Best of Breed

[Tommy]

$DNGDF - Dynacor: My Top Overall Stock Pick For 2014

http://seekingalpha.com/article/1859931-dynacor-my-top-overall-stock-pick-for-2014?source=email_sto_edi_pic_4_4&ifp=0

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in OTC:DNGDF over the next 72 hours. (More...)

Editors' Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.

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)Credit: Yahoo! Finance

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 lead to a higher margin.

- Cash on hand of $10.3 million at quarter end compared to $3.3 million at December 31, 2012.

(click to enlarge)Credit: Dynacor Gold Corporate Presentation

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)Credit: Dynacor Gold Corporate Presentation

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.