Yamana Gold Is Doing OK, But I Still Prefer New Gold

Oct.30.13 | About: Yamana Gold (AUY)


In this article I'll have a closer look at Yamana Gold (NYSE:AUY), which is a gold producer focused on its operations in South America. The company has just released its quarterly results which seem to be very robust at first sight. I will provide my view on the company's financial statements and balance sheet which will result in my investment thesis at the end of this article. The aim of this article is not to re-chew the obvious numbers but to dig deeper than just those headline numbers.

I will also explain why I like New Gold (NYSEMKT:NGD) better than Yamana, and I will use the basics of my article about New Gold to compare its numbers with Yamana.

My view on the financial results

Yamana Gold reported a gold-equivalent production of almost 307,000 ounces (consisting of 264,000 ounces of "pure" gold and 2.2 million ounces of silver), which is a 4% increase compared to the previous quarter. This resulted in 7% higher revenue which almost reached the $500M mark during Q3, coming in at $456.7M (which still is a huge drop from last year's $600M). As the All-In Sustaining Cash cost decreased to $730 per gold-equivalent ounce, the company enjoyed a very attractive operating margin.

As said, Yamana reported revenue of $456.7M, and operating earnings of $90.5M. The operating earnings are still quite high because the company slashed its general and administrative spending by 20% and its exploration expenditures by a severe 50% in order to preserve some cash. This had a positive impact of approximately $15M on the operating expenses.

As I said in several earlier articles, I think it's very important to have a look at the cash flow statements of a mining company as those usually give a much better impression of the underlying operations. By looking at the cash flow statements, the operating cash flow was actually closer to $177.5M, which is almost double the operating earnings. However, due to a change in working capital, the cash flow from operations was approximately $100M. Yamana Gold was free cash flow negative in Q3 as it spent approximately $218M on its plant and equipment. Fortunately the company was able to fund these expenses by using the cash on its balance sheet so no new debt was issued.

Let's now make a first comparison between Yamana Gold and New Gold. Yamana Gold was producing at an AISC of $730/oz whilst New Gold produced at a cost of $779/oz. However, while this number will stay relatively stable over at New Gold (thanks to New Afton's negative cash cost), Yamana Gold has been guiding for a higher cost per ounce in 2014 and in 2015. So if one looks at the profitability of both companies, New Gold seems to be a better deal as Yamana's cash costs will increase to $900/oz in 2015.

My view on the balance sheet

In difficult times like this, we need to be very careful when looking at the balance sheet of companies, as investors are looking for companies which can be very flexible and have no balance sheet constraints.

Yamana's working capital position decreased to "just" $178M, which indicates there isn't a lot of wiggle room left considering the net cash outflow of $148M in Q3. The current ratio had decreased to just 1.28 (a ratio higher than 1 means the company has sufficient current assets to cover its current liabilities). Granted, AUY's current ratio is still higher than one, but it looks like some action will be needed later this year to increase the working capital and current ratio.

I would like to compare the balance sheet of Yamana Gold with New Gold's balance sheet, which has a working capital of $564M and a much higher current ratio of 6. This means that value investors might be inclined to prefer New Gold over Yamana Gold because of its better balance sheet. Granted, Yamana is a much larger producer, and also operates more mines, which reduces the risks a bit more. Also keep in mind that two of Yamana's mines are still in the commissioning phase and are ramping up toward commercial production. Once these mines are up and running, I'm expecting a decrease in capex and an increase in operating cash flow for Yamana, which might relieve some pressure from the balance sheet.

On the positive side, Yamana's book value per share is approximately $10.23, so the shares are currently trading below this book value, even if one would deduct the value of the goodwill on its balance sheet. As New Gold's share price is also trading around its book value, there is no clear winner here.

Yamana is also paying a dividend which costs the company $49M on a quarterly basis and almost $200M per year. I feel that if the current conditions for the price of gold remain the same as in the past few quarters, Yamana should consider a dividend cut. If the company would slash the quarterly dividend to $0.025/share (resulting in a 1% dividend yield), Yamana would be able to keep $120M per year inside the company which it could use an additional buffer for further capital expenditures and to repay some of $1.1B long term debt.

This is why people might actually prefer Yamana over New Gold, as Yamana currently offers an attractive 2.6% dividend yield, while New Gold still doesn't pay a dividend.

Investment Thesis

Even though Yamana Gold had an excellent quarter in terms of output, I'm getting a bit worried by the company's balance sheet, as its working capital position has decreased to less than $175M. I hope this will be just temporary and am hoping the increased output from next year on will be beneficial for the working capital position.

I also think it would be a wise move for Yamana to cut the dividend to preserve cash, as long as the gold price remains at these relatively low levels. Don't get me wrong, Yamana isn't a bad buy, but at this point I would prefer to buy New Gold instead of Yamana, thanks to NGD's flexible balance sheet. The only advantage of owning Yamana over New Gold is the fact that Yamana is one of the few dividend-paying gold mining companies.

In my previous article I made a case for writing put options on Yamana Gold, and I still think this is a valid strategy. Since the previous article, the option premium for a P8 Jan 2014 decreased from $0.60 to $0.19, for a 200% gain, and the P12 for the same date saw a gain of 20%.

At this point it could be worthwhile to write a P9 Jan 2014 for an option premium of $0.45, or an annualized yield of approximately 20%. If you're a real bargain hunter, you might be interested in writing a P7 April 2014 for a premium of $0.21, which results in an annualized return of 6%.

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.

Additional disclosure: I currently have no position in Yamana Gold, but might write an out of the money put option, as explained in the article.