Falling Production and Rising Costs Put Pressure on Alamos Gold Inc

With rising costs at its sole operating mine and delays in permits of key projects, Alamos Gold faces several tough years ahead.

Mar 31, 2014 at 10:41AM

In times of falling gold prices, gold producers can sustain their cash flow levels by battling costs and increasing production levels. However, this is not the case for Alamos Gold (NYSE:AGI). The company expects to produce between 150,000 and 170,000 ounces of gold in 2014, lower than the 190,000 ounces of gold achieved in 2013. What's more, Alamos Gold expects a rise in its all-in sustaining costs to $950-$1,000 per ounce. As a result, Alamos Gold's shares are under pressure and have already lost 25% this year. Will this trend continue?

Negative trends at the sole operating mine
Alamos Gold has just one operating mine, Mulatos, in Mexico. Production at this mine has been falling since 2012, when the mine produced 200,000 ounces of gold. At the same time, costs have been rising. All-in sustaining costs at the mine were $681 per ounce in 2012, while they were $772 in 2013. As stated above, the costs will significantly rise this year.

Still, the level of costs is substantially below current gold prices, which gives the company room to breathe. Costs are a crucial factor to consider as gold prices remain under pressure and could easily drift toward the $1,200 mark, putting big pressure on high-cost producers like IAMGOLD (NYSE:IAG). IAMGOLD targets 2014 all-in sustaining costs in the range between $1,150 and $1,250 per ounce. IAMGOLD's performance greatly depends on whether the company will be able to hit the low end of its cost guidance. Otherwise, its shares will experience more downside.

Uncertainty in Turkey
As production at Mulatos is declining, Alamos Gold has to start production at its development projects as soon as possible. Two of the company's projects in Turkey, Kirazli and Agi Dagi, are already in the permitting stage. Kirazli is expected to produce 99,000 ounces of gold annually when it starts commercial production, while Agi Dagi is expected to produce 143,000 ounces of gold annually.

These mines will greatly increase Alamos Gold's production levels. The problem is the company experiences difficulties on the permitting stage. The company states that the recent political instability in Turkey has increased the uncertainty around when the permits will be obtained. Alamos Gold expects that hearing about Kirazli project permit will take place within five months from now. If the permit is obtained, Kirazli will be ready for first gold production in 18 months. This means that the company couldn't count on cash flow contribution from the project for at least two years.

Time to go shopping?
Alamos Gold finished the fourth quarter with $410 million of cash on the balance sheet, so the company can afford to purchase a producing mine. Silver Standard Resources (NASDAQ:SSRI) has recently been in the similar situation, with the sole producing mine and excessive cash on the balance sheet. Silver Standard Resources decided to diversify into gold and agreed to buy Marigold mine from Goldcorp and Barrick Gold.

However, Marigold was a high-cost mine when it was operated by Goldcorp. Whether Silver Standard Resources will be able to push costs down remains a question. The key takeaway from Silver Standard Resources' story is that it is difficult to buy a low-cost producing mine, because such mines are rarely on sale.

Bottom line
Alamos Gold faces several tough years ahead. As costs are rising and production is falling, the company's cash flows will come under pressure. The uncertainty regarding project permits in Turkey adds to the pressure. However, the company has a very strong balance sheet with lots of cash and no debt. The amount of cash cushion is more than enough to take Alamos Gold through the years of decreased cash flow.

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