Which Gold Stock Will Outperform Its Intrinsic Value The Best?

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Includes: ABX, AEM, AU, AUY, EGO, EPS, GFI, GG, KGC, NEM, SPY
by: Alberto Abaterusso

Summary

Gold mining stocks have seen their share price declining a lot during the last 5 years.

It only makes sense to consider an investment in gold stocks when they're priced significantly below their intrinsic values.

How can we determine the intrinsic value of a gold mining stock?

Gold mining stocks have seen their share price declining a lot during the last 5 years. As you can see from the picture below, all of them lost a lot in terms of share price ranging from -16.71% of Agnico Eagle Mines Ltd (NYSE:AEM) to -69.56% of GoldFields (NYSE:GFI).

Click to enlarge

Inside the interval there are (NYSE:AU) with -60.93%, (NYSE:AUY) -55.82%, (NYSE:EGO) -69.37%, (NYSE:NEM) -30.44%, (NYSE:GG) -61.39%, (NYSE:KGC) -66.31% and (NYSE:ABX) -52.93%. At the same time the S&P 500 (NYSEARCA:SPY) has grown 62.97%.

Business performance of gold mining companies is dependent on the prices of the precious metals they mine, so it only makes sense to consider an investment in them when they're priced significantly below their intrinsic values.

…below their intrinsic values..

Let's say that it makes sense to consider an investment in stocks when they are priced below their intrinsic values, i.e. if you are a value investor. Significantly means to get an edge over the market: buying stocks that are selling for less than the intrinsic value. The difference between what the investor pays to buy a stock and its intrinsic value is what the value investor looks for and calls 'margin of safety'.

Many investors use a handy approach to find undervalued companies: The Price-To-Book Ratio.

If we were to consider as best investment and choose on the basis of P/B in the following bouquet of gold mining stocks (see table below), there are two cheap stocks: Yamana Gold Inc. and Eldorado Gold Corp. So apparently there aren't so many options in terms of price-to-book ratio:

Most Recent Annual

Company name

Exchange

Currency

Price

Price-to-

book ratio

ABX

Barrick Gold Corp...

NYSE

USD

20.50

3.21

KGC

Kinross Gold Corp...

NYSE

USD

5.22

1.50

GG

Goldcorp Inc. (NYSE:USA)

NYSE

USD

18.21

1.15

NEM

Newmont Mining Corp

NYSE

USD

36.24

1.64

EGO

Eldorado Gold Cor...

NYSE

USD

4.32

0.80

AEM

Agnico Eagle Mine...

NYSE

USD

51.26

2.62

GFI

Gold Fields Limit...

NYSE

USD

4.45

1.27

AU

AngloGold Ashanti...

NYSE

USD

16.77

2.28

AUY

Yamana Gold Inc. ...

NYSE

USD

5.08

0.94

Click to enlarge

Source: Google Finance.

The table below shows companies that have a negative return on avg equity. Large discrepancies between P/B and ROE, a key growth indicator, can sometimes send up a red flag on companies :

Most Recent Annual

Company name

Exchange

Currency

Price

Price-to-

book ratio

Mkt Cap

Return on avg equity

ABX

Barrick Gold Corp...

NYSE

USD

20.50

3.21

23.33B

-32.57

KGC

Kinross Gold Corp...

NYSE

USD

5.22

1.50

6.41B

-22.55

GG

Goldcorp Inc. (USA)

NYSE

USD

18.21

1.15

14.83B

-28.21

NEM

Newmont Mining Corp

NYSE

USD

36.24

1.64

18.83B

1.79

EGO

Eldorado Gold Cor...

NYSE

USD

4.32

0.80

2.89B

-34.07

AEM

Agnico Eagle Mine...

NYSE

USD

51.26

2.62

11.01B

0.60

GFI

Gold Fields Limit...

NYSE

USD

4.45

1.27

3.65B

-11.22

AU

AngloGold Ashanti...

NYSE

USD

16.77

2.28

6.88B

-1.96

AUY

Yamana Gold Inc. ...

NYSE

USD

5.08

0.94

4.75B

-36.34

Click to enlarge

Source: Google Finance

Graham recommends a 'ratio of price to assets' (or price-to-book-value ratio) of no more than 1.5.

And if Graham's 'blended multiplier' (P/B x P/E must be less than 22.5) still works as an initial screen to identify reasonably-priced stocks, none of them passes the test.

Most Recent Annual

Company name

Exchange

Currency

Price

P/E

Price-to-

book ratio

ABX

Barrick Gold Corp...

NYSE

USD

20.50

-

3.21

KGC

Kinross Gold Corp...

NYSE

USD

5.22

-

1.50

GG

Goldcorp Inc. (USA)

NYSE

USD

18.21

-

1.15

NEM

Newmont Mining Corp

NYSE

USD

36.24

193.41

1.64

EGO

Eldorado Gold Cor...

NYSE

USD

4.32

-

0.80

AEM

Agnico Eagle Mine...

NYSE

USD

51.26

482.45

2.62

GFI

Gold Fields Limit...

NYSE

USD

4.45

-

1.27

AU

AngloGold Ashanti...

NYSE

USD

16.77

-

2.28

AUY

Yamana Gold Inc. ...

NYSE

USD

5.08

-

0.94

Click to enlarge

Source: Google Finance

Financial situation and debts: who is the least worse?

The current ratio is used to test a company's liquidity by deriving the proportion of current assets available to cover current liabilities.

All the companies apparently have readily short-term assets available to pay off their short-term liabilities. They therefore have no liquidity problems. But if we take into account Graham's test of a 2-to-1, GG, GFI, AU and AUY would be excluded since they do not have 'a sizable cushion of working capital that - on average - should sustain them through hard times' (see commentary on 'Stock Selection for the Defensive Investor' chapter of the Intelligent Investor).

Most Recent Quarter

Company name

Exchange

Currency

Current ratio

Lt debt to assets

Total debt to assets

Lt debt to equity

Total debt to equity

ABX

Barrick Gold Corp...

NYSE

USD

2.69

35.24

35.98

124.63

127.23

KGC

Kinross Gold Corp...

NYSE

USD

3.22

21.30

24.37

41.33

47.28

GG

Goldcorp Inc. (USA)

NYSE

USD

1.74

13.92

14.88

23.17

24.79

NEM

Newmont Mining Corp

NYSE

USD

3.28

21.87

23.23

47.31

50.26

EGO

Eldorado Gold Cor...

NYSE

USD

2.36

10.82

10.82

15.67

15.67

AEM

Agnico Eagle Mine...

NYSE

USD

3.33

15.85

16.21

25.02

25.59

GFI

Gold Fields Limit...

NYSE

USD

1.73

32.71

33.01

70.59

71.25

AU

AngloGold Ashanti...

NYSE

USD

1.76

36.24

37.19

113.31

116.29

AUY

Yamana Gold Inc. ...

NYSE

USD

1.26

18.74

20.49

36.84

40.28

Click to enlarge

Source: Google Finance

The Interest Coverage Ratio is used to determine the ability of the company to pay interest on outstanding debt. The interest coverage ratio is calculated by dividing company's earnings before interest and taxes (EBIT) of one period by the company's interest expenses of the same period. A ratio under 1 means that the company is having problems generating enough cash flow to pay its interest expenses. Ideally you want the ratio to be over 1.5.

Most Recent Quarter

Company name

Exchange

Currency

Interest Coverage (NYSE:TTM)

ABX

Barrick Gold Corp...

NYSE

USD

2.22

KGC

Kinross Gold Corp...

NYSE

USD

1.80

GG

Goldcorp Inc. (USA)

NYSE

USD

--

NEM

Newmont Mining Corp

NYSE

USD

3.46

EGO

Eldorado Gold Cor...

NYSE

USD

4.99

AEM

Agnico Eagle Mine...

NYSE

USD

2.75

GFI

Gold Fields Limit...

NYSE

USD

128.47

AU

AngloGold Ashanti...

NYSE

USD

2.44

AUY

Yamana Gold Inc. ...

NYSE

USD

-1.34

Click to enlarge

Source: Reuters

The interest coverage ratio ranges from -1.34 (NYSE:) to 128.47 (NYSE:). The). The Interest average of the industry and sector are respectively 0.23 and 12.03.

If you look at Long-Term debt to equity ((mrq)) and total debt to equity ((mrq)) ratios, ABX and AU seem to have the worst debt situation than other companies. ABX and AU are more indebted than the others but it seems that they don't have any difficulties in paying interest expenses on outstanding debt.

Profitability and free cash flow

Companies' trailing 12-months metrics are as follows: the operating margin ranges from -210.16 to 13.56 ; the net income ranges from - USD4.2B to USD322 M ; the earnings per share ((NYSEARCA:EPS)) ranges from -USD4.80 (GG) to USD0.38 . With reference to EBITDA (company's earnings before interest, taxes, depreciation and amortization), ABX shows the best number with an EBITDA of USD3.6 B.

Companies' most recent quarter metrics are as follows:

Most Recent Quarter

Company name

Exchange

Currency

Dividend

Operating margin

Net income

Ebitda

ABX

Barrick Gold Corp...

NYSE

USD

0.02

16.84

-72.00

869.00

KGC

Kinross Gold Corp...

NYSE

USD

0.00

3.02

-15.30

254.50

GG

Goldcorp Inc. (USA)

NYSE

USD

0.06

9.64

80.00

349.00

NEM

Newmont Mining Corp

NYSE

USD

0.02

23.18

166.00

806.00

EGO

Eldorado Gold Cor...

NYSE

USD

0.00

8.52

-3.89

42.48

AEM

Agnico Eagle Mine...

NYSE

USD

0.08

8.69

27.79

188.26

GFI

Gold Fields Limit...

NYSE

USD

0.02

-50.79

-255.00

-41.10

AU

AngloGold Ashanti...

NYSE

USD

0.00

-10.04

-74.00

245.00

AUY

Yamana Gold Inc. ...

NYSE

USD

0.00

14.27

38.40

169.20

Click to enlarge

Source: Google Finance

How can we determine the intrinsic value of a gold mining stock?

We have two possibilities (Browne, Christopher H. The little book of value investing. Vol. 6. John Wiley & Sons, 2006):

The first one involves making a company-specific estimate of what the stock would be worth if the company was sold to a knowledgeable buyer in an open auction.

For example, in the case of Kinross I would consider the $3.00 share price of the bought deal public offering as a value that also includes the NPV p.s. of the one phase expansion project at Tasiast mine.

The second method involves a set of financial ratios that are good indicators of value. Then we can construct a model for a good, cheap stock by observing the financial characteristics of stocks that perform well. You can use some of the financial ratios that I have presented in this article.

In my first article on Goldcorp Inc., I used a dividend discount model (DDM) to value the gold mining stock. Some might argue that this is not the appropriate method to evaluate gold mining stocks.

Instead of dividends also earnings can be used or even free cash flows, that is the amount of cash left over after the company has paid all its expenses and what was spent for capital expenditures (reinvested into the company).

Stocks that are in the same industry as ABX, and have a market capitalization greater than or equal to $3,000,000,000.00, and have a free cash flow any value as of 6/16/2016:

Company name

Exchange

Free Cash Flow

ABX

Barrick Gold Corp...

NYSE

$2,544,000,000.00

KGC

Kinross Gold Corp...

NYSE

$831,600,000.00

GG

Goldcorp Inc. (USA)

NYSE

$1,060,000,000.00

NEM

Newmont Mining Corp

NYSE

($134,000,000.00)

EGO

Eldorado Gold Cor...

NYSE

$199,572,000.00

AEM

Agnico Eagle Mine...

NYSE

$543,743,000.00

GFI

Gold Fields Limit...

NYSE

$118,300,000.00

AU

AngloGold Ashanti...

NYSE

$1,269,000,000.00

Click to enlarge

If we make: A) a good guess of the return on a gold mining stock (for example in a two-factor model where return on gold mining stock Y is a function of the return on the market, S&P 500, and the return on gold), that we can use as the cost of equity to determine the Weighted Average Cost Of Capital of the stock; B) a reasonable guess about the rate at which the stock's free cash flow will grow in perpetuity; C) a good guess about the stream of future FCF for the next n years, why not try to estimate the intrinsic value of a gold mining stock with a DCF?

Considering that the seasonality of the mining sector is primarily driven by the seasonality of gold prices, late July and late October may offer an interesting entering point for long term investors and therefore reduce the risk to buy an overvalued stock.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.