estimates vs. a historical multiple of ~5.4x cash flow, it isn’t cheap from a P/NAV basis, trading at over 1.0x P/NAV. This is based on an estimated net asset value of ~$1.46 billion, leaving the stock trading at 1.07x P/NAV. Assuming the company can grow into a 600,000-ounce producer at sub $1,150/oz costs, it could command a 1.10x P/NAV multiple with a mostly Tier-1 jurisdiction profile. However, with that not yet proven today, I see a fair multiple being 1.0x P/NAV, leaving the stock fully valued on a P/NAV basis.

If we use a 65/35 weighting and value the stock on P/NAV (US$2.03) and cash flow basis and apply a multiple of 6.5x forward cash flow (US$3.77), we arrive at a fair value for OceanaGold of US$2.65. This translates to a 21% upside from current levels, which suggests that the stock could break out to new 52-week highs if it were to trade in line with fair value. That said, I require a minimum 40% discount to fair value when starting new positions in small-cap producers, and after applying this discount, the stock would need to head below US$1.60 to head into a low-risk buy zone. Obviously, there’s no guarantee that the stock pulls back by this magnitude, but this is where the stock would become highly attractive and there would be minimal risk when establishing a new position with a large margin of safety in OCANF.

Finally, looking at the technical picture, the current setup suggests we are not near a low-risk buy zone. The good news is that the stock has relieved its overbought condition from January. However, we have updated resistance at US$2.64 and no strong support levels in place until US$1.38 to US$1.44, translating to $0.34 in potential upside to resistance and $0.76 in potential downside to support. Based on the current 0.45 to 1.0 reward/risk ratio vs. a minimum reward/risk ratio of 5.0 to 1.0 for small-cap names, OCANF is nowhere near a low-risk buy zone, and I would view any rallies above US$2.35 before April into the top end of this range as an opportunity to book some profits.

Summary

OceanaGold had a solid year when considering inclement weather across its portfolio, but has another high-cost year on deck with increased sustaining capital, the impact of a full year of inflationary pressures, and the recent hiccup at Macraes. However, after getting past this year, the company should see one of the more significant portfolio improvements sector-wide, similar to what has allowed Alamos Gold (AGI) to outperform its peers. This is based on a combination of growth and significant margin improvement, with an FY2025 goal of ~600,000 ounces at $1,175/oz, translating to a ~60% increase in AISC margins assuming a conservative $1,800/oz gold price. For this reason, I see OCANF as a solid buy-the-dip candidate.

That said, I prefer to buy stocks when they’re hated and seeing significant selling pressure, and the time to buy OCANF was below US$1.60 when I noted it would move into a low-risk buy zone, not near US$2.25 when it’s up over 65% from its November lows. Instead, I see the better value currently being i-80 Gold (IAUX), a small-cap producer that has the potential to grow into a similar production profile (400,000 to 500,000 ounce producer) but with less than half the enterprise value, trading at less than 0.55x P/NAV, and with all of its future production in Tier-1 jurisdictions (Nevada). So, while I would become interested in OCANF if we were to see a sharp pullback, I continue to see better opportunities elsewhere for now.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.