On Wednesday, December 11, IAMGOLD (IAG) announced that it would be suspending its dividend of $0.25/share/year, or $94 million, sending shares plunging more than 10% to their lowest level in over 5 years. This is substantial considering the unusual strength seen in gold mining shares more generally, which fell less than 1% on a day when the gold price was down over 2%.
On the surface it might appear that the company is simply reacting to lower gold prices--it is not a low cost producer and it has $640 million in debt outstanding, and with gold prices so low it would make sense that the company might want to attempt to preserve capital. Yet I think that there are other factors at work. After all the company did not cut its dividend during the summer when the gold price fell to an even lower level than $1,230/ounce where it sits today. Furthermore, since then the company shut down one of its higher cost operations--Yatela--which means that its overall production costs have come down. In all its profitability (albeit meager), its large cash position ($466 million), its strong working capital position ($635 million), its $750 million line of credit, and the fact that its debt is long term and not an immediate concern all indicate that the company could have continued to pay its dividend for several years at the current gold price.
The only other explanation is that the company needs the capital for something else. This theory makes even more sense when we consider the fact that the company had intended to release two economic assessments for major projects by the end of the year--one for the Cote Gold Project in Ontario, and another for the expansion of the Niobec niobium mine in Quebec. The timing of the dividend cut along with the observation that it was not necessary leads me to believe that the company intends to preserve capital in order to fund one of the two aforementioned projects, and that consequently we have reason to believe that management has reason to be so confident in the future of one of these projects that it would feel justified in cutting the company's dividend in order to use this capital to fund it.
This being the case, contrary to the knee-jerk reaction we saw in the market on Thursday, I believe that the shares of IAMGOLD should be purchased in anticipation of an announcement of results from the economic assessment for one of these two projects. While we do not yet know the specifics, we do know that both the addition of Cote to the company's gold mine arsenal, and the expansion of Niobec are game changers for the company.
To see why it is useful to take a brief look at the company's current production. From there I will discuss the two projects at hand more closely, and I will show the impact that either one of these two developments (commencement of production at Cote or expansion of production at Niobec) would have on the company, .
An Overview of IAMGOLD
IAMGOLD currently operates four gold mines predominantly in what are deemed politically risky jurisdictions in South America and in western Africa, although some of this production is in Canada. It produces about 900,000 ounces of gold annually, and its all-in sustaining costs are roughly in line with the spot price (all in sustaining costs for Q3 were $1,216/ounce). In addition the company operates the Niobec niobium mine in Quebec which produces roughly 5 million kilograms of niobium annually at roughly $20/kg. (it reports a $19/kg operating margin but not operating costs), which probably comes to about $30/kg, leaving $10/kg for profit, when administrative costs and taxes are figured into the equation.
While the company's Canadian assets (the Doyon division gold mines that produce about 130,000 ounces of gold annually with AISE of $900/ounce in Q3 and Niobec) are excellent investors have correctly been concerned that the company operates mines in Burkina Faso (Essakane), Suriname (Rosebel) and Mali (Sadiola). Sadiola in particular has been disastrous in that its costs have spiraled out of control (AISC of $1,800/ounce in Q3). Characterized broadly IAMGOLD is a high cost producer that operates mostly in risky jurisdictions, and for a sector that has generated an enormous amount of investor pessimism these two characteristics signify Armageddon. Thus it is no wonder that investors have sold off the shares of IAMGOLD from well over $20/share during the peak in 2011 to just $3.40/share today.
The two projects in question, however, tell a different story.
The Cotes project in Ontario has enormous potential. Not only is it 516 square kilometers of exploration property, but IAMGOLD has already found an estimated 8 million ounces of gold most of which is 0.9 grams per tonne of measured and indicated resources, which is a decent grade for a surface mine.
The project is currently undergoing an economic assessment that is supposed to be completed this year or perhaps early next year. Preliminary estimates suggest that the company can mine 60,000 tonnes of ore daily (about 22 million tonnes annually) for 15 years. Assuming that a third of this is waste the mine will be able to produce over 400,000 ounces of gold annually, which amounts to nearly a 50% increase in production from current levels. A low cost of production coupled with a low capex expectation (rudimentary estimates have this figure at $1.4 billion for the life of the mine) would mean that the current resource could be worth a large fraction of the current value of IAMGOLD ($1.3 billion), and at higher gold prices the figure could exceed this valuation. To give the reader an idea, if the mine's costs are in line with its other surface mines with similar grades (e.g. Rosebel), then it will generate $50 million annually at current gold prices before interest payments and taxes. At $1,600/ounce gold this figure sky-rockets to $200 million.
Niobec in Quebec is already producing 5 million kilograms of niobium annually, and it does so very profitably (in fact this is by far the company's highest margin business). However it could be producing a lot more. IAMGOLD currently estimates that Niobec has 2.6 billion kilograms of niobium in the form of niobium pentoxide (N2O5), and 1.8 billion are in the form of probable reserves.
In order to increase production at Niobec the company is performing an economic assessment that should have been completed by now. If it demonstrates that expansion is economically desirable then it intends to find a JV partner in order to increase production. This will ease the financial burden to the company should expansion take place, but the final mine should be large and will require a lot of capital on the part of both partners.
In a previous article I estimated that the mine can produce 22 million kilograms of niobium annually if it operates for 40 years and produces just half of Niobec's probable reserves. If the JV deal is 50/50 this would leave 11 million for IAMGOLD. Of course given that the mine's estimated niobium resources are nearly three times half of the probable reserves this figure is extraordinarily conservative. But at the same time even if costs increase so that net margins drop from $10/kg. to $8/kg. this would give the company $88 million in free cash-flow annually for 40 years. Using a 7% discount rate and a mine expansion capex figure of $1 billion ($500 million attributable) IAMGOLD's share of Niobec would be worth $755 million (the company's market capitalization is just $1.3 billion and its primary asset is gold, not niobium). Again these figures are very conservative, and IAMGOLD's share of Niobec could easily be worth substantially more.
What These Projects Mean To IAMGOLD
Cutting a dividend is a drastic step and it is generally one that is only taken when a company really needs capital. As I have already mentioned IAMGOLD does not need this capital to pay creditors: it has just $88 million due in the next two years and another $88 million due in the subsequent two years. (cf. IAMGOLD's Q3 financials, p. 49). I have also mentioned that I suspect that the dividend elimination was a step taken to fund the development of one (or both) of these two projects. I suspect that the cut was announced when it was because the company wanted to retain the $47 million dividend payment due next week (IAMGOLD pays a biannual dividend), yet it wasn't ready to make an announcement regarding its economic assessment (management could have made the decision using unofficial preliminary knowledge). While this claim is certainly speculative I don't believe that any other explanation fits the scenario, especially given that the "flexibility to take advantage of opportunities when they arise" was cited as a reason for the dividend suspension in the company's news release.
But while the specific intent behind the dividend suspension is speculation (albeit educated speculation), the value of the two aforementioned properties to IAMGOLD--both quantitatively and qualitatively--would certainly merit such a drastic move.
While we don't yet know the specifics regarding the valuations of Cote or the expanded Niobec, we do know that their values are substantial relative to the current depressed valuation of IAMGOLD, presuming positive economic assessments. Cote will potentially add over 400,000 ounces of annual production driving the company's production up nearly 50% upon commencement to at least 1.3 million ounces. Expansion at Niobec will add at least 6 million kilograms of niobium production, and probably more.
Equally as important is the redistribution of political risk that results from production at Cote or expanded production at Niobec. Now the company produces over 80% of its gold in what are perceived to be high-risk jurisdictions. While the actual risk of mining in a place such as Burkina Faso is debatable, investors are hesitant to invest in mining companies with significant exposure to such regions. If Cote goes into production suddenly nearly half of the company's gold production will be in Canada, and if you include production from Niobec--expanded or not--the company generates most of its profits in low-risk Canada.
Ultimately I think investors misinterpreted IAMGOLD's dividend elimination, and they were too quick to sell without realizing the benefits that would likely ensue from redeploying this capital in its Canadian assets. In doing so they pushed the share price down when it probably should have risen, creating an excellent buying opportunity.