When fear and volatility rear their ugly heads, investors will traditionally turn to more conservative investments -- such as gold. Presumably, this is what happened during the bitterly fought presidential campaign. In 2016, the price of gold, which ended the year up about 8%, had climbed as much as 28% at one point.
Similarly, many gold stocks enjoyed quite the ride last year -- rides that have extended into the new year, leaving some companies trading at seriously low prices. Of course, this doesn't mean these companies are worthy of investment. So let's grab our pickaxes and see what we can uncover.
Minding the miners
When considering gold-mining companies' stocks, it's important to recognize that the traditional price-to-earnings ratio doesn't have as much merit. Because of non-cash charges -- like depreciation -- it's not uncommon for companies to take large writedowns on their assets, resulting in skewed earnings figures. Yamana Gold, for example, recorded non-cash impairment charges of $2.6 billion. In the company's annual report, management acknowledged that "the largest contributor to the impairment was the writedown of values relating to exploration land and potential ounces."
Instead of the P/E, therefore, we'll consider the companies on the basis of price-to-cash from operations on a trailing-12-month (TTM) basis. Cash flow, after all, is one thing management can't be massaged.
|Company||Price-to-CFO Per Share (TTM)|
|Agnico Eagle Mines||11.2|
|IAMGOLD (IAG 2.73%)||4.6|
|Yamana Gold (AUY 4.24%)||3.6|
|Kinross Gold (KGC 0.76%)||3.6|
So what have we found? Kinross Gold, Yamana Gold, and IAMGOLD all trade at a significant discount -- less than five times trailing cash flow -- to their peers. To provide even more context for how ridiculously cheap these three stocks are valued, let's consider them in terms of the larger contexts of the industry and S&P 500, which trade at 10.0 and 9.9 times trailing cash flow, respectively, according to Morningstar.
A shared reason for hitting rock bottom
It's misguided to attribute the valuations of Kinross Gold, Yamana Gold, and IAMGOLD to only one factor; however, it's important to acknowledge trends where they exist -- like the relationship between the stocks' valuations and the companies' abilities to control costs. It stands to reason that investors would be willing to pay a premium for companies that excel at reining in spending; conversely, companies that are inferior at controlling costs should trade at a discount to their peers. After all, companies that maintain the lowest all-in sustaining costs (AISC) are best suited to withstand the inevitable downturns in the price of gold, so examining the companies' AISC per gold ounce for fiscal 2016 should give us the proper insight.
|Company||FY 2016 AISC|
|Yamana Gold||$911 (co-product basis)|
Except for the nominal difference between Yamana Gold and Newmont Mining, we find the relationship we had anticipated: The cheapest valuations align with those companies least adept at managing costs. There are always other factors at play, though. Goldcorp, for example, trades at 15.3 times trailing cash flow, but it reported a far from exceptional $856 AISC last year. In this case, the stock is trading at a premium probably because it inspires investors' confidence with its strong balance sheet and investment-grade credit rating. So valuable as this exercise was, though, let's focus on some of the more specific reasons the market is assigning these stocks some lower price tags.
It's not only Yamana's performance in the previous year that's giving investors pause; management's expectations for the years ahead are probably other factors. Forecasting a slight improvement in 2017, management anticipates AISC to total $890 to $910 per gold ounce. Though that's not a disastrous forecast, when taken along with management's comments that it's forgoing near-term growth through acquisitions for organic growth, it's clearer why some investors find Yamana's stock unfavorable. This seems short-sighted, though, for the company expects its Cerro Moro project -- which has the potential to be one of the company's cornerstone mines -- to commence production in 2018.
Although Kinross Gold may trade at a discount because of its estimated fiscal 2017 AISC -- $925 to $1,025 per gold ounce -- the more likely culprit is the uncertainty regarding the company's Tasiast mine in Mauritania. Acquiring Tasiast in the 2010 acquisition of Red Back Mining for approximately $8 billion, Kinross has found the mine to be anything but a golden opportunity. In the years following the acquisition, Kinross Gold has taken about $5.6 billion in writedowns on the asset. Things are looking up, though. Management expects the phase one expansion -- which will increase production by 87% and reduce production cost of sales by 48% -- to commence production in 2018, and it expects to complete a feasibility study on the phase two expansion by the end of 2017. Until these projects are executed, though, the stock will probably continue to trade at a deep discount.
IAMGOLD also expects to maintain high AISC in the year ahead, forecasting for $1,000 to $1,080. Should the company achieve the midpoint of this guidance, it would represent a slight improvement over the $1,057 it reported last year; however, the company would still maintain some of the highest costs in this group. Perhaps another likely reason for the company's depressed stock price is the quality of its portfolio, which consists of three gold-producing mines and several mines in the development and exploration phases. Although the company escaped fiscal 2016 without any writedowns, it reported $621 million in impairment charges in fiscal 2015 -- suggesting to investors that the company's portfolio may not be as valuable as it seems.
Ascertaining the reasons a stock is trading at a steep discount to its peers is anything but simple. But one thing is for sure: Investors want to see gold-mining companies that maintain low AISC, since lower costs translate to better margins. It's reductive, however, to dismiss companies simply because of high AISC -- as is the case with Yamana Gold, which has high AISC but could prosper in the long run should Cerro Moro meet expectations. I think that of these ridiculously cheap stocks, Yamana Gold represents the most compelling argument for further investigation.