Caledonia Mining: Use The Growing Dividend To Lower Cost Basis

Summary

• Although record production was announced in Q3, the market remains unconvinced.
• The dividend now, though, has been increased by over 100% over the past 2 years.
• We expect the disconnect to ultimately end.
• Investors should use this period to dollar cost average.
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As we can see from the year-to-date chart in Caledonia Mining (NYSE:CMCL), shares have not enjoyed a productive 11 months. We remain long-term bullish on this stock although investors need to be prepared for more volatility over the near term. We state this because there is every opportunity that gold at present is continuing its decline into its 8-year cycle low. This means that in all probability, gold's multi-year low remains ahead of us. We are now close to six years into the present cycle which means investors may potentially have to wait a further two years before gold finally confirms its next 8 YCL. Bullish investors in the mining space can't seem to get their heads around this and with fair reason. Mining companies continue to report record profits and grow their dividends aggressively with Caledonia being no exception. Nevertheless, we continue to see share price declines as a clear disconnect between Caledonia's fundamental "story" and its associated share price action continues to gain traction.

The benefit though of lower prices is that one can really get compounding in gear with aggressive reinvestment of the dividend. Therefore, from this perspective, let's take a look at the trends of some of the key financial metrics which make up Caledonia's dividend.

Caledonia's yield presently comes in at 4.45% based on a forward annual payout of $0.56 per share. Straight off the bat, this looks like a solid number given the average yield in the gold mining sector comes in at 1.83%. Furthermore, given how relentlessly management has been increasing the dividend in recent times as we can see below, there is every possibility that the forward amount of $0.56 will continue to grow. The $0.01 sequential increase in the dividend in the most recent third quarter was, in fact, the seventh quarterly increase in the dividend over the past two years. This means the current quarterly payout of $0.14 is more than double what was paid out in Q3-2019 ($0.068 per share). A really encouraging trend.

Source: Investor Presentation

To see where this extra cash is coming from to pay for the increasing payouts, we go to the cash flow statement. Operating cash flow came in at a very impressive $7.1 million for the third quarter on the back of record production and lower costs per ounce. Although investing spend was elevated in Q3 ($8.56 million) which resulted in negative free cash flow, dividend orientated investors need to read more into the numbers because we do not see an issue with affordability. This is the problem with just looking at free cash flow numbers to assess dividend affordability instead of researching the fundamentals of the firm.

For example, Caledonia's capex spend over the past four quarters amount to $36 million and we expect elevated spend to continue until work on the central shaft is fully completed. Furthermore, more capital will be needed for the solar project (which will ultimately provide a percentage of Blanket's power) as well as a possible further $5 million for the Connemara North exploration project if the option is exercised next year.

Knowing that there is a lead time between elevated capex spend and higher cash flow, investors need to remain patient here. In fact, we can already see encouraging trends such as the $7.1 million operating cash flow generated in Q3 which brings the trailing twelve-month number to $33 million. Suffice it to say, Caledonia's record gold production is having an impact on cash flow and other key metrics and we expect this trend to continue.

Furthermore, Caledonia's equity continues to increase ($151 million) on the back of this heavy-lifting and there is no real interest-bearing debt to speak of on the balance sheet. Furthermore, the company continues to report ample liquidity with approximately $50 million of current assets on the balance sheet at the end of Q3 as opposed to $15 million of current liabilities. $13 million of stock was issued in Q3 of last year to raise cash of which $9 million has been used for capex spend and the dividend. Over $12 million of equity though has been added to the balance sheet within this timeframe even when we take into account the sizable dividend increases during this period. Therefore, expect capital raises to continue if desired.

To sum up, in relation to Caledonia's dividend, investors should not focus on the firm's free cash flow at present but rather look at how the company is set to grow its earnings significantly in years to come. Yes, the gold price has to cooperate to an extent but higher volumes, as well as the solar project, will, ultimately, lead to lower costs for the company over time. Expecting more increases to come. We look forward to continued coverage.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of CMCL either through stock ownership, options, or other derivatives. 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.