Falco Resources: 4.5 Million Ounces In Quebec

Summary

If you are looking for a three-bagger, you can't go wrong with GDXJ. And if you are looking for a five-bagger, SILJ will do the trick. However, if you want a good risk/reward stock with 10-bagger potential, those are becoming hard to find. But I have one for you: Falco Resources (OTC:FPRGF).

Falco Resources is in what I call the sweet spot, with a fully diluted market cap between $100 million and $150 million. Once a stock reaches the $100 million level, the risk reduces, because investors have recognized its value. Conversely, once a stock exceeds $150 million, the upside potential begins to diminish.

This range of $100 to $150 million does not apply to all miners. Often a company displays extraordinary value well before it reaches $100 million and long after it exceeds $150 million. However, most companies are in the sweet spot from $100 to $150 million. That is usually the ideal time to buy them from a risk/reward viewpoint.

This range is where you will find late-stage development projects, near-term producers, or mid-tier producers. What you are really investing in are emerging mid-tier producers. Most mid-tier producers are valued over $100 million, so buying in this range is catching an early mid-tier producer. These are the companies that can grow quickly. At this valuation, most of these companies will only have one producing mine, or their first mine under development. Thus, you are getting in early. Remember, you usually don't make your big money on the first mine, but their second and third.

Whereas the risk is substantial for junior gold and silver mining stocks, the upside is also substantial. My current focus is on both undervalued producers and companies with solid projects that are advancing toward production. My range is wider than $100 to $150 million market cap, but if a company falls into that sweet spot, I am more likely to buy it.

I consider all junior development companies as high-risk speculation stocks, because you can never know if they will make it into production. If they have trouble with financing, or if the geology is analyzed incorrectly (e.g. Rubicon Minerals (OTCPK:RBYCF)), or if any number of issues arises, these stocks can drop like a rock. Also, management is crucial and can disappoint investors with poor decisions and bad execution. Lastly, quality projects tend to get taken out by larger companies, which generally do not have the upside potential that I am looking for.

I think now is a good time to look for undervalued companies with growth potential. If we are in another gold bull run that could see new highs above the 2011 level of $1,935(see historical prices), then it would be wise to spot the potential winners. The biggest winners are likely to be those that are currently valued under $150 million, and are either producing or sitting on development projects that have all of the factors needed to be successful.

My investing style is to focus on potential future cash flow in conjunction with higher gold prices. For instance, what is the future value of XYZ gold stock if they develop a 5 million oz project and produce 300,000 oz annually at $2,000 gold? If you just do a quick and dirty analysis using potential future cash flow, you get 300,000 oz x $500 (estimated cash flow per oz with all-in costs at $1500 per oz) = $150 million in annual cash flow. If you multiply that by 10, you get a $1.5 billion valuation.

Note that some companies were valued at 30x cash flow during the last mania in stocks in 1980, and a 10x cash flow valuation is quite common today for strong mining companies. A conservative method is to use 5x cash flow.

It's amazing how valuable a mining company could become when it owns large profitable projects. There are many development stocks today with solid projects. Not all of them will be successful in building their mines, so it is a crapshoot picking the winners early. The smart play is to watch these stocks and see who is going to get financing. Of course, the longer you wait, the higher your entry price will be.

The most ideal stock is an undervalued company that is either financed to build its first project, or is an undervalued producer with growth prospects. The only way you can understand the risk of an undervalued stock is to do your own due diligence. Below, I will go step by step and show you what to look for when analyzing a mining stock. But even with this data in hand, you should do your own due diligence to confirm what I have written.

Even if you think you know a stock intimately, the data will change. If there is one constant in the story of a stock, it is change. And the higher the risk, it seems like the data changes more frequently. Whereas a major or a strong mid-tier producer can weather a data change, a junior can drop in value a significant percentage on small changes (refer to Orezone Gold's(OTCPK:ORZCF) recent news release). The volatility can be staggering, and sometimes juniors do not survive these changes.

The two most important rules to follow to limit your risk exposure are: 1) Only invest in a company that has the goods. In other words, do not chase drill results. Make sure that your company has at least one very good project. 2) Do not invest more than 1% of your portfolio cost-basis into a high-risk stock. Thus, if your invested dollars total $100,000, then your max is $1,000 for a high-risk stock.

This may seem too low, but you have to stay humble and acknowledge the high risk. If you think the stock is low risk, then you can triple this total to a maximum of $3,000. You may be thinking that you could end up with 80 stocks. Perhaps, but this won't happen if you buy bullion and/or ETFs as a foundation. With bullion and ETFs, you can go over the $3,000 limit.

The following analysis is based on data from my website www.goldstockdata.com.

Falco Resources has a large gold project in Quebec on 175,000 acres. The Horne mine is a 4.5 million oz deposit at 2.6 gpt, with significant amounts of silver (25 million oz), copper (260 million lbs) and zinc (1.2 billion lbs) for offsets. Management appears to be solid, delivering both an updated 43-101 and a PEA relatively quickly in 2016.

The capex is larger than I would like at $905 million. That will be difficult to finance. Cash costs are projected to be under $500 per oz because of offsets. However, the after-tax IRR is only 17% at $1300 gold because of the high capex. They plan to produce 230,000 oz annually. A pre-feasibility study is due in 2017, which was financed with a $10 million loan.

Production at Horne stopped in 1976, but it still has significant infrastructure and should be easy to permit. The CEO is a proven mine builder and operator. What I like about this stock is their potential to find another mine on their 175,000 acres in a gold district. It's usually the second mine where you make your big returns.

There are a few red flags: takeover target, financing, and the timeline until production. I would expect production around 2021. Falco has quadrupled in value this year, but I think it still has 10 bagger potential from its current FD market cap of $112 million.

The 3 Ps

Properties

• Does it have a flagship project? Yes, long life mine.
• Does it have a pipeline of projects for growth? No, single project.
• Does it have the exploration potential to expand resources? Yes, 175,000 acres to explore.
• Is the grade and recovery rate satisfactory? Yes.
• Is the location satisfactory? Perfect location. Past producing mine in 1976.
• Does it own it? Yes, 100%.

People

• Is it an exploration or production team? Both.
• Does it have experience? Yes, it is a highly experienced team.
• Does it have a track record for building mines? Yes.
• Is it investor friendly and not always diluting? Yes, dilution is still low.
• Is the team large enough to build a mine? Yes.
• Have you listened to a CEO interview? Yes, its CEO seems to be solid.
• Is it cash focused? So far it has avoided debt.
• How much stock does management own? Insider holdings of about 28%.
• Do the website and company presentation provide adequate guidance and details? Yes.

Projects

• What are the resources? 4.5 million oz at 2 gpt.
• What documentation has been released (PEA, Pre-feasibility Study, Feasibility Study)? PEA (preliminary economic assessment).
• What is the capex? $900 million.
• What is the after-tax IRR? 17% at $1,300 gold.
• What are the estimated cash costs and all-in costs per oz? $500 per oz cash costs and about $900 per oz all-in costs.
• Can it be financed? Won't be easy. Could impact potential returns.
• How will it be financed (debt, equity, streaming)? Unknown.

Share Structure

Is it highly diluted? Yes. It has 123 million fully-diluted shares.

Timeline Risk

Production in 2021.

Market Cap Size

$112 million. It's in the sweet spot.

Stock Chart

Is this a good entry point? Yes.

Balance Sheet

What is its cash/debt situation? $10 million in cash and zero debt.

Valuation

• What is its potential future market cap growth rate at $2,000 gold? 1,900% at 230,000 oz (see below).
• What is its potential future free cash flow at $2,000 gold? $230 million annually at 230,000 oz (230,000 x $1,000). (This assumes all-in costs are $1,000 per oz).
• What is its future reserves valued at today? $25 per oz at 4.5 million oz ($112 million/4.5 million oz).

Future market cap growth:

Current Market Cap: $112 Million.

Future Market Cap: 230,000 oz x $1,000 = $230 million annual cash flow x 10 = $2.3 billion

Compare the two values and you get a 1,900% increase.

Is Falco Resources highly undervalued? Yes, with a potential increase of 1,900% and future reserves valued at $25, it is highly undervalued. If you consider share dilution to pay for the feasibility study, engineering, and financing the mine, the upside is considerably lower. If it builds the mine, perhaps it will be a 10+ bagger.

Note: I use $2,000 as my future gold price because I think it is a realistic expectation. We reached $1,935 in 2011, and the next economic crisis should push gold much higher. Many are projecting possible gold prices of $5,000 or higher. While I think $5,000 gold prices are possible, I think $2,000 is likely. My expectation is that this should occur within two to five years.

You can check the data included in this article at Falco Resources' website and my own.

Disclosure: I am/we are long FPRGF.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.