K92 Mining Inc. (TSX: KNT) is engaged in the production of gold, copper, and silver from the Kora deposit at the Kainantu Gold Mine in the Eastern Highlands province of Papua New Guinea, as well as exploration and development of mineral deposits in the immediate vicinity of the mine. The company declared commercial production from Kainantu in February 2018 and is in a strong financial position. The company commenced an expansion of the mine based on an updated Preliminary Economic Assessment on the property, which was published in January 2019 and updated in July 2020. K92 is operated by a team of mining company professionals with extensive international mine-building and operational experience.

Investment Rationale

• Revenue Soared in Q3FY20: K92 Mining recorded solid top-line growth in Q3FY20, largely attributed to increased production and higher realized gold prices versus the comparative period.

• Record Cash Position: The company posted a record cash position of USD 41.2 million on September 30, 2020, compared to USD 21.6 million on December 31, 2019. This was driven by a gigantic jump in net income to USD 9.3 million against the net loss reported a year-before period, a USD 12.84 million cash flow operating activities against a cash outflow of USD 2.6 million in the same quarter of the previous financial year, and a lower cash outflow from investing activities. 

• Negligible Balance Sheet Risk: The company has a very low debt contribution in its balance sheet, with a total debt/equity ratio of 0.05x against the industry average of 0.23x, with a strong coverage ratio above 30x at the end of the September quarter 2020.

Source: Refinitiv (Thomson Reuters)

• Industry Leading Margin Profile: The company delivered a robust quarterly result and outperformed the industry median on various margin parameters.

Source: Refinitiv (Thomson Reuters) 

• Technical Support at 200-day SMA: After a recent fall took place in K92 shares led by weakness in the gold prices in the international markets, the stock is taking support near its long-term support level of 200-day SMA and hovering above it for the past six trading sessions. Moreover, RSI is recovering from oversold territory, and 14-day RSI is crossing over the 30 hurdle zone, indicating a potential upside from the current trading levels.

Technical Chart (as on February 24^th, 2021). Source: Refinitiv (Thomson Reuters)

• Risk Associated with Investment: The company business is significantly exposed to the volatility in the gold prices. A sharp correction on the gold prices would have a weigh on the company’s margin, perfectibility and shareholder’s return. Further, a resurgence of COVID-19 cases could hamper the group’s production and mining operations as well.

Gold Industry Outlook for 2021

• Gold is likely to remain in the limelight in 2021: Many investors are concerned about the potential risks resulting from expanding budget deficits, which, combined with the low interest rate environment and growing money supply, may result in inflationary pressures. This concern is underscored by the fact that central banks, including the US Federal Reserve and European Central Bank, have signaled greater tolerance for inflation to be temporarily above their traditional target bands. Gold has historically performed well amid equity market pullbacks as well as high inflation. In years when inflation was higher than 3%, gold’s price increased 15% on average.
• Emerging markets economic recovery to benefit gold demand: Market surveys indicate that most economists expect growth to recover in 2021 from its dismal performance during 2020.  And although global economic growth is likely to remain anaemic relative to its full potential for some time, gold’s more stable price performance since mid-August may foster buying opportunities for consumers.  The economic recovery may particularly realize in countries like China, which suffered heavy losses in early 2020 before the spread of the pandemic was controlled more effectively than in many western countries. Given the positive link between economic growth and Chinese demand, we believe that gold consumption in the region may continue to improve.  Similarly, the Indian gold market appears to be on a stronger footing. While jewellery demand was still below average, it had substantially recovered from the lows seen in Q2 of last year.

Financial Highlights: Q3FY20

Source: Company Filing

• The group sold 19,265 oz of gold, 487,087 lbs of copper and 7,166 oz of silver. Gold concentrate inventories of 5,859 oz as of September 30, 2020, recorded a quarterly increase of 2,420 oz.
• Quarterly revenue came in at US$ 35.6 million, a 70% increase from Q3 2019, driven by a ~29% surge in the average gold realized selling price per ounce and increased production.
• The average realized selling price per ounce, net for the quarter under consideration, stood at $1,815/oz against $1,409/oz reported in the same quarter of the previous financial year.
• Operating cash flow (before working capital adjustments) stood at US$ 14.8 million or US$ 0.07 per share and earnings before interest, taxes, depreciation, and amortization (EBITDA) of US$ 17.4 million or US$ 0.08 per share.
• Net income came in at US$ 9.4 million or US$ 0.04 per share.
• The company reported cost of sales at US$ 15.9 million (2019 - US$ 12.2 million) consisting of mining, processing, mine technical services, maintenance, finance and admin at the site, operational health and safety, depreciation and net smelter royalties. The increase in the cost of sales was attributable to the increase in operational activity, as demonstrated by the increase in ore mined from 73,861 tonnes in Q3 2020 compared to 30,006 tonnes in Q3 2019
• Gross profit came in at US$ 19.7 million against US$ 8.8 million reported a year-before period, led by a higher increase in gold realized prices.
• The balance sheet significantly strengthened during Q3, with cash increasing by US$ 6.5 million to US$ 41.2 million and debt decreasing by US$ 2.1 million to US$ 7.0 million as of September 30, 2020.
• The company reported successful commissioning of the Stage 2 Plant Expansion to double throughput capacity to 400,000 tonnes per year and continued development of the twin incline following the lifting of the State of Emergency in June.
• As of September 30, 2020, the company had a cash and cash equivalents balance of US$ 41.2 million (December 31, 2019 – US$ 21.6 million) and working capital of US$ 61.2 million (December 31, 2019 - US$ 25.0 million), which consisted of current assets of US$ 88.3 million (December 31, 2019 - US$ 47.2 million) and current liabilities of US$ 27.2 million (December 31, 2019 - US$ 22.2 million).
• The company’s cash balance and additional cash flow from operations are expected to be sufficient to fund operations, capital requirements and debt repayments for at least the next twelve months.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 42.94% of the total shareholding. Van Eck Associates Corporation is the entity holding maximum shares in the company at 10.91%. RBC Global Asset Management Inc. is the second-largest shareholder, with an outstanding position of 5.6%. 

Source: Refinitiv (Thomson Reuters) 

Valuation Methodology (Illustrative): EV to EBITDA based Valuation Metrics

Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months

Peer Comparison

Source: Refinitiv (Thomson Reuters) 

Stock Recommendation: The company is built upon strong fundamentals, with rapid, self-funded production growth and significant resource growth. The company has sizeable High-Grade Tier 1 Asset Resource, and High-Grade, low-cost underground mine, and all the mines have consistently delivered a positive ounce reconciliation.

Further, higher gold average realization prices and bolstered production profile have significantly strengthened the company’s financial position, supported by Revenue growth of 63%, totalling US$ 111.1 million in YTD Q3 2020 compared to US$ 68.3 million in YTD Q3 2019. The company reported a robust result in Q3FY20 and outperformed the industry median on various financial metrics.  Moreover, the company is generating a significantly higher ROE for its shareholders. The company’s reported TTM ROE stood at ~40%, which is significantly higher and reflects the efficiency of the management in deploying shareholders money and committed to maximizing shareholder’s wealth.

Also, the company has maintained a higher spread between ROCE and WACC of 23.7%, which is significantly higher and reflects that the company is generating a superior free cash flow, which is a key competitive advantage for the K92 investors as a higher free cash flow provides a greater margin of safety to investors.

Moreover, gold prices are expected to be stable in 2021 on account of expected demand recovery for physical gold from China and India as these economies are recovering steadily from COVID-19 pandemic led distortions.

Therefore, based on the above rationale and valuation, we recommend a “Buy” rating at the closing price of CAD 6.70 on February 24, 2021.

1-Year Price Chart (as on February 24^th, 2021). Source: Refinitiv (Thomson Reuters)

*Recommendation is valid at February 25, 2021 price as well.

Disclaimer

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