According to Newmont Mining (NYSE:NEM), "Our strategy is to provide shareholders with leverage to gold." While the fact that the company collects about 90% of its earnings from gold is one reason for this, another one could have an even larger impact on the miner's shares.
To protect or not?
Gold is a commodity that trades on supply and demand. The gold Newmont pulls out of the ground is no different than the gold Barrick Gold Corp. mines. And the market for gold is generally very liquid, filled with potential buyers and sellers. It's a fact of life with which every gold miner must contend.
Some choose to protect themselves by using hedging. That essentially locks in a price for the gold they are going to mine. It allows management to know, with good certainty, what the company will earn in a given year assuming it can keep costs and production at planned levels. This is particularly helpful when gold prices are falling, since a hedged gold miner will have locked in higher prices.
However, when the price of gold is rising, a miner that hedged its output will earn less than it could because it locked in lower prices than the yellow metal is fetching on the market. That's the trade-off for the protection hedging affords. Newmont Mining does not hedge.
That means Newmont's revenue and earnings are tied tightly to gold price movements. When gold is going up, Newmont's earnings will head higher much faster than a miner that has hedges in place. On the flip side, when gold is falling, Newmont's earnings will head south faster, too. At the end of the day, Newmont is kind of a middle of the road gold miner when it comes to operating costs and profitability. That is unless you expect gold to rally, in which case Newmont's exposure to the spot market means it's likely to benefit quickly.
Put a number on it
So how big a deal is being unhedged? Well, Newmont expects gold to average around $1,200 an ounce in 2015. However, if gold were to average $1,300 an ounce, the company's free cash flow would increase by $350 million. That's a big deal.
According to CEO Gary Goldberg (yes the CEO of a gold miner is named Goldberg), "During 2014, we generated $2.1 billion in adjusted EBITDA, and $341 million in free cash flow." So, a gold price advance of $100 could more than double the company's free cash flow from 2014. Now imagine if gold really took off, say up to $1,500 an ounce. That would increase free cash flow by roughly $1 billion.
Newmont CFO Laurie Brlas, noted during the fourth-quarter conference call that "We continue to fund dividends from free cash flow." In fact, Newmont's dividend is tied directly to the price of gold. So a gold rally would also have a quick and, likely, dramatic impact on the stock, and shareholders would see extra cash in their pocket via an increased dividend.
It's never that easy
Clearly, there's more going on at the company than just the price of gold. And the above examples assume everything else in the world remains constant, which never happens. Some things that could go wrong include increased costs and mine closures due to accidents or outright disasters. But that's not the point. The takeaway here is that if gold goes up in price, Newmont is going to benefit pretty quickly. And if you own shares of this miner, you will, too.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.