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Dynacor Gold - The Numbers Don't Lie And A Re-Rating Will Follow Soon
Jun. 3, 2014
The Investment Doctor
SeekingAlpha.com
Disclosure: I am long DNGDF. (More...)
Summary
* Dynacor Gold should be seen as a services provider and not as a mining company.
* Dynacor expects to expand its operation base by 160% before the end of this year, and by 300% within the next 36 months.
* Using a conservative starting point, the NPV8% of Dynacor's toll milling business is $3.78/share.
* Additionally, Dynacor has a net cash position of almost $20M which increases daily.
Introduction
In this article I'll have a closer look at Dynacor Gold (OTC:DNGDF) which is quite a special company. Instead of mining gold, the company is actually a services provider as it does not operate its own mine, but allows smaller miners to use Dynacor's mill to process their ore. I will explain why this company should be valued as a services provider and not as an exploration company.
The volume on the US exchange isn't too bad with 11,000 shares per day, but I'd still recommend to trade in shares of Dynacor Gold through the facilities of the Toronto Stock exchange where the company is listed with DNG as its ticker symbol. The average daily dollar volume there is approximately $60,000.
As always, all images in this article were directly taken from the company's website, press releases, technical reports and presentations. As Dynacor is a Canadian company I have - where applicable - recalculated all amounts from CAD into USD using an USD/CAD exchange rate of 1.08.
What is toll milling and what are the advantages and risks?
Alright, let's start by explaining what toll milling actually is. A toll milling company is a company which owns a mill and processes mineralized ore from third parties which don't have their own processing facility and thus need to rely on third-party operated mills like Dynacor's mill. Dynacor purchases the mineralized ore and processes it to end up with gold and silver as end-product, which the company then sells.
So who are Dynacor's suppliers of ore? Those are usually artisanal miners which produce a limited amount of tonnes per day and don't have their own processing facilities as it wouldn't be efficient to have a mill with a throughput of just a few tonnes per day. And when I say 'artisanal miners,' I really mean those are 'mom and pop' type of operations where a father and his sons are recovering ore.
Why are these people selling to toll mill operators? There's a straightforward answer (actually there are several reasons) to this question as well. First of all, artisanal miners don't have their own processing facilities and it wouldn't make sense for them to build one, because their output is so low. Would it be a good idea to 'pool together' with a few fellow miners? Probably, yes. But don't forget most of these people aren't too keen on taking the responsibility of operating a mill (and I don't mean this in a negative way. Miners are miners and can't always be familiar with (legal and administrative) procedures inherent to owning and operating a mill). Additionally, if the paperwork of the mill hasn't been filed correctly, the facility will be destroyed and the owners/operators could be sentenced to 20 years in jail. That's not really a risk those artisanal miners are willing to take.
Secondly, a professionally managed processing facility should obtain higher recovery rates than small-scale plants. This is confirmed by seeing Dynacor Gold's recovery rate which is consistently around 95%. This means that Dynacor's plant is very efficient, and it definitely makes sense for the artisanal miners to use an efficient plant with a recovery rate of 95% instead of trying it themselves, reaching a recovery rate of 60% and facing 20 years in jail.
I have now highlighted the advantages for the artisanal miners, but what's Dynacor's main advantage? Well first of all, it isn't really subject to the price of gold. Should the gold price go down to $1000/oz, its margins will obviously be lower, but the company won't go out of business. Additionally, by operating just a mill, it doesn't get involved in the (very) capital-intensive mining business and as such doesn't have huge operational risks. These three reasons make it very attractive to have a closer look at a toll milling company to capture benefits from the mining sector.
Are there risks? Of course there are. As said, should the gold price go down, Dynacor's margins will be lower. Should the gold price go up, Dynacor shareholders won't benefit as much from a price rise compared to gold miners. Additionally, there's always a legislative risk even though the company has been toll milling in Peru for several years now. As you can see, Dynacor's business isn't very exciting, the company mainly is just a boring 'services provider.'
Another key factor Dynacor will have to take into consideration is that it will have to make sure it continues to purchase the ore from legal miners, as acquiring ore from illegal mines would result in an immediate shutdown of the mill. And a shutdown is actually an understatement, because as you can see later in this article, the Peruvian army is using illegal mills to practice with explosive devices, so Dynacor would be pretty stupid to risk everything it has by buying illegal ore.
The fact that the company is doing everything legally can be found in the statement the company is allowed to export the gold from Peru again after a thorough check from the government where the ore was sourced from, which would not have been the case if the gold was derived from 'suspicious' ore. As Dynacor has now also promised to buy the ore from a list of miners/mining companies approved by the government, I dare to say the risk of Dynacor 'accidentally' buying illegal ore is reduced to practically zero as it will be able to prove it bought the ore from operations which were undeniably approved by the government.
How does Dynacor Gold make its money?
Okay, let's now see how Dynacor generates its cash flow. First of all, it purchases mineralized ore from the artisanal miners. Milling doesn't happen for free, and Dynacor charges a fee per processed tonne of ore, and probably also charges extra for the use of chemicals et cetera. Through grade control, Dynacor is able to effectively estimate the gold and silver content in the ore, and pays a percentage of the face value after deducting an allowance based on the expected recovery rate.
By paying a discounted value of the ore (which is a common business practice), Dynacor is actively taking steps to mitigate the gold price risk, in order to be covered against short-term price volatility.
The recent crackdown on illegal mining in Peru - good news for Dynacor Gold, but what's Peru's end game?
The reason why the toll milling business in Peru is receiving more attention than before is caused by the fact the Peruvian government is coming down hard on illegal mining activities in the country. And as actions speak louder than words do, the Peruvian army regularly raids illegal mining and milling activities, and destroys the illegal operating plants.
This means that the legal Peruvian miners have less possibilities to process the ore at illegal plants, so the government is actually helping the legal milling companies to strengthen its position in the country. Unfortunately this also had a negative impact on Dynacor, as it had to cease production for about a month until some details were clarified. This was an unfortunate event, but I think it will be a non-recurring event, given the situation was resolved quite fast.
So what's Peru's long-term plan? As the government seems to be very serious about formalizing the mining activities in the country and end the illegal mining and milling activities, that there are plans for a bigger end game. As a lot of these artisanal miners don't pay (enough) taxes, I think we are evolving to a scenario whereby the toll mill will already levy an 'anticipative' tax on the artisanal miners. This would create a quadruple win-situation; official milling companies get the support from the government, illegal mining will be stopped, the artisanal miners can now 'come clean,' and the government receives the taxes it's owed.
So if this is a fantastic business model, why aren't there more companies entering the scene?
I don't want to be a party-pooper, but recently at least two other small Canadian companies have entered Peru and are aiming to start up their own toll milling businesses, meaning Dynacor will face some competition in the near future.
But I'm not really scared, because the Peruvian pie is large enough to share with several others. On top of that, Dynacor has been working in Peru for quite a while and probably has the necessary relationships to attract more ore for its new facilities. So whilst at first sight it might look like the competition will destroy Dynacor's first mover advantage, I'm not worried at all, because after all, most of these milling facilities will remain limited to just a few hundred tonnes a day, which is peanuts. Additionally, as I explained in the previous paragraph, a lot of currently operating mills were destroyed by the government during raids against illegal milling. This means that there will most definitely be a demand for new (legal!) milling capacity, so I personally expect new entrants in this space just to replace old (illegal) processing facilities so that there won't be a change in the supply/demand equilibrium. The Peruvian small-scale mining sector is huge, and there's room for a lot of additional capacity without disturbing the pricing mechanism.
This all sounds nice, but what's the value of Dynacor's toll milling business?
As the company should be seen as a services provider and not as a mining company, you can't really determine its fair value by calculating an NPV on a pre-determined mine life, which is the case with 'real' mining companies.
A first question you'd have to ask yourselves is 'is its revenue model perpetual?' The answer to this question actually isn't that simple. Whilst one would be quick to say 'yes, it's perpetual as it's a service providing company,' one has to look at the underlying type of business, and mines (even the artisanal ones) have per definition a finite mine life. Does this mean Dynacor's revenue model also has an end date? Yes, but as I expect the smaller mines to be up and running for the next few decades, I will assume Dynacor's business model has an infinite (well, 'quasi-infinite' would be a better description) life expectancy, so I can use the formula (net cash flow / discount rate) to determine the fair value.
Let's dig in the company's financial statements. In 2013, Dynacor generated an operating cash flow of $10.3M and will have spent approximately $1M in sustaining capital expenditures (note: I don't add expansion capex to the equation as that wouldn't be fair, considering expansion capex usually are non-recurring and one-time events). Allow me to be conservative and apply an additional 20% discount to this number (to take a gold price fluctuation and possible higher taxes into consideration). This results in an after tax net cashflow of roughly $7M per year in a very conservative scenario.
As you all know, the formula to calculate the NPV of a perpetual revenue model is (net cash flow / discount rate). If I'd use a discount rate of 8% (because it's a proven business model which has been operating in the past few years without any issues), the fair value for the current toll mill operation would be $88M.
However, that's just the current situation. The company was producing at a rate of 230 tonnes per day, and expects to increase this throughput to 300 tonnes per day (+25%) and to achieve a run rate of 600 tonnes per day at its new facility in Chala (which should be up and running at 300 tonnes per day within a year).
So the production rate should increase by an astonishing 160% later this year which will obviously have a huge impact on the operating cash flow as well. Even if I'd be very conservative and let the cash flow increase by just 100% (to err on the safe side), Dynacor should have a net operating cash flow of roughly $15M by the end of this year. If I'd once again try to determine the fair value by using a discount rate of 8%, both the Chala and Huanca mill will have an NPV8% of $188M, based on a production rate of 600 tonnes per day. Keep in mind this production rate will very likely be increased further down the road but I'm not taking that into consideration right now.
If I'd now use a ratio of 50/50 for both scenario's (again, to be on the conservative side, as there's no doubt the company should be at a run rate of 600 tonnes per day by the end of this year), the toll milling business should be valued at $138M.
Source: financial statements
If this already sounds exciting (again, my assumptions are quite conservative!), don't forget to add the net cash value to the equation, as the company had a net cash position (here: current assets + deferred tax assets - total liabilities) of $17.6M (and a net working capital position of $17.8M, see previous image), resulting in a total fair value of $155M for Dynacor Gold.
And oh, I didn't even take the Tumipampa exploration asset into account, where a maiden NI43-compliant resource estimate is expected later this year.
Investment thesis
Dynacor Gold should see its processing capacity increase by 160% by the end of this year, and this will have huge consequences for the free cash flow of the company and should result in a re-valuation of the share price by the market.
I have established a fair value of $155M for Dynacor Gold, which results in a fair value of $4.24/share, which is 173% higher compared to the last closing price of $1.55. Even though the share price has tripled in 18 months time, it's not too late to get in, as you're investing in a company with a proven business model and management team, backed by $0.49/share in positive working capital. Throw in an expected 160% production increase by the end of this year and a 300% increase within the next 2-3 years, and this company might very well be one of the best growth-stories in the mining sector. Additionally, you get the exploration upside from Tumipampa thrown in for free.
Even though the company isn't paying a dividend right now, income investors should also put Dynacor on their radar, as the company wants to become a dividend payer down the road. If Dynacor would pay out just 1/3rd of its net annual cash flow at 600 tonnes per day, the annual dividend would be $0.12/year for a yield of 8.4%.
Editor's Note: This article covers a stock trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.
http://seekingalpha.com/article/2250173-dynacor-gold-the-numbers-dont-lie-and-a-re-rating-will-follow-soon
Dynacor: My Top Overall Stock Pick For 2014
Nov 24 2013
Steve Nicastro
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in OTC:DNGDF over the next 72 hours. (More...)
Dynacor Gold (OTC:DNGDF) remains one of the most undervalued, unknown companies in the gold sector, but I think investors are slowly starting to catch on to the story.
I first wrote about Dynacor in an article on Sept. 5 when the shares traded at $1.42. Since then, Dynacor reported outstanding Q4 earnings results and the shares have rocketed higher to $1.68 a share, outperforming nearly every other gold stock on the market.
Still, Dynacor remains an incredible value and several key catalysts await which could send shares even higher. Dynacor is my top pick among the gold sector in 2014 and I will try to convince investors below.
Company Information
Dynacor has 36,316,111 shares outstanding. With a current share price of $1.62, the company has a market cap of $58.69 million. The company had cash on hand of $10.3 million at the end of the quarter and virtually no debt, so Dynacor has a current enterprise value of about $48 million.
The 52-week range for the share price is $.82 - $1.67. Average trading volume on the OTC markets is 8,575, which means the stock is very thinly traded. On the TSX, the stock trades under DNG.TO, and volume is higher at 42,650.
Dynacor is Outperforming the Market; Technicals Remain Bullish
You will see in this chart below that shares of Dynacor are up 30 percent on the year. Meanwhile the (GDX) Gold Miners Index is down 50 percent and the (GLDX) Gold Explorers Index is down around 70 percent.
(click to enlarge)
However, I expect even greater things in 2014.
Dynacor: Why Is It Outperforming?
It is difficult to call Dynacor a gold stock because the company isn't a miner or pure explorer - one part of their business is exploring for gold, while the core of the business is ore processing.
Dynacor owns and operates a successful gold ore processing plant in Peru. The company receives ore from local miners and gets to choose which ore to process, allowing the company to pick the highest grade ore they can find.
Higher gold prices generally lead to higher margins in the ore processing business for Dynacor. However, while lower gold prices means lower margins, the company remains profitable, even at $1,250 gold as we saw in the most recent quarter.
Here are a few reasons why Dynacor is outperforming the market:
#1 Positive Quarterly Results, But Bigger Things to Come
Dynacor reported some pretty impressive results for the last quarter:
- The company announced operating income of $4.6 million and net income of $3.0 million ($.08 a share) for the quarter.
- The company recorded record quarterly gold sales of 20,598 ounces.
- Cash gross operating margin per ounce of gold sold was $285 ($1,320 per ounce selling price), which proves that the business model works in any gold environment. The margin sold in Q3 2012 was $331 per ounce, as higher gold prices leads to a higher margin.
- Cash on hand of $10.3 M at quarter end compared to $3.3 M at December 31, 2012.
(click to enlarge)
Update on New Mill
The company is currently producing around 20,000 of gold per quarter at its ore processing division in Huanca. However, the company is currently constructing a new mill at Chala, Peru, which will have an initial capacity of 300 tpd and be readily expandable to 600 tpd.
The new mill will cost approximately $10 million to construct and it is very likely that the company will fund the remaining construction of the new mill with cash on hand.
This new mill should allow the company to process 25,000 ounces per quarter; with an expansion to 600 tpd, they could be producing as much as 32,500 ounces per quarter. However, the company should also be producing the gold at lower costs due to brand new equipment and a decrease in electricity costs as the company will be connected to the power grid in Chala.
Construction is underway and the only permit that the company still needs is a permit for the actual mill itself. However, the company expects to receive this permit sometime in the next few months and since they have received permits for construction, the building of the new plant is already well underway. The company is still aiming to test the new plant in Q2 2014, with the new plant commissioned and in operation by mid-2014.
An upgrade to 450 TPD will take place shortly after. At 450 TPD, the company expects to produce 25,000 ounces of gold per quarter. With a gross margin of $300 per ounce, which should be attainable even at current gold prices, the company would record cash flow of $5-7 million per quarter; with a plant upgrade to 600 TPD, the profits could be even greater.
Of course, if the price of gold were to go higher, margins would also increase. In 2012, full year margins were $317 an ounce, up from this previous quarter's $280 an ounce. With the new mill's efficiency, margins should be even greater. If Dynacor were to record a gross margin of $350 an ounce and produce more than 100,000 ounces of gold from Chala, the results could be phenomenal.
#2 Non-Dilutive Company
Dynacor prides itself on being a non-dilutive gold company. The company has only 36 million shares outstanding and this share count has remained steady over the years.
Dilution has been a huge problem for many junior gold mining companies in this market. Many junior gold miners developing a project or trying to get into production have had to deal with cost overruns and other issues, with many having to take on debt or issue millions of shares at depressed share prices.
Next, many exploration companies simply have to issue equity to continue exploration. This is simply the nature of their business model.
However, Dynacor does not have this problem as they are self-financed with their profitable ore-processing business. This is a huge plus for shareholders, especially since the company will most likely not have to take on debt or issue equity to finish construction at the new mill.
#3 Big Upside Remains at Tumipampa With Drill Results Coming
Dynacor has a $2.8 million drilling and exploration program underway on its flagship copper and gold exploration property, Tumipampa, located on the Andahualas-Yauri Belt in Peru. This gold belt hosts a number of gold-silver-copper skarn deposits such as Las Bambas, Los Chancas, Constancia, etc.
Tumipampa is surrounded by 6 senior mining companies who have invested over $8 billion in mine development in this region as you'll see below.
(click to enlarge)
Again, this exploration drilling is auto-financed through the company's ore processing division. It is a huge plus that Dynacor does not have to go to the market to issue shares to explore the property.
Some investors might argue that Dynacor should focus solely on their ore processing business. After all, exploration does cost money.
However, the Tumipampa property has the type of home-run potential that can't be ignored by investors and I believe the company is making the right choice by actively exploring the property.
The company reported positive drill results in a Sept. 27 news release:
"During the months of July and August, six (6) holes were drilled HDD7- HDD12. Drill hole HDD8 intercepted the Avelia Ines vein and returned 4.767 g/t Au and 0.2% Cu over 1.1m and drill holes HDD9 and HDD10 revealed close to the surface disseminated gold mineralization with 0.457 g/t Au over 12.4 m and 0.151 g/t Au over 12.2 m."
"This new discovery demonstrates that gold mineralization is very widespread on the Tumipampa property and can be found: (A) associated to polymetallic ores in the skarn, (B) in high grade gold vein structures such as the Manto Dorado, and (C) as low grade disseminated gold in pyritic ore associated to brecciated quartz. As shown by drill holes HDD9 and HDD10 disseminated gold ore is found very close to the surface from depths of 20.0 and 14.8m, respectively."
Meanwhile, underground drilling from within the cross-cut began in August and drill results should be coming in soon. An initial resource estimate is to be expected early 2014. I think that the most likely long-term outcome for Tumipampa is Dynacor finding a partner for the property to get it through to production.
The company could also sell the property completely or try to get it into production itself, and perhaps use its own mill to process the gold.
Dividend Discussion is on the Table
I recently brought up the idea of a dividend to Dale Nejmeldeen, Investor Relations at Dynacor. I argued that this could be a great way to get the shares trading somewhere near a reasonable price. He replied shortly after and said that a dividend will definitely be on the table.
If you do the math, it would not take much money for Dynacor to pay a very decent sized dividend, since the company only has 36 million shares outstanding and is producing robust amounts of cash flow.
For example, in the most recent quarter, Dynacor reported cash flow from operating activities before change in working capital items of $3.5 million, or $14 million on an annual basis. If the company can increase this to $5 million a quarter, which I feel is attainable with the new mill, we are looking at $20 million cash flow annually.
If the company paid out just 30 percent of its cash flow in dividends, it would amount to $6 million in dividends paid for the year. This would amount to dividends paid per share of $.166.
At the current share price of $1.68, this would amount to a dividend yield of 9.9 percent.
Even if the company decided to pay just $2 million per year in dividends or .055 per share, this would still result in a dividend yield of 3.3 percent! At the same time, I believe the company would still have enough money to explore its property at Tumipampa, even under both scenarios.
This is one huge benefit to investing in a non-dilutive, profitable company like Dynacor. I would not be shocked to see Dynacor start paying a small dividend in late 2014 or early 2015 as the company expands its new mill to 600 TPD and actively explores its Tumipampa property.
Bottom Line? My Top Overall Stock Pick for 2014
Dynacor is not only my top gold stock for 2014, but it's my top overall pick. To summarize:
VALUE: Dynacor has a current enterprise value of $48.39 million; meanwhile, the company is generating positive cash flow of $3 million per quarter at their current operations, or $12 million annually. This gives the company an EV/cash flow ratio of just 4.1.
The company also boasts a return on equity of 49 percent, among the highest in the industry. With the new plant online in 2014, profits should only increase. Even if the new plant were to somehow not work out, the company is still running a very profitable operation at Huanca.
LOWER-RISK: Dynacor is one of the lowest-risk microcap stocks I've ever seen. The company has made a name for itself as an honest and reliable business partner in Peru. The company has a very solid balance sheet with very little debt and $10 million in cash, with working capital of $14 million.
KEY CATALYSTS IN 2014: The company has begun construction at its new mill at Chala, which will start at 300 TPD but upgrade to 600 TPD with lower operating costs. Construction is ongoing and the only permit that remains outstanding is the permit for the actual mill. The company says the permit should be coming in very shortly and there is no reason for the delay; the fact that they have begun construction without this final permit tells me that they believe they will receive it without any problem.
Meanwhile, the company's exploration property has a ton of upside potential and can be seen as a "bonus" for investors. I want to emphasis again that the Tumipampa project is surrounded by 6 senior mining companies who have invested over $8 billion in mine development in this region. It should be very interesting to see the upcoming drill results.
However, even without this exploration property which holds big upside in my view, and even without the new mill at Chala, Dynacor is still a solid buy.
The exploration property holds a tremendous amount of upside potential and the company has several options for the property going forward. The company will continue to drill and come out with the first resource estimate; several drill results are pending and should be released to the market shortly.
Dynacor has risen more than 20 percent since my first article but still remains very undervalued. The company has a number of key catalysts coming, which is why I've ranked the stock my top overall pick for 2014.
http://seekingalpha.com/article/1859931-dynacor-my-top-overall-stock-pick-for-2014?source=email_rt_article_readmore
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