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Gold Stocks: Only The Most Efficient Will Shine True

February 27, 2012 | About:
It is earnings season. For the world’s largest gold producers, profits continue to flow due to the sustained and historically high price for gold. A primary risk for all of these firms is a downturn in gold prices. Regardless of whether gold prices remains high or falls, equity investors should focus their attention on whether producers are efficient. Three of the largest players are Barrick Gold Corporation (ABX), Goldcorp Inc. (GG), and Newmont Mining Corporation (NEM). This article will demonstrate why investing in only the most efficient will shine true over the long-term.

First, I will focus on Barrick Gold Corporation (ABX), the world’s largest gold producer. The company opened up its most recent mine in the Cortez Hills of Nevada in mid-2012. The company’s newest mines have significantly lower cash costs than older existing mines. Reducing production costs is a highly desirable strategy should gold prices fall. According to posted financials for 3rd Quarter 2011, Barrick’s revenue for the 9 months ending September 30th, 2011 grew by $2,533 million, an increase of 31.7% over the same period in 2010, while production costs grew by 12.34%. Although revenue growth outpaced production cost, gold volume sold over the period actually dropped by -3.34%.

Barrick will be required to replace gold ore reserves at low cost or face margin compression on any pullback in the price of gold. The company is actively looking to do so, but whether declining volumes can actually be replaced while maintaining high returns on equity, currently at 19.14%, remains an open question. Net earnings attributable to shareholders improved for the nine month period and earnings per share grew from $2.66 in 2010 to $3.53 in 2011. Barrick is currently trading at around $47, near the bottom quartile of its 52 weeks range ($42.50-$55.95) and trades at a lower PE multiple, 11.37, than the industry average of 16.8 times earnings. Barrick is likely the best value of the three large miners, but investors should remain cautious. Gold prices remain historically high and although Barrick is pro-actively working to lower costs there are no guarantees it will be successful.

Next, we have Goldcorp Inc. (GG), one of the world’s fastest growing gold producers with 17 properties and several precious mineral sites under development in Canada, Mexico, Guatemala, the Dominican Republic, Argentina and Chile. Over the next five years, Goldcorp expects to grow gold production by 60%. For the 9 months ending September 30th, 2011, Goldcorp’s revenues grew by $1,429 million, an increase of 59%. According to the 3rd Qtr MD&A Report more than half of this increase of $770 million was due to a 30% increase in gold prices and a 7% increase in gold sales volume.

Contrary to its name, Goldcorp also produces other non-ferrous metals such as silver, zinc and copper. The company saw silver post a 214% increase in silver sales volume along with volumes increases for zinc and copper. Production costs rose during the same period leading to lower net earnings attributable to shareholders and lower earnings per share. The company reported earnings of $1.84 per share for the nine months ending September 30, 2011, versus $2.03 per share for the same period in 2010.

Goldcorp’s management announced an aggressive growth strategy through 2015, but already faces lower returns on equity than either Barrick or Newmont. The company’s current ROE is 9.36% versus 19.14% for Barrick and 19.57% for Newmont. Goldcorp is currently trading at around $47, near the bottom half of its 52 weeks range ($41.91-$56.31) and trades at a higher PE multiple, 23, than its industry peers. Goldcorp is increasing volume faster than its peers, but at a significant cost. To attract investors, the company needs to stabilize or lower production costs. Investors should avoid the stock until the company has shown this ability.

Last but not least we have Newmont Mining Corporation (NEM), the world’s second largest gold producer with operations in the United States, Canada, Mexico, Peru, Indonesia, Ghana, Australia and New Zealand. According to posted financials for the 3rd Quarter 2011, Newmont’s revenues for the nine months ending September 30th, 2011 grew by $600 million, an increase of 8.6% over the same period in 2010. Costs attributable to sales production costs grew by 9.85%.

The company reported that they achieved record net cash provided from operations for the 9 month period of $2,666 million; however there are some additional areas to consider when assessing the company’s performance. Net attributable costs applicable to sales of gold also increased for the nine month period, from $366 to $497 per once, a 35.8% increase. Gold production dropped for the period by -8.8% and gold volume sold also dropped by -9.28%, while proceeds from the sale of gold grew by 17%. Investors should infer that Newmont essentially saw operating performance worsen, but rising commodity prices masked the overall impact. Income per share attributable to shareholders decreased for the nine month period to $2.82 per share in 2011 from $2.98 per share during the same period in 2010. Excluding a 28 cents decline due to discontinued operations earnings per share rose to $3.10.

Management has set production targets to increase by 35% over the next 5 years, but this likely predicated on high commodity prices to justify high cost operations. Newmont’s lowest cost mine Yanacocha, which is in Peru, is also one of its oldest and well past its prime. During the 3rd quarter Yanacocha faced a 45% increase in the cost per ounce. Newmont’s 52 week price range is currently $50.50 - $72.42. Current share price is close to $59.50. The stocks’ price to earnings ratio is 13.58 times, which is lower than industry peers, but likely, incorporates the company’s higher cost operations. The company seems fairly valued and does not likely offer much long term value for investors.

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