Though gold prices remain above $1,200, gold miners have been unable to capitalize on that. In fact, gold miners have seen a precipitous decline in stock values over the last year. Now it appears many are approaching metrics at which value investors might be enticed into taking a position.
Value play or value trap?
Let's start with IAMGOLD (IAG +4.23%). IAMGOLD has declined from the $12 range down to around the $4 mark over the last year. Currently it sports a price-to-book ratio of 0.4 and a price-to-sales ratio of 1.2. With a low debt-to-equity ratio of 0.2, a good value investor should take a closer look.
Unfortunately, upon closer examination, there are several red flags here, suggesting the company could be set for further declines.
First of all, let's address the issue of market cap and book value. Of the $1.6 billion in market cap, only $539.5 million as of Sept. 30 was in cash or cash equivalents and gold bullion at market value. So for those of you who think that purchasing this position amounts to buying gold at $0.44 on the dollar, forget that thought.
Next, the cost of sales is skyrocketing while gold yields are decreasing. IAMGOLD has struggled with mine depletion, extraction costs, and gold confined to increasingly harder rock in its existing mines. In the third quarter of 2013, IAMGOLD reported an 18% increase in sales costs year over year, citing these problems, which show little sign of abating.
On a positive note, I commend the management for at least giving investors a heads up for the coming declines. Here is how the company summed up its poor future outlook: "[P]riorities continue to be cost reduction, disciplined capital allocation and cash preservation. Accordingly, the company is reevaluating capital expenditure plans, initiating programs to lower working capital, reviewing its dividend policy, reassessing its life of mine plans and driving further cost reductions."
The wise investor knows that this translates into decreased capital investment, shorter mine life, fewer projects on the horizon, layoffs, and lower dividend payments. All spell a decrease in stock price since there is a limit to how much cost cutting can impact the bottom line.
Eureka!!! Wait -- not so fast
One company avoiding these skyrocketing costs is Barrick Gold (ABX +2.47%). It has managed to keep costs under control for its operations over the last year, dropping from $1,010 in Q3 2012 to $916 in Q3 of 2013. However, its stock has plunged 55% over that same time. So does that mean that Barrick is right for a value play? The short answer is absolutely not. A price/book of 1.4 is hardly enough to entice the value investor. Barrick has too much debt on its balance sheet (evidenced by the long-term debt-to-equity ratio of 1.1) to expand comfortably.
Therefore it had to either dilute shares (an investor nightmare considering the recent drop) or sell assets deemed underperforming in hopes of acquiring more productive mines. It has opted for the latter strategy and sold three (once deemed high-quality) mines. It plans to reinvest in more productive mines, but projections for the operations are optimistic, making this a risky strategy. Plans call for sustained $1,100/ounce gold, and if gold prices fail to cooperate over the long term, this position will fail to fulfill expectations for years to come.
A foolish (lower case) ETF
Barrick and IAMGOLD can both be found in the Market Vectors Gold Miners ETF (GDX +3.38%). This ETF is composed of 37 separate gold miners varying in market caps. Heavily beaten down and attracting the attention of value investors, this ETF should still be avoided for numerous reasons.
More gold miners are falling into this same position through no fault of their own. Much of the readily accessible gold has already been exploited, forcing miners into increasingly more remote locations. Extraction costs are moving higher based on greater input costs (fuel, capital equipment, etc.). Existing mines are facing more difficult conditions as mine depth increases or harder rock is encountered.
These problems are just the tip of the iceberg. Combined with labor unrest in some regions, declining gold prices, and decreasing demand, these miners could see more rocky times ahead.
