The Q2 Earnings Season for the Gold Miners Index (GDX) has finally come to an end and one of the last companies to report its results was Teranga Gold (OTCQX:TGCDF). While the majority of the sector was busy revising guidance lower and struggling with impacted operations, Teranga Gold has had an incredible start to FY2020. Not only has the company seen a better-than-expected ramp-up at its newest Wahgnion Mine, but also Sabodala is set to be transformed by being combined with the Massawa acquisition. Based on the company’s organic growth potential as Sabodala-Massawa Gold Complex [SMGC] ramps up and the potential for added production long term from the Golden Hill, I have moved the stock up to rank #3 among African gold producers. Therefore, I would view any pullbacks below C$12.60 as low-risk buying opportunities.
Teranga Gold released its Q2 results in mid-August and reported quarterly gold production of 89,000 ounces, up 40% from the year-ago period. The significant increase in production year over year was attributed to the company’s newest Wahgnion Mine moving to commercial production in Q4, offset by a weaker quarter at Sabodala due to lower head grades. This solid performance helped Teranga to generate record revenue of $164.2 million, up 96% year over year. This is one of the strongest revenue growth rates in the sector for large gold producers, only slightly behind Kirkland Lake Gold’s (KL) 107% revenue growth due to the addition of Detour Lake. However, the quarter’s biggest news was the SMGC economics, with expected average annual gold production of over 380,000 ounces. Let’s take a closer look at the quarter below:
As we can see from the chart above, Teranga Gold has not been materially affected by the COVID-19 headwinds, with quarterly gold production down just over 2% sequentially, but mostly in line with the previous two quarters. The culprit for the slightly weaker performance was the company’s flagship Sabodala Mine where gold production was down 28% year over year due to both lower grades and slightly lower throughput. During the quarter, Sabodala processed ~1.05 million tonnes, a slight decrease from ~1.08 million tonnes processed in the previous quarter. However, head grades fell by 24% to 1.53 grams per tonne gold, while recovery rates also slipped 190 basis points. This led to a considerable drop in production to just 44,677 ounces, and we saw all-in sustaining costs climb over 20% to $976/oz due to the lower gold sales. The good news is that this soft quarter is not representative of what gold production will look like in the future.
For starters, mining in Q2 was slightly affected by fatigue management protocols, which resulted in lower hours worked. This was not helped by the fact that Teranga burned through the higher-grade Gora stockpiles. Meanwhile, as noted by Teranga, the company began mining Sofia in July and used some of its shovels and excavators in Q2 to help with constructing a haul road to Sofia. Therefore, we should see much higher grades going forward as Sofia is one of the highest-grade deposits at Massawa, and the most significant headwind to operations in Q2 was grades. In fact, milled head grades are expected to increase by over 80% in FY2021 based on the mine plan (~2.90 grams per tonne gold). Therefore, while some investors might be scratching their heads at a near $1.9 billion valuation for a ~ 400,000 ounce producer, it’s important to note that Sabodala’s production should increase 40% to 360,000 ounces with the integration of Massawa next year.
Moving over to Wahgnion, it was an exceptional second quarter since commercial production was announced with ~ 43,200 ounces produced, down just over 10% from the ~ 51,300 ounces produced in Q1 2020. While this might not look all that impressive on the surface, the mine saw record throughput of 911,000 tonnes in the quarter, and the weaker production was a direct result of lower head grades. Therefore, if not for the lower head grades (1.57 grams per tonne gold vs. 1.87 grams per tonne gold), this would have been a record quarter across the board for Wahgnion. As noted by Teranga, ore tonnes milled was 36% higher than expected in Q2 due to higher leach kinetics, which allowed for de-bottlenecking to aid with higher throughput rates. Meanwhile, a higher oxide to fresh blend being fed to the mill helped deliver the record throughput that’s well above nameplate capacity. Based on the solid operating metrics, the company has increased its guidance to 157,000 ounces at the midpoint for Wahgnion at all-in sustaining costs of $950/oz.
If we take a closer look at the results in the chart above, we can see that while cost of sales came in at a new 2-year high in the quarter at $1,142/oz, this was more than offset by the higher average realized gold price of $1,697/oz. This massive 30% jump in the gold price year over year ($1,697/oz vs. $1,302/oz) helped Teranga deliver record sales margins of $555/oz, an increase of 94% year over year. The good news is that while the increased margins directly resulted from the higher gold price, we should see a tailwind from the cost of sales in FY2021. This is because Sabodala is the largest contributor to production, and all-in sustaining costs are expected to drop below $700/oz next year. Therefore, I would not be surprised to see the cost of sales margins increase another 20% over the next year with a high single-digit tailwind from costs, and another 7% tailwind from the gold price assuming the metal stays above $1,800/oz.
Moving over to Teranga’s growth metrics, it was a massive quarter for the company as revenue hit a new all-time high of $164.2 million. As we can see in the chart above, revenue has been steadily increasing over the past two years, but the higher gold price and increased production were massive contributors in Q2. If we look ahead to Q3, we should see yet another record quarter given that the company had $36.3 million in unsold gold bullion inventory related to shipment timing, and is working with a record gold price in Q3. Therefore, it would not be surprising to see triple-digit revenue growth in Q3, given that the company is up against relatively easy year-over-year comps and is benefiting from gold held back in the previous quarter. Given that the sector’s average revenue growth rate is closer to 30%, these revenue growth rates for Teranga are outstanding.
Some investors might still be scratching their heads over the current valuation as we’ve got a Tier-3 jurisdiction gold producer trading at a $1.9 billion valuation with less than 390,000 ounces of annual gold production based on FY2020 guidance. While this is true, the above chart should explain the hefty premium here, as Teranga is undergoing a massive transformation on the back of its Massawa acquisition last year. As shown above, Teranga is set to grow from a ~ 385,000 ounce producer to a ~ 533,000 producer almost overnight, with a significant decrease in all-in sustaining costs due to both economies of scale at SMGC and much higher-grade Massawa ore. Therefore, while the investment thesis for Teranga was previously a solid one, but nothing extraordinary, it’s since improved massively. Based on this, I have moved Teranga up to the #3 rank among African gold producers, from a previous position of #5.
Given the significant transformation Teranga is undergoing and the potential for a third asset in Golden Hill, there’s a lot to like about the story currently. Typically, I would recommend selling out the majority of a position after a 100% advance in twelve months, but I see Teranga Gold as a Hold here, despite the 109% return year to date. Ultimately, the company’s long reserve life, organic growth profile, and industry-leading costs make it a special situation in the sector for those comfortable with Tier-3 gold producers. Based on the strong investment thesis here and the company’s ability to continue to over-deliver on guidance, I would view any pullbacks below C$12.60 as opportunities to add exposure.
Disclosure: I am/we are long GLD, KL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: 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.
Originally published on Seeking Alpha