The S&P 500 has rallied 10% over the past year, heading to all-time highs. However, several of its components have underperformed the index. I would like to highlight some sectors that have underperformed the market this year. These include the Basic Materials Sector (IYM) which is down 1% YTD.
Within the Basic Materials sector, the precious metal miners group is one of the leaders in underperformance. For example, the Market Vectors Gold Miners ETF (GDX), an ETF that incorporates some miners described here, has declined 22% year-to-date and about 30% over the last six months. Most miners have underperformed the S&P 500, sliding 20-40% YTD due to lower gold prices. However, recently, there have been a mixed bag of articles about gold prices (one example for higher prices and one example for lower prices).
As gold rotates to favor, investors focus their attention on low forward P/E and dividend-paying companies. In this article, five mid-size market value miners that are not widely known to the common investor will be analyzed for potential capital appreciation.
Figure 1.Performance of KGC (green), BVN (dark blue), GFI (purple), IAG (yellow), GORO (red) against the S&P 500 (light blue).
Although on the fundamental analysis point of view, these companies may look attractive due to low forward P/E and modest dividend offers, they have issues that have affected their production resulting in lower income in 2012 compared to 2011. I will briefly explain what led to the decrease in net income for each of the companies.
Kinross Gold Corporation (KGC)
Kinross, an $8.97 billion market value company, has quickly grown over the last years to become one of the world's leading gold mining companies. According to its most recent earnings report, the production of gold in 2012 exceeded its production guidance, with 2.62 million ounces produced. Further, the production cost remained at $706/oz, which was "in-line with guidance". In addition, the company expects to maintain its production between 2.4 - 2.6 million ounces at a "cost of sales" between $740 - $790/oz for 2013. However, provided that gold prices increase, the company should see growth in its net income even as its production costs rise.
The company's solid business model allowed it to reduce expenses by $300 million to $1.9 billion in 2012. Further, the company expects to reduce its expenses by $300 million to finish at $1.6 billion in 2013. The company is operating with a negative profit margin due to the developing of new projects. Investments in new projects include the Russian project "Dvionoye", which should deliver its first ore in the second half of 2013. The miner increased its gold equivalent production by 3% from 2.54 million ounces in 2011 to 2.62 million ounces in 2012. However, the net earnings-per-share decreased due to declining gold prices.
From the fundamental point of view, the company is trading with a forward P/E of 9.03, and it is offering a 2% dividend. In my opinion, although the company is increasing gold production, a long position should be considered if gold prices increase.
Compañia de Minas Buenaventura SA (BVN)
Compañia de Minas Buenaventura SA, a Peruvian-based $7 billion market value company, has not fared as well as KGC on a year-to-date basis. According to its most recent earnings report, the company's gold sales content decreased by 25% from 0.50 million ounces in 2011 to 0.44 million ounces in 2012. On the other hand, the silver sales content increased by 18% to 17.4 million ounces. Further, its mines reduced their gold production, while production costs rose by 30%. In addition, the general and administrative expenses in 4Q12 rose by 32% to $21.6 million on a quarter-over-quarter basis. Consequently, the miner's net income decreased 20% to $684.7 million for the 2012 fiscal year from $858.9 million in 2011.
On the management point of view, its undergoing projects include: 1) "Pampa Verde", a new open pit with completion expected in 3Q2013. 2) "Rio Seco", a manganese sulfate plant. 3) "Huanza Hydroelectrical Plant", a power plant that begun operations on February 26, 2013.
Although the company has diversified into energy and chemical production, I do not believe the company has a strong business model. Its sales on a quarter-over-quarter basis are declining due to decreasing gold production. For this reason, the dividend may not be sustainable in the interim. In my opinion, a long position should not be considered in this company.
Gold Fields Ltd. (GFI)
Gold Fields Ltd., a South African-based $5.7 billion market value company, has also sailed in rough waters. According to its most recent earnings report, its normalized EPS declined from $1.08 in 2011 to $1.01 in 2012. One of the causes for the decline were the strikes on the KDC and Beatrix mines, which resulted in the mines reducing their output by 30%. In addition, the company's production cost is $946/oz, compared to the industry's average of $700/oz. Further, the production in the "Ya-Rona" shaft was disrupted by a fire. Due to a lower net income in 2012, the dividend was cut 30% from $3.20 in 2011 to $2.35 in 2012. Nevertheless, the salary of its CEO was hiked by 31% while "the company lost $1.6 billion dollar in market value last year".
The company may look attractive on the valuation point on view because it is trading with a P/E of 18.33, and a forward P/E of 3.32. It is also offering a 1.82% dividend to its shareholders and it is operating with a profit margin of 9.61%. However, as discussed in the previous statement, the company has multiple issues regarding poor management. These matters have to be resolved before a long position can be considered in the stock.
IAMGOLD, a Canadian-based $2.68 billion market value company, operates six gold mines in Canada, South America and Africa. Further, the mine "Westwood" is starting production this year, which should increase gold production. However, since its production will be slow in the beginning, higher production costs are expected for the first year. Moreover, the mines "Rosebel" and "Essakane" experienced a brief drop in their gold's grade. On the sales point of view, the price at which gold was sold increased 7% from $1,555/oz in 2011 to $1,667/oz in 2012. However, gold sales declined by 8% to 827,000 ounces. As a consequence, the diluted EPS for 2012 declined by 23% from $1.08 in 2011 to $0.84 in 2012.
From a valuation point of view, the company is trading with a P/E of 7.99, and a forward P/E of 7.23. It offers a 3.5% dividend to its shareholders, and it is operating with a profit margin of 22%. However, in order to consider the company for a long position, an increase in gold production must be reported by the miner.
Gold Resource Corporation (GORO)
Gold Resources Corporation, a $680 million market value company, is targeted by dividend-seeking investors because it offers a monthly dividend of 5%. It is operating one mine in Southern Mexico, and it has five explorations in the same region. Gold and silver accounted for 82% of the revenues in 2012. Copper, lead and zinc accounted for 18% of the revenues in 2012. It is important to mention that its production costs for the precious metal is $419/oz, while the industry average is $727/oz. However, costs of operation increased in 2012 causing an EPS decline from $1.03 in 2011 to $0.64 in 2012.
From the fundamental point of view, GORO is trading with a P/E of 11.7, and a forward P/E of 10.6. It is operating with a profit margin of 45%. However, I would not consider a bullish posture until the miner starts operating another mine.
The Wrap Up
Gold prices have declined for the last six months. As a result, miners have underperformed the market by declining 20-40% on YTD basis. From the five companies described above, KGC possess the strongest business model. The other four companies have shown poor management decisions, which has led to a decline in gold production. These factors may have negatively affected their share price.
In conclusion, even though these companies may seem attractive on a fundamental analysis point of view, they have production problems that could drive their price-per-share levels even lower. I would not recommend entering a long position in any of these miners until we see improvement in their production and rising gold prices.
Jonathan Wolfe is gratefully acknowledged for providing guidance to enhance my writing skills.