Over the past few weeks the stocks in the Gold mining sector have fallen dramatically. This has provided an excellent opportunity to investigate companies in this sector for investment purposes. One company worth considering is AuRico Gold Incorporated (AUQ). While there are many different factors to look at and consider when investing, in the article below I will look at the debt side of the company. I will analyze AuRico Gold's total debt, total liabilities, debt ratios and WACC. From this analysis we should get an idea if the company is highly leveraged, how much it is paying for its debt, what it's paying in taxes and how much to expect in return for investing in this company over the long term.
Gaining knowledge about a company's debt and liabilities is a key component in understanding the risk of a company. In 2008 and 2009 we were able to see some of the repercussions that highly leveraged companies with large amounts of debt succumbed to. Taking into account the debt side of a company might not reveal the "pop" on the upside that an investor would like, but it will help ensure that the company is able to keep its capital and use it for growth in the future.
On February 21, 2013 AuRico Gold announced its inaugural dividend. The dividend will pay $0.16 per common share annually. The company announced the dividend based on "growing production at the Young-Davidson mine, expanding margins, declining capital requirements and a strong balance sheet." One aspect of a strong balance sheet is the debt side of a company.
3. Total Debt to Total Assets Ratio = Total Debt / Total Assets
This is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. It is calculated by adding short-term and long-term debt and then dividing by the company's total assets.
A debt ratio of greater than 1 indicates that a company has more total debt than assets; meanwhile, a debt ratio of less than 1 indicates that a company has more assets than total debt. Used along with other measures of financial health, the total debt to total assets ratio can help investors determine a company's level of risk.
- 2010 - $10 million / $819 million = 0.01
- 2011 - $25 million / $3.174 billion = 0.001
- 2012 TTM - $15 million / $3.223 billion = 0.001
AuRico Gold's total debt to total assets ratio has decreased over the past three years. As the total debt to total assets ratio has decreased, this indicates that since 2010, the company has added more total asset value than total debt. As the number is currently well below 1, this indicates that the company has more assets than total debt. Because this number is extremely low, this metric indicates very low financial risk to the company.
4. Debt ratio = Total Liabilities / Total Assets
Total liabilities divided by total assets. The debt ratio shows the proportion of a company's assets that is financed through debt. If the ratio is less than 0.5, most of the company's assets are financed through equity. If the ratio is greater than 0.5, most of the company's assets are financed through debt. Companies with high debt/asset ratios are said to be "highly leveraged." A company with a high-debt ratio or that is "highly leveraged" could be in danger if creditors start to demand repayment of debt.
- 2010 - $153 million / $819 million = 0.19
- 2011 - $933 million / $3.174 billion = 0.29
- 2012 TTM - $904 million / $3.223 billion = 0.28
In looking at AuRico Gold's total liabilities to total assets ratio over the past three years, we can see that this ratio has also increased. The ratio has increased from 0.19 in 2010 to 0.28 in 2012 TTM. As the 2012 TTM numbers are below the 0.50 mark, this indicates that AuRico has not financed most of the company's assets through debt. As the number has increased, so is the risk to the company.
5. Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity
The debt-to-equity ratio is another leverage ratio that compares a company's total liabilities with its total shareholders' equity. This is a measurement of how much suppliers, lenders, creditors and obligators have committed to the company versus what the shareholders have committed.
A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in the company reporting volatile earnings. In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations, and therefore is considered a riskier investment.
- 2010 - $153 million / $667 million = 0.23
- 2011 - $933 million / $2.241 billion = 0.42
- 2012 TTM - $904 million / $2.320 billion = 0.39
Compared with 2010, AuRico Gold's debt-to-equity ratio has increased. The ratio has increased from 0.23 to 0.39. As the ratio is currently well below 1, this indicates that shareholders have invested more than suppliers, lenders, creditors and obligators. 0.39 indicates a low amount of risk for the company. As the ratio is well below 1 and considered low, so is the risk for the company.
6. Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity
(LT Debt = Long-Term Debt)
The capitalization ratio tells the investors the extent to which the company is using its equity to support operations and growth. This ratio helps in the assessment of risk. Companies with a high capitalization ratio are considered to be risky because they are at a risk of insolvency if they fail to repay their debt on time. Companies with a high capitalization ratio may also find it difficult to get more loans in the future.
- 2010 - $4 million / $671 million = 0.01
- 2011 - $20 million / $2.261 billion = 0.01
- 2012 TTM - $10 million / $2.330 billion = 0.005
Over the past three years, AuRico Gold's capitalization ratio has decreased from 0.01 to 0.005. This implies that the company has more equity compared with its long-term debt. As this is the case, the company has had more equity to support its operations and add growth through its equity. As the ratio is decreasing, financially this implies a slight decrease of risk to the company. As the ratio is only 0.005 this implies extremely low financial risk.
7. Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt
This coverage ratio compares a company's operating cash flow with its total debt. This ratio provides an indication of a company's ability to cover total debt with its yearly cash flow from operations. The higher the percentage ratio, the better the company's ability to carry its total debt. The larger the ratio, the better a company can weather rough economic conditions.
- 2010 - $98 million / $10 million = 9.8
- 2011 - $160 million / $25 million = 6.4
- 2012 TTM - $157 million / $15 million = 10.47
Over the past three years, the cash flow to total debt ratio has increased. The ratio has increased from 9.8 in 2010 to 10.47 in 2012 TTM. As the ratio is well above 1, this implies that the company has the ability to cover its total debt with its yearly cash flow from operations.
Based on the five debt ratios listed above, we can see that AuRico Gold has very little financial risk based on its debt and liabilities. As the price of gold looks to be strong in 2013, the company should be able to make money on its assets and not be burdened by massive amounts of debt and debt obligations. The next step will reveal how much the company will pay for the debt incurred.
Cost of Debt
The cost of debt is the effective rate that a company pays on its total debt.
As a company acquires debt through various bonds, loans and other forms of debt, the cost of debt is a useful metric. It gives an idea as to the overall rate being paid by the company to use debt financing.
This measure is also useful because it gives investors an idea as to the riskiness of the company compared with others. The higher the cost of debt, the higher the risk.
8. Cost of debt (before tax) = Corporate Bond rate of company's bond rating.
- Convertible Senior Notes due 2016 = 3.50%
- Current cost of Debt as of January February 21th 2013 = 3.50%
9. Current tax rate (Income Tax Total / Income Before Tax)
- 2009 - $12 million / $13 million = 92.31%
- 2010 - $(21) million / $(168) million = 12.50%
- 2011 - $96 million / $257 million = 37.35%
- 2012 TTM - $85 million / $276 million = 30.80%
2011 - 2012 TTM 2-year average = 34.07%
In 2011 - 2012 TTM AuRico Gold has averaged tax rate of 34.07%.
10. Cost of Debt (After Tax) = (Cost of Debt Before Tax) (1 - Tax Rate)
The effective rate that a company pays on its current debt after tax.
- .0350 x (1 - .3407) = Cost of debt after tax
The cost of debt after tax for AuRico Gold is 2.31%
Cost of Equity or R Equity = Risk Free Rate + Beta Equity (Average Market Return - Risk Free Rate)
The cost of equity is the return a firm theoretically pays to its equity investors (for example, shareholders) to compensate for the risk they undertake by investing in their company.
- Risk Free Rate = U.S. 10-year bond = 1.98% (Bloomberg)
- Average Market Return 1950 - 2012 = 7%
- Beta = (MSN Money) AuRico Gold's Beta = 1.27
Risk Free Rate + Beta Equity (Average Market Return - Risk Free Rate)
- 1.98 + 1.27 (7- 1.98)
- 1.98 + 1.27 x 5.02
- 1.98 + 6.38 = 8.36%
Currently, AuRico Gold has a Cost of Equity or R Equity of 8.36%, so investors should expect to get a return of 8.36% per-year average over the long term on their investment to compensate for the risk they undertake by investing in this company.
(Please note that this is the CAPM approach to finding the cost of equity. Inherently, there are some flaws with this approach and that the numbers are very "general." This approach is based off of the S&P average return from 1950 - 2012 at 7%, the U.S. 10-year bond for the risk-free rate which is susceptible to daily change and Google finance beta.)
Weighted Average Cost of Capital or WACC
The WACC calculation is a calculation of a company's cost of capital in which each category of capital is equally weighted. All capital sources such as common stock, preferred stock, bonds and all other long-term debt are included in this calculation.
As the WACC of a firm increases, and the beta and rate of return on equity increases, this is an indicator of a decrease in valuation and a higher risk.
By taking the weighted average, we can see how much interest the company has to pay for every dollar it finances.
For this calculation, you will need to know the following listed below:
Tax Rate = 34.07% (AuRico Gold's two-year average Tax Rate)
Cost of Debt (before tax) or R debt = 3.50%
Cost of Equity or R equity = 8.36%
Debt (Total Liabilities) for 2012 TTM or D = $904 million
Stock Price = $6.50 (February 21th, 2013)
Outstanding Shares = 246.39 million
Equity = Stock price x Outstanding Shares or E = $1.601 billion
Debt + Equity or D+E = $2.505 billion
WACC = R = (1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)
(1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)
(1 - .3407) x .0350 x ($.904/$2.505) + .0836 ($1.601/$2.505)
.6593 x .0350 x .3609 + .0836 x .6391
.0083 + .0534
Based on the calculations above, we can conclude that AuRico Gold pays 6.17% on every dollar that it finances, or 6.17 cents on every dollar. From this calculation, we understand that on every dollar the company spends on an investment, the company must make $.0617 plus the cost of the investment for the investment to be feasible for the company.
Debt Side Summary
All indications above reveal that AuRico Gold is a financially sound company on the debt side. Currently, there are no "fed flags" such as being overleveraged, or having a very high debt-to-equity ratio indicated with this stock. The CAPM supports this statement by revealing that the investor needs 8.36% year-over-year over the long term to get good value on his or her money.
2013 Operational Guidance
On February 21, AuRico Gold published its operational guidance. AuRico Gold is expecting to produce 190,000 to 220,000 ounces of gold in 2013, which is a significant increase over 2012. One of the main factors in the increase of production is the increased production from the Young-Davidson mine. In 2013, the company is expecting 120,000 - 140,000 ounces of gold from the mine at a cost of $575-$675 per ounce and an all-in cash cost of $1,250-$1,350.
Currently, many analysts have a good outlook for AuRico Gold. Over the next few years analysts at MSN money are predicting AuRico Gold to have an EPS of $0.35 for FY 2012 and an EPS of $0.42 for FY 2013. Analysts at Bloomberg are estimating AuRico Gold's revenue to be at $332 million for FY 2012 and $348 million for FY 2013. In December of 2012, BMO capital markets gave AuRico a rating of "Market Perform" with a target price of $9.50. A $9.50 price target signifies an upside of 46.15% from this point.
The above analysis reveals that AuRico Gold Incorporated is a very financially sound company on the debt side. The analysis indicates that AuRico Gold has not overextend itself getting the Young-Davidson mine into production and has set itself up nicely for growth in the future. Currently, analysts have a $9.50 price target on this stock. As the chart below indicates, this is excellent opportunity to invest in a financially sound gold mining company with future prospects, a nice dividend and good upside potential.
Chart sourced by Finviz