Alamos Gold Stock: Weather the High Inflation Storm (NYSE: AGI)

The March CPI report showed US inflation rose 8.5% from a year earlier, the biggest 12-month increase since December 1981. Inflation index jumped 6.5%, the biggest 12-month change since August 1982.

Gold is one of the best assets to own when inflation is at its peak. According to the World Gold Council, based on year-over-year changes in the US CPI and LBMA gold price between 1971 and 2020, the average annual return for gold is approximately 27 % when the CPI is above 5% (i.e. high inflation).

While gold is a great asset to own now, gold mining stocks represent an even better way to survive and thrive in this high inflation environment.

One of my top gold mining stock picks is Alamos Gold (NYSE: AGI). For the following reasons.

1) Growth + leverage in the face of rising gold prices

Gold stocks offer on average 2 to 3 times leverage on rising gold prices. During the 2001-2011 bull market, the Gold Bugs Index (in blue) showed substantial leverage in the price of gold (in red). If production increases rapidly, the leverage is even greater. From its inception in 2003 until 2011, Alamos significantly outperformed the Gold Bugs Index, going from developer to growing producer.

After many years of stagnant production, growth is picking up for Alamos.

The Company currently has three producing mines, all located in favorable mining jurisdictions. Island Gold and Young-Davidson – both located in Canada – account for around 2/3 of production. Island Gold is quickly becoming one of the best gold mines in the world as grade and resources have increased significantly over the past 5-6 years. The Mulatos mine in Mexico completes the group. Alamos expects gold production of 440,000 to 480,000 ounces this year from the trio, with production increasing to 460,000 to 500,000 ounces in 2023 and then to just under 600,000 ounces in 2025 when Island Gold’s expansion is complete. There is still more potential (~75,000 ounces) in the Island Gold mine plan, and additional development opportunities at Mulatos could increase production even further. The Lynn Lake project in Canada represents another step change in production, if the company develops this asset.

2) Better insulated from inflation

The chart below shows production growth in more detail, but the multi-year cost forecast is also a major advantage for Alamos. Cost control is essential in this environment. For Alamos, it’s high-quality, low-cost growth that can ride out inflation. The company expects a temporary increase in all-in sustaining costs this year, but costs will trend down by around $100 per ounce in 2023 and 2024 as higher-grade ore from Mulatos is mined. in line. AISC drops precipitously in 2025 to just $800 an ounce as Island Gold’s high-grade mine ramps up production to over 200,000 ounces of gold (not including recent resource growth). Gold companies are not inflation proof, which is why it is important to buy miners who expect lower costs, as they will be able to offset inflationary pressures and at least to maintain their margins. While continued inflation may not allow AGI to meet its AISC target of $800 an ounce in 2025, if the mines meet production expectations, the company should see higher margins and lower costs relative to today.

The company is also well protected against inflation this year, as it actively hedged the majority of its exposure to the Canadian dollar and diesel (at rates 45% below current price) at its Canadian mines at the start of the year. year. These hedges showed a gain of $4.1 million in the first quarter of 2022.

Alamos is also less exposed to rising input costs (such as diesel) because Island Gold and Young Davidson are underground mines connected to the power grid.

3) A balance sheet built for growth and inflation

Alamos had $124.2 million in cash and no debt at the end of the first quarter of 2022. Maintaining a strong balance sheet has been a hallmark of the business since its inception. AGI is well placed to fund all of this growth internally through operating cash flow and its treasury. It will not need to go into considerable debt – and more expensive every day – which would weigh on its balance sheet.

4) Short term bullish catalyst will reverse recent underperformance

AGI is flat for the year while its peers are 10% higher on average. The main reason for the stock’s underperformance is that the Mulatos mine is experiencing lower-than-expected production and higher costs in the short term, which is pushing the AISC higher this year. Island Gold is also in a lower grade streak, with Q1 2022 expected to be the weakest quarter. The first half of the year will be tough, with AISC for the company well above $1,300 an ounce.

However, the cost increase at Mulatos is only temporary, as La Yaqui Grande – a satellite operation – will go live next quarter. Construction is 90% complete. When it reaches full production of 123,000 ounces per year, the AISC will drop to $578 per ounce. So expect a sharp turnaround in Mulatos starting next quarter with the rise of La Yaqui Grande. Alamos estimates that the AISC at Mulatos will drop $500 per ounce in the second half of 2022.

Grades mined at Island Gold are also expected to increase over the remainder of the year, which will positively impact production and costs.

5) Clear Value

On a historical basis, AGI is trading significantly below the valuation it commanded in the previous bull market – just 3.5x revenue and 8.5x operating cash flow, a steep discount to P ratios. /S and P/CF from 2007, and much cheaper than most S&P 500 companies.

Based on discounted cash flows, NPV of Island Gold and Young Davidson exceeds enterprise value by $2.95 billion:

• Island Gold had an after-tax (5%) NPV of nearly US$1.7 billion at current gold prices and an exchange rate of 0.75 CAD/USD in the 2020 Phase III study. Since then, reserves and resources have increased by 1.4 million ounces. An updated mining plan will be released this summer, and assuming a similar 80% resource conversion, this represents approximately 1.1 million additional ounces of gold. I would conservatively estimate that after-tax NPV increased to US$2.0-2.2 billion, and that takes into account 2020-2021 recognized cash flows and a $350 million increase in capital expenditures. investment (due to inflation and increased project scope).
• Young-Davidson is now at a stable state and generates $100 million in free cash flow per year. Assuming a 15-year mine life and similar free cash flow, the after-tax (5%) NPV is approximately $1 billion.

Investors get Mulatos, Lynn Lake, assets in Turkey and the incredible exploration potential of Island Gold for free.

The after-tax (5%) NPV of La Yaqui Grande is $260 million at $1,750 gold and over $300 million at today’s gold price. This assessment does not include other Mulatos reserves. Lynn Lake’s NPV was $290 million at $1,500 gold in the 2017 feasibility study. Since then, reserves have increased 27% to 2.1 million ounces.

6) AGI has experienced a deep correction, is oversold and technical data indicates a reversal

AGI was at $9.20 two weeks ago, but shares fell around 20% as the wider sector corrected. The dip to the $7.00 low last week was due to weak first-quarter earnings results. But stocks are hugely oversold and undervalued, and the company hit expectations last quarter, which is likely why AGI rebounded quickly. AGI is now back above key 200-day support; it seems that the technical data indicates that the correction is complete.

Risk

CapEx inflation at Island Gold is the biggest risk to the company. The 2020 CapEx growth estimate for the Phase III expansion was just over US$500 million, of which nearly US$100 million has been spent.

The expansion project mainly consists of the sinking of a shaft and certain improvements to the plant. The shaft and accelerated underground development represent more than half of the total cost. This is not an infrastructure-intensive surface project. As a result, I don’t believe inflation will affect Island Gold in the same way as built-from-scratch projects.

However, Phase III will be a larger project than before, given the increased reserves and resources, and there may be additional capital requirements.

I have adjusted for this risk, as I factored a substantial increase in CapEx into my NPV estimate for Island Gold, and do not factor in the increase in resource quality since the previous study which will somewhat offset the cost increase.

It should be noted that Alamos said in the Q1 2022 earnings press release that the updated study is: “should highlight a much more valuable operation.” This statement implies that the project overcomes the higher CapEx.