Gold and silver are in a long-term bull market as central banks around the globe have been racing to debase their currencies in an effort to increase the money supply and provide easy credit. First we had the European Central Bank's announcement of an unlimited bond-buying program. Then Ben Bernanke and the U.S. Federal Reserve announced a massive third round of quantitative easing, aka QE3, consisting of buying $40 billion in mortgage assets monthly until unemployment improves. Even the Bank of Japan announced its own round of easing. I suspect other central banks will follow. Given this climate of endless easing, I believe that gold and precious metals will continue to benefit.
Gold and silver have pulled back this month. The gold ETFs, IAU and GLD, and the silver ETF, SLV, are down 3.6%, 3.7% and 6.7%, respectively in the last month. When these precious metal ETFs as well as gold stocks hit lows at the end of July, I recommended them as buys. I reiterated these buys throughout the month of August highlighting many companies along the way. The mining company ETFs I recommended in August - GDX, GDXJ, NUGT and SIL - were up 9.1%, 6.5%, 26.7% and 11.8%, respectively, from August through September. This month, they are down 5.4%, 5.0%, 17.7% and 2.2% respectively, similar to the precious metal ETFs decline.
For the mid- to long-term investor, existing central bank actions along with global uncertainty has already set the long-term trajectory of precious metal prices upward. Thus, I am reiterating these ETFs all as buys at current levels for the long-term investor. I further believe that gold and silver miners may outperform the metals over the next year or so as their correlation with the metals return to historical norms. In this article, I want to highlight the one gold miner that I have been buying on the recent pullback off of the highs. That company is Yamana Gold (AUY). I have given it limited coverage in a few of my mining articles related to larger competitors Goldcorp (GG), Barrick Gold (ABX) and Newmont Mining (NEM). After covering the gold and precious metals sector for some time I think AUY is an opportunity buy at current levels.
AUY is principally a gold producer, but it also engages in excavating other precious metals such as silver, copper, molybdenum, and zinc. The company has operations throughout the western hemisphere but mainly in Mexico, Brazil, Argentina and Chile. AUY's property portfolio includes seven operating gold mines in total, including the Chapada mine, the Jacobina mining complex, and the Fazenda Brasileiro mine in Brazil. In Chile, it operates the El Peñón mine and the Minera Florida mine. In Mexico, AUY operates the Mercedes mine. In Argentina, the primary project is at the Gualcamayo mine. AUY also has a 12.5% indirect interest in the Alumbrera copper/gold/molybdenum mine in Argentina. Finally, the company holds interests in various advanced and near development stage projects and exploration properties in Brazil, Chile, and Argentina.
Most Q2 earnings reports in the gold mining sector were disappointing and AUY was no exception. AUY reported a Q2 miss on top and bottom lines. Net earnings came in at $43 million or 6 cents per share versus the 22 cents estimated by analysts. This was 77% decline from the $195 million profit, or 26 cents per share, in the same quarter a year ago. Excluding one-time items, the company said adjusted profit was 18 cents per share. Revenue came in at $536 million down from $573 million as lower metal prices and reduced volume of copper concentrate sales impacted the quarter. The company said the decline was somewhat offset by increased sales of gold contributed by the Mercedes Mine in Mexico which was under construction a year ago.
Gross margin for Q2 was 62.5%, which was 400 basis points worse than the comparable quarter last year. Operating margin was 26.5%, which was 1,470 basis points worse than the comparable quarter last year, while net margin was 8.0%, 2,600 basis points worse than the prior-year quarter. Total gold production was 288,700 ounces compared to 278,737 ounces a year ago, while total copper production slipped to 40.4 million pounds, which was down from 70.7 million pounds a year ago. The company sold 268,441 gold equivalent ounces, which were up from 261,926 ounces a year prior. Copper sales fell to 37.4 million pounds from 41.6 million pounds a year ago.
The balance sheet of the company shows $698 million in cash and equivalents on hand at the end of Q2 with an increasing debt-to-asset ratio. Some of this debt results from the fact that AUY has increased its exploration budget nearly 300% over the last four years, positioning it for continued top line growth in the years ahead. AUY still has a debt-to-equity ratio of less than 0.1, whereas its larger competitors GG, ABX and NEM have taken on more debt to finance multi-billion dollar projects. Cash flow amounted to $241 million in the quarter compared with the year-prior figure of $331 million. The decline stemmed from lower earnings and investment into developing its assets. They also recently announced the completion of the previously announced agreement to acquire all issued and outstanding shares of Extorre Gold Mines Limited. Further, a lot of progress has been made at most of the company's exploration and development projects as summarized in table 1.
Table 1. Yamana Gold's Project Development Progress Highlights, As Reported To Investors At Close Of The Second Quarter, August 2012.
Project Operation Site
Mineralization has now been identified along a strike length of almost 16 kilometers with the discovery of significant gold and copper mineralization encountered approximately 2,500 meters south of Corpo Sul. This will potentially enhance throughput through the blending of these higher grade ores and allow further development in size and scale to result in an entirely new mine. Additional concessions along the strike to the south were acquired providing further regional upside potential.
Maria Lazarus, located 10 kilometers west of Jordino, has returned drill results similar to Jordino in both grade and width. Drilling two kilometers south east of Jordino intersected coarse visible gold indicating that the system is open in that direction. These discoveries continue to confirm a cluster of mineralized zones and represent possible ore sources for production at Pilar.
Results from the feasibility study indicate production of approximately 175,000 ounces per year for the first four years and a mine life of 11 years. Discussions have begun with joint venture partner, Codelco (43% owner of the project), on the feasibility study, possible optimizations and advancing the project toward a construction decision.
El Peñón, Chile
A new vein has been discovered approximately 300 meters east of Fortuna and a new zone of significant mineralization has been identified south of the main Dorada vein and to the west between Dorada and Providencia. Drilling has delineated a new high-grade deposit at the Elizabeth vein located 400 meters east of Victoria within Pampa Augusta Victoria. This will significantly extend mine life and further enhance production at, or above, a 440,000 ounce sustainable production level.
New discovery at Barrancas where drilling has intersected mineralization approximately 600 meters north of Lagunas Norte. Infill drilling at Lupita is confirming the width and grades of mineralization and continuing growth of measured and indicated mineral resources. These are expected to enhance the mineral resource base, extend mine life, and facilitate higher throughput and sustainable production levels.
Looking ahead, production for fiscal 2012 is slated to be about 1.2 to 1.3 million gold equivalent ounces, most of which will come from the Mercedes mine in Mexico as production ramps up. For fiscal 2013, production is expected to be around 1.5 to 1.7 million gold equivalent ounces, most of which will come from full-year production from Santa Luz and Ernesto Pau-a-Pique operations. By fiscal 2014, production is targeted to be at a sustainable level of approximately 1.75 million gold equivalent ounces. This includes production from the existing mines and development projects for which construction decisions mentioned in table 1 have been made. Should the company stay on track and on budget it is poised for strong growth. I presume that the company believes it will stay on budget and grow steadily as it increased the dividend 18% to 6.5 cents per share in the most recent quarter.
Analysts are quite bullish on the stock. AUY recently had its price target increased from $21.00 to $24.00 by analysts at RBC Capital, who have an outperform rating on the stock. Further this month there were a series of analyst commentaries that were positive on the stock. Scotia Capital upgraded the stock from a sector perform rating to an outperform rating in a report issued on October 18, 2012. Other equities research analysts have also recently issued reports about AUY. Analysts at Barclays Capital initiated coverage on AUY in a research note to investors on October 16, 2012. They also set an overweight rating and a $25.00 price target on the stock. Separately, analysts at Morgan Stanley initiated coverage on AUY research note to investors on October 10, 2012. They set an overweight rating and a $25.00 price target on the stock. Finally, analysts at Dundee Securities raised their price target on shares of AUY from $17.00 to $22.00 in a research note to investors on October 3, 2012.
AUY has a 52-week range of $12.68-$19.82 and at the time of this writing trades at $18.39 a share on average daily volume of 6.3 million. While trading at a premium relative to GG, NEM and ABX on its current P/E multiple of 32.8, the forward P/E is still an attractive 12.0. The five-year PEG ratio is a 1.8 however, but does not reflect potential (or likely) surges in precious metal prices in the next five years. Analysts currently have a $21 price target consensus on the stock with a mean recommendation of 'buy'. The company reports its Q3 earnings next week on October 29, 2012 and with the increase in gold prices AUY is poised to beat estimates. I believe that AUY has great potential in the long-term due to its debt management, ability to maintain and raise the dividend, as well as clear growth plans moving forward.