Description

Allied Nevada Gold (Ticker: ANV)

Situation Type: Value / Pre M&A

Full disclosure: I am not a gold bug. I have little interest in having a debate about currency debasement, monetary easing, and the destruction of paper currencies.  I believe ANV shares trade at an undemanding valuation and nearing an inflection point for the shares to re-rate and appreciate materially. I believe a sale of the company is a 2013 event, and could result in a competitive bidding situation. The shares are not difficult to hedge in the event you have a bearish view on metals. 

Approximate Trading Metrics:

Price: ~$28.70

Shares Outstanding: ~90mm

Average 3 month Trading Volume: 700k/day

Short Interest: ~7mm shares (7.6%)

2013 Estimated CF/share: ~2.80

2014 Estimated CF/share:  ~3.50

2013 Estimated EPS: ~2.50

2014 Estimate EPS: ~3.25

2014 Estimated P/E: ~8.8x

Estimated Current NAV/share: ~$39

Duration: 9 – 12 months

Probability Weighted Price Target / Return:

~$46 / ~60%+

Trade Recommendation (consider creating pure alpha trade):

• Buy ANV common stock
• Consider Short large cap mining to hedge via GDX or components (NEM, GG, ABX, AU, etc.)
• Consider Short GLD to compliment mining hedge and reduce volatility
• Position bundle: I prefer a 60-75% large cap miner hedge / 25-40% gold hedge

Situation Overview:

ANV is a gold mining company that owns 100% of Hycroft Mine in Winnmuca, Nevada. The company recently reported disappointing results, that missed buy-side and sell-side estimates by a wide mark, and the shares have traded off. Despite the recent results, the company is well positioned in a geography will little political risk, for the shares to re-rate inline with Tier II piers, and a premium to Net Asset Value.

Entry Catalyst:

Disappointing quarterly results / conference call: 2012 production outlook was recently revised to the lower end of its previous stated guidance of 180k oz to 150k oz. Cash costs have recently come in higher at $527 oz, but full year remains at $475-$495 oz. CAPEX was also recently raised to $285mm from $225mm. Despite the downgrade to expectations, the company should be fully financed and funded going forwards. The opening comments from the CEO Scott Caldwell are fairly straightforward:

“Now, let’s be honest, the management’s not real happy with the performance in this quarter. It was disappointing on several metrics.”

Background on Hycroft:

http://www.alliednevada.com/company/index.aspx#

http://www.alliednevada.com/properties/hycroft/index.aspx

Last Quarter Results / Guidance: http://www.alliednevada.com/investors/news/pdf/872012-1.pdf

• Gold production missed by 6k oz
• Cash costs were inline but missed expectations
• EPS missed expectations by $0.13 cents
• ANV reset production expectations to 180k from 180k-200k. As management pointed out on the conference call, the missed production was mainly due to Hycroft’s inability to process loaded carbon on site. This should be mitigated by the toll-trolling agreement with Yukon Nevada. 
• http://finance.yahoo.com/news/allied-nevada-signs-agreement-yukon-213000726.html
• Gold sold is now expected to be 150k oz
• Cash used was $8mm vs expectation to generate cash
• Mill expansion costs are on track, but could be under funded by $200mm

Investment Merits:

• Fully funded business plan
• Highly incentivized insiders: see proxy

http://www.sec.gov/Archives/edgar/data/1376610/000119312512150547/d329814ddef14a.htm

• Potential from re-rate from 0.7x to inline with peers at 1.5x
• Undemanding valuation
• Relatively defined duration / event path
• Sentiment near lows after recent quarterly earnings disappointment

Valuation:

Currently ANV trades at 0.7x NAV. Once production increases from 180k to 250k oz/year in 2013 the shares should re-rate to 1.25x-1.50x inline with peers. During this re-rate the company will most likely be sold to a strategic large cap miner. I believe the Hycroft mine is capable of doing at least 250k oz by 2013. At 1.5x NAV, the shares would trade for ~$55/share or ~90% higher

Risk / Reward:

Shares have recently traded down from the mid $40’s to the mid/high $20’s. If shares were to trade back to NAV, that would be a return of ~37% before any M&A premium. From a risk perspective, ANV may need to raise more capital, which ultimately could dilute the current capital structure. I view this risk as low, as ANV recently issued senior notes for $400mm at 8.375%, which closed in late May 2012. However, the capital plan could be $100-$200mm short in 2014.

Scenarios / Probabilities:

• Dilutive financing required: $20/share – 5% probability
• Management execution / misses expectations: $25/share – 25% probability
• Management execution and 250k oz is met in 2013 shares re-rate $50/share – 50% probability
• Sale of the company / Competitive Bidding: $70/share – 20% probability
• Summary: probability weighted outcome (ex position bundle hedges) - $46 or ~60% higher.

Management:

I view the management team as a key differentiator, and motivated to create value.

• Scott Caldwell is the CEO, and before that was the COO of Kinross Gold
• Bob Buchan is the Chairman, and was the founder of Kinross Gold
• The board is impressive as well: http://www.alliednevada.com/company/directors.aspx#

CEO Comments from August earnings call sum up the situation and sentiment:

“Well, in conclusion, as I mentioned at the start of this, management and the Board is certainly not ecstatic about the quarter we had. We are all stakeholders, meaning management and insiders, we still own just under 15% of the outstanding shares of the company and recognize the importance of earnings and sales or sales hence earnings, I’m talking metal sales here, and particularly gold sales.

So we recognize the need for that. We have a realistic plan, it’s an achievable plan to dramatically improve our sales of metal, both gold and silver. Steve talked about that and I talked about it, 150,000 ounces for the year and we’re working on mechanisms to close the gap to reduce that inventory.

Permitting and construction of the crusher and mill are proceeding well as Tracey mentions and I’ve mentioned quite frankly, permitting is outpacing operations/construction at this stage of the game, which is good news. and so we’re pursuing all options to accelerate mining equipment engineering/procurement to build this thing to keep pace with our permitting.

We’re focused on the short-term, but really our eye is always on the long-term and the price here is to get this mill up and running and go from a couple of hundred thousand ounce producer or in sales of gold in a million in silver to a million gold equivalent if you want to talk to and we’re really focused on that project.”

Shareholder base:

Nothing really stands out of interest other than there are a few event-driven and value investors including: Baupost (5mm), Perry Capital (2mm), Royce

Risks:

• Operational technical risk: I view this risk as low as Hycroft is operational
• Commodity price risk (this can largely be hedged out if so inclined – see above)
• Political risk: US congress is evaluating 2 bills that may impose net or gross revenue royalty. i.e National Royalty Risk. Nevada is considered a friendly political place, if not the friendliest in the world
• In the event management does not act in best interests of shareholders, the next annual meeting is in April 2013. All directors up for election, but insiders own a decent amount of slug probably deterring a public activist
• Earnings disappoints
• The revolver is currently $30mm, and management is looking to increase that to $100m before the end of the year. Any hiccup in this process will send a negative message

Exit Catalysts:

• Re-rate of shares inline with Tier II peers could result in material share appreciation of 69%-103%
• Improvement in sentiment after recent execution issues and shares could appreciate back to NAV or ~36% higher
• Sale of the company could result in appreciation of 100%-145%
• Competitive bidding situation

Exhibit / Materials:

http://www.alliednevada.com/investors/pdf/120613-anv-investor-day.pdf

Catalyst