Exploring Gold Miner Stocks: Mid-Year 2009 Analysis 13 comments
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There are several ways to value large gold producers. One of the conventional methods is to use “price to earnings” ratio calculations, commonly referred to as “PE”. This method of analysis is the one of the most basic valuation techniques. Lower PE ratios suggest a company is undervalued relative to competitors. PE ratios are best used as a “first cut” in due diligence to see how the market is valuing gold mining companies relative to others in the industry.
As the table below (sorted by 2010 PE ratios) shows, current PE levels in 2010 for 14 major and mid tier gold producers elegantly break down into two groups—those above a 20 PE and those below.
Three out of five of the most undervalued companies based on PE ratio are South African gold miners. This is not surprising because of higher operational risk and political risk involved with mining in South Africa. There continue to be miner deaths reported this year in South Africa and investors are still stinging from power generation disruptions last year.
Peruvian gold and silver miner Buenaventura (BVN) is relatively undervalued. The Company closed its hedge book back in February 2008, stumbled on low grade ore at their Yanacocha project, and reported negative earnings in Q4 2008. More recently, work stoppages and protesters at their Orcopampa mine have stalled production. An operationally smooth second half of 2009 would help boost Buenaventura share prices going into 2010.
Lihir Gold (LIHR), an Australian gold miner, is also relatively undervalued using PE ratios. This is probably in large part due to a long history of operational challenges at their world class Lihir Island mine (below sea level) in Papua-New Guinea.
The two largest gold producers in the world, Barrick Gold (ABX) and Newmont Mining (NEM) are surprisingly relatively undervalued for conservative investment plays in the gold mining industry. It remains curious that Barrick and Newmont are lagging in PE valuation. Both companies are projected to increase production at a faster rate than other gold miners listed above with the exception of Agnico-Eagle (AEM) and Randgold (GOLD). Fast growing mid-tier gold miners like Agnico-Eagle and Randgold appear to have gotten a little ahead of themselves relative to other company valuations based on PE ratios for 2010.
Goldcorp (GG) is in a slower growth phase going into 2010 than in past years. It has several world class mines throughout North and South America. Goldcorp is also the most overvalued company in the table with a projected PE ratio of 44 for 2010. Of course, longer run investors like Goldcorp’s aggressive plans to expand gold production by about 50 percent over the next few years.
Kinross Gold (KGC) Kinross has producing mines in Russia, Chile, Brazil, Nevada, Alaska, and Washington State. The Russian mine is high grade. Investors are concerned about political risk in Russia. Kinross is in a consolidation phase after considerable growth in production and with $800 million cash on hand is probably looking to make an acquisition to expand its production profile. The share price has had a nice run recently, driving Kinross’ PE valuation higher.
Mid tier producer Yamana Gold (AUY) is coming off the heels of a sale of three high cost mines to Aura Minerals (ORAUF) in early June. Yamana received over US$200 million and may have sold the properties below market value. Despite the controversy, Yamana increased their “war chest” by 200 percent with this deal. The Company is rumored to be on the lookout for acquisitions with a lower cost profile than the assets just sold. The share price could lag until an acquisition is announced. That is unless, of course, a larger gold producer decides to add Yamana’s mostly Brazilian assets to its portfolio of properties.
Companies to watch closely are the high cash cost miners like Harmony Gold (HMY), IAMGOLD (IAG), Gold Fields (GFI), Anglo-Gold Ashanti (AU), and Randgold. These companies will likely have higher earnings growth than the other miners if the price of gold jumps above $1,000 an ounce in the second half of this year. Higher cash costs translate into greater leverage to changes in the price of gold. Companies with higher cash costs per ounce have higher cash flow growth rates than companies with lower operational costs when the price of gold rises. Likewise, high cost producer cash flow suffers more than low cost producers when the price of gold declines.
El Dorado Gold (EGO) has the lowest cash costs of all the companies in the table at about $270 per ounce. As a result, El Dorado has higher quality earnings because it is less sensitive to the price of gold. El Dorado’s producing mines are in Turkey and China and present some political risk. Nevertheless, investors who like low cost producers find El Dorado attractive. That may be one reason why it has a 26 forward PE ratio for 2010.
We have seen a recent price run up over the past couple of weeks for many gold mining stocks. Despite this run up in share prices, several companies are sporting PE ratios under 20 for 2009 and 2010. A rise in the price of gold over $1,000 an ounce in the second half of 2009 would move the share prices higher for many large gold producers.
Second quarter earnings season is upon us. Keep your eyes on the larger gold producers. Companies that beat expectations this quarter by driving down operational costs could show significantly higher share prices in the second half of 2009 and into 2010.
Disclosure: No positions
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This article has 13 comments:
South African miners aren't undervalued. They are appropriately valued, based on the inadequate power grid they rely upon that shows no hope for being improved.
NEM is so big, bulky, numb and stalled that it is unerringly boring to investors.
BVN is in Peru, and Peru is a difficult place to operate gold mines.
EGO is in Turkey (a ferocious Islamist government that may nationalize the mines any day to finance a military push into Kurdish Iraq) and China (whose government has no qualms about changing corporate operating conditions in a heartbeat to suit its self-serving agenda).
KGC has mines in Russia (you can't trust 'em), and three states in the USA (over-regulated, too many lawyers and lobbiests). Brazil is the one good place to mine they are set up in now. If they buy Yamana Gold they'll have a pipeline for future production with low costs of production.
Barrick may beat Kinross to the punch and scoop up Yamana first.
So it's shaping up to be a nice year or two if you're long AUY.
Lihir - forget about the ocean - that thing is on a recent volcano. Steam galore in the pit - just look to the West of the main pit on Google Maps for one plume. Still a world-class deposit and probably snapped up soon.
South Africa - Much much worse than the power crisis (alleviated greatly by the economic collapse) is the new dictator Zuma. Zimbabwe (note the "Z"-milarity) is an example what will happen in South Africa in the next years. Any Rand the miners invest into their deep mines is wasted money. If I was forced to value their stocks, I would multiply their next 5 year's of profits by 50%, from 5-10 years by 25%, and after that by NADA (that's when they will be nationalized at the latest), in order to calculate the PEs. They are actually grossly overvalued! It's like betting against the bank.
Don't worry about Turkey - hey are bending backwards to join Egypt's corn bowl, eh Brussel's subsidies. As a German I refuse that idea. But for investing into EGO it's great news.
"P/E is not a useful valuation metric in the mining industry. Relative discounts to NAV or Enterprise Value to Reserves ratios are more useful indicators of relative value for this industry."
Comments, anyone?
Btw, i appreciate the political and logistical contexts that author and readers are providing here.
On Jul 02 12:25 PM West Coast Commentator wrote:
> Yamana's sale of the San Francisco mine is not surprising, and a
> testimony to what happens when an investment banker (Marrone) thinks
> he knows better - for years this property was touted to be a 250,000
> oz/year ultra-low cost jewel, only to disappoint once in production.
> At less than 100,000 oz/year and with production costs above $500/oz
> - good riddance. As a Yamana shareholder I hope they will do a better
> job overseeing less mines. But with Marrone you never know - he always
> overpays at the peak for some crap (Northern Orion). One very good
> reason their PE lags behind (makes me kringe - why didn't I invest
> in Kinross instead?).
Mining industry insiders have historically focused on valuation metrics based on reserves with an eye to acquisition and growing their companies. That makes sense.
Investors have become increasingly interested in cash flow and earnings for all companies--including gold producers--since the 1997 Bre-X gold scandal, the dotcom meltdown in 2001, and the crash of 2008.
Any time someone suggests that earnings metrics like PE are useless for comparing gold producers, I raise an eyebrow. Earnings matter, but they certainly aren't the only thing to look at when assessing whether or not to invest in large gold producing companies.
Other key items to look at in the due diligence process include proven management, reserves in the ground, debt, cash on hand, hedge book, political risk, and currency risk.
Thank you for reading my article and for your comment!
On Jul 02 01:02 PM tc1 wrote:
> I recall motley fool poster TMFSimchiruna's remark:
> "P/E is not a useful valuation metric in the mining industry. Relative
> discounts to NAV or Enterprise Value to Reserves ratios are more
> useful indicators of relative value for this industry."
>
> Comments, anyone?
> Btw, i appreciate the political and logistical contexts that author
> and readers are providing here.
>
>
your article submitters, to at least most
of your bloggers comments.
Thank you, Seeking Alpha.
This is a (new) low cost producer with large upside.
On Jul 02 02:02 PM Alan Young wrote:
> Based on P/E, none of these are bargains. You have to think the price
> of gold will escalate substantially to get decent earnings.
If I were Lihir I would divest those mines such an Bonriko as well as their other Australian portfolio to push the MOPU system at Lihir Island and develop thier African mines. I know people hate Africa but S.A gives it a worse name. Sure there are many bad countries in Africa, but you can't generalize every country as such.
I never look at P/E ratios because i think using EV/EPS is much more telling.
Other than Yamana and the Eagle, I think Jaguar will provide one of the highest rates of return.
With large cap names I tend to harp more over what company has the lowest cash costs and expansion potential and not the PE ratio.
Are you saying there is nothing to the inflation play, the miners are worn out, and that the CB can hold PMs down indefinitely? Or, are you just spinning?
We need fear and a lack of faith in the dollar to make this market move.It looks like it is not going to happen even in the seasonal period. Pray for Obama to spend again and I think he might.