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Are Gold Miners Cheap?

Are Gold Miners Cheap?

By Bob Kohut 18.03.2013


Back in September 2012 when gold hit a high of US$1784.50 per ounce, Bank of America Merrill Lynch (BAML) analysts forecasted gold racing to $3,000 or even as high as $5,000 over the long term.

BAML's analysts argued that gold was on a well-defined uptrend and that the best long story for commodity markets was gold. The big factor driving gold, according to BAML, was aggressive monetary policy easing. "You really want to be invested in gold," BAML's Sabine Schels, head of fundamental commodity research reportedly said.

The chart below charts the gold price year over year as of 13 March 2013:

The chart shows gold crashing through its 200-Day Moving Average in February 2013. 

In response, analysts are cutting forecasts:

•    Goldman dropped its three-month gold-price forecast from $1,825 to $1,615 an ounce; its six-month forecast from $1,805 to $1,600 an ounce; and its 12-month forecast from $1,800 to $1,550 an ounce.

•    BAML sees “headwinds” and doesn't envisage gold hitting $2,000 until 2014.  Short-term forecasts for 2013 have been lowered to $1,680.

•    Nomura of Japan lowered its 2013 forecast to $1,602 per ounce from $1,981, and its 2014 forecast to $1,750 from $1,800.

•   BNP Paribas, Credit Suisse, Societe Generale and Citi have also slashed forecasts.

Interestingly, in a 7 March note to investors, Credit Suisse pointed to “record outflows” in ETF gold holdings, signaling a significant change in both the technicals and fundamentals for gold.

There's plenty to suggest, however, that the gold price can recover: continued low yields in government bonds, loose monetary policy, fluctuations in the US dollar, and quantitative easing.  Futhermore, the fundamental drivers of the gold price - such as inflation and global economic woes - remain. Presently the equities market is racing, and funds are moving out of gold and into equities. But that situation can reverse if the equities market suffers a correction.

During gold's long bull run, gold mining stocks have largely dragged behind the price of goldMiners on the whole have looked cheap compared to the price of the commodity.  And over the last little while gold miners have only become cheaper.  The following 2-year price chart tracks GLD, the largest Gold ETF, with shares backed by gold bullion; GDX is a gold miners' ETF.  Take a look:

As you can see, the pace of underperformance accelerated in 2012 - mining stocks fell as the gold price advanced. So what happens if the gold price continues to sink lower? Should investors shun gold mining stocks altogether?

Let’s take a look at some of Australia’s gold miners.

Notoriously volatile junior miners are companies with a great story, but no earnings.  Funding exploration activities without revenue means borrowing and share dilution through capital raises - often multiple times.  Yet juniors have a seductive appeal for those with a high risk appetite, such as gold explorer Andean Resources. In 2010, Andean listed on the ASX and the TSX (Toronto Stock Exchange) - with an outstanding story about its high grade gold assets in Argentina.  Canadian gold producer Goldcorp outbid a rival and gobbled up Andean at a 35% percent premium over Andean’s closing price and a 56% premium over its recent share price average.

While there are no guarantees, news of favorable asset reports can act as catalysts for stock price.  Operations in non-Australian locations can also serve to minimise gold price risk as new discoveries work their catalytic magic.  There are solid mining stocks that operate only in Australia, such as St.Barbara Ltd (SBM), Regis Resources Ltd (RRL) and others; but they will be judged more on fundamental performance than rank speculation. 

Australia is one of the top gold producing countries on the planet with known reserves.  That is the point.  Certainly it is possible for major new discoveries here, but there may be better potential for discovery elsewhere.  Right now global mining powerhouses are looking to Africa as an attractive area for gold exploration.

For those reasons, we have selected gold miners with story potential and/or operations outside of Australia.  Here is our table:

Company

Code

Market Cap

Share Price

2 Year % Change

P/E (Forward)

Gearing

Total Cash

Newcrest Mining

NCM

$16.7B

$21.85

-39%

12.49

21.05%

$97M

Perseus Mining

PRU

$831.2M

$1.82

-35%

7.26

0

$39.67M

Oceana Gold

OGC

$757.3M

$2.58

+12%

5.49

43.76%

$96.5M

Dragon Mining

DRA

$43.5M

$0.49

-62%

1.20

5.49%

$14.38M

Vantage Goldfields

VGO

$22.73M

$0.10

-57%

5.92

4.23%

$2.96M

 

In 2011 gold mining shares tumbled as the gold price advanced.  For this reason, we've included the percentage change in the share price over 2 years.  As you can see, it’s pretty grim.  

Newcrest Mining (NCM) is one of the top five gold miners in the world, with large reserves; it also has new projects underway for future growth.  The company has seven gold mines across four countries – Australia, Indonesia, Papua New Guinea, and Africa.  Newcrest has exploration projects in progress in the United States, Canada, and Peru.

The company has increased revenue every year over the past decade and increased net profit every year for the past four.  Earnings per share, however, have dropped from $1.58 in FY2010 to $1.42 in FY2012.  Newcrest has a dividend yield of 1.6% and cut its payout from $0.50 per share in FY2011 to $0.35 in 2012.

Major analysts, including CIMB Securities, Macquarie, Credit Suisse, and BA-Merrill Lynch have BUY ratings on NCM.  Most cite the anticipated growth from the company’s mine at Lihir in PNG as a major reason to buy this stock.

The current gold bull has been running for over a decade so let’s see how NCM’s share price has fared over that period.  Here is the chart:

Perseus Mining (PRU) qualifies as a “story unfolding” stock with its targeting of under-explored gold belts in West Africa.  It has already transitioned from gold explorer to gold producer as of 1 January 2012.  The operational mine is in Ghana and the company plans to go into production from a second mine in Cote d’Ivoire (Ivory Coast) in 2014.  

Debt is always a concern with smaller miners and Perseus reduced its gearing from 16.8% at the end of FY 2012 (June) to zero gearing as of the most recent quarter along with zero debt. The first revenue and net profit of $47 million came in a year the price of gold was volatile.

Most major analysts give Perseus the thumbs up.  CIMB Securities, Citi, Macquarie, Credit Suisse, and UBS have BUY recommendations on PRU, albeit with high risk.  The company had experienced problems with a crusher at its Ediken mine in Ghana, which was resolved in March.  JP Morgan has a NEUTRAL rating awaiting news on the crusher repair.  Here is its ten-year price chart:

Oceana Gold (OGC) has three mines in operation in New Zealand with a development project underway at Didipio in the Philippines - a gold/copper operation.  The company’s shares trade in Australia, Canada, and New Zealand.  It began trading on the ASX in 2007 and is the only stock in our table with positive performance year over year.  Oceana bucked the trend and there are several reasons that could explain the outperformance.  First, the company arranged debt financing, although the gearing is still somewhat high.  Second, the Philippine project got the necessary commissioning and should improve Oceana’s production, cash costs, and cash flow.  Third, investment firm Goldman Sachs blessed OGC by adding the company to its high conviction list in the belief the Didipio project in the Philippines will add substantial earnings growth to the company in 2013.  Here is the company’s one year chart:

Oceana's share price fell alongside the price of gold but began to rebound shortly after the release of FY2012 earnings, which were less than stellar, showing a decrease in revenue and a more than 50% drop in net profit.  However, the “story” results for the Didipio project were positive and the share price advanced.  Following the earnings release Citi and JP Morgan reiterated BUY recommendations, citing positive growth anticipated in 2013.

The remaining stocks in the table qualify as junior miners.  Dragon Mining (DRA) is based in Australia but its principal production and exploration activities are in Finland and Sweden.  Full Year 2012 unaudited results were released on 26 February and although revenues increased to $79 million from $75 million, net profit showed a loss of $4.5 million, an improvement over the 2011 loss of $6.2 million.  Net operating cash flows, which were positive in 2011 at $13.3 million, dropped to a negative $4.38 million.  

The company, however, released positive expectations about exploration activities.  The release followed positive news about an Earn-In agreement between Dragon and Agnico-Eagle Mines Limited for Dragon’s Hanhimaa Gold Project in northern Finland, a major part of the Dragon story.  The agreement gives Agnico the opportunity to earn a 51% stake in the project with staged expenditures as Agnico manages the development of the project.  The stake could go as high as 71% depending on how much money Agnico invests over a defined time frame.  

This frees up resources for Dragon’s other activities in the region, which are substantial.  The company has two operating mines in Finland along with seven exploration projects.  In Sweden Dragon has an operating gold mine and processing plant as well as a joint venture exploration project.  Most of these projects are in early drilling stage which means the story could grow with each positive update, providing of course they are positive.  Geologists consider the Central Lapland Greenstone Belt in northern Finland to be the area of highest potential for gold discovery in Finland.  Dragon has three exploration projects there.

Here is a two year price chart for Dragon along with the last stock in the table, Vantage Goldfields (VGO):

Vantage is a junior miner with a miniscule market cap of $22 million and a share price at 10 cents.  So what’s the story here?  The company operates in South Africa’s second largest gold-producing region with abundant infrastructure already in place.  Roads and an electrical grid are present throughout.  The Barberton Greenstone Belt of South Africa has been producing gold for more than 100 years.  Vantage currently has three principal mines in the region, the Lily Mine, the Barbrook Mines Complex, and the Taylors Mine, along with a Central Metallurgical Complex to process the ore from each mine, along with a central processing facility.

The more exciting part of the story is the 16,000 hectares of unexplored territory in the Barberton Field licensed to Vantage.  These properties have favorable geological formations as well as dormant mines that could be brought back into production with modern mining technology.  The first such project will be the dormant Worcester Mine.

There is no sovereign risk in South Africa, although labor disputes have plagued the company.  Gearing is low, with total debt as of the most recent quarter of $2.40 million against total cash on hand of $2.96 million.  The company’s balance sheet along with exploration assets and proven reserves should be enough to raise additional funding if needed.  So why then, you might wonder, is this stock trading for a dime?

VGO has been trading on the ASX since 2010.  The company began in South Africa as Eastern Goldfields in 2004 with US$8 million in capital raised from private placements.  In 2008 and 2009 VGO borrowed to pay for acquisitions in the region.  Eastern Goldfields was trading in the US on the OTC Bulletin Boards before delisting and reinventing itself in an ASX IPO that raised $30 million.  With so many operations underway in such a short period, the company has not released targeted production dates, which obviously disappoints interested investors.  However, this is a junior miner with a story to watch.

Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au. You should seek professional advice before making any investment decisions.



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