Orla Mining: Tough Comps On Deck In Q1 (TSX:OLA:CA)

We’re nearing the halfway mark for the Q1 Earnings Season and the results have been encouraging overall, even with the gold price averaging just ~$2,070/oz in Q1. This is because we’ve finally seen the strength in the gold price outpace the impact of inflationary pressures, allowing several producers (large and small) to enjoy all-in sustaining cost [AISC] margin expansion on a year-over-year basis. Unfortunately, Orla Mining (NYSE:ORLA) is one name that will struggle to enjoy the same AISC margin expansion, with the junior producer up against difficult comps from Q1 2023 even with the benefit of near-record production reported last month.

In this update, we’ll dig into the Q1 results, recent developments, and how its valuation stacks up vs. other growth stories in the sector.

Q1 Production & Sales

Orla Mining released its preliminary Q1 results last month, reporting quarterly production of ~33,200 ounces of gold. This translated to a 28% increase from the year-ago period (Q1 2023: ~25,900 ounces), with increased tonnes stacked on its pads at higher grades. This has placed Orla in an excellent position to beat its annual guidance midpoint for the third consecutive year, with year-to-date production sitting at ~28.9% of its guidance midpoint with three quarters left to go. Meanwhile, the company will also enjoy industry-leading sales growth in the period, with ~32,000 ounces sold in Q1 2024 (Q1 2023: ~26,900 ounces) at a much higher average realized gold price that likely came in close to $2,080/oz for the quarter.

Digging into the results a little closer, Orla continued to see stacking rates above nameplate capacity at ~19,600 tonnes per day (nameplate: 18,000 tonnes per day) and stacked ~1.78 million tonnes in the period at an average grade of 0.82 grams per tonne of gold. This compared favorably to ~1.70 million tonnes at 0.80 grams per tonne of gold in the year-ago period, while tonnes mined were flat at ~1.94 million tonnes. Finally, its strip ratio came in even lower on a year-over-year basis at just 0.45 (Q1 2023: 0.61), but this figure is expected to creep up as the year progresses with Orla guiding for an annual strip ratio of 1.20.

Given the strong start to the year, Orla ended the period with ~$118 million in cash and nearly $30 million in net cash, giving it one of the strongest balance sheets among its peer group. This strong cash position with total liquidity of ~$180 million compares very favorably to the estimated ~$240 million capex bill for its Railroad South Project (assumes 25% to 30% inflationary pressures from 2022 study), with Orla in an excellent position to fund this construction while maintaining a strong balance sheet, placing it in rare air among peers like Alamos Gold (AGI) that have carried limited debt during their growth phases and largely financed their new builds from cash on hand and cash flow generation during the construction phase.

Q1 2024 Preview

Looking ahead to the company’s Q1 2024 results that will be reported late next week, this would otherwise be a blow-out quarter for the company from a margin standpoint given the near-record production, but this is an abnormal quarter for Orla from a sustaining capital standpoint. And while I expect ~30% revenue growth to ~$67.0 million, roughly half of sustaining capital is expected to land in Q1 with elevated expenditures this year related to its Phase 2 heap leach expansion.

The result of this front-end loaded sustaining capital spending is that all-in sustaining costs [AISC] are likely to come in closer to $1,000/oz or a ~40% increase year-over-year vs. Q1 2023 levels ($693/oz). So, while Orla should still enjoy industry-leading AISC margins of above $1,000/oz in the period, we will see some margin compression on a year-over-year even with the higher gold price vs. the difficult comps of ~$1,195/oz in Q1 2023. This is not a huge deal and is not reflective of the FY2024 cost profile, with AISC likely to land closer to $900/oz and over 30% below the estimated industry average. Still, I would prepare for a mediocre report from a margin standpoint given the difficult comps and elevated sustaining capital.

Recent Developments

As for recent developments, it’s been a busy few months for Orla Mining, with the company consistently active on the development front and similar to Calibre Mining (OTCQX:CXBMF) in the sense that it’s always aggressively drilling its portfolio to unlock future growth. On the M&A front, Orla has made another acquisition, scooping up Contact Gold in Nevada to bolster its land position on the prolific Carlin Trend. Orla paid ~$8 million which resulted in minimal share dilution and added Contact’s Pony Creek Project (~4,500 hectares) which lies adjacent to its South Railroad Project in Nevada (its most advanced development asset) and also picked up the Green Springs Project (past producer) on the Cortez Trend which sits south of the Mt. Hamilton Project (Waterton), directly beside Calibre’s Gold Rock Project and southeast from Calibre’s smaller Pan Mine.

(*) Green Springs is being drilled by Centerra (CGAU) with a four-year agreement where Centerra can earn up to 70% of the project with $10.0 million in expenditures. (*)

While Orla may not end up with all of Green Springs if Centerra continues to like what it’s seeing from the drill bit (highlight hit at X-Ray Zone hit ~35.1 meters at ~2.0 grams per tonne of gold last year), it will maintain full ownership of Pony Creek which is a solid asset with an inferred resource of ~430,000 ounces at 0.52 grams per tonne of gold (largest deposit is the Bowl Zone) directly beside where it plans to build a new open-pit heap leach mine later this decade and upon the receipt of all required permits. As the map above shows, Pony Creek sits just to the south of the two deposits contributing to the South Railroad mine plan (Pinion and Dark Star).

Looking at other developments, Orla has seen no shortage of impressive intercepts from its massive Camino Rojo Sulphides Project, which lies beneath Camino Rojo Oxides (its current mine) and boasts a resource of ~259 million tonnes at 0.88 grams per tonne of gold and 7.4 grams per tonne of silver or ~7.3 million ounces of gold and ~62 million ounces of silver. However, since starting drilling here on this sulphide opportunity (which will require a new processing facility) and the focus has been on infilling higher-grade portions of this resource. Some highlight intercepts released earlier this year from infill drilling (true widths) include:

• ~52 meters at 2.54 grams per tonne of gold
• ~78 meters at 2.08 grams per tonne of gold
• ~89 meters at 2.22 grams per tonne of gold
• ~51 meters at 2.36 grams per tonne of gold
• ~28 meters at 3.41 grams per tonne of gold

Besides much higher grades than the average grade in the much larger and lower-grade sulphide footprint, Orla has also hit moderate base metals credits in these intercepts and has uncovered a high-grade polymetallic extension to the primary mineralized footprint at depth (including moderate grades silver, lead, zinc, and copper). (*) Highlight intercepts from this zone include 11.9 meters at 3.70 grams per tonne gold-equivalent and 5.6 meters at 12.73 grams per tonne of gold-equivalent, plus 11.7 meters at 6.25 grams per tonne gold-equivalent and 4.4 meters at 4.1 grams per tonne gold-equivalent in a separate intercept. This is certainly an exciting development for investors, and we should get a better idea of economics and how the updated resource looks over the next 6-18 months, with an updated underground resource due by year-end and a PEA/PFS likely to follow.

(*) These polymetallic intercepts complement thicker high-grade intercepts released previously that include 46.5 meters at 5.25 grams per tonne gold-equivalent and 13.5 meters at 5.74 grams per tonne gold-equivalent (*).

As for negative developments, the Panamanian Ministry of Commerce and Industry rejected Orla’s requests to extend its mining concessions (including Cerro Quema) and confirmed that these concessions were canceled. This development was not surprising given that there was little hesitance shutting down ~2% of annual copper production and over 5% of Panama’s GDP at Cobre Panama (owned by First Quantum). That said, while Cerro Quema was an interesting asset, it was the #3 development asset behind Railroad South at #2 and was hardly baked into the valuation at the time of the news on the canceled concessions. Orla noted that it plans to file a notice of intent to arbitrate, but it’s possible that it may be able to work something out medium-term with a new President elected this week.

Valuation

Based on ~355 million fully diluted shares and a share price of US$4.00, Orla trades at a market cap of ~$1.42 billion and an enterprise value of ~$1.39 billion. This market cap figure may leave some investors scratching their heads given that Orla is a ~120,000-ounce producer, but it’s important to note that Orla has a project capable of producing ~190,000 ounces per annum in years 2 and 3 of its mine life (*) (Railroad South), and another mid-scale production opportunity with Camino Rojo Sulphides. Hence, there is a path to Orla Mining becoming a 400,000+ ounce producer by the end of this decade capable of generating ~$300 million in annual free cash flow.

(*) While Railroad South has extremely high production levels in years 2 and 3 with the benefit of higher-grade Dark Star ore, average annual production sits at just ~124 ounces, making this similar in scale to Camino Rojo Oxides but with a higher strip ratio (4.1/1.0). (*)

That being said, Orla is currently trading at ~0.85x P/NAV (a significant premium to its junior producer peer group) based on its estimated net asset value of ~$1.69 billion (6%) and nearly 15x FY2024 free cash flow estimates based on estimates of ~$100 million in free cash flow. This makes it significantly more expensive than other high-margin and single-asset names elsewhere in the sector like K92 Mining (OTCQX:KNTNF) at ~0.55x P/NAV and Torex Gold (OTCPK:TORXF) at ~0.70x P/NAV but with both companies having greater scale than Orla and a much quicker path to ~400,000 ounces per annum (in fact Torex is already there).

Based on the current permitting timeline for South Railroad (production in 2027), Orla will be lucky to hit the 300,000 ounce per annum production mark by H2 2028 at ~$1,000/oz AISC while K92 Mining will graduate to ~500,000 ounce per annum producer status at sub $700/oz AISC in 2027. Today, K92 Mining trades at a lower enterprise value than Orla (~$1.2 billion vs. ~$1.4 billion) yet will be generating significantly more free cash flow at higher margins in the 2025-2028 period. So, with higher-grade producers with lower LOM AISC trading at significantly lower FY2025 free cash flow multiples, I continue to favor other names currently and think Orla may need time to grow into its valuation.

So, what’s a fair value for the stock?

Using what I believe to be fair multiples of 1.0x P/NAV (6%) for a single-asset producer in Mexico and 12x FY2024 free cash flow estimates and a 65/35 weighting to P/NAV vs. P/CF, I see a fair value for Orla of US$4.50. This points to a 7% upside from current levels which does not offer nearly enough of a margin of safety in my view from current levels. So, while a rising gold price will lift all boats, I continue to prefer other names elsewhere in the sector that trade at far more attractive relative valuations, such as K92 Mining at ~0.55x P/NAV (6%) and barely 4x FY2026 free cash flow estimates.

Summary

Orla Mining put up another phenomenal quarter operationally in Q1 and has three things going for it. The first is a simple high-margin asset that continues to generate consistent free cash flow to help build up its balance sheet ahead of a busy second half of the decade for growth. The second is a peer-leading pipeline among its junior producer peers with the potential to add 300,000+ ounces per annum from its current pipeline. Third, the company has a strong management team that’s consistently delivered on promises and has consistently surprised to the upside in terms of beating guidance and exploration success.

That said, there is no investing without valuation as Joel Greenblatt says, and while Orla passes with flying colors on quality and growth, it’s hard to argue for the stock trading at an attractive valuation today. Hence, a move higher in the stock relies more on the gold price than peers given that it’s far easier for a producer to re-rate from 0.50x P/NAV to 1.0x P/NAV like K92 Mining than it is to re-rate from 0.90x P/NAV to 1.80x P/NAV which is what would be required for Orla to double in price from current levels. In summary, while Orla makes a solid buy-the-dip candidate, I don’t see nearly enough margin of safety to justify paying up for the stock above US$4.05.