The definitive report on CGLD:
In a quest to uncover the best-of-the-best gold producing
stocks some simple analysis can help investors narrow
down the field. Knowing how a gold miner ranks in a handful
of high-level fundamental categories can reveal its position
when scrubbed up against its industry peers.
Does a miner produce its gold at a low cost from a longlife
project(s)? Does it have good management? Are its
financials under control? Does it have a growth strategy?
Provocatively these simple questions bring unfavorable answers
for a large number of gold miners. And like separating
the wheat from the chaff, this winnowing exercise is an
important step in separating the weak gold stocks from the
strong ones. The resulting pool is the best-of-the-best.
In this pool there is a wide spectrum of stocks that range
from the world’s biggest senior gold producers to micro-cap
junior producers making their small but important impact on
the gold mining industry. The larger miners seem to capture
the majority of mainstream attention not only because
of safety in numbers but economies of scale. When all their
projects are merged for collective operational performance
and risk, there is wiggle room on the individual mine level.
But the smaller miners are much more scrutinized, with
their success often riding on a single operation. With only
one mine, risk cannot be spread and this mine must have
stellar fundamentals. One major flaw and a junior cannot
hold weight in this pool of elites. But if a junior does qualify
with excellent across-the-board fundamentals, its stock has
just as much if not more promise than the seniors.
One such junior that makes this pool of elites is Capital
Gold. And like Minefinders and Alamos, Capital Gold’s success
rides on a single operation. The El Chanate mine in
Sonora, Mexico is a low-cost and long-life operation, Capital
Gold has excellent management and financials, and it has
incredible growth potential. These high-level fundamentals
rank CGLD as one of the best-of-the-best gold stocks. Now
it’s just a matter of convincing the rest of the markets.
I say this because Capital Gold is what I consider to be a
micro-cap junior producer. Even though its market cap is
well less than $100m and it is not very liquid from a daily
capital-flow perspective, I believe this stock is one of the
most undervalued in the entire gold mining industry. There
is vast potential for investors to capitalize on Capital Gold.
CGLD has been around for over 25 years. Throughout
most of its history it was known as Leadville Mining and Milling
Corp, focusing on a prolific gold mining district in the
Rocky Mountains. But its pivotal move in 2001 to acquire
some Mexican mineral concessions is what put it on the
right path to becoming the profitable gold producer we see
today. When it realized its focus would shift from Colorado
to Mexico in 2003 it changed its name to Capital Gold.
The fashion in which Capital Gold was able to construct
its mine shows that it has a superior management team. El
Chanate was brought to life on time and within budget. And
CGLD has done a fine job staying aggressive with exploration
as seen by El Chanate’s growing reserves. Ultimately
even though this mine is smaller-scale, it is very profitable
and has immense growth potential. Once the word gets out
on CGLD its shares should soar from the current levels.
Mining Operations
El Chanate Location: Sonora, Mexico
2008 Production ~50k oz Average Gold Grade 0.7 g/t
Gold Reserves 832k oz Mine Life Remaining 11+ yrs
El Chanate resides within what is known as the Golden
Triangle of the Sierra Madre gold belt. Such operations as
Mulatos (Alamos Gold), Dolores (Minefinders), Ocampo
(Gammon), and La Herradura (Peñoles) show the strength
of the gold reserves in this region. Even the area specific to
El Chanate has seen small-scale gold mining since the early
1800s, shown by old mine workings scattered about.
El Chanate saw its first modern exploration, in search for
copper, in the late 1960s by a subsidiary of Phelps Dodge.
Over the next 30 or so years the ownership of the El Chanate
mineral concessions changed hands several times and
had undergone a number of exploration programs that returned
mixed results. But with a little due diligence conveying
a lot promise at the prospective El Chanate deposit,
Capital Gold had the confidence to make its 2001 move.
Capital Gold signed an agreement with then-owner AngloGold
Ashanti to acquire 100% of the concessions that
contained El Chanate in exchange for $50k in cash, a scaling
net smelter return (NSR) of 2% to 4%, and a net profits
interest (NPI) of 10%. AU was also granted a one-time option
to purchase 51% of El Chanate if the deposit ever exceeded
2m ozs of contained gold. If the option was exercised
it would have to pay CGLD 2x the total project costs.
Once the deal was finalized Capital Gold immediately
initiated an exploration campaign that led to a late 2002
scoping study. Positive results from this study then prompted
a 2003 feasibility study that was optimized in late 2005.
This study revealed spectacular economics and led to a
construction decision, of which activities commenced in Q2
2006. The original mining plan anticipated annual gold production
of about 48k to 50k ozs over a 5-year mining life.
This $18m project built an open-pit heap-leach operation
that was finished by mid-2007 and was ramped up to full
commercial production by the end of the year. Incredibly
this mine was completed on time and within budget, a rarity
in the mining industry. Even better was in concert with development,
ongoing exploration greatly added to El Chanate’s
luster. Gold reserves would more than double!
In order to capitalize on this increase in reserves, Capital
Gold knew it would need to radically alter El Chanate’s mining
plan. Now without any changes to the existing infrastructure
it was able to increase plant throughput to operate
at a rate of 60k ozs per annum. Then with a modest $4m
capex CGLD has been able to expand the leach pad and
make improvements at the processing plant. With this expansion
about complete El Chanate should be operating at
a production capacity of 70k ozs per annum in 2009.
But even with all this excitement the prospects are looking
even better for El Chanate. First was the July 2008 announcement
that AngloGold Ashanti elected to not exercise
its option to acquire a 51% interest in this mine. Since AU
would have to pay twice every single dollar that CGLD
spent on El Chanate, it was looking at a bill of around $90m.
Perhaps in times past AU would have pulled the trigger on
this option, but $90m was not in its budget this summer.
Also exciting at El Chanate is the potential to yet again
increase its gold reserves. The rich mineralization at this
deposit should be amenable to much more reserves than
the 800k+ ozs already defined. A recently initiated deep
drilling campaign and additional lab work is expected to upgrade
a big chunk of the 1m+ ozs that currently reside in the
resources categories. And with this deposit open to the
east and at depth, total resources should continue to grow.
With resources growing so fast Capital Gold is obviously
looking at further expansions to increase El Chanate’s gold
production. And it has taken the next step with its recent
order of a secondary crusher that could increase production
volume by up to 30%. And the recent ordering of this
crusher will not likely be the last of CGLD’s innovative expansionary
plans in the coming years. Capital Gold is striving
to grow El Chanate into a mid-tier mining operation.
And it has every incentive to do so. In its first fiscal year
(YE July) of operations cash costs were under $250/oz (excluding
royalties). With these exceptionally low cash costs,
in the lower quartile of the entire industry, El Chanate is
long going to be a wildly profitable mining operation. So
with the depth and breadth of El Chanate continuing to impress,
the original mining plan has obviously been scrapped
for a much more robust operation. I expect this mine will be
producing gold for at least 10 years and possibly a lot more.
Financials
In order to fund the development of El Chanate, Capital
Gold performed equity and debt financings in 2006. The
equity financing came in the form of a private placement
that gave it gross proceeds of about $8.6m. This was then
followed by a debt financing of $12.5m. Unfortunately this
debt facility was laden with hedging requirements.
Often times hedging is a necessary evil that juniors must
accept in order to procure capital. And since Capital Gold is
in this report, I do not consider these hedges material nor
are they showstoppers. At first glance this hedge agreement
looks awful, with gold production sold forward at
$500/oz. But thankfully it is structured so the damage is
minimal. CGLD owns call options ($535/oz strike price) to
offset the forward sales, opting for a net cash settlement.
So basically every quarter until the hedgebook is closed
CGLD writes a check to the bank for the difference between
the calls and the forwards, $35/oz. With an 8k-oz-perquarter
commitment, this is the equivalent of $280k. Now if
this hedge was indefinite, this would be a major problem.
But as of its recent quarter end, there were only 67k ozs
remaining. And CGLD has indicated it will hedge no more.
By Q4 2010 this hedge book should be closed. So looking
at this hedge from a different angle, over the next 9
quarters Capital Gold has about half of its gold production
hedged at $35/oz under the spot price of gold. And measured
by the total reserves at El Chanate, only 8% are actually
hedged. This is not optimal, but it is not too bad either.
As a shareholder I can live with this small hedgebook.
Overall Capital Gold has a strong balance sheet. It does
still have about $7m remaining in long-term debt, but it also
has sufficient-enough cash to settle its debt and its hedgebook.
It obviously cannot do this as it must maintain liquidity
requirements, but Capital Gold’s healthy cash balance
from its growing cash flows puts it in a fantastic position.
This is evident with its ability to self-fund the capex requirements
of the El Chanate mine’s recent expansion project.
As for the royalty agreement Capital Gold is currently
writing those checks to Royal Gold. In February 2008 Royal
Gold purchased AngloGold’s El Chanate royalty. With the
gold price where it is today the NSR is 4%, capped at $17m,
and the NPI is 10% capped at $1m. Interestingly when
CGLD was looking for financing for El Chanate in 2006 it
was in advanced talks with RGLD for a royalty loan. Thankfully
it went with its current facility that will soon be paid off.
Two large royalties would not be good for the bottom line.
Looking at the revenue that Royal Gold reported from El
Chanate in Q3 2008, this royalty adds up to the equivalent
of about $62/oz. If this was added to the cash costs they
would still be around $300/oz. So far over $2m has been
paid under this royalty agreement and the NPI is just about
maxed. The life of El Chanate will well-outlive this royalty.
A couple of other notes on the financial front are Capital
Gold does have access to a $5m line of credit. I doubt it will
need this for anything other than an acquisition with its
strong cash flows, but just having the availability in this environment
is important. Also Capital Gold currently has
shareholder approval for a 1-for-4 to 1-for-6 reverse split.
The intent of this reverse split is to boost the share price in
excess of $2.00 in order to qualify for an AMEX listing.
An AMEX listing will give CGLD a lot more exposure in
the US markets, most importantly to institutional investors.
But considering the existing market environment CGLD has
decided to hold off on performing this reverse split until
there is a little more stability in the gold stock arena. When
this does happen it could be a nice boost for shareholders.
Summary
Market Cap $89m P/E Ratio 13.9
52-week Low $0.23 52-week High $0.95
US Exch-Symb OTC-CGLD CAN Exch-Symb TSX-CGC
Working Capital $13m Operating Mines 1
Devel. Projects 0 Explor. Projects NA
Gold Reserves 832k oz Gold Resources 1.1m oz
2008 Production ~50k oz 2009 Est. Prod. ~70k oz
Mkt. Cap./rez-oz $107 2008 Cash Costs ~$245/oz
The bottom line is even though measured by its market
cap Capital Gold ranks as one of the smallest junior gold
producers, it has some of the biggest potential of all the
gold stocks. CGLD’s impressive El Chanate mine has seen
incredible growth on the resource front with nearly 2m ozs
to date. With this massive cache CGLD has every incentive
to grow the mine from what was supposed to be a smallscale
short-life operation to a robust mid-tier gold mine.
Capital Gold has already altered El Chanate’s mining
plan to increase production by about 45% over the original
feasibility-study estimates. And I suspect it will continue to
reengineer and expand operations in the future to further
grow the production profile of this mine. Also a boon to
CGLD’s strength is its strong cash flows and very-low-cost
gold production. Because of this despite its remaining project-
loan debt and a small hedge, CGLD has solid financials.
With very profitable operations feeding a healthy cash
balance, Capital Gold is in an excellent position to expand
its portfolio via acquisitions. In this rough environment
many of the juniors in northern Mexico will not survive. And
CGLD is taking a close look at advanced gold projects in
the surrounding region that it could possibly acquire for
pennies on the dollar. In contrast I suspect that CGLD
would be a tempting target for larger miners looking for
quality operations. I hope it doesn’t sell-out this cheap.
