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Summary

  • Yamana took the conservative approach to calculate its gold reserves when gold prices were high, in comparison to its peers; this approach allowed the company to mine lower grade ores.
  • The company is taking initiatives to control its all-in sustaining costs (AISC) by reducing its capital spending this year; this will help the company to improve its liquidity position.
  • Although low gold price had negatively impacted Yamana's liquidity position, the company has managed its debt better than its peers.

An end to a tough year

Yamana Gold (AUY) reported financial results for 2013 with both revenue and earnings missing analyst estimates. Gold prices tumbled 28% last year, and the company recorded a steep decline of 21% in its annual revenue. However, gold price has shown improvement this year, which will positively impact the company's revenue.

On a positive note, the company displayed an improving cost structure throughout 2013. Gold miners use a standard metric to report the total costs associated with producing gold known as the all-in sustaining costs (AISC). After reporting a high AISC of $1,014 per ounce in the first quarter of 2013, Yamana managed to reduce its AISC to an average of $924 for the last three quarters.

Owing to lower gold prices, gold miners have been under added pressure to reduce production costs. Last year, gold companies were forced to take tough measures in order to reduce expenditures. Barrick Gold (ABX) suspended developmental work at its Pascua Lama project, previously expected to attain production by mid-2016, due to project delays and declining gold prices. However, Barrick won't resume developmental activities at the mine until gold prices move upwards. The suspension of the Pascua Lama project came as a serious blow to the company's near-term prospects; the mine was dubbed as one of the world's lowest cost gold mines.

Barrick generated around $850 million from the sale of high-cost and non-core assets in the last seven months. Earlier this year Barrick and Goldcorp (GG) sold their respective stakes of 33.3% and 66.7% in the Marigold mine for a total of $275 million. The mine reported a very high AISC of $1,604 per ounce of gold in the first nine months of 2013. Going forward, the sale of high cost mines will help gold miners reduce their overall AISC. In terms of AISC, Barrick Gold appears to be slightly better than Yamana Gold. However, Yamana's 2014 AISC expectation of less than $925 per ounce reflects the company's optimism about reducing its AISC.

AISC ($ per ounce)

Yamana

Barrick

Goldcorp

2013 actual

947

915

1,031

2014 expected

<925

920-980

950-1000

Despite the fact that Yamana reported an 8% decline in gold reserves in 2013, the company still uses a conservative price assumption of $950 per ounce for calculating its gold reserves. The use of a lower price assumption has allowed the company to mine lower grade ores that are profitable despite today's lower gold prices. On the other hand, both Barrick and Goldcorp used higher gold-price assumptions when gold prices went up and were forced to slash their reserves considering the current price environment. The fall in gold prices has rendered some of the companies' lower quality ores unprofitable to mine. As a result, Barrick and Goldcorp recorded considerable reserve declines of 26% and 15% respectively.

Measures to improve financial flexibility

Owing to the lower gold-price environment, Yamana Gold outlined a series of measures that it will undertake this year to improve its overall financial flexibility. The company will be reducing its capital spending by almost 54% from $1.05 billion in 2013 to $480 million this year. This will allow the company to operate within its AISC target of less than $925 per gold ounce in 2014. Further, the company has reduced its quarterly dividend 42% from $0.065 to $0.0375. As a result, I expect the company's liquidity position to improve in the coming quarters. As seen below, Yamana Gold's liquidity position has deteriorated over the past three years.

Yamana Gold

2011

2012

2013

Quick ratio

1.90

1.03

0.77

Yamana's quick ratio has declined over the years with the company posting a quick ratio of less than 1.0 at the end of 2013. As a result, the company would have found it difficult to fund short-term obligations. However, reduced capital spending and lower dividend payments will ensure the company's liquidity position will improve this year.

Although Yamana's liquidity position has worsened, the company has displayed better debt management on a relative basis.

Parameter

Yamana

Barrick

Goldcorp

Debt-to-equity

16.6%

96.6%

11.7%

Debt-to-assets

10.4%

34.9%

7.8%

Cash flow to debt ratio

0.55

0.32

0.41

With a total debt of around $1.19 billion, Yamana appears to be better placed than Barrick in terms of debt management. Moreover, the company recorded a higher cash flow to debt ratio, indicating better ability to pay off debt obligations.

Conclusion

The use of a conservative price assumption has enabled Yamana Gold to invest in projects that are economical to mine in the current price environment. The reduced capital spending in 2014 will result in a lower AISC that will help improve its profit margins. Even though the company will be paying lower dividends this year, this will help improve the company's liquidity position. Considering the company's fundamentals, I believe Yamana's stock has good upside potential.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: Fusion Research is a team of equity analysts. This article was written by Madhu Dube, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article

Source: How To Play Yamana Gold