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This is not a trick question.
What would you pay for $70 billion worth of buried treasure? What if that treasure was spread about in pockets across two continents?
Given the substantial costs and logistical headaches you would incur to recover the loot, you're going to demand a discount, but how much of a discount?
These are the sorts of questions that investors researching mining stocks must ask themselves routinely. Assessing valuations in the industry is tricky business: part finance, part geology, part risk-management, part trend-forecasting, and part, well, art.
But you don't have to be a maestro to spot the sweet combination of deep value and solid growth prospects built into the shares of Yamana Gold (NYSE: AUY ) . Maintaining the honor of the industry's lowest production cost -- at just $103 per gold-equivalent-ounce (GEO) for the second quarter -- Yamana's gross margin led the bonanza parade with an astonishing $924 per GEO. The comparable margins of mid-tier rivals Agnico-Eagle Mines (NYSE: AEM ) and Eldorado Gold (NYSE: EGO ) underperformed that of Yamana by 20% and 15%, respectively.
Barrick Gold (NYSE: ABX ) led the majors in the second quarter with by-product costs of just $358 per ounce, but on the strength of its copper production, Yamana undercut the cost structure of world's largest gold miner by $255 per ounce! As production ramps up for the second half, Yamana expects its costs to diminish further still.
The long list of year-to-date improvements over the first half of 2009 featured an 88% increase in mine operating earnings, a 78% increase in net income, a 55% bump in revenue, and a 38% expansion of the gross margin. To celebrate, Yamana increased its dividend by 33% in what I have predicted will become a long-standing industrywide trend. Just last week, Newmont Mining (NYSE: NEM ) spiced up its dividend by 50%.
The real cause for celebration, meanwhile, lay in Yamana's awe-inspiring development update. In addition to six producing mines, the miner is on track to begin production at three new pending mines during 2012, and produce 1.5 million ounces by 2013. This week, the miner announced positive decisions to proceed with construction of two additional projects: an underground mine beneath the open- pit operation at Gualcamayo, and a stand-alone mine called Pilar that combined will add roughly 200,000 ounces per year. Recently added reserves brought Yamana's buried treasure to 18.5 million ounces (net of H1 production). With exploration proceeding well at multiple properties, including a new gold-only deposit discovered at Chapada, 2010 is shaping up as a solid year for reserve growth for Yamana.
Now, let's go back to our original question from above, and modify it with the operational backdrop of six producing mines, four new mines (plus a mine expansion) pending, and meaningful scope to continue locating more buried treasure than that which has already mapped out. Bundle all that into the lowest-cost production profile in the industry, and then how much would you pay for that $70 billion treasure? Is it $35 billion? Or $25 billion? How about $7.5 billion?
Yamana's combined reserves of gold, silver, copper, molybdenum, and zinc carry a mammoth market value of more than $71 billion, and the company has ample means to convert much of that stash into revenue over the years. Yet still, shares represent a 90% discount to that market value of total reserves. I believe that Yamana's shares would begin to approach a fair value at three times their current price tag, and that the scope for significant organic reserve growth and increasing product prices could expand that fair value further still.