Unsatisfied with a mere bet on bullion? Desirous of a big, fat, chunky wager on gold prices?
May I suggest Detour Gold Corp., a mining stock whose zigs and zags make the volatility in the gold price look picayune by comparison. Detour is a single-asset company, with a young mine near Detour Lake in Northern Ontario. In the past 52 weeks, it's traded as low as $2.88, upon the surprise resignation of its chief executive officer, and as high as $15.62 in June, when gold prices were above $1,300 (U.S.) an ounce. Detour stock was $6.60 (Canadian) at the beginning of November. It closed at $8.67 on Wednesday.
Despite that rapid rise this month, analysts believe it has plenty of room to run. The average 12-month target price is $13.56, an upside of 56 per cent (one of the higher possible returns among large and mid-size miners, according to Bloomberg data). And some of the bulls are well above that average: Analyst Richard Gray of Cormark just lowered his target price from $23.50 to $18.75. He calls Detour "the ultimate risk-reward name in the gold sector, and right now the upside (reward) far outweighs the current downside (risk)."
Well, let's dwell on those risks before we give the impression that Detour investors are just one pitch away from a home run. In Saturday's Globe Investor, we detailed the major issue in the mining industry: Companies that took on significant debt to fund expansions or acquisitions are in a perilous place when gold falls. Analysts are now using prices of $1,100 (U.S.)-an-ounce and below in their models.
RBC Dominion Securities analyst Stephen Walker includes Detour on a list of miners that would need to make cuts or deferrals to discretionary spending at that price level for gold, which currently trades about at $1,160. The company has more than $600-million in long-term debt and lease obligations, and has yet to be consistently free-cash-flow positive.
Rahul Paul of Canaccord Genuity Corp., who has a "buy" rating and an $11 (Canadian) target price, notes that while the balance sheet, which also features $137-million (U.S.) in cash, "is in significantly better shape" than a year ago, "the debt levels offer limited protection in the event of a significant and prolonged decline in the gold price from current levels."
Mr. Paul believes the company can make it to the end of 2016 with no additional capital-raising at gold prices averaging $1,091 or higher. But, he says, the bigger issue is a $500-million convertible bond coming due Nov. 30, 2017; the company won't generate sufficient cash flow to settle the debt unless the gold price averages $1,326 from now until then, he forecasts.
Of course, every analyst has his or her own model, with varying assumptions for production and long-term profitability. Right now, however, the key metric for Detour in these early stages is "throughput," the amount of ore and waste pulled out of the earth each day. The Detour mine has lower grades of gold than other mines and requires more moving of dirt to extract the metal.
"Mill throughput provides the clearest gauge as to how the ramp-up is going," says Steve Parsons of National Bank Financial, who has an "outperform" rating and $12 (Canadian) target price. "Since the fixed-cost component of running a mine is very high, particularly for low-grade bulk tonnage mines, pushing tonnes is paramount. This enables higher production and a marked decline unit costs."
Another reason analysts and investors are focusing on these numbers, Mr. Parsons says, is because senior gold producers tend to wait for smaller companies to have a visible ramp-up path before making an acquisition offer – perhaps a key part of Detour's attractiveness.
CIBC World Markets' precious metals analysts listed Detour as a potential acquisition target, calling it "an Osisko look-alike." (Osisko Mining Corp. prompted a bidding war earlier this year ultimately won by Agnico Eagle Mines Ltd. and Yamana Gold Inc.)
And, according to a report from Bloomberg News, U.S. hedge fund Passport Capital told its investors in a July 31 letter that Detour was "the most attractive takeout candidate in the gold space." A spokeswoman for the fund declined to comment Wednesday.
It will likely take a rebound in the gold price to make the major producers more deal-minded. And gold will certainly have to reverse course to make Detour a long-term success. If a bullion boom is in your forecast, however, there may be few names better to play it than Detour.
David Milstead