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Why You Can Trust This Low-Cost Gold Miner to Succeed
Posted by: Patricio Kehoe (IP Logged)
Date: November 13, 2013 09:49AM

A few months back I covered a series of gold mining companies in an attempt to hash out a good investment despite plummeting commodity prices. Yet what seemed like a depressed gold price back in early September, when one ounce of the basic metal was selling at around $1,350, pales in front of current prices, which are hovering around the $1,260 mark. Under these difficult circumstances, firms such as Eldorado Gold Corp (EGO) and AngloGold Ashanti Limited (AU) face very different outlooks.

Low-Cost Production and Prudent Management

In a low-price environment, companies that can produce at very low cash-cost levels have an edge over the competition. A good example is Eldorado, a Canadian gold miner with operations in Brazil, Greece, Turkey and China. The firm is one of the best positioned in the industry, thanks to total unit costs under the $500 per ounce mark. With the industry average lying at around $700 per ounce, Eldorado has a clear advantage over rivals, especially when gold prices continue dropping.

Eldorado’s ability to generate healthy cash flow levels in a hostile environment has allowed the firm to pave the road for future projects, without incurring high levels of debt. Management has been particularly smart over the past months, putting projects such as the Kisladag (Turkey) expansion on hold, and delaying others (Skouries, Perama Hill and Certej). This prudent strategy has allowed the company to manage its cash properly, thus reducing the risk involved in the execution of new projects. Despite the slow ramp-up, Eldorado’s low-risk strategy, along with its low-cost developments, is bound to shield the firm’s balance sheet over the coming years.

With a sustainable low-cost position and expansion projects slowly underway, Eldorado is facing quite a favorable outlook. Hence, it comes as little surprise that investment guru Ray Dalio recently increased his stake in the firm by over 340%. Contrary to most industry peers, the company’s cash levels far exceed its accumulated debt. The 1.8 percent annual dividend yield is also an attractive feature for shareholders.

Nevertheless, Eldorado is currently trading at 24.5 times its trailing earnings, meaning investors must pay a hefty 72.5% price premium relative to the industry average. Despite this fact, I feel very bullish regarding this stock’s future.

Geopolitical Risk and High-Cost Operations

Unlike Eldorado, Johannesburg-based AngloGold Ashanti faces above-average cash costs, which have become a burden for the firm. A high degree of exposure to the elevated production costs derived from mining activity in South Africa has served as an incentive for expansion projects away from this continent. Australia and South America are the chosen locations for the move towards lower-cost and politically stable regions.

Although the firm’s operations in Ghana, Guinea, Tanzania, Namibia, the Democratic Republic of Congo (DRC) and Mali do not suffer from the exuberant costs of its South African mines, geopolitical instability remains a recurrent issue for the gold miner. Unfortunately, asset appropriation remains a common fear among companies operating in the region, especially when violent political regime change occurs. In 2010 for example, First Quantum (FM)’s copper and cobalt assets were appropriated by the DRC’s government. Considering AngloGold Ashanti mines significant amounts of gold at the Kibali mine in the northeast of this country, uncertainty is a constant.

Yet geopolitical risk can be minimized, especially by moving to more stable mining jurisdictions. The Tropicana project in Australia is a clear example of how the firm intends to deal with unstable political environments and high cash costs. Further expansion projects in the U.S., Brazil and Argentina follow the same line of reasoning, and have been applauded by shareholders.

Despite recent attempts to escape inflation ridden, and geopolitically unstable regions, AngloGold Ashanti continues to face an uncertain future. Investment gurus John Burbank and John Hussman have reduced their positions in the firm significantly, despite its low price. As no profit was to be made, these two hedge fund managers probably decided the firm was not going to bounce back any time soon.

Large debt levels, and a low annual dividend yield of 1% add to the company’s unattractive profile. Unless it is willing to risk a great deal for an uncertain future, most investors will stay away from AngloGold Ashanti. Considering share prices have dropped from approximately $31 per share at the beginning of 2013, to around $15 in November, I feel bearish regarding this firm’s future performance.

A Clear Choice

After hovering around the $1,700 per ounce mark at the end of 2012, gold prices plummeted, and are currently struggling to stay above $1,260 per ounce. For a high-cost producer like AngloGold Ashanti, this means trouble. Eldorado on the other hand, despite a slowdown in expansion projects, has been able to continue growing thanks to healthy cash flows generated through its low-cost operations. When looking at the gold industry, this is undoubtedly one of the best positioned companies to deal with the current hostile price environment.

Disclosure: Patricio Kehoe holds no position in any stocks mentioned.



Guru Discussed: John Burbank: Current Portfolio, Stock Picks
John Hussman: Current Portfolio, Stock Picks
Stocks Discussed: EGO, AU,
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