With fears about an inflationary economy looming, many investors are naturally looking into gold investments. While the Street is currently bullish about Goldcorp (GG) and rates it a "strong buy", I believe that Kinross Gold (KGC) has meaningfully larger upside. Not only does it trade at lower multiples, the bar has been set lower and new discoveries are not being properly valued. Even though the Street only rates it a "weak" buy, the firm has shown strong operational execution of late and trades significantly below peer levels.
From a multiples perspective, Kinross is clearly the cheaper of the two. It trades at a respective 14.6x and 9.2x past and forward earnings while Goldcorp trades at a respective 20.1x and 14.4x past and forward earrings. Despite the praise that Goldcorp receives for its low cost production, Kinross actually has gross margins that are a staggering 1,290 basis points higher than that of its competitor at 57.3%. This enables the firm to benefit more from increases to scale.
In addition, at the third quarter earnings call, Kinross' CEO, Tye Burt, noted stellar performance:
"Overall, Kinross had an active and productive third quarter. We continued to deliver strong financial results with a 26% in revenue, a 28% increase in adjusted operating cash flow, a very significant increase in adjusted net earnings, and a 37% increase in our margin, which grew to a record $673 per ounce. Third quarter attributable production of 575,065 ounces included 20,238 ounces from the former Red Back assets based on the closing date of September 17th through the end of the quarter.
Some highlights from our portfolio of operations included Paracatu, which continues to exceed our budget and expectations. The site produced over 129,000 ounces this quarter, which is a 51% increase from Q3 of 2009. Cost of sales decreased to $505 per ounce, a 34% improvement from the same period last year and a 4% improvement from Q2. Year-to-date, Paracatu has produced approximately 365,000 ounces, above our budget and guidance expectations".
Results were particularly strong in North America, while accounting for lower grades. Management guided for higher Russian and U.S. production, but lower production in South America. Going forward, I am optimistic about the oxide discovery at La Coupa and the feasibility results of new projects. On the other hand, the firm faces onerous challenges from the Ecuadorian government over the Fruta del Norte project, which will yield high grade. It reached a non-binding agreement with the local government for a windfall tax on 70% of gold returns over $1,650/oz, a corporate tax of 22%, and sliding scale royalties, among other things.
Consensus estimates for Kinross' EPS are that it will grow by 43.1% to $0.83 and then by 54.2% and 12.5% more in the following two years. Assuming a multiple of 15x and a conservative 2012 EPS of $1.14, the rough intrinsic value of the stock is $17.10, implying 44.8% upside. If the multiple were to decline to 9x - unreasonable, in my view - and 2012 EPS turns out to be 21.9% below the consensus due to, say, political and labor unrest, the stock would fall by 23.8%. This indicates strong favorable risk/reward that the market has yet to fully appreciate.
Goldcorp has an attractive story in its own right. Much has been said, for example, about the Cerro Negro project 600m above sea level. Reserves are at around 4.26 Moz Au and are likely to expand. In addition, the drill program has expanded potential at Marianas and San Marcos with strike length increases. This will likely yield ore shoots larger than expected. With that said, the firm faces significant risks with ramp up in Penasquito and shares are, in my view, likely to compress slightly from here.
Consensus estimates for Goldcorps' EPS are that it will grow by 62.8% to $2.23 and then by 40.8% and 23.2% in the following two years. Assuming a multiple of 18x and a conservative 2012 EPS of $3.05, the rough intrinsic value of the stock is $54.90, which implies only 20.7% upside.