AuRico Gold (AUQ) (AuRico) is a Canadian gold mining company with a market capitalisation of close to $2B currently operating two mines in Canada (Young-Davidson) and Mexico (El Chanate) respectively. AuRico has just come out of what they labelled a 'transformational year' 2012. In this article we would like to look at these transformations and query the investment case for this company.
Let's recap those transformational events in 2012 quickly.
1) In May AuRico announced completion of the sale of their interest in two Australian mines (Fosterville and Stawell) for a consideration of $55M in cash and $10M in shares in Crocodile Gold Corp (CROCF.PK). The block of CROCF shares was sold in October. To be precise, AuRico's interest in these two Australian mines was through Northgate Minerals which AuRico had purchased only months earlier. Presumably, the acquisition of Northgate was driven by the Young-Davidson development project and the two Australian assets came as an add-on to that.
2) In July AuRico announced completion of the sale of the El Cubo mine near Guanajuato in Mexico to Endeavour Silver (EXK) for $100M in cash and further $100M in EXK shares worth another $100M at the time of closure. The share component was sold a couple of months later at a loss of $5M.
5) In addition to all this wheeling and dealing AuRico's CEO of five years René Marion stepped down quite suddenly due to health reasons in July, and a long-standing class action was settled at a cost of $13.25M in November.
Quite the opposite of a boring year in anyone's book. Nevertheless, the company seemed pleased with the outcome.
To summarise: this consolidation involved the sale of four operating mines, and the start-up of one other mine effectively reducing AuRico into a two-mine operation.
Consider an announcement made by AuRico in October 2011 stating:
... AuRico is now positioned as a leading intermediate gold producer with five operating mines and Young-Davidson targeting production at the end of Q1 2012.
And contrast this with the announcement just over a year later after the aggressive divestment of the four mines where the new strategy was explained by AuRico as 'streamlining their asset base' underpinning their 'strategy of focusing on its portfolio of large, low-cost, long-life gold assets in North America'.
Let us now have a brief look at the mines that were divested in 2012 and how the sale of these assets stacks up in the context of the explanation given by the company summarised above.
1) Crocodile Gold reported in June 2012 that
…after a transitional period in May, both mines produced more ounces of gold in June than in any other month in 2012.
Subsequent reports indicate that production targets have been reached and gold production was stable. While the mining activities are scheduled to terminate at Stawell at the end of 2013, production will continue at the Fosterville mine with promising drill results indicating a possible extension of the present mine life of three years.
Our view: These two Australian mines produce gold and seem to turn a moderate profit, but they are hardly crown jewels for a company the size of AuRico. Moreover, these two mines are located a very long way from headquarters.
2) Endeavour Silver seems to have their hands full with what they call the turn-around of the El Cubo mine. Two months after closing of the acquisition they published their plans on how to turn El Cubo into a profitable operation. The list of improvements outlined in this plan along with other indications since then does not shine a favourable light on the management of the El Cubo mine under AuRico. Endeavour Silver has published frequent updates on the El Cubo operations and it seems that Endeavour Silver are well under way now to making this mine profitable.
Our view: The El Cubo mine is geographically compatible with AuRico's declared strategy, and one can't help but wonder why Endeavour Silver is seemingly able to create value where AuRico had not been able to do so.
3) The Ocampo mine had been a problem child for quite some time before the mine was finally sold to Minera Frisco. Problems at the mine caused the share price to plunge by 14% in July 2012 and performance issues haunted AuRico all year in 2012 and probably before. There is no information on Minera Frisco's plans with this operation publicly available to date, but it is safe to assume that rigorous measures will be implemented by the new owners in order to create profits at the Ocampo mine.
Our view: Again, we question why AuRico was unable to contain and solve the problems at the Ocampo mine, while Minera Frisco seems to have the confidence to do so.
Let us turn our attention back to the streamlined AuRico of now.
On paper, the Young-Davidson mine looks like a very promising asset which should create significant value over the coming years. The recently published preliminary operational results indicate that production targets were only just reached (56,138 oz compared to the targeted 55,000 oz - 65,000 oz) and cash cost was significantly above guidance ($690-$710 compared to the targeted $550-$650). The results for the second operating asset, the El Chanate mine in Mexico, were reported to be within target, although targets had been lowered during 2012.
Due to the sale of the four mines AuRico had a lot of cash at its disposal. Some of this cash has already been allocated. A long-standing class action against the company was resolved, and the company has just announced the buyback of 12.8% of its outstanding undiluted shares. Furthermore, the company intends to announce an inaugural dividend policy before the end of March.
Here is our case for shorting AuRico starting now:
1) The share buyback was heavily oversubscribed, and only about a third of the shares offered up for buyback were actually bought back by AuRico. This indicates that a lot of shareholders are uncertain about the company's present valuation and the way forward. Presumably, many shareholders will try to sell the remaining two thirds of their holdings in the near future on-market, creating downward pressure on the share price in the coming days and weeks.
2) Many investors will certainly appreciate the maiden dividend that has been foreshadowed. However, AuRico is a much smaller company now with only two operations remaining. Any substantial dividend announced in the near future will raise the question whether or not this dividend can remain sustainable once the cash reserves generated from the 2012 asset sales will be used up. Shareholders might be tempted to cash in on the maiden dividend and then run for the exit creating further downward pressure on the share price.
3) The inability to turn the El Cubo mine and the Ocampo mine into profitable assets is fresh in our mind, and the question lingers what would be the management's actions if problems occurred at one of the remaining operations?
4) A recent article on SA valued AuRico at a fair price of $5.63 per share which is about 30% lower than the current market price. We concur with the valuation presented in this article.