Yamana Gold: All Set For A Turnaround

| About: Yamana Gold (AUY)

Summary

AUY shares have taken a beating over the past three months due to a combination of weak results and lower gold pricing, but a turnaround is possible.

AUY will release its third-quarter results later this month and it should report an improvement in both the top and bottom lines due to higher production and improved gold pricing.

AUY will achieve a 4% cost reduction and could see a 19% gold pricing jump, which will enable it to post a profit as compared to a loss last year.

Even though Yamana Gold (NYSE:AUY) shares have gained more than 95% on the market so far this year, the company's performance on the market has weakened in the past three months. In fact, over the past quarter, Yamana Gold shares have declined to the tune of 27%, driven by the company's tepid performance in the last reported quarter. What has added to the stock's decline is the fact that the price of precious metals such as gold have weakened of late.

For instance, gold prices have dropped from a high of $1,348 an ounce last month to $1,271 an ounce at the end of last week, representing a decline of almost 6%. This decline in gold pricing has had a negative impact on the price of Yamana Gold. But, I think that Yamana Gold could make a comeback on the market once it reports its third-quarter results next week. In this article, we will take a look at the reasons why Yamana could execute a turnaround post its results.

Why Yamana can beat top line expectations

Analysts expect Yamana to post revenue of $518 million for the third quarter, which represents an increase of over 15% from the prior-year period. More importantly, the company is expected to execute a massive turnaround in the bottom line, posting a profit of $0.04 per share as compared to a loss of $0.02 per share in the year-ago quarter.

This improvement in Yamana's top and bottom lines is not surprising as a combination of higher gold prices, low costs, and enhanced production might help it beat estimates. For the current year, Yamana forecasts that its gold production will come in at an average of 1.28 million ounces. Now, in the first six months of the year, the company has achieved production of 621,146 ounces. This means that in the second half of the year, Yamana's production will come in at 658,854 ounces.

This indicates that Yamana can be expected to produce an average of 329,427 ounces in the third quarter. If the company is able to achieve this level of production, it will represent an increase of over 1%.

More importantly, Yamana's production increase will be augmented by an increase in the price of gold. For instance, in the year-ago period, the company clocked an average realized price of $1,122 an ounce. In comparison, in the third quarter of the current year, average gold prices were $1,334 an ounce.

This means that on a year-over-year basis, Yamana's average realized gold price could increase close to 19%. Hence, it won't be surprising if the company actually manages to beat Wall Street's top line expectations as analysts are expecting a 13% rise in the revenue, while in reality, a 19% increase in gold pricing and a 1% rise in production could allow it to beat that estimate.

What about the bottom line?

As already discussed above, Yamana is expected to bring about a massive turnaround in its bottom line performance. However, the majority of the improvement in the bottom line will be a result of higher gold prices and increased production. I'm saying this because Yamana's cost profile has trended a bit higher than last year so far.

For instance, in the first six months of the year, Yamana's all-in sustaining costs per ounce of gold came in at $884 an ounce, up from all-in sustaining costs of $875 an ounce in the year-ago quarter. However, for the full year, the company forecasts that it will be able to achieve a consolidated all-in sustaining cost profile of $845 an ounce. In order to achieve the same, Yamana will have to drastically lower its costs in the second half of the year. In fact, if Yamana is to achieve its consolidated cost targets for the year, it will need to achieve all-in sustaining costs of $808 an ounce.

If Yamana is able to achieve this cost target, it will be able to record a decline of almost 4% in the all-in sustaining cost. Hence, in light of the 4% reduction in costs and a 19% increase in gold prices, Yamana should be able to improve its bottom line performance remarkably in the third quarter.

Impact on earnings

As already discussed above, Yamana Gold is expected to report a massive increase in its bottom line. In this section, we are going to quantify the expected increase in Yamana's margins as compared to the prior-year period that will give us a better idea as to how much its performance can improve.

As pointed out earlier in the article, Yamana's average realized price for the third quarter should come in at $1,334 an ounce. Assuming that the company produces 329,427 ounces of gold in the third quarter in order to meet its annual target, its overall revenue will be around $439 million from the gold segment.

The overall costs incurred to produce this much gold will be around $266 million, assuming all-in sustaining costs of $808 an ounce as pointed out earlier. This means that Yamana's operating margins from the gold segment will be an impressive $173 million. In comparison, last year, Yamana's revenue from the gold segment in the third quarter of 2015 was $365 million, driven by production of 325,897 ounces and a price of $1,122 an ounce.

The cost to produce this much gold came in at $274 million as all-in sustaining costs were $841 an ounce. This equates to gold operating margins of $91 million. Hence, on a year-over-year basis, Yamana's gold operating margins will increase close to 90%, which is why a massive turnaround is expected in the bottom line.

More margin improvements ahead

More importantly, if Yamana shares spike following its earnings report, investors should continue to hold the stock as a potential rise in gold prices will lead to further margin improvements. I'm saying this because after the recent interest rate decision by the Fed and a weaker dollar, gold prices have risen over the past week.

More specifically, gold prices have risen close to 1.6% as compared to last week as it became evident that the Fed won't be hiking rates this month. For the month of November, the rate hike probability is just 8%, while for December the probability is 70%, which the market has already priced in.

However, a Fed rate hike does not look likely since job growth in the U.S. has slowed down, and this could affect a rise in interest rates since it indicates a weak economy. In fact, in September, U.S. job growth was 156,000 as compared to an expectation of 175,000 new jobs. This was also way below the average monthly increase of 180,000 new jobs this year.

Additionally, U.S. manufacturing PMI data has also weakened of late, falling to a three-month low of 51.5 in September. This was driven by a decline of 0.7% in construction spending while analysts were anticipating an increase of 0.2%. Additionally, auto sales have also started slipping on the back of weakness in fleet demand. As a result of this uninspiring economic data, gold prices could continue gaining momentum since they are inversely related to interest rates.

This is the reason why analysts at RBC are of the opinion that gold could rise to $1,500 an ounce next year. If gold actually rises to this level, Yamana's operating margin on each gold ounce could rise to $655, assuming that its all-in sustaining costs are consistent next year. In comparison, the average price of gold so far this year is $1,260 an ounce. Assuming that Yamana hits its cost target of $845 an ounce for 2016, its operating margin will be $415 an ounce. Hence, on a year-over-year basis, Yamana's gold operating margins could increase by almost 60%.

Conclusion

Yamana Gold's performance on the market has been strong so far this year on the market, but the stock has lost some momentum of late. However, the good part is that the company's upcoming results are anticipated to be strong, which could allow it to make a comeback. So, in my opinion, it will be a good idea to stay long Yamana Gold as the company is quite capable of staging a turnaround after its upcoming results.

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.