A Close Look at Yamana Gold

Includes: AEM, AUY
by: Bill Cara

When you hear that Yamana (NYSE:AUY) is Cramer’s favorite gold stock, you have to know that it’s over-priced, but also well-known. :-)

Cramer used to like Crystallex (KRY), but switched to Yamana because the company is mining in South America (Brazil/Argentina) and Central America (Honduras), but not Venezuela. Not being concerned about Venezuela to near the same extent (although the political risk is real), I prefer Crystallex.

What’s not to like about the growth of this mid-tier producer Yamana? Annual gold production from existing mines is likely to grow in the following sequence (ounces per year): 352k (2006), 601k (2007), 745k (2008), and 841k (2009).

The company’s stated target is to get 1.0 million oz of production for 2008, which means they have to grow the company by at least one-third via acquisitions in the next 12-months. That’s a big appetite – a year ago, Marrone said he was targeting 400,000 oz for 2008. What a difference a year makes.

As I see it, the cash cost to produce an oz of gold from existing mines is likely to fall from about $300/oz to under $200 in 2008, so the leverage of increased production and lowered operating costs per oz, in addition to the promotional flair of the CEO, will surely translate to continued investor enthusiasm for the stock.

Aggressive CEO Peter Marrone is a good promoter and a proven acquisitor. He’s a bit like Goldcorp’s Ian Telfer in that respect.

The problem of course is that when Marrone sits down at a negotiating table for acquisitions, the target company is also interviewing Goldcorp, IAMGOLD, Barrick, Goldfields, Newmont, and a few others.

AUY is not, in my view, the best value in the mid-tier gold producers, but it’s pretty good and should be on your watch list.

On a direct comparison basis, I prefer Agnico-Eagle (NYSE:AEM) in the mid-tier producers because I think Agnico-Eagle management is more aggressive on cost management and providing shareholder value, while Marrone, given his appetite, is prone to over-pay for acquisitions.

AUY closed yesterday at US$9.69/C$10.95. I have a price target of about C$15, and I recommend buying on the dips because if, as and when it announces its next acquisition, the share price, like with Goldcorp, is likely to drop because the premium to be paid these days is about +35-pct over current market prices.

Notes from Wall Street analysts re Yamana Gold:

• With the RNC, Desert Sun and Viceroy acquisitions, along with the start-up of its Chapada mine next year, Yamana will be one of the largest intermediate gold producers in 2008. Marrone highlighted the company's strong balance sheet (no debt), the recent declaration of a dividend, its leverage to gold (gold unhedged), and its commitment to exploration in Brazil and Central America.

• Over the next months, the company expects to report on several significant milestones: demonstrated performance at Sao Francisco, cost improvements at the Jacobina complex, startup of Chapada, completion of the Viceroy acquisition, delivery of the Sao Vicente feasibility, and expansion plans at the Jacobina complex.

• The Sao Francisco mine was declared commercial on August 1, 2006, ahead of company expectations, and management says the operation is performing better than anticipated. The cash cost structure by year-end is expected by management to be better than $240/oz, whereas Merrill Lynch is currently forecasting 2006 total cash costs of $286/oz and production of 71,000 ounces compared to AUY’s forecast of 75,000 to 90,000 ounces. ML’s production forecasts include a slight cushion for normal startup issues. Sao Francisco comprises 17% of ML’s NAV estimate for the company, will have a mine life of over 8 years, and is expected to produce 130,000 ounces of gold in 2007 at total cash costs of $186/oz.

• Chapada construction is 98% complete. Management indicated that construction is progressing on schedule and is 98% complete at the copper gold Chapada project in Brazil. The company intends to begin first concentrate production in October. Chapada is forecast to produce 15mlbs of copper and 15,000 to 19,000 ounces of gold in 2006 and 128mlbs of copper and 180,000 to 200,000 ounces of gold in 2007. Chapada is Yamana’s key asset and comprises 46% of ML’s NAV estimate for the company.

• Costs: costs are rising for all producers; however, the market appears not to want to know about it until margins are squeezed. At present price appreciation has outrun cost appreciation, but this will stop when prices peak – industry costs unlikely to come down for some time given labour, equipment, consumables prices etc.

• Development/Permitting Risk: Yamana is exposed to development risk and permitting risk as it brings exploration projects into production. Development risks include construction delays, unforeseen issues and permitting delays.

• Political and Foreign Exchange Risks: Yamana is also exposed to potential political risk as most of its operations are located in Central and South America, with one in Honduras, one in Argentina and the remainder in Brazil, and to currency risk, as 30% of operating costs for the company are based in Brazilian Reais. In our (ML Mining Research) cost forecasts we have assumed Real/USD exchange rate of 2.2, which is slightly more conservative than Merrill Lynch’s official forecast of 2.3 in 2006 and 2.45 in 2007.

• Industrial Risk: While industrial risks such as strikes and shutdowns are a concern for all industrial companies, we believe that Yamana has employed sufficient measures, particularly active community, industrial, and political relations.