Alamos Gold (TSX: AGI) is a Canada based gold producer. The group currently operates three mines; two in Canada and one in Mexico and it has a strong portfolio of development-stage projects in Canada, Mexico, Turkey and the United States. The group was formed in 2003 through the merger of Alamos Minerals and National Gold. At the end of the financial year 2019, the Company has proven and probable minerals reserves of 9,726,000 ounces Au. Alamos group's majority of revenue comes from the Canadian market (68.72%), and 31.28% to the group's revenue comes from Mexico. Institutional ownership in the Company stood at 77.11%, and strategic entities ownership in the Company stood at 0.30%.

Investment Rationale

• Record High Gold Prices Expanding Company's Margin Profile: In the third quarter of 2020, safe-haven yellow metal registered a new all-time high of USD 2,089.20/oz during the August 07, 2020 trading session. The prices of gold are up approximately 8.60% in the third quarter of FY20. This is going to increase the margins and profitability of the gold miners, as higher underlying commodity prices are going to increase the average realized price per ounces. Also, margins are going to enhance because the majority of gold miners are also likely to benefit from the increase in economies of scale, as the marginal costs of incremental unit production will be significantly lower. Alamos Gold is well-positioned to capitalize on higher average realized gold prices and margin expansion through the increase in the economies of scale.

• Groundwork has been laid for Strong Free Cash Flow Growth: The group's outlook for the second half of the FY20 is positive, which is led by the completion of lower mine expansion, higher production and lower costs, lower capital intensity and strong free cash flow growth in the H2FY20 and beyond. The Phase III expansion of Island Gold announced earlier this month had outlined a bigger, more profitable, and long-life operation. The expansion is expected to take throughput rates 67% higher to 2,000 tpd, which is likely to result in significantly higher production. With this expansion, the group is expecting an average annual gold production of 236,000 ounces per year starting in 2025 upon completion of the shaft. This represents a 72% increase from the mid-point of initial 2020 production guidance.

• Strong Liquidity and Capital Resource: The Company's liquidity position remained strong. At the end of the second quarter of FY20, the Company had cash and cash equivalents of USD 201.3 million compared to USD 182.8 million on December 31, 2019. In addition, the Company has USD 400.0 million of liquidity available under its recently amended credit facility. The management believes that the Company's liquidity position of USD 631.5 million, which comprised of cash and cash equivalents, equity securities and a credit facility, together with cash flows from operations, is sufficient to support the Company's normal operating requirements and capital commitments on an ongoing basis.

• No Balance Sheet Risks: At the end of the second quarter of FY20, the Company has no debt standing in its balance sheet, which implies no balance sheet risks for the Company. Further, The Company's liquidity position remains strong, and it expects to transition to strong free cash flow generation in the second half of 2020 and remained well-positioned to fund its internal growth initiatives.

• Risks Associated to Investment: The Company's financial performance is largely dependent on the price of gold, which directly affects the Company's profitability and cash flow. The price of gold is subject to volatility and is affected by numerous factors, such as the strength of the US dollar, supply and demand, interest rates, and inflation rates, all of which are beyond the Company's control.

Gold Industry Outlook

Prices of Gold are up ~27% on a YoY basis, and a pickup in the investors' demand for gold is the key driver. Investor demand for gold in the first half of 2020 accounted for almost 50% of the overall global gold demand. Within this segment, it was investments in the ETFs and other similar instruments that drove the demand, whilst demand for physical bars and coins came down.

1-Year Gold Price Chart (as on September 09, 2020, after the market close). Fig. in USD/oz

Source: Kalkine, Refinitiv (Thomson Reuters)

The COVID-19 pandemic and a flurry of measures taken by the Federal Reserve and the government have put the dollar under pressure and pushed gold prices to record high. Investors of all types are piling into safe-haven assets in unprecedented numbers, and when even the most gold sceptic investors are starting to bet big on bullion, one may conclude that things have fundamentally changed.

Further, a record Inflows into gold ETFs accelerated in Q2, taking H1 inflows to a record-breaking 734 tonne. First half inflows surpassed the 2009 annual record of 646 tonne and lifted global holdings to 3,621 tonne. The gold price (in USD) gained 17% in H1, following a 10% increase during Q2. The gold price reached record highs in numerous currencies, including euros, sterling, rupee and renminbi among others.

Source: World Gold Council.

The COVID-19 pandemic is upending asset allocation, with central banks across the globe have aggressively slashed rates and enhanced asset purchasing programmes to stabilize and stimulate their economies. However, these actions are leading to several negative consequences on asset performance. Further, widespread fiscal stimuli and ballooning government debt levels are raising concerns about a long-term run-up of inflation, or significant erosion of the value of fiat currencies. Also, we believe that inflow in Gold-backed ETFs will continue to increase, given the heightened uncertainty in the other asset classes.

In coming days, it is expected that major consumer of physical gold such as India and China, which together account for around 50% of consumer gold demand, will sustain demand for the yellow metals. The expanding middle class in India and China and broader economic growth is likely to have a significant impact on gold demand in future. Further, the application of gold in the varied number of industries including energy, healthcare and technology is likely to increase. All of these bodes well for the demand of the yellow metal.

2QFY20 Financial Highlights - AGI

 Source: Company Filing

• Total gold production, during the second quarter of FY20 stood at 78.4k oz against 125.2k oz reported in the same period of the corresponding financial year. Production was impacted by the downtime of the Northgate shaft at Young-Davidson and temporary suspension of operations at Island Gold and Mulatos due to COVID-19. Mulatos and Island Gold resumed operations in May with both returning to normal operating levels in June 2020.
• The company sold 74,605 ounces of gold at an average realized price of USD1,692 per ounce, which resulted in a revenue of USD 126.2 million. Revenue reported a decline of 29% on a YoY basis against USD 168 million reported in the same quarter of the previous financial year. The group generated a cash flow from operating activities of USD 49.6 million.
• During the second quarter of 2020, the company’s average realized gold price stood at USD1,692 per ounce, slightly below the average London PM Fix price of USD1,711 per ounce due to losses on gold hedging contracts.

Source: Company Presentation

The group’s consolidated total cash costs and AISC came in higher, primarily reflecting COVID-19 related delay in completing lower mine expansion at Young-Davidson. However, Costs expected to decrease significantly in H2 2020. Further, despite downtime, Mulatos & Island Gold generated USD19 million and USD9 million of mine-site free cash flow, respectively.

The group expects stronger production at sharply lower costs in H2 2020. The group expects the gold production in the range of 83,000 to 93,000 oz with a total cash cost of USD 800/oz to USD 840/oz and mine-site AISC of USD 990/oz to USD1,030/oz.

Technical Analysis

After taking support at the lower Bollinger Band on September 07, 2020, the stock was moving up and traded above the middle Bollinger Band which is 20-day SMA. More importantly, the band is squeezing, and the stock has crossed over its middle Bollinger Band and edging higher, this indicates a potential upside from the current trading level.

Source: Refinitiv (Thomson Reuters)

Further, its shares have registered strong relative price strength against the benchmark index and the sector peers over the past three months and YTD basis. The group’s share price increased by ~28% in the last 3 Months and outperformed the index by 24% at the same time. On a YTD basis, its shares have bagged ~70% and significantly outperformed the index by ~77% at the same time.

Moreover, at the last traded price of CAD 13.34, its shares have traded significantly above the crucial long-term support level of 200-day Simple Moving Average (SMA), with Price/200-day SMA ratio stood at 1.32x, which implies that the stock is in bullish trend. Also, the long-term moving averages are also rising, which is another strong uptrend indicator.

Source: Refinitiv (Thomson Reuters)

Stock performance

In a year over period, its shares have registered a 52w High price of CAD 15.52 (on July 28, 2020) and a 52W low price of CAD 4.43 (on March 16, 2020). At the last traded price of CAD 13.34, its shares traded approximately 14% below its 52W peak and 201% above its 52W bottom.

Valuation Methodology (Illustrative): Price to Cash Flow Based Valuation Metrics

*Note: All forecasted figures have been taken from Refinitiv (Thomson Reuters)

Stock Recommendation: H1FY20 was a transformational year for Alamos and provided the foundation for the Company's strong outlook. With mining rates ramping up at Young-Davidson, and Mulatos and Island Gold returning to normal operating levels during the second quarter, the Company expects to deliver strong company-wide free cash flow growth in the second half of 2020.

Production of 78,400 ounces and total cash costs of USD933 per ounce in the second quarter of 2020 were impacted by the planned downtime of the Northgate shaft at Young-Davidson to complete the final step in the lower mine expansion, and temporary suspensions at Mulatos and Island Gold due to the COVID-19 pandemic.  However, production is expected to increase sharply in the third quarter at significantly lower costs. Also, the transition to the highly productive lower mine infrastructure is expected to drive production higher and costs lower in the second half of 2020.

The Phase III expansion of Island Gold announced earlier this month had outlined a bigger, more profitable, and long-life operation. The expansion is expected to take throughput rates 67% higher to 2,000 tpd, which is likely to result in significantly higher production in the long term.

Further, we are bullish on the gold prices and believe that despite a little pull-back, gold, as an asset class would continue to remain in the limelight as uncertainty over the global economic growth, has heightened, with economies across the globe witnessing very slow recovery rate and COVID-19 cases continue to edging higher day by day. Further, ETFs are showing no sign of decline in gold buying, which is likely to send yellow metal prices higher. As the gold prices are likely to remain elevated, we believe that average realized gold prices per ounce would continue to expand, which would lead to margin expansion, higher free cash flow for the Company.

Therefore, based on the above rationale and valuation done using the above methodology, we have given a "Buy" recommendation at the closing price of USD 13.34 (on September 09, 2020, after the market close), with lower double-digit upside potential, based on the NTM Peer's Average Price-to-Cash Flow Per Share of 13.8x on the FY20E Cash Flow Per Share. We have considered Kirkland Lake Gold Ltd, Yamana Gold Inc and Equinox Gold Corp etc., as a peer group for the comparison purpose.

*Recommendation is valid at September 10, 2020 price as well.

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