Welcome to Episode 112 of Special Situation Investing.
Saying Fortitude Gold (OTCQB: FTCO) has been on my watch list for years would an overstatement. More accurately, I noticed it as a new spin-off in mid 2021, saw it had spiked right out of the gate, and casually concluded the opportunity had passed. With my preference for asset-light royalty companies over capital-intensive miners, I gave the company little attention over the years since. That was until a random conversation on Christmas day prompted a few questions about the company. I finally dug deeper and what I found was not what I expected.
The Company
Fortitude Gold was originally part of Gold Resource Corporation (GORO). It was spun-out to shareholders on December 31, 2020. Shareholders received one share of Fortitude for every 3.5 shares held of GORO as of December 28, 2020.
Today’s focus is not the spin-off transaction, but a few details help understand the company as it stands three years latter.
For starters, the company was a natural candidate to be split up with two very different sections—two gold mines in Mexico and a handful of gold mining properties in Nevada, USA. Post spinoff, Fortitude owned the Nevada properties and GORO owned the assets in Mexico.
As is always the case with spin-offs, it’s insightful to see what company the original management ended up in. In this case, three of Fortitude’s four executive officers all came over from Gold Resources. Fortitude’s vice president of corporate development, chief financial officer and CEO, all once filled those roles at GORO. During one interview, the CEO, Jason Reid, said the original plan was for him to be CEO of both companies. But in order for the companies to be distinct enough to allow the spin-off to be a tax-free distribution, he could only be CEO of one.
If the stock price action between the two companies is any indication, it appears he chose wisely. The chart below shows Fortitude starting at $3.30, increasing to $8.45, and currently sitting at $6.26. GORO, on the other hand, steadily decreased from $2.77 to $0.29, nearly a 90% decrease.
So what is Fortitude Gold?
Here’s a slightly condense version of how the company describes itself on its website:
Fortitude Gold is a junior gold producer with operations in Nevada, U.S.A, one of the world’s premier mining friendly jurisdictions. The Company is led by an industry experienced and proven management team who previously directed Gold Resource Corporation…
Fortitude Gold targets high-grade gold open pit heap leach operations averaging one gram per tonne gold or greater. Our flagship Isabella Pearl mine reached first gold production in April of 2019 just over 10 months from project groundbreaking. The deposit’s proven and probable gold grade average is estimated at 3.05 grams per tonne gold with the high-grade Pearl zone of the deposit estimated to average ~4 grams per tonne gold. At December 30, 2019, total mine life of the Isabella Pearl deposit was estimated at 4 ½ years at an average ~40,000 gold ounce per year production run rate, after the initial twelve month production ramp-up.
The Company’s property portfolio consists of 100% ownership of five high-grade gold properties. All five properties are within an approximate 30-mile radius of one another within the prolific Walker Lane Mineral Belt. [Note: a sixth property since this section of its website was updated.]…Our business strategy is to grow organically, remain debt-free and distribute substantial dividends.
In summary, Fortitude is a junior gold miner. Perhaps you, like us, don’t usually care for miners, or maybe you do. Either way, here’s a few of the things that caught our attention.
A Different Strategy
Fortitude Gold’s strategy differs from most junior gold miners. In addition to attracting investors looking for exposure to gold, it draws in those seeking yield by distributing a sector-leading dividend.
Attracting a larger pool of investors, Fortitude seeks to outperform its peers both with greater potential upside and less downside. So far the strategy appears effective. Take a look at the two charts below. The left one shows Fortitude outperformed its peer group ETF, the GDXJ, since being spun-out. The one on the right shows a time frame that eliminates the large spike Fortitude had right after the spin-off. It shows that even while decreasing, it decreased less than its peers.
Management plans to maintain this differentiation between Fortitude and its peers by focusing on profitability not growth. This quote by Reid stood out:
If you step back and look at Fortitude Gold in the broader spectrum of the mining space and producers, 40,000 ounces a year isn’t impressing anybody. I don’t mind that because I’m not trying to impress anybody with the amount of ounces we produce. I don’t want to ever be the largest producer. I don’t want to just grow. I want to be one of the more profitable producers.
So far the company is proving quite profitable. It has an average net margin of 22% over the past three years. This has allowed the company to build up cash of $52 million on a $142 million market cap and employ an average combined $20 million in drilling and capex each year, all while maintaining an average dividend yield of 7%. Supporting all of this is the fact that Fortitude has one of the lowest all in sustaining costs (AISC) in the industry—only $625 per ounce compared to the global average of $1350. In today’s gold market, Fortitude can produce an ounce of gold for $625 and sell it for over $2000. Quiet impressive.
At this point, one should be asking: how does Fortitude maintain this outstanding performance and can it continue? The key to answering both questions lies in understanding Fortitude’s properties.
Unique Properties
Fortitude’s crown jewel—the Isabella Pearl mine—is currently the company’s only producing mine. That this mine was up and running in only ten months and has low-cost economics is what allowed Fortitude to quickly meet its dividend goal. The Isabella Pearl is low cost because it is an open pit mine—which is cheaper than underground mining—and because it has exceptionally high grade, compared to other U.S. open pit mines. Grade, for those who don’t know, is how the industry quantifies the amount of product—in this case gold—in each tonne of earth mined. Isabella Pearl has grades north of three grams per tonne compared to comparable U.S. open pit mines, most of which have grades of less than 0.5 g/t.
So the Isabella Pearl is the answer to how Fortitude has provided its outstanding results thus far. But unfortunately the mine’s days are numbered. In 2019, its total mine life was projected to end in mid 2024. Due to further discoveries on site, production is now expected to continue through mid 2025, with the potential for more extensions.
To maintain the production past 2025, the plan initially depends on production from two other properties—County Line and Golden Mile. Both properties have been extensively drilled with promising results and both have permits waiting approval from the Bureau of Land Management.
Both County Line and Golden Mile are geographically close to Isabella Pearl. As a result, management plans to use what it calls a “hub-and-spoke method” by which it will utilize Isabella Peal’s infrastructure as much as possible while extracting from these other mines. This will limit the need to build full mines at the other two sites. As an example, the County Line property is just fourteen miles from Isabella Pearl. The plan is to truck the aggregate from County Line to Isabella Pearl necessitating only minimal infrastructure on site. This should have two affects: quicker approval by the BLM (since there’s less to approve) and cheaper production.
While County Line is the closest property to Isabella Pearl, the plan is similar for the other mining properties—use the hub-and-spoke method to efficiently mine 40,000 ounces per year while maintaining Fortitude’s low AISC and high dividend.
While they are not yet in production, drilling confirms all of Fortitude’s properties have grades above 1%.
Since its properties have respectably high grades and can benefit from economies of scale due to close proximity, a path to maintaining low costs and high dividends and remaining a “more profitable miner” appears possible.
A Few Additional Points
Here’s a quick bullet point list of a few other things that stood out about Fortitude:
Unlike many mining companies, juniors in particular, that use dilutive share issuances to fund growth, Fortitude funds its exploration and mine development with its cashflow. It has kept its share count at 24 million since inception. It plans to maintain this track record moving forward.
Management showed that they are invested in the company when they left Gold Resource Corporation and joined Fortitude. Additionally, all four executives own common stock ranging from the CEO’s ownership of 6% of shares outstanding, another owns 3%, another owns 2%, and the last two each own 1%. This ownership is not as high as we’d like to see but it’s better than nothing.
Even though it’s a miner, Fortitude doesn’t have thousands or even hundreds of employees. At the time of its last annual report, it employed sixty full-time employees, including the four executive officers, and employed approximately thirty-five individuals through third parties. Additionally, services such as environmental permitting, mining, surface exploration drilling and trucking are contracted out on a case-by-case basis. Low headcount decreases the chance of high inflation impacting the company’s bottom line too hard.
Here’s one that blew my mind. The company actually has a small, but growing, stash of gold and silver bullion that it builds by keeping some of its own product. In the latest earnings call, the CEO said that he believes all gold miners should “put their money where their mouth is,” if they think gold is such a great investment, they should own it. He added the following:
We took advantage of the volatility in the gold price during the quarter to add to our growing physical metal bullion holdings as part of our treasury diversification program. We now hold both physical gold and physical silver bullion in our treasury.
The bullion in treasury now totals close to $1 million as recorded in Fortitude’s latest reports. Another reason he said they own the bullion is the threat of inflation.
Before we leave the inflation topic, Fortitude’s management has also stocked up on much of the supplies need to build out their next two mines. They said they saw the prices of everything going up and noticed cracks in supply chains and they thought it best to get things while they could. This is just one example of many of management running the company in a very commonsense manner.
Conclusion
There’s much more that could be said about Fortitude Gold. I didn’t even get to talk about one of its properties that potentially has a multi-million ounce deposit. No joke. But I’m okay with that because that’s not what impressed me about the company. I was impressed by its unique, straightforward strategy for rewarding shareholders. The company is officially on the watchlist but neither my co-host or I are shareholders at present.
On that topic, while we’re fans of dollar-cost-averaging into positions, not putting capital to work in Fortitude was an easy decision. This is because Fortitude is not our “best idea.” As discussed in our piece Position Size, we allocate to our best idea until it no longer is our best idea. Currently, Fortitude is not even in the top five. My co-host and I have recently had a few conversations about allocation as our number two pick is flirting with becoming number one. Perhaps more on that in our next Portfolio Update.
If you want to make your own decision about Fortitude Gold, I highly recommend you start by reading the Value Investors Club write-up and then give these interviews and investor’s calls a listen (here, here, here and here) and of course, read its filings.
With that we wrap up today’s piece. Thank you for your support and constructive feedback. We are better investors because of your interactions. Thank you. All we hope is that something we provide in these weekly pieces helps you in your journey as well. See you next Saturday.
A “More Profitable” Miner: Fortitude Gold (FTCO)