Illegal Blockade Ends, Is Argonaut Gold (TSX:AR) Poised To Run?

Ralph Kettell III November 3, 2015

Share Price: $1.38 CAD
Market Cap: $215M CAD
Shares Outstanding: 155,350,000
52-Week Range: $1.14 – $3.14 CAD

Argonaut Gold is a Canadian gold producer that controls two operating mines, El Castillo and La Colorada, in Mexico. The company is on target to meet its production guidance for 2015, with an estimated output of 135,000 to 145,000 gold equivalent ounces (GEOs). Over the past few years, Argonaut Gold has achieved impressive growth in its production profile, increasing its total production from less than 30,000 ounces in 2009 to in excess of 125,000 ounces in 2014.

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Figure 1: Argonaut Gold’s annual gold production from 2009 – 2014.

In Q3 2015, Argonaut Gold completed a 220,000 square meter expansion of the heap leach pads at El Castillo and the company is also in the process of upping capacity at La Colorada. Based on these initiatives, the expectation is that El Castillo and La Colorada should be capable of reaching combined annual production levels of 150,000 – 180,000 gold equivalent ounces.

El Castillo and La Colorada have both been efficient and well-managed operations over the past few years. All-in sustaining costs at the two mines have averaged a bit over $900/oz. during the past few quarters, a figure that comes in well under the industry average. A blockade at El Castillo, initiated by local landowners in late October, briefly halted some operations at the mine; however, the parties quickly reached a satisfactory resolution. I do not anticipate any tangible impact on El Castillo’s Q4 production, nor am I concerned about future work stoppages.

Argonaut Gold’s master plan calls for the company to become a mid-tier gold producer, targeting annual output of 300,000 – 500,000 ounces. With three development projects in the pipeline, including the large scale Magino Project in Canada, the company would seem to be in prime position to fulfill this strategic objective. Unfortunately for Argonaut Gold, however, several events have conspired to make this objective untenable, at least in the near term.

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Figure 2: Argonaut Gold’s long-term production strategy. Source: Corporate presentation

The prolonged bear market in gold has hit Argonaut Gold’s share price particularly hard – it has fallen by nearly 80% just since the beginning of 2014. Large Capex projects, like Magino, have fallen especially out of favor with financiers and investors.

The Magino Project has a Capex exceeding $300M; simply put, it is too risky for Argonaut Gold to contemplate moving forward at Magino until market conditions improve. A joint venture arrangement is also highly unlikely – large cap miners find themselves saddled with unsustainable debt loads and ugly balance sheets. Their focus is squarely on retrenchment, not expansion. While the Magino Project alone could add 200,000 ounces per year of production to Argonaut Gold’s bottom line, it is unlikely to happen anytime soon.

The company’s other two development projects, both located in Mexico, are significantly smaller in scale and have much lower associated Capex projections.

The San Antonio Project was obtained in 2011 as part of Argonaut Gold’s $137M acquisition of Pediment Gold Corp. The La Colorada Project was also part of that deal, but San Antonio was considered to be the centerpiece of the acquisition.

San Antonio boasts highly favorable project economics, even in the current depressed gold price environment. A PEA released in 2012 on San Antonio estimated that the project would produce 85,000 ounces of gold annually over a 15-year mine life. The initial Capex required to develop San Antonio would be only $84M; moreover, AISC at the project are forecasted to be ultra-low, clocking in at under $650/oz.

Argonaut Gold originally envisioned having the San Antonio project in production by 2014, but the company has been stymied in that effort. Significant environmental concerns, mostly related to the potential contamination of the local water supply, prompted the regional government on Mexico’s Baja Peninsula to block permitting at San Antonio. Efforts by Argonaut Gold to have this decision overturned in court have failed.

There is some hope that development at San Antonio will eventually be allowed to proceed, but permitting has already been held up for more than two years. From Argonaut Gold’s perspective, this is most inopportune, as the San Antonio Project had the potential to increase the company’s gold production substantially and generate a lot of additional cash flow. Argonaut’s management team has suggested that once local elections take place later in 2015, some movement may begin to occur. Only time will tell.

With prospective development at Magino and San Antonio in a holding pattern, San Agustin is the lone development project in Argonaut Gold’s portfolio that could be slated to become a mine in the near future. Like San Antonio, San Agustin has robustly positive project economics and a relatively low initial Capex.

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Figure 3: Project economics and LOM plans for San Agustin and San Antonio. Source: Argonaut Gold Technical Reports

San Agustin is located just 12 km from the El Castillo Mine. Argonaut Gold views San Agustin as a highly synergistic extension to El Castillo – ample opportunity exists to share resources between the two sites, including buildings, mining equipment, and personnel.

There is no doubt that San Agustin will be a nice addition to Argonaut Gold’s stable of active mines. Unfortunately, however, developing San Agustin is not a game changer for the company, in the way that Magino and San Antonio would be. Bringing San Agustin online would give Argonaut Gold up to 50,000 ounces of additional annual output, far short of the 85,000 ounces that San Antonio would provide annually.

To make this distinction even more clear, let’s consider the after tax net present value (NPV) of the two projects. At a gold price of $1250, using a 5% discount rate, San Agustin has an after tax NPV of $81.6M; by comparison, at the same gold price and using an 8% discount rate, San Antonio has an after tax NPV of $206M.

It had been expected that Argonaut’s management team would make a formal decision on whether to proceed with development at San Agustin by the end of 2015, but it appears that timeline may have shifted. The company is looking to incorporate newer drill results into a revised resource calculation that could expand the project’s overall resource potential. CEO Pete Dougherty has said that he expects that it may take 6-9 months to permit the San Agustin project and an additional 7 months to complete the construction of a mine. Mid-2017 seems like a realistic target date for production at San Agustin to commence.


The preceding analysis was not meant to be a takedown of Argonaut Gold; on the contrary, Argonaut Gold has proven to be one of the stronger companies operating in an unforgiving gold market. Alas, management was thrown an unexpected curve ball at San Antonio, and that has made it substantially more difficult for the company to achieve its objective of becoming a mid-tier gold producer.

Argonaut Gold should have strong potential upside moving forward. The company’s stock price has shed 80% of its value since the beginning of 2014 and is down even more from its peak of over $10 per share. Furthermore, Argonaut Gold’s market capitalization of roughly $210M today is well below the $341M it paid just to acquire the Magino Project in 2013, through its takeover of Prodigy Gold.

The company’s balance sheet is in good shape, with $44M in cash and cash equivalents and only a nominal amount of debt. Developing the San Agustin Project should be quite doable, using a combination of the company’s free cash flow and a small amount of debt or equity financing.

There are strong fundamentals in place, but Argonaut Gold needs to develop a clearer strategy going forward. The company has successfully navigated its way to becoming a nearly 150,000 ounce per year gold producer – no small feat. In fact, it appeared that Argonaut was well on its way to achieving its goal of becoming a mid-tier producer back in 2013. Today, however, there is much more uncertainty as to whether that goal can be met in a reasonable timeframe. Much hinges on the fate of San Antonio.

I am taking a wait and see approach with Argonaut Gold. For now, I believe there are several companies that have an easier path to join the global ranks of mid-tier gold producers. These include two Australian miners, Newmarket Gold and Perseus Mining. I will be reviewing those opportunities in the near future. Stay tuned.

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