Yamana Gold: Buy At The Bottom

Summary

• AUY's share price is breaking out higher.
• Its fundamentals are improving.
• I am buying a longer-dated call spread.

Yamana Gold (AUY) is breaking out higher alongside strength in precious metals. Its share price has fallen significantly in recent years due to the collapse in silver and gold prices. Management has reduced costs and expanded production over that time. Now, as precious metal prices stabilize, the company stands to improve profit margins, improving investor optimism. I am buying a call spread as a way to earn high risk-adjusted returns.

Price Action

AUY looks to be forming a bottoming pattern after years of decline. The company is heavily invested in the precious metals space, and therefore fell significantly following the collapse of gold and silver metal prices. As the metals have stabilized in recent years, however, AUY's share price has similarly formed a bottoming pattern in the low single-digits.

The company's profit margins expand and contract due to fluctuations in precious metals prices, thus leading to the correlation between the two assets. In recent years, management's ability to cut costs and lower the cost of production, while also expanding overall production, leveraged the company to gain from a rise in precious metal prices. Due to recent strength in both gold and silver, I am a buyer of AUY. Its breakout above $2.80 was significant and could lead to further upward momentum. I have a stop-loss level at roughly $2.6, should its share price reverse lower, proving my investment thesis incorrect.

Fundamental Narrative

AUY looks like an attractive investment at current levels due to its increasing production, and improved cash flow, as the company is leveraged to rising precious metal prices. Over the last year, management increased its gold production guidance by a couple of tonnes, while silver guidance was also increased. The company was able to exceed not only its elevated guidance by several tonnes for gold and silver, but also exceeded its budget expectations, according to management.

This leveled expansion, containing costs, has been accretive to shareholder value. Management expects increasing gold and silver production in 2018 as its Cerro Moro mine comes into production. Moreover, AUY expects to produce 900,000 ounces of gold and 8.15 million ounces of silver, with an approach and parameter used for budgeting being consistent with those used in 2017. The use of geo guidance can help give management a better sense of the size of its production platform.

Looking at 2018, gold and silver costs are expected to deliver at a lower and all-in sustaining cost per ounce compared to 2017. The addition of Cerro Moro and its low-cost structure is the main driver for cost decreases, according to the earnings call. That being said, management expects to deliver precious metal production at an impressive byproduct all-in sustaining cost between $725 and $745 per ounces of gold and at $10.50 and $10.80 per ounces of silver. As precious metal prices potentially continue to rise due to both geopolitical issues and inflation fears, profit margins for the company should similarly improve.

Below is a chart of AUY's revenue and earnings per share metrics. As precious metal prices have declined in recent years, the company's top-line growth has similarly stalled. Its EPS fell lower from 2012-2016, but a better cost structure and rising precious metals prices boosted bottom-line growth from 2016 to present. A continued increase in precious metal prices should further boost the company's margins, as was discussed earlier.

Additionally, management is making an effort to improve the company's cash flow. Over the last year, AUY transacted a $300 million senior note deal, enhancing its financial flexibility and ensuring cash flows in the next several years are available for purposes other than debt repayment, according to management. From a shareholder perspective and from an overall financial health point of view, it has improved the company's flexibility. Rising precious metal prices should uniquely benefit AUY due to its cost structure and expansion in the space. This should boost investor sentiment in the company, leading to share price gains going forward.

The Trade

I am gaining exposure to AUY through a call spread strategy. This allows me to reduce the position's time decay, while also reducing the overall cost of buying call options out until January 2019. I am specifically buying the Jan 2019 $3-4 call spread for roughly $0.25. This gives me a profit potential of $0.75, or a 3:1 payout. If the position runs higher, I stand to make a decent profit, but also have losses capped at $0.25, with time decay working in my favor should I stand correct.

Remember that it is possible to lose your full principle when buying options, therefore weight the position appropriately.

Source: Think or Swim

Conclusion

AUY is breaking out higher alongside strength in precious metals. Its share price has fallen significantly in recent years due to the collapse in silver and gold prices. Management has reduced costs and expanded production over that time. Now, as precious metal prices stabilize, the company stands to improve profit margins, improving investor optimism. I am buying a call spread as a way to earn high risk-adjusted returns.

Analyst’s Disclosure: I am/we are long AUY. 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.