The price of gold and the dollar index are inversely proportional. With the U.S. economy showing signs of recovering and fears about the eurozone and sovereign debt crisis abating, investors are gradually reducing their commodity hedges and putting their money into equities and other growth assets. As this transition occurs, I think profitable commodity businesses can slip through the cracks and become undervalued. Too much attention is paid to the price of the commodity itself, while investors neglect closely examining the intrinsic value of the businesses that actually provide these raw materials. Given the current market conditions, I think this is exactly what we are seeing with Goldcorp (GG). Indeed, I believe there is a lot to like about its business that warrants its consideration as an attractive value opportunity.
Unlike big diversified mining companies such as Vale (VALE), Rio Tinto (RIO) and Freeport-McMoRan (FCX) that face a plethora of risks associated with the trend of falling commodity prices, I like Goldcorp because it really is a classic value play. As opposed to Vale, Rio Tinto and Freeport-McMoRan which have seen their share prices fluctuate given the instability of iron ore, Goldcorp truly specializes in one thing - mining gold, and it does this extremely well.
Consider that despite being a much smaller producer, Goldcorp has surpassed long time market leader and much larger Barrick Gold (ABX) as the world's biggest gold miner in terms of market capitalization. Goldcorp has a market cap above $36 billion while Barrick Gold's total value is around $35.6 billion. What jumps out at me about Goldcorp is what happens when I dive deeper into this comparison. Goldcorp has a far smaller output than Barrick Gold. While Barrick Gold will mine between 7.3 and 7.5 million ounces this year, Goldcorp only plans to mine between 2.35 and 2.45 million ounces. Additionally, Goldcorp has a stronger profit margin of 35% compared to Barrick Gold's 31%. Taken as a whole, these figures scream efficiency. Specifically, it means that even though Goldcorp mines less gold on aggregate, it pockets a greater percentage of revenue on each ounce obtained. In an industry with such high costs, Goldcorp's ability to contain expenditures and manage resources is very impressive.
The big question for investors of course is whether Goldcorp can keep it up, to which I believe the answer is yes. By focusing on low cash costs and operating in regions with low political risks, GoldCorp maintains a conservative philosophy towards developing its assets. As Chuck Jeannes, Goldcorp's CEO, explains, "What we try to do when we acquire assets, is to acquire things that are very young in their life cycle, so that they have significant opportunity for growth going forward."
At its sites in Lead, South Dakota, Los Filos, Mexico and Red Lake, Ontario, the company is making good on its strategy. In South Dakota for example, Goldcorp spent $16 million on mining costs but made $58 million in earnings from the operation. In Mexico, it illustrated a similar result garnering $302 million while spending only $74 million. Equally impressive are the results in Ontario, where the company has earned $866 million at a cost of only $204 million. As opposed to Barrick Gold's aggressive expansion strategy that hasn't always paid off (see its Pascua Lama project for example), Goldcorp's meticulous and more cautious approach to site management has prevented the firm from overextending on operational expenses. In addition to helping secure better margins that I think will ultimately translate into strong long term performance results, this approach is also benefiting shareholders. Goldcorp has steadily made dividend payments to investors since 2003.
I believe another positive indicator of Goldcorp's future prospects and business strength emerges when you look at how the company has seemed to better weather industry trends. Indeed, most gold stocks peaked in September of 2011, and the firm's competitors such as focused gold producers El Dorado (EGO) and Kinross Gold (KGC) stocks suffered more than Goldcorp's. Compared to Goldcorp's decline of 24%, El Dorado's shares have fallen by more than 28% and Kinross Gold's shares have declined by upwards of 35%. Barrick Gold's shares also fell far more than Goldcorp's as the stock declined by 37%.
What I see when I look at Goldcorp is a very strong business that via a variety of indicators illustrates an edge on competition given its intelligent mining strategy and ability to earn profits at market leading efficiency. In my view, these factors make it a good long term play regardless of how gold performs. Although gold has spiked recently, historically it is a lot less volatile than most commodities and even many equity indices such as the S&P 500. While it's certainly possible that the price of gold may drop and thus impair Goldcorp's price in the short-term, I think Goldcorp is a fundamentally sound business which should allow it to withstand any short cycle fluctuations and come out ahead in the long run. On the other hand, if as Raymond Kay, Deutsche Bank's (DB) global head of metal trading suggests, and gold continues its historic rise by eclipsing the $2,000 mark, it could mean a very strong upside for Goldcorp in the immediate future, which would obviously reward investors handsomely.
Clearly, I'm not the only one that sees Goldcorp's potential to shine. Barclays Capital recently issued an overweight rating and a $62 price target for the firm, while Canaccord Genuity raised their price target on shares from $53 to $62. With the company trading at $14 less than its 52-week high, I think there is a lot to like about this gold producer's outlook moving forward.