We’re now more than one-third of the way through the Q3 Earnings Season for the Gold Miners Index (GDX), and the most recent name to release its results is Golden Star Resources (GSS). It’s been a busy year for the company thus far with the bold sale of its serially under-performing Prestea Mine last quarter, and thus far, it looks like this decision has paid off. While the trade-off for this sale is that Golden Star has become a single-asset Tier-3 gold producer, the benefit is that Prestea will no longer be an anchor on margins, eroding all operational success at the Wassa Mine. Based on Golden Star’s climbing earnings estimates, the stock is now trading at barely 6x FY2021 annual EPS, making the stock a Hold on valuation for those comfy with Tier-3 jurisdictions.
Golden Star released its Q3 results last week and reported quarterly gold production of 41,600 ounces, a 20% increase year-over-year that more than made up for the loss of Prestea as a producing asset. Meanwhile, the much stronger gold (GLD) price led to a surge in free-cash-flow [FCF], with Q3 FCF up 476% to $14.4 million from $2.5 million in the year-ago period. Finally, revenues were actually up year-over-year despite relying on one asset, which provided tough year-over-year comps. Let’s take a closer look at the results below:
As the table above shows, it was a strong quarter at the company’s Wassa Mine in Ghana, with year-to-date gold production up 10% year-over-year and quarterly gold production up 20%. The company’s higher gold sales of 40,900 ounces vs. 33,900 ounces not only beefed up quarterly revenue to $74.2 million (Wassa only), but they also helped the company to benefit from higher margins with all-in sustaining costs down from $1,093/oz to $1,023/oz. When combined with the significantly higher average realized gold price of $1,813/oz, this led to all-in sustaining cost margins doubling in the quarter from $335/oz to $790/oz. This was a massive benefit to Golden Star as the margins at Wassa have been negligible up until recently. The chart below shows the quarterly gold price (yellow line), with costs (red bars), with the gap between these two figures representing the company’s all-in sustaining cost margin.
The catalyst for the improved operational results was much higher throughput, with Wassa processing over 554,000~ tonnes in Q3 vs. 427,400~ tonnes in the year-ago period. However, the significant improvement in throughput was partially offset by lower feed grades of 2.43 grams per tonne gold vs. 2.70 grams per tonne gold. This is because the company processed more low-grade stockpile material in the quarter and took advantage of strength in the gold price. Fortunately, the lower grades only had a minor impact on gold recovery rates, with gold recovery dropping just 60 basis points year-over-year to 94.8% from 95.4% in Q3 2019.
The one negative in the quarter was that underground mined grades continue to sit at levels near multi-year lows, with Q3 gold grades coming in at 2.80. This is not ideal and is relatively low for an underground mine. However, it’s worth noting that grades were affected by slower development rates due to a shortage of skilled workers related to COVID-19, and this led to a delay in access to higher-grade stoping areas. The good news is that this was offset by record underground mining rates of 4,980 tonnes per day, a 12% increase from the previous record mining rates. Therefore, I believe we can give the company a pass in Q3 on grades and wait to see how underground grades look in the next couple of quarters now that some travel restrictions have been lifted, allowing for an increased contribution from skilled operators.
Overall, this was a solid quarter at Wassa, and I’ve purposely chosen to ignore Prestea results as they are now discontinued operations following the sale. Based on the solid Q3 results, Golden Star’s guidance is sitting at 167,000 ounces with a cost mid-point of $960/oz. This means that the company will transition from an above-average cost producer to a slightly below-average cost producer, assuming they can keep up the solid work at Wassa. While a relatively average-cost producer in a Tier-3 jurisdiction doesn’t make for an outstanding investment thesis by any means, it has prompted me to take the stock off my Avoid list. For years, the biggest issue with Golden Star was that they were wasting progress at Wassa by trying to turn around a seemingly hopeless Prestea operation with $1,500/oz plus costs. Fortunately, the sale has finally allowed the company to focus on margins and delivering positive free-cash-flow.
As we can see from the chart above, Golden Star’s earnings trend continues to improve from Q2 levels, with FY2020 earnings estimates soaring from $0.26 to $0.30 and FY2021 earnings estimates up from $0.42 to $0.66. This is a direct result of the much higher gold price, and it’s left Golden Star on track for a breakout year in FY2021. Earnings breakouts occur when annual EPS stagnates for years and then finally hits a new multi-year high, and if Golden Star can have a solid year in FY2021, we should see the previous high in FY2017 ($0.56) surpassed. It’s also worth noting that the triple-digit growth rate next year is quite impressive, making Golden Star one of the highest-growth names on the US Market currently.
If we look at quarterly revenue, it’s understandable to be a little disappointed as gold prices have hit record highs, and Golden Star’s Q3 revenue is down sequentially and up only 7% year-over-year. However, the Q3 2020 figure I have used is based solely on Wassa. I have done this because I see no point in reporting total revenue from a discontinued operation that will no longer benefit the company starting in Q4. Therefore, while quarterly may not see very impressive growth over the next year given that it’s up against tough year-over-year comps with a shift from two mines to a single mine, the adjusted revenues are actually quite impressive, with Wassa revenue up from $48.4 million to $74.2 million, representing 54% growth year-over-year.
So, why waste any time investing in a Tier-3 single-asset gold producer?
While there’s certainly an argument to be made that single-asset producers in Tier-3 jurisdictions are the least attractive area of the gold space, the improving costs due to the sale of Prestea is a very positive development. As the chart above shows, Golden Star will move from a rank of 47th out of 60 names in the sector to 38th based on my high end of cost estimates at $1,000/oz, and potentially to 30th if it can meet guidance of $960/oz. Therefore, this shift to a single-asset producer is actually a benefit in this rare case, as there was nothing to write home about when costs were coming in near $1,200/oz (FY2019 costs: $1,159/oz). Meanwhile, the valuation here is reasonable if one is comfortable with the risks of Tier-3 jurisdictions. This is because Golden Star is trading at barely 6x FY2020 earnings estimates at a share price of $3.96 and estimates of $0.66.
Personally, I am not comfortable with single-asset Tier-3 gold producers, but it’s hard to ignore the improved investment thesis here. If Golden Star can continue to deliver solid results from Wassa and report over $0.64 in annual EPS for FY2021, the stock is certainly cheap here and a Hold for speculative investors. However, with larger producers in safer jurisdictions available to buy at closer to 10x earnings, this is where I am focusing. For now, I continue to maintain my Hold rating on Golden Star Resources based on improved margins, an attractive valuation, and strong earnings growth.
Disclosure: I am/we are long GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.