3 Big Gold Miners Look A Bit Better Now

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Includes: ABX, GG, NEM
by: Simple Digressions

Summary

In the long term the big gold mining companies still underperform junior gold miners.

There is a good reason - since the beginning of this bull cycle in gold (January 2016) the big gold sector has been getting worse.

However, the third quarter of 2018 was not that bad as previously. As a result, most recently the big gold sector has been slightly outperforming the junior gold miners.

The three big gold mining companies discussed in my previous reports, Barrick (ABX), Goldcorp (GG) and Newmont (NEM), have just published their 3Q 2018 reports so it is a good time to check the sector’s performance. In this article I discuss the results delivered by these miners.

As usually, let me start this edition of the Big Gold survey from the joint statement of operations.

Methodology

I have gathered the data presented in financial statements published by Barrick, Newmont and Goldcorp and created the joint statement of operations for these miners (called “the Big Gold” or “the trinity”). The results are expressed in millions of US dollars.

To calculate certain financial measures I am using the concept of the so-called “an ounce of gold equivalent”. According to this method, costs of production, margins etc. are divided by ounces of gold equivalent (for example, silver ounces sold are recalculated into their gold equivalents using the average price of gold recorded in each reporting period).

Big Gold - joint Statement of Operations

The table below shows the Big Gold joint statement of operations for the first three quarters of 2018, 2017 and 2016:

Source: Simple Digressions

Comment:

  • Firstly, revenue went down 9.4%, compared to the first three quarters of 2017. Most recently, it has been a typical pattern drawn by big gold mining companies – due to lower reserves and fire asset sales made during the last bear market in precious metals, the sector is producing and selling lower amounts of gold, silver and other metals
  • Lower production has a negative impact on sales volume. As a result, during the first three quarters of 2018 the trinity sold only 10.0 million ounces of gold equivalents (a 11.3% drop, compared to 2017 YTD)
  • This negative pattern was slightly mitigated by stronger gold prices ($1,278 per ounce in 2018 YTD vs. $1,251 in 2017 YTD)
  • This year the sector has been producing its metals at a bit higher unit direct cost of production than in 2017. As the chart below shows, over the last three quarters this cost was fluctuating between $666 and $684 per ounce (or $674 per ounce in 2018 YTD vs. $610 in 2017 YTD):

Chart 1

Note: a direct cost of production is defined as: direct production costs / gold equivalent sold

  • Interestingly, in 3Q 2018 Goldcorp reported a very high direct cost of production of $863 per ounce of gold (due to putting online the second open pit at its flagship property, the Peňasquito mine). However, despite this negative one-off event, the sector saw a drop in its average unit cost of production from $684 per ounce of gold in 2Q 2018 to $666 per ounce. In my opinion, it means that the big gold sector is able to adjust to lower gold prices quite quickly
  • Definitely, a higher unit cost of production had a negative impact on a gross margin delivered by the sector ($3.3 billion in 2018 YTD vs. $4.2 billion in 2017 YTD)
  • Additionally, the trinity, instead of cutting administrative expenses, increased them from $469M in 2017 YTD to $494M in 2018 YTD. This time Barrick and Newmont were the villains, reporting the highest increase. Goldcorp made progress, cutting these costs from $112M in 2017 YTD to $101M in 2018 YTD:

Source: Simple Digressions

  • Further, other costs and impairment charges are typical one-off events so I have excluded these items from the calculation of operating profits – the result is disclosed in the row titled “Operating income excluding impairments and other costs”.

As a result, the final conclusion is unsatisfactory – due to higher costs and lower sales volume, the sector reported a lower operating profit than in the previous years. The deterioration is obvious.

Now let me look at the economics of mining.

Economics of mining

It is my favorite section because it shows the way the miners perform at different prices of gold. To remind my readers, the measures discussed below are recalculated into ounces of gold equivalent sold.

Source: Simple Digressions

Gold prices

As the table above shows, during the first three quarters of 2018 the trinity was selling its metals at an average gold price of $1,278 per ounce, slightly higher than in 2017 YTD.

Unit direct cost of production

A unit direct cost of production went up from $610 per ounce of gold in 2017 YTD to $674 per ounce in 2018 YTD (an increase of 10.5%).

Gross margin

Despite higher gold prices, in 2018 YTD a gross margin reported by the sector was the lowest during the current bull market in gold (starting from January 2016).

Cash flow

Now, although a gross margin was 5.8% lower than in 2017 YTD the trinity reported only a slightly lower cash flow from operations (excluding working capital issues) of $398 per ounce of gold equivalent ($401 in 2017 YTD). However, due to significantly higher investment in working capital and higher spending on mineral properties and equipment (CAPEX), a final free cash flow was substantially lower than in 2017 ($26 per ounce of gold equivalent vs. $107 in 2017). While I understand why the trinity reports higher CAPEX (in order to grow the big gold mining companies have to put online new projects and explore their properties), a higher investment in working capital is questionable (particularly when the sales are going down).

Finally, let me go back to the cash flow from operations (excluding working capital issues). The chart below shows cash flow figures reported on a quarterly basis:

Chart 2

Source: Simple Digressions

It is easy to spot that in 3Q 2018, despite substantially lower gold prices realized than in 2Q 2018 ($1,208 per ounce vs. $1,300), the trinity was able to deliver the cash flow from operations of $361 per ounce of gold equivalent sold. In my opinion, it was a very positive event - the trinity was able to deliver a comparable cash flow at lower gold prices (the blue rectangle).

Net debt

Note - net debt is defined as: debt less cash.

As the chart below shows, between 1Q 2016 (the beginning of the current bull cycle in precious metals) and 1Q 2018 the big gold sector had cut its net debt significantly (the red arrow). Then, since 1Q 2018 this measure has leveled off (the red rectangle) - it looks like there is a natural barrier preventing the big gold mining companies from going lower with the debt it holds. And I am not surprised – as discussed above, this year the sector reported a close-to-zero free cash flow, reducing its ability to cut the debt further.

Chart 3

Summary

In my last report on the big gold sector I made the following conclusion:

“In my opinion, 1H 2018 may be defined as a period of deteriorating fundamentals. Despite strong gold prices, costs of production went up and margins shrank. As a result, generally all financial items across the board had worsened”

The results reported during the first three quarters of 2018 confirm this negative thesis but, keeping in mind that most recently the price of gold has gone significantly down, the third quarter of 2018 was not that bad as it looks. For example:

  • Cash flow from operations (excluding working capital issues) was only slightly lower than in previous quarters (when gold prices were substantially higher)
  • Direct cost of production was reduced from $684 per ounce of gold equivalent in 2Q 2018 to $666 (despite higher costs reported by Goldcorp)
  • Net debt remained unchanged, compared to previous quarters

As a result, although big gold mining companies are still underperforming junior gold miners in the long term (the red arrow on the chart below), in the short term they look pretty well (the blue arrow)

Chart 4

Source: Stockcharts.com

Disclosure: I am/we are long CEF, GDX.

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.