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Summary

Investing in gold miners can be risky. The market vectors gold miners ETF (NYSEARCA:GDX) has dropped almost 40% during the last year and many gold miners' valuations are close to their multi-year low levels. The industry faces various challenges including deteriorating gold price and increasing mining cost.

The decreasing gold price will force miners to shut production and the gold mining industry will eventually recover after the supply and demand reach a new balance. But it may take several months or years before this recovery can happen. Until then, the industry will continue to face challenges and there could be more bankruptcies or consolidations. If you believe the gold mining industry will recover and want to invest in this industry, it is crucial to conduct a thorough credit analysis and invest in companies that have the lowest default risk in the industry. In this article, I provide this analysis and compare the default risk of several largest gold miners (senior gold miners). My analysis focuses from four angles: credit ratings, Altman's Z-score, risk factors and debt structure.

I picked nine large gold mining companies to conduct my credit analysis. These nine companies are:

  1. Barrick Gold Corporation (NYSE:ABX)
  2. Newmont Mining Corporation (NYSE:NEM)
  3. AngloGold Ashanti Limited (NYSE:AU)
  4. Gold Fields Limited (NYSE:GFI)
  5. Newcrest Mining Limited (OTCPK:NCMGY)
  6. Kinross Gold Corporation (NYSE:KGC)
  7. Goldcorp Inc. (NYSE:GG)
  8. Yamana Gold Inc. (NYSE:AUY)
  9. Agnico Eagle Mines Ltd (NYSE:AEM)

Figure 1 shows the price movements of these nine companies over the last 6 months. Table 1 shows several key statistics of these nine companies as of Q1 2013.

Figure 1. Six Months Stock Performance

(click to enlarge)

Table 1. Key Financial Statistics

ABX

NEM

AU

GFI

NCMGY

KGC

GG

AUY

AEM

Market Cap

15,893

14,154

48,570

38,907

8,792

5,686

21,805

7,627

4,888

Cash & Equivalents

2,342

1,453

6,284

5,276

97

1,421

2,014

343

295

Preferred & Other

2,691

3,231

194

2,039

146

77

213

47

0

Total Debt

14,798

6,389

32,401

18,372

3,203

2,154

2,275

861

811

Enterprise Value

31,040

22,321

74,880

54,043

12,044

6,496

22,279

8,192

5,405

Revenue

14,340

9,362

51,968

38,146

3,879

4,333

5,101

2,312

1,865

Growth %, YoY

-3

-11

2

3

-13

11

-5

2

-1

Gross Profit

6,612

4,029

17,090

1,407

2,620

2,153

1,240

675

Margin %

46

43

33

36

60

42

54

36

EBITDA

7,071

3,731

17,635

18,261

1,715

1,981

2,532

1,164

735

Margin %

49

40

34

48

44

46

50

50

39

Net Income Before XO

-855

1,877

4,424

3,958

830

-2,488

1,579

374

256

Margin %

-6

20

9

10

21

-57

31

16

14

Adjusted EPS

4

3

21

4

1

1

2

1

2

Growth %, YoY

-23

-27

-37

-63

-36

-5

-19

-17

-7

Cash from Operations

5,252

2,196

12,216

11,224

942

1,271

2,069

1,044

646

Capital Expenditures

-6,484

-3,024

-15,593

-12,028

-2,466

-1,711

-2,551

-1,521

-500

Free Cash Flow

-1,232

-828

-3,343

-804

-1,524

-440

-482

-477

145

Credit Rating

Table 2 shows credit ratings from Moody's and S&P for each of the nine companies. Most companies have investment grade ratings, except AU and GFI (BB+ rated), AUY (Not Rated) and AEM (Not Rated).

Table 2. Public Credit Ratings

S&P

Moody's

ABX

BBB

Baa2

NEM

BBB+

Baa1

AU

BB+

Baa3

GFI

BB+

Ba1

NCMGY

BBB

Baa2 *-

KGC

BBB-

Baa3

GG

BBB+

Baa2

AUY

NR

NR

AEM

WR

NA

Altman Z-score

The Altman Z-score was created by Edward Altman in 1968 as a measure to predict bankruptcy for publicly traded corporations. As the name suggests, the Altman Z-score is a linear combination of five financial ratios that can be calculated from data found on a company's financial statements. The five financial ratios reflect a company's liquidity, earnings power and balance sheet strength. Z-scores above 3.0 indicates that bankruptcy is unlikely in two years, scores between 1.8 and 3.0 are inconclusive, and scores below 1.8 indicates an increased risk of business failure.

Table 3 shows historical Altman Z-scores for these nine companies. The four companies that have a Z-score in the dangerous zone are AU, KGC, GFI and ABX. And AEM is the only company that has a Z-score higher than 3. The Z-score rank is: AEM > GG > AUY > NCMGY > NEM > ABX > GFI > KGC > AU.

Table 3. Altman Z-score

Z SCORE

2013 Q1

2012 Q4

2012 Q3

2012 Q2

2012 Q1

2011 Q4

2011 Q3

2011 Q2

2011 Q1

ABX

1.80

1.99

2.14

2.14

2.38

2.43

2.52

2.41

3.59

NEM

1.98

2.12

2.33

2.26

2.37

2.92

2.63

2.57

2.92

AU

0.78

0.94

1.15

1.43

1.50

1.44

1.18

1.23

0.99

GFI

1.71

1.51

1.33

1.38

1.93

1.37

1.42

1.31

1.41

NCMGY

2.39

2.66

4.05

6.23

7.64

8.01

8.55

6.81

4.85

KGC

1.54

1.65

1.92

1.85

2.15

2.53

3.64

4.54

4.29

GG

2.43

2.89

3.50

3.09

3.57

3.52

3.41

3.56

3.42

AUY

2.41

2.61

2.94

2.64

2.69

2.72

2.62

2.29

2.30

AEM

3.24

3.84

3.85

3.20

2.86

2.90

4.24

4.40

4.61

Risk Factor Analysis

Although the Altman Z-score was widely accepted by the financial industry as a predictor of bankruptcy, it has its limitations (see this paper). The main problem is that Z-score works best for manufacturing industry, but its accuracy decreases for other industries. Furthermore, because of its popularity, more and more companies manipulate their financial statements to get a better Z-score, which limits the effectiveness of Z-score. Instead of splitting hairs on more sophisticated math models, we explored several risk factors that affect a company's credit profile.

Companies default because they cannot repay debts that they owe to their creditors. This failure typically happens in two scenarios: in the first scenario, the company fails to generate enough cash to pay the interest and principal due on its debts; in the other scenario, the company fails to repay its debts when they mature.

In this section, I present three risk factors that can measure the probability of the above two scenarios. These factors are widely used by credit rating agencies and banks in their own credit risk models to predict default probability.

  1. Debt/EBITDA (measures financial leverage): I choose total debt/EBITDA ratio to measure the degree to which a company has incurred obligations in anticipation of future earnings and cash flow that may be used for debt repayment. The metric has limitations in that EBITDA is not a measure of cash flow because it does not take into account other cash needs including working capital and capital spending. Despite these limitations, debt/EBITDA remains a key ratio used by lenders and regulators for evaluating a company's financial leverage. Any limitations to this metric are mitigated by the use of operating cash flow (FFO), which is described below. The lower debt/EBITDA ratio, the greater the flexibility a company can manage through challenges in the economy or competitive environment.
  2. EBITDA/Interest (measures interest coverage): I choose EBITDA/Interest ratio to measure a company's ability to meet the carrying costs of financial obligations from its operating results. The higher the ratio, the greater the flexibility to absorb an earnings decline before impairing the ability to make timely interest payments.
  3. FFO/Debt (measures debt coverage): I choose FFO/Debt to measure a company's ability to generate cash flow in relation to its existing debt. Strong and stable debt-to-cash flow ratios are very good indicators of a healthy credit profile and can also be a competitive advantage by providing greater strategic and financial flexibility during business downturns.

Table 4 shows trailing 12 months risk factors for these nine gold mining companies. I also listed an industry average value for the ease of comparison. Table 5 shows the quarterly percentage change of these risk factors. I made the following summaries from these two tables:

  1. Until now most gold miners' leverage ratio are not high (average Debt/EBITDA ratio is 1.4, compared to S&P 500's Debt/EBITDA ratio of 1.9). However, since the EBITDA is based on the period between Q2 2012 and Q1 2013, when the gold price was much higher than today's price, I expect the leverage ratio to significantly deteriorate over the next few quarters. Therefore, it makes more sense to compare the relative ratio value instead of focusing on the absolute ratio value.
  2. ABX, NCM, NEM and AU have higher than industry average leverage ratio. AUY and GG have the lowest leverage ratio.
  3. AU, ABX and NEM have the worst interest coverage ratios. KGC, GFI, GG and AUY have the strongest interest coverage ratios.

Table 4. Trailing 12 Months Risk Factor Values

Risk Factor

Industry Average

ABX

NEM

AU

GFI

NCMGY

KGC

GG

AUY

AEM

Total Debt / EBITDA

1.36

2.09

1.71

1.69

1.01

1.87

1.09

0.90

0.74

1.10

EBITDA / Total Interest

23.58

8.80

8.83

7.88

39.26

13.98

55.65

43.30

24.26

10.23

FFO / Total Debt

0.61

0.35

0.34

0.41

0.61

0.29

0.59

0.91

1.21

0.80

FFO

4,094

5,252

2,196

12,203

11,223

942

1,271

2,069

1,044

646

Table 5. Risk Factor Quarterly Percentage Change

Risk Factor

Industry Average

ABX

NEM

AU

GFI

NCMGY

KGC

GG

AUY

AEM

Total Debt / EBITDA

11%

13%

10%

-10%

67%

-19%

221%

23%

3%

11%

EBITDA / Total Interest

-11%

-25%

-22%

61%

-62%

302%

-54%

10%

-25%

-11%

FFO / Total Debt

-10%

-11%

-13%

-18%

-60%

20%

-66%

-20%

-4%

-10%

Debt Structure and Amortization Schedule

In this section, we analyze the debt structure and amortization schedule for these companies. Typically, an evenly distributed amortization schedule is better than a concentrated schedule because it minimizes the refinance default risk.

Figure 2 shows the percentage of maturing debts of each company. We can learn the following things:

  1. AEM has the most concentrated debt amortization schedule (75% of its debts mature in 2017). NEM also has concentrated debt amortization schedule (53% of its debts mature in 2015)
  2. The chart shows that NEM, GG and GFI all have a large percentage of their debt mature in the next two years. If the gold industry continues to deteriorate, it will be problematic for these companies to repay their debt.

Figure 2. Debt Amortization Schedule

(click to enlarge)

Table 6 shows the weighted average coupon for these nine companies. A high coupon rate increases the debt servicing burden, reduces company's income, and increases its default risk. Table 6 shows that NEM and AEM has the highest coupon rate, followed by GFI and AUY. GG has the lowest coupon rate, followed by AU.

Table 6. Coupon Rate

ABX

NEM

AU

GFI

NCMGY

KGC

GG

AUY

AEM

Weighted Average Coupon Rate

4.67

6.63

4.06

5.00

4.63

4.80

3.00

5.26

6.18

Conclusions:

Just like the stock price, a company's credit quality depends on multiple factors and no single indicator can do the magic. In this article, I presented several factors and indicators that may best reflect a company's credit healthiness. I drew the following conclusions from my analysis:

  1. AU, ABX and NEM have the lowest credit quality within the nine miners that I analyzed. Among these three, AU is the worst. It shows the lowest Z-score, has a high leverage and very low interest coverage ratio. ABX and NEM also have low Z-score, high leverage and low interest coverage ratio. If the gold industry continues to deteriorate, these three companies have the highest probability to default.
  2. AEM, GG and AUY have the highest credit quality within the nine miners that I analyzed. They all have decent Z-score, a low leverage and high interest coverage ratio. They have the highest probability to survive even if the gold industry continues to deteriorate.
  3. The other companies' (NCMGY, GFI and KGC) credit quality ranks between the above two categories.

It should be noted that your investment decision should not be purely based on a company's default probability. A safer firm such as GG has very low leverage, which limits its upside potential when the industry recovers. Also the "dangerous" firms such as AU's and ABX's prices have already heavily discounted due to the default risk. However, firms such as AUY, which have relatively healthy balance sheet, but whose shares got hammered similar to their more risky counterparts, may show a good investment opportunity.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: A Credit Analysis For Gold Mining Companies