Yamana Gold: Finding Value

Yamana Gold (NYSE: AUY) is a difficult company to follow. It seems that as soon as you get a handle on the business, something changes. I originally bought the company thinking of it as a simple business: Pull gold out of the ground, sell it and then profit, but it’s not that simple.

One of the factors that must be considered regarding Yamana is the cost of developing new mines. Yamana has grown gold production dramatically in just the past few years, and it has done this through new mine development and acquisition. Despite this new production, it is still difficult to tell if there has been value created for shareholders.

Yamana has financed the majority of its development and acquisitions with share issuances. Any “win” on the side of development has been almost entirely offset by share dilution. Going forward, Yamana will have to continue this practice as debt financing has grown increasingly difficult. The company has set a production goal of 2 million gold equivalent ounces by 2012. It has also indicated that 2009 production should be in the range of 1.3-1.4 million gold equivalent ounces, while 2010 should be in the range of 1.4-1.5 million ounces. Based on these goals and its indicated costs of production, I’ve tried to create a forward-looking income statement.

click on charts to enlarge

Revenue

Revenue is based on the lower range of gold equivalent ounce production along with the minimum range of copper production at the Chapada mine. This revenue figure is based on gold at $800 per ounce. Copper is estimated at $1.75 per pound.

Cost of Revenue

Cost of Revenue is based on the upper end of Yamana’s projected range at $375 per gold equivalent ounce. This cost grows to $395 in 2011 and to $405 in 2012.

General & Administrative

I assume some expense control in General and Administrative expenses. Based on the recent acquisitions, there are likely some cost savings to be obtained here, so I haven’t projected these expenses to grow as fast as revenues.

Hedging

It is rather difficult to estimate how the hedging costs will work out. I have kept this fairly consistent with its 2008 experience.

Cash Flow

As part of the cash flow portion of this model, I’ve added back Depreciation and Amortization and then subtracted sustaining capex as noted in the company’s most recent press release concerning its 2009 and 2010, outlook.

Shares Outstanding and Development Requirements

I’ve kept the cash balance relatively consistent, and estimated that Yamana will continue to issue shares to fund mine development costs. Based on the previously noted assumptions, there is incremental value to shareholders. Assuming a P/CF of about 22, the share price would be about $15 in 2012.

Sensitivity and the Price of Gold

This model is based on the price of gold staying around $800. As I wrote this, it was hovering around $950. If the price of gold rises to $1,000 per ounce in 2012, its cash flow would be $1.00 per share. If it falls to $650, then its cash flow would fall to around $0.40 per share.

Conclusion

Despite the difficulties in projecting forward earnings, I believe that holding Yamana does make sense in order to gain exposure to gold prices. As the world economy continues to struggle, the price of gold should remain high. It seems that the more uncertainty there is, the higher the price of gold climbs. Yamana’s production increases continue to serve as a kind of hedge against falling gold prices - up to a point. However, if gold falls below $650, returns would definitely suffer.

Disclosure: I currently hold shares of Yamana Gold.

Comments

[silverwood:]

Dan, good analysis and very conservative. There is a strong possibility that gold can rise to $1200 and hold a floor of $1000 after that this year. That would make AUY a $20+ stock. I'm also glad to see someone who is commenting on a company that has some skin in the game...Disclosure: I currently hold shares of Yamana Gold. I am also long AUY.

Feb 17 11:03 AM

[Truefire:]

There are boat loads of cash on the sidelines, TRILLIONS!! Those investors are running out of options.

I LOVE the mining companies. Yamana & Newmont. They are gonna fly.

Feb 17 11:47 AM

[Dan Wieman:]

Thanks, silverwood.

Who knows what gold will do over the next couple of years. I know problems in the banking sector are only just beginning. With unemployment rising very rapidly, banks are now starting to deal with problems that usually occur in a down economy.

One would think that continuing government intervention and an unstable banking environment would only cause the price of gold to rise further.

On Feb 17 11:03 AM silverwood wrote:

> Dan, good analysis and very conservative. There is a strong possibility
> that gold can rise to $1200 and hold a floor of $1000 after that
> this year. That would make AUY a $20+ stock. I'm also glad to see
> someone who is commenting on a company that has some skin in the
> game...Disclosure: I currently hold shares of Yamana Gold. I am also
> long AUY.

Feb 17 02:31 PM

[West Coast ...:]

Case in point: Marrone is a good CEO - UNFORTUNATELY he throws tonnes of money at the wrong companies (Northern Orion) at the peak of valuation and now that the juniors are trampled in the dust he does... NOTHING! Something is wrong here, and their IR is not responding to requests for clarification (ever since I got more specific ;-).

Still, I'm holding on to my AUYs (even though their actions cause some auy)

Feb 17 04:36 PM

[E.D.Hart:]

AUY carries a lot of future value for its copper in the ground.

Feb 17 05:08 PM

[Mayascribe:]

One cost that was omittted was the huge savings in the lower cost of oil. Most of 2008, gold, after its $1030 high, was going down, while oil was skyrocketing.

Now the opposite is happening. I appreciate conservative estimates; that's always the prudent way to go. I believe $800/oz is a little low, and, even though there's is no way of truly knowing how much is saved from the lower energy costs, the fact remains is that they are substantially lower than during 2008.

Regards!

Feb 17 08:32 PM

[ROLEXDAYTONA:]

This and other stocks got hit hard, to get to 2008 level Gold must be 2000$

Feb 17 08:58 PM

[X-15:]

The big question I have is -what happens if the US debt picture becomes untenable? What happens if the worlds currency, the dollar has a crises of confidence? What would the outcome be if the dollar skids 20%?

Feb 17 09:29 PM

[naidle:]

Can you explain this?

Thanks.


On Feb 17 08:58 PM ROLEXDAYTONA wrote:

> This and other stocks got hit hard, to get to 2008 level Gold must
> be 2000$

Feb 17 11:47 PM

[old guy:]

I am very high on NEM and AUY and have done well so far and recently have added to my holdings....BO spending will cause inflation which will add value!

Feb 17 11:57 PM

[arlin:]

I believe AUY's estimates are based on $700 gold.As already stated Energy is 25% of the cost of minning gold and its down from $147 bbl to $35bbl,Also Auy is a Money maker in the currency swaps between their operations and selling gold in dollars, roughly 20%.

Feb 18 06:13 PM

[Dan Wieman:]

The press release linked above from Yamana indicates that they are forecasting $800/ounce in 2009 and $825/ounce in 2010.


On Feb 18 06:13 PM arlin wrote:

> I believe AUY's estimates are based on $700 gold.As already stated
> Energy is 25% of the cost of minning gold and its down from $147
> bbl to $35bbl,Also Auy is a Money maker in the currency swaps between
> their operations and selling gold in dollars, roughly 20%.

Feb 19 12:08 AM

[MateoJoe:]

Dan,
Good write up. I've owned since six and change and keep researching so your work is appreciated.

One question: Do you or any other posters know how much of AUY's production is forward hedged?

Thanks.

Feb 20 11:21 AM

[Dan Wieman:]

I haven't looked lately, but Yamana has typically hedged only copper prices. Management counts copper as a sort of by-product from their Chapada mine and uses revenue here to offset productions costs. Their strategy in the past has always been to remain unhedged on the price of gold, and I haven't seen anything to indicate a change in that strategy.


On Feb 20 11:21 AM MateoJoe wrote:

> Dan,
> Good write up. I've owned since six and change and keep researching
> so your work is appreciated.
>
> One question: Do you or any other posters know how much of AUY's
> production is forward hedged?
>
> Thanks.

Feb 20 03:07 PM

[MateoJoe:]

Went and did some research:

Reading through the Q3 report, they have some really nice ($2.00 to 3.00/lb) prices locked in through 2012 for copper. They also hedge the US$ against the Brazilian Real (sp?). But no hedges on gold itself. So if your forcast assumes 800/oz. then the current action should reward nicely.


On Feb 20 03:07 PM Dan Wieman wrote:

> I haven't looked lately, but Yamana has typically hedged only copper
> prices. Management counts copper as a sort of by-product from their
> Chapada mine and uses revenue here to offset productions costs. Their
> strategy in the past has always been to remain unhedged on the price
> of gold, and I haven't seen anything to indicate a change in that
> strategy.

Feb 20 04:43 PM