Excavating a Pair of Mining Stocks

 | Jan 15, 2013 | 4:30 PM EST
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One of the best feelings of being an investor is waking up to find one of the stocks in your portfolio is the recipient of a buyout offer at a substantial premium to its current price. It is like winning a small lottery: unexpected, but very welcome. I got to experience this on Monday as one of the core positions in the small-cap portion of my portfolio, Aurizon Mines (AZK), received a buyout offer from Alamos Gold for an approximate 40% premium.

Consolidation among the smaller gold miners makes good strategic sense. Despite historically high prices for gold and  silver, the sector has been challenged over the last few years. Significant cost inflation in operating costs, strikes and troubles ramping up production are just some of the headwinds the industry has faced.

All of this explains why these mining stocks have significantly underperformed the rise in the price of these metals over the last five years. Consolidation would provide economies of scale and improve margins. In addition, many of these small miners are selling below their fair value given the substantial move in precious metal prices over the last decade. Here are two small mining stocks that are cheap as stand-alone entities but also could provide a "buyout kicker."

Endeavour Silver (EXK) focuses on the growth of its silver production, reserves, and resources in Mexico and Chile. It has a similar market cap to Aurizon.

Four reasons Endeavour is cheap at under $8 a share:

  1. The company just announced that silver production rose 20% in 2012. Gold production was up more than 75%, albeit off a much lower base. It was the eighth straight year of increasing production.
  2. The company will clock in with better than 60% revenue growth in 2012 and analysts currently project around 40% revenue gains in fiscal 2013.
  3. Despite this growth, the stock sells for less than 9x forward earnings.
  4. Endeavour has a clean balance sheet with no net debt. The company has quadrupled operating cash flow over the past three years.

Gold Resource (GORO) produces gold and silver from its properties in Mexico.

Four reasons GORO is a bargain at $15 a share:

  1. The company has a solid balance sheet with net cash and a dividend approaching 5% (4.9%).
  2. Analysts expect almost 20% revenue gains in 2013 and insiders have been net buyers of the stock over the past six months.
  3. The company is one of the lowest cost producers in the industry (approximately $400 per ounce in 2012) and the stock trades at a reasonable 14x forward earnings.
  4. The stock's price has been cut nearly in half over the last six months due to the company's problems with ramping up production. Management plans to increase production of gold by more than 50% by 2015. The stock should perform well if they can execute that plan.

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