HomoCosmicos/iStock via Getty Images

HomoCosmicos/iStock via Getty Images

It was a tough Q1 Earnings Season for the Gold Miners Index (GDX), with elevated absenteeism (labor tightness, COVID-19) impacting production for many miners. However, one name that bucked the trend was K92 Mining (OTCQX:KNTNF), which reported a 49% increase in gold-equivalent production year-over-year and a 42% increase vs. pre-COVID-19 levels. This is attributed to its recent plant expansion, which continues to perform well above plan. Based on K92 Mining's industry-leading growth and exceptional margins, I would view pullbacks below US$5.70 as low-risk buying opportunities.

Kainantu Mine Mineralization (Company Website)

Kainantu Mine Mineralization (Company Website)

K92 Mining released its Q1 results last month, reporting quarterly production of ~28,200 gold-equivalent ounces [GEOs], a 49% increase from the year-ago period. This was driven by higher throughput following the completion of its Stage 2 Expansion in H2 2021, offset by slightly lower head grades (8.3 grams per tonne gold vs. 8.5 grams per tonne gold). While this may be tracking at just ~22% of the company's annual guidance mid-point, it's important to note that production is back-end weighted this year, benefiting from higher throughput from its current Stage 2A Expansion and new mining equipment. Hence, I don't see any reason to get discouraged over what might appear to be a slow start to the year relative to guidance. Let's take a closer look below:

K92 Mining - Quarterly GEO Production (Company Filings, Author's Chart)

K92 Mining - Quarterly GEO Production (Company Filings, Author's Chart)

Looking at the chart above, we can see that K92 Mining has seen meaningful growth in production since it began operations at its Kainantu Gold Mine in Papua New Guinea, with production up more than 180% from Q1 2018 levels. This has been attributed to steady growth in the company's throughput rates, and it's been accomplished despite difficult two years, given that COVID-19 has created headwinds from an operational standpoint. However, despite this impressive growth vs. a peer group that's seen limited growth production, the company is not even close to done yet.

This is because K92 is currently working to increase throughput to 500,000 tonnes per annum, with its new filter press operational, the additional TC-1000 secondary crushed expected to be installed this quarter, and new mining equipment on the way. Notably, even without the installation of the flotation cells, the plant is already operating at near its expected Expansion run rate (1,370 tonnes per day), with a 1,300 tonnes per day run rate achieved in 45% of days in March. These results are encouraging, suggesting that the current plant could see slightly higher than planned throughput rates, similar to what we saw from the Phase 2 Expansion relative to its targeted run rate.

K92 Mining - Stage 2A Expansion Progress (Company Presentation)

K92 Mining - Stage 2A Expansion Progress (Company Presentation)

From a mine development standpoint, the company continues to see solid progress, with its twin incline advancement 15% above plans in Q1 and tracking at 10% above development plans for the past three quarters. Currently, incline #2 has advanced just over 1,000 meters as of quarter-end, while incline #3 has advanced over 1,060 meters. Combined with additional mining equipment, this will allow the company to increase its mining rates to support its growth. In addition, its new Judd mining front has shown favorable geotechnical conditions and improved mining flexibility with the addition of a second mining area at Kainantu.

Kainantu Mine - Mining Areas (Company Presentation)

Kainantu Mine - Mining Areas (Company Presentation)

Moving over to costs and margins, this has been a tough spot for the sector over the past three quarters as inflationary pressures across labor, fuel, materials, and consumables have led to guidance misses for many producers. In addition, they've also led to negative revisions in FY2022 and FY2023 costs, with previous cost guidance looking far too ambitious with rising diesel prices and mid-single-digit and even double-digit labor inflation. However, K92 Mining also excelled in this department, reporting all-in sustaining costs [AISC] of $788/oz, 35% below the estimated FY2022 industry average.

These costs were well below its guidance mid-point of $930/oz and significantly lower on a year-over-year basis, helped by increased ounces sold, higher by-product credits, and slightly lower sustaining capital. Combined with a slightly higher average realized gold price of $1,769/oz (Q1 2021: $1,738/oz), K92 Mining enjoyed meaningful margin expansion, with AISC margins improving to $981/oz vs. $697/oz in Q1 2021. It is worth noting that the company was up against easy year-over-year comps due to a rough Q1 last year. Still, the company has enjoyed margin expansion on a two-year basis as well, placing it in a population of only a few among its peers.

Gold Producers - Gold Price, Costs, Margins (Company Filings, Author's Chart)

Gold Producers - Gold Price, Costs, Margins (Company Filings, Author's Chart)

Finally, it's worth noting that given K92 Mining's footprint as a relatively small operation with industry-leading grades, it is moving considerably less volume per ounce of gold produced, somewhat shielding it from higher fuel prices. This is not the case for companies like Argonaut Gold (OTCPK:ARNGF), Victoria Gold (OTCPK:VITFF), and other high-volume, low-grade producers that move considerable volumes at low grades while also seeing their costs to treat their ore rise considerably. Hence, while K92 Mining is not insulated from inflationary pressures like royalty companies are, it is in better shape given that it operates a very high-grade underground operation.

While the Q1 performance was solid, with high double-digit revenue growth and a triple-digit increase in operating cash flow ($22.7 million vs. $7.7 million), the long-term outlook should have investors the most excited. As discussed in previous updates, K92 Mining is planning a Stage 3A Expansion, intending to increase production to ~350,000 GEOs per annum by 2026. This is expected to be achieved by building a separate plant that's capable of processing 1.2 million tonnes per annum at similar grades, a more than 100% increase from the current production profile.

According to the company, a new study should be released this summer, which will give a better idea of the project economics, where we could see a slight increase in upfront capex due to cost creep. However, even after adjusting for cost creep on certain items and higher labor costs, I would still expect phenomenal project economics, given the increase in scale and potential to see costs dip below $625/oz long-term. Besides, K92 is looking at the possibility of running two plants and utilizing its existing plant in addition to the new plant. In this scenario, which will be explored in a new PEA, capacity would come in at 1.7 million tonnes per annum, suggesting the potential for 425,000+ GEOs per annum, or nearly 250% growth from current levels.

Based on this long-term growth outlook, K92 Mining will be able to buck the trend of declining margins sector-wide, assuming it can execute successfully on its plans. This is because the much larger Kainantu operation will see the company's all-in sustaining costs dip by more than 20% vs. estimated FY2022 levels, paving a path towards $1,125/oz AISC margins even at a $1,775/oz gold price. Under this scenario, K92 Mining would be one of the lowest-cost producers sector-wide and could easily command a market cap north of $2.25 billion, given that it would have few (if any) peers at this margin profile.

Based on an estimated year-end ~243 million fully diluted shares and a share price of US$6.80, K92 Mining trades at a market cap of ~$1.65 billion. If we compare this to other junior to mid-tier producers, this would appear to be a very lofty valuation. However, K92 Mining has an industry-leading growth rate and is one of the only juniors with a clear path to mid-tier producer status, given its Phase 3 Expansion plans. This easily justifies a premium multiple, with its industry-leading cost profile also being a key differentiator (potential for sub $625/oz AISC once completed phase 3).

Kainantu Mine - Papua New Guinea (Company Presentation)

Kainantu Mine - Papua New Guinea (Company Presentation)

Based on an estimated net asset value of $1.96 billion, derived from an estimated NPV (5%) of $2.05 billion less corporate G&A, I see a fair value for K92 Mining of US$8.07. While this points to some upside from current levels, I prefer to buy at a minimum 30% discount to fair value for single-asset producers, especially those in non-Tier-1 jurisdictions. This is because single-asset producers already carry a higher risk than their dual/multi-asset peers, given that any issues at an operation are magnified when there aren't other operations to support it while the problem is resolved.

Fraser Mining Institute - Investment Attractiveness Index (Fraser Mining Institute)

Fraser Mining Institute - Investment Attractiveness Index (Fraser Mining Institute)

Meanwhile, although K92 Mining hasn't had issues in Papua New Guinea, it is ranked in the bottom-third of jurisdictions by the Fraser Mining Institute. Investors shouldn't have to worry about anything for the next two years, with the Mining Lease [ML150] and License for Mining Purpose [LMP78] not coming due until 2024. Still, investors should ensure an adequate margin of safety in case an unexpected issue arises. After applying a 30% discount for its non-Tier-1 jurisdiction and single-asset producer status, the low-risk buy zone for K92 Mining comes in at US$5.65.

J1 Vein Mineralization (Company Presentation)

J1 Vein Mineralization (Company Presentation)

Following the M&A transactions over the past year, it's becoming a little easier to find growth in a sector where it's been challenging to find anything but low-growth or no-growth companies. However, while there are some solid growth stories, K92 Mining stands head and shoulders above the rest, being the top-3 growth story in the sector with a ~29% compound annual production growth rate looking out to 2026. Just as important, this growth will be combined with meaningful margin expansion, another rare trait in a rising cost environment. Given this favorable setup, I continue to see K92 Mining as a top-12 producer sector-wide, and I would view pullbacks below US$5.70 as low-risk buying opportunities.

This article was written by

Disclosure: I/we have a beneficial long position in the shares of GLD either through stock ownership, options, or other derivatives. 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. Given the volatility in the precious metals sector, position sizing is critical, so when buying small-cap precious metals stocks, position sizes should be limited to 5% or less of one's portfolio.