With runaway spending raising concerns over inflation, gold presents one of the best defensive investments today. Two producers in the industry that analysts are bullish about are Barrick Gold (ABX) and AuRico (AUQ). I have previously argued here that the former has substantial upside and limited downside. I find similar risk/reward in the latter.
From a multiples perspective, both are fairly cheap. Barrick trades at a respective 11x and 8.2x past and forward earnings while offering a dividend yield of 1.3%. AuRico trades at a respective 11.1x and 6.8x past and forward earnings. AuRico is the riskier of the two given high expectations, coupled with greater stock volatility.
Accordingly, the Street slightly prefers Barrick, which has a more established brand and network. Gross margins for both firms are slightly higher than 61%. Contrasting with these two is New Gold (NGD), which trades at a respective 21.5x and 16.3x past and forward earnings. This company has limited multiples expansion and shareholders are largely reliant on management. Lack of exposure to sovereign debt issues also limits risk-adjusted returns.
Investment professionals are generally confident about AuRico's ability to outperform the market. With operations proceeding quicker than expected and successful integration of buyouts, AuRico deserves its near "strong buy" rating. The company reported record results in the third quarter:
During the third quarter the Company continued to deliver strong performance across the key operational and financial metrics including production, cash costs and operating cash flow, and reported a significantly increased quarter-end cash position of 42% to $145 million. Through the recent transformational acquisition of Northgate Minerals in late October, AuRico has emerged as a new leading intermediate gold producer with a robust production profile, a low cost base, an attractive growth platform and a compelling valuation.
Perhaps most impressive is that the company is beginning to mine Young Davidson open-pit ore. Around a quarter of years worth of production will be stockpiled, which should improve margins as price trends normalize. Young Davidson will be a key producer and thus far it appears that there are minimal concerns to development due to faster than expected progress. AuRico is well positionted to start underground mining much earlier than the 1Q14 target.
The major risk that the gold producer faces is in its high cost projects. The Fosterville and Stawell mines should be sold to de-risk the business and inspire investor entry. Production is not so much of an issue, since it is expected to dramatically increase to 634K oz AuEQ in 2012.
Consensus estimates for AuRico's EPS are that it will skyrocket by 253.1% to $1.13 in 2011 and then by 14.2% and 20.9% more in the following two years. Assuming the multiple holds steady at around 11x and a conservative 2012 EPS of $1.25, the stock has 62.9% upside. If the multiple plummets to 7x and 2012 EPS turns out to be 14% below consensus, the stock would fall by 7.9%.
Barrick is attractive in light of its international expansion and track record of beating expectations. In the third quarter, the company had stellar production of 1.93M oz at $453/oz and is aiming for 9MMoz by 2015. Management remains committed to increasing the dividend, having raised it by more than 170% over the last five years. While the large multibillion-dollar Donlin Gold and Cerro Casale projects have their risks, confidence in Red Hill and Gold Rush discoveries will offset the impact. Going forward, I also believe that management has gotten the message from shareholders and will start to explore smaller-scale plays.
Consensus estimates for Barrick's EPS are that it will grow by 47.9% to $4.91 and then by 22.2% and 12.8% more in the following two years. Assuming a multiple of 12x and 2012 EPS of $5.70, the rough intrinsic value of the stock is $68.40, implying 42.4% upside. If the multiple were to plummet to 8x and 2012 EPS turns out to be 12.8% below the consensus, the stock would fall by 12.9%. It is, in my view, a hedging miracle.