AngloGold Ashanti: Losing Its Luster

AngloGold Ashanti (AU) ended the week on a horrendous note. Its shares experienced two brutal sessions in a row, plummeting 18% since Wednesday. What happened? The shares had become wildly overbought and simply had gone up too much in too short of a time giving it an unrealistic valuation. Profits took a hit, and hit hard, especially when the price of gold fell below $900 and AU disclosed that its previous production guidance for the first quarter was too high at 1.13 million ounces and the company cut guidance by 2.5%, to 1.1 million ounces. AU blamed the shortage on temporary mine closures related to safety issues. The market does not like negative surprises and consequently punished the shares brutally on a 50% jump in share volume.

The shares are still too high: The stock nearly tripled in the last six months from $13 to $39, but could easily retrace up to one half of those gains, back down to the $26 area. The stock is still too expensive in comparison with its peers.

Key ratios versus the competition: AU is bloated with debt ($2 billion), has minimal book value and a higher share price to sales ratio compared with other gold producers such as Newmont (NEM), Barrick (ABX) and Goldcorp (GG). AU’s debt to equity ratio of .83 is almost three times higher than ABX’s .30 reading, and twice that of NEM’s .47 debt to equity ratio. GG is lucky enough not to have a debt to equity ratio, since it is essentially “debt free”. AU’s price to sales ratio of 3.77 is about 32% higher than the group’s average of 5.53, providing further evidence of a price disconnect.

AU is selling at more than five times its book value, followed by ABX at 3.85, NEM at 2.95, and GG with the highest relative book value, at only a 1.59 multiple of book.

Cost to produce: At an extraction rate of $450 per ounce, AU is at the high end of producers and this should be reflected in its valuation, but so far it has not been factored in. Credit Suisse seems to agree, as it recently downgraded its opinion on the company from “outperform” to “underperform”.

I admit, I was woefully wrong last December when I recommended shorting this stock, but I am sticking to my guns on this one, with a “what goes up, must come down mentality”. The crux of AU’s problem is its dependence on the price of gold. It really has no control over the precious metal’s direction and is a “sitting duck”, when it is exposed to the” whims” of the commodity markets. It is certainly better when companies have control over their own destiny, rather than the other way around. Shorting the shares at this juncture makes sense, as the trend has certainly changed in favor of the bears with downside momentum building. An additional 15% drop seems realistic and an appropriate place to eventually cover.

Disclosure: Short AU.

Comments

[charliezap:]

This article is just silly. What do book value and price/sales ratio have to do with analyzing gold stocks? What matters most is earnings power relative to the stock price. In this regard, AU is the best buy among the major golds, having the lowest price/earnings ratio, based on Marketwatch consensus numbers.

Consensus is $2.72 for 2009 for a PE of 11.5 times at the current price. Some analysts, such as UBS, have estimated over $3 for 2009.

By comparison, the respective PE's for ABX, NEM and GG are 18, 22 and 44!

As for debt, the interest coverage ratio is a comfortable 6.2 times, not far short of Barrick's 7 times (12-month trailing basis). Yes, AU is more leveraged to the price of gold than other majors, and yes, the gold price is under pressure from potential IMF sales. On the other hand, the great reflation attempt underway now by the US and other major countries guarantees the debasement of their currencies. The gold price will hold up, and go up. Your short position will prove to be unwise, except possibly as a very short term trade.

Apr 06 09:18 AM

[Lee Eugene ...:]

The bottom line is that there was a surge in the stock when the news broke that John Paulson was picking up the 11% minority interest from Anglo American. This was a big overhang on the stock. I traded it for a day then took the money and moved on. The moral of the story is that shadowing a successful hedge fund player does not always work.

Apr 06 03:50 PM

[Fly Boy:]

None of this or earnings matters. What matters is POG minus price to mine it multiplied by reserves. Then, you have the value of gold in the ground versus gold out of the ground.

Everyone treats these like they make widgets. The true value is what is in the ground. Not what the cash flow is. It's like trying to justify the PE for GLD or something. These aren't software companies.

Apr 06 08:52 PM

[charliezap:]

In concept Fly Boy is right. One should consider reserves and prospective reserves, as well as near term earnings. But earnings, or cash flow, are the mother's milk, for dividends in the dividend discount model, or for future expansion and extension of reserves, in the discounted cash flow model. My main point is that ratios like price/book and price/sales are meaningless for a gold mining operation, and anyone trading on the basis of such ideas will lose his shirt.

The article also marked AU down for having a relatively high cost per ounce. From an investor point of view, this can be both a disadvantage and an advantage. If you are a gold price bull, it is an advantage, because of the operating leverage -- you get more bang for the buck if the gold price rises (greater percentage increase in profit margin).

Apr 08 09:41 AM