Karora Resources: Another Solid Quarter

Just over six weeks ago, I wrote on Karora Resources (OTCQX:KRRGF), noting that while the stock was tracking well against FY2023 guidance, there was still no margin of safety which made it difficult to justify paying up for the stock above US$3.45. Since then, the stock has suffered a ~25% drawdown which is above that of its peer group (~15%) before bottoming out just above the ideal buy zone I highlighted of US$2.50. The strong bounce off its recent low can be attributed to another impressive quarterly performance in Q3 and a sharp rebound in the gold price, which gained over 5% last week just as many market participants had finally thrown in the towel, judging by extreme pessimism heading into the week (shown below). In this update, we'll look at the Q3 results, its updated valuation, and whether the stock offers an adequate margin of safety.

All figures are in United States Dollars unless otherwise noted.

Q3 Production & Sales

Karora released its Q3 results last week, reporting quarterly production of ~39,500 ounces of gold, a 3% increase year-over-year. This has pushed the company's year-to-date production of ~120,200 ounces, leaving it tracking at ~79% of its FY2023 guidance midpoint. And not only would this mark another record year for the company for gold production (FY2022: ~133,800 ounces), but it would also continue the company's track record of over-delivering on promises, a unique attribute within the sector and especially among the junior producer space where the track record of delivery can be more spotty due to relying on only one to two mines which can magnify any potential hiccups when it comes to delivering on guidance.

Looking at the larger picture below, the company is tracking ahead of my previous FY2023 estimates (~158,000 ounces) assuming it can deliver a similar performance in Q4 (38,000+ ounces), with Karora now set to potentially hit the 160,000-ounce top end of guidance if it can put together a 38,000+ ounce quarter, with it tracking at ~75% of the top end currently. However, while the record production is exciting, the growth will continue in a big way, with this year's ~19% growth set to be followed by double-digit growth next year to 181,000 ounces even assuming it delivers into the low end of guidance. And looking ahead to 2025, investors will see the fruits of this labor (higher mining rates) from a financial standpoint. This is because Karora's free cash flow is strained short-term because of the elevated capex, 2025 will benefit from higher production, lower operating costs, and significantly less growth capital, with the potential to generate upwards of $125 million in free cash flow.

Margins & Recent Developments

Moving over to costs and margins, investors may have seen only moderate margin improvement in Q2 2023, but we should see a further improvement in Q3 2023 with the company lapping easy year-over-year comparisons from Q3 2022. This is because its average realized gold price should average at least $1,920/oz up from $1,717/oz in Q3 2022. So, even assuming higher all-in sustaining costs [AISC] of $1,160/oz related to higher power, fuel, labor, and contractor costs offset by higher ounces sold, AISC margins should improve to $750/oz, translating to a ~16% increase year-over-year. Hence, it should be another strong quarter from a financial standpoint for the company, and its net cash position certainly supports its growth and higher capital spend next year planned next year (~US$70 million).

As for recent developments, there are lots to be excited about here as well, with Karora completing its second vent raise and expecting to complete its third by year-end, allowing the company to have sufficient ventilation to support its ~2.0 million tonnes per annum mining rates which will grow Beta Hunt into a 150,000+ ounce per annum operation (FY2022: ~79,000 ounces). Just as importantly, the company continues to enjoy exploration success across its portfolio, with high-grade drill results from Fletcher South, Spargos, and Mason, which all support continued reserve growth net of depletion. And given the results which continue to match or exceed current reserve grades, there's the possibility that Karora could significantly increase its Beta Hunt reserve base to 800,00+ ounces by year-end 2025 once tighter drilling is complete.

Looking at the exploration results a little closer, the major highlight has been the Fletcher Shear Zone, which the company believes could be a structural analog to its Western Flanks Zone (shown in green). And while previous results from the Fletcher Shear Zone [FSZ] were promising and supported the potential for a 2.0-kilometer strike length for this mineralized system, it's the results from Fletcher South that are the most exciting given that the grade and thickness of these intercepts continue to be exceptional, including highlight hits of 6 meters at 15.9 grams per tonne of gold and 32 meters at 4.8 grams per tonne of gold. And even more important from a capex and cash flow standpoint is that Fletcher South (highlighted by the high density of red dots in the below image next to Larkin) is right near existing nickel infrastructure in the Beta Block and Larkin, providing relatively easy access with limited required development to bring these ounces into the mine plan assuming infill drill continues to be successful.

Meanwhile, on the other side of the Alpha Island Fault, the company continues to report solid results from Mason, which has extended the strike by an additional 100 meters, growing gold resources in an area that the company only discovered three years ago with Larkin. Meanwhile, drilling at the northern end of Larkin has led to increased confidence in upgrading the resource from inferred to indicated according to the company, and the company also reported solid results from Spargos (a small high-grade satellite opportunity) that has extended the deposit at depth. So, while Karora may have been held back from a capitalization standpoint from resources in the past with it being hard to justify an $800+ million market cap [US$4.50] for a company with barely 1.0 million ounces in reserves company-wide (implying a valuation of ~$800/oz), progress is certainly being made here, with there looking to be upside to 1.5+ million ounces of reserves company-wide medium-term.

Valuation

Based on ~183 million fully diluted shares and a share price of US$3.02, Karora trades at a market cap of ~$550 million and an enterprise value of ~$520 million. This leaves Karora trading at just ~4.4x FY2024 operating cash flow estimates, making it one of the cheaper producers sector-wide, and especially among those trading in Tier-1 ranked jurisdictions. And using what I believe to be a fair multiple of 6.25x FY2024 cash flow estimates (adjusted from 7.0x to reflect sector-wide multiple compression) and 1.0x P/NAV using a 65/35 weighting, respectively, I see a fair value for the stock of US$4.35. This points to a 43% upside from current levels, suggesting Karora could have a significant upside to fair value if the sector can swing back in favor.

That said, I am looking for a minimum 40% discount to fair value for starting positions in small-cap names to ensure a margin of safety, and following Karora's recent rally, it's moved out of its ideal buy zone. This is because if we apply this discount to Karora's estimated fair value of US$4.30, its ideal buy zone comes in at US$2.65 or lower. So, although there's no question that Karora is undervalued and this rally could continue if the price of gold can maintain its recent momentum, I still don't see a low-risk buying opportunity just yet. Hence, while I think Karora is one of the better-run junior producers in the sector, I continue to see more attractive bets elsewhere.

Summary

Karora put together another solid report in Q3 and is on track to easily beat its guidance mid-point with an outside chance of hitting the top end of guidance (160,000 ounces) given that it's sitting at ~75% of full-year guidance already. Meanwhile, the company continues to see exploration success at its flagship Beta Hunt Mine, with multiple new discoveries over the past two years and extensions to these discoveries, including very encouraging results from Fletcher South. However, while Karora may be undervalued, its relative valuation is less attractive than it was in September 2022 given that we've seen even deeper pullbacks in many of the larger producers sector-wide. So, while I continue to see Karora as one of the top-5 junior producers in the market, I would need a pullback below US$2.65 to get more interested in starting a new position.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.