With many gold producers struggling to generate cash and deliver positive earnings, Gold Fields (NYSE: GFI) bucked the trend with good results in both areas during their second quarter. Gold Fields reported net income of $19.0 million for the second quarter compared to a loss of $129 million in the same quarter of 2013, though it should be noted that $127 million of the 2013 loss was related to an impairment charge. Revenue increased by 17% from $637 million to $747 million. Gold Fields achieved second quarter free cash flow margins of 18% which exceeded the 15% goal they have set for themselves for the first time.
Gold Fields has stated that their main goals are to improve margins and generate cash flow, both of which they are doing successfully. Like many other gold majors, Gold Fields is now fully focused on producing quality, low cost ounces as opposed to producing as many ounces as possible without regard for costs. Cash flow from operating activities minus net capital expenditures, environmental payments, debt service costs and non-recurring items was $65 million which was a vast improvement over the outflow of $230 million in the second quarter of 2013. For the second quarter Gold Fields achieved all-in sustaining costs of $1,050 an ounce which was a 26% decrease from $1,416 an ounce in the prior year's quarter. This beat yearly guidance for AISC of $1,125 an ounce, however, during the second quarter results, Gold Fields maintained their cost guidance for the year. Gold production increased from 451,000 ounces in the second quarter of 2013 to 548,000 ounces mainly as a result of the 2013 acquisition of the Yilgarn South assets from Barrick Gold (NYSE: ABX).
Gold Fields intends to use its cash generation to improve their balance sheet by reducing net debt. To that end, Gold Fields managed to reduce net debt by $52 million in the second quarter which brings their year to date net debt reduction to $101 million. During the second quarter, Gold Fields sold the Yanfolila project in Mali to Hummingbird Resources for $20 million in Hummingbird shares and sold its 51% stake in the Chucapaca project in Peru to its joint venture partner, Buenaventura (NYSE: BVN) for $81 million. These sales are in line with Gold Fields' mandate to divest non-core assets. Gold Fields also stated that their focus on growing cash flow through quality assets has led them away from greenfields exploration as a growth strategy which means that Gold Fields should be spending less on exploration moving forward.
One of the biggest risks to investors is the uncertainty surrounding Gold Fields' South Deep mine. Gold Fields spent $3 billion to acquire South Deep and has spent about another $1 billion on development so far. South Deep hosts the second largest gold deposit in the world behind only Freeport McMoran's (NYSE: FCX) Grasberg mine and as such is Gold Fields' most important asset. Timetables and production targets for the mine have shifted several times and this is one of the reasons the stock has underperformed over the last few years.
Gold Fields had previously set a production target of 1 million ounces a year by 2013. South Deep is now projected to produce 650,000 to 700,000 ounces a year by 2017 at all-in costs of $900 an ounce. Gold Fields is expecting to be cash break even at South Deep in the first half of 2015 and then fund the remainder of the project from operational cash flow. The life of the mine is more than 50 years and South Deep has resources of 76.2 million ounces along with reserves of 38.2 million ounces.
Gold Fields has brought in an International Geotechnical Advisory Board made up of industry leaders to review South Deep's current destress mining technology to determine whether there are any safer, more cost effective methods that can be used. The team identified two alternative methods that may be better suited than the current destress method. Gold Fields is planning a pilot project to test out these two methods starting in the fourth quarter. While it should be seen as a positive sign that Gold Fields has brought in outside expertise, the worry for investors is that the management team at Gold Fields still does have a firm grasp on how to optimize mining at South Deep.
South Deep performed poorly during the second quarter with AISC of $1495. This was mainly because gold production decreased by 34% due to lost production as a result of the mine being shut down after two fatalities. To make matters worse at the end of July, the Department of Mineral Resources sent a letter to Gold Fields threatening to cancel or suspend operations because Gold Fields has failed to implement a social and labour plan which is required under South African mining law. Despite poor results at South Deep and the fact that South Deep will remain shut down over the next few months, Gold Fields reaffirmed their 2014 guidance for total production of 2.2 million gold equivalent ounces at all-in sustaining costs of $1,125 an ounce.
Gold Fields has delivered solid second quarter performance and the company appears to be moving in the right direction with their strategy of focusing on cost reduction, divesting non-core assets and generating cash flows from operations. Still, in the long run, Gold Fields' performance will be largely tied to how well South Deep performs. While Gold Fields has a lot of potential upside, there is also considerable downside risk if things go sideways at South Deep. Despite the risks, I believe the risk/reward balance is tilted towards the reward side. Gold Fields has done a good job of cutting costs and getting leaner and I expect that they will be able to further drive down costs and optimize performance at their mines.
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