IAMGOLD Corporation (IAG) is a multinational mining company that is based in Canada. The vast majority of its revenues, 88% in 2012, are attributed to gold. Aside from the precious yellow metal, the company also has significant interest in ferronobium, or nobium, which is used to produce steel. As gold prices have plummeted, and global steelmaking capacity can exceed all sources of demand, shares of IAG have depreciated 60% in 2013. Considerable long term value may now be offered. While the price of gold is difficult to predict, the company pays a dividend to help smooth things out.
For some background, in 1991 Co-founders Mark Nathanson and William Pugliese created the International African Mining and Gold Corporation (“IAMGold”) pursuant to identifying a gold deposit at Sadiola Hill in Mali. After carrying out further operations in Africa, and exploration in South America, the company began trading on the Toronto Stock Exchange in 1991 and then on the New York Stock Exchange in 2005.
In 2006, IAMGOLD made another of its important acquisitions, gaining ownership of several international mines previously owned by Gallery Gold Limited and Cambrior Inc., including the Doyon Division Gold Mine in Quebec, Canada and the Niobec Niobium mine.
In 2011, the firm was awarded an Environmental and Social Responsibility Award. In 2013, it was included on the Maclean’s/Sustainalytics list of the 50 Most Socially Responsible Corporations in Canada.
The company currently has a stake in six operating gold mines on three continents. Its niobium mine is one of the world’s top three, responsible for an 8% market share. It now has a 41% joint venture interest, with AngloGold Ashanti in Sadiola, where the company originated, and it is reported on one line with a 40% stake at nearby Yatela.
IAMGOLD just released its third quarter results for 2013. Production was previously expected to trend higher in the third quarter, and to end the year within guidance of 875,000 to 950,000 ounces. Also, the corporation had announced a $100 million cost cutting plan for 2013. It just reported 220,000 ounces, resulting in 640,000 in 2013, and 77% completion of the plan.
For the future, gold’s price is almost certainly the key variable, and its 22% decline since January is confronting the entire industry.
Financial Strength and Dividend
The stock is currently attractive for several reasons. Perhaps the most obvious is the yield, as IAG pays out $0.125 twice a year for 5.42%. As many readers are aware, a dividend is one of the most favorable attributes an equity can have. Cash is returned to shareholders that can be reinvested so that results compound over time. Further, it provides a cushion for the stock price in the event of a sell off as money tends to flow to a corporation when its yield increases.
However, a cut may result in severe losses. In order to assess the safety of payments, several metrics are used. The payout ratio measures the amount of earnings paid out in dividends. While IAG has been decelerating, reporting non-GAAP earnings of $0.08 per share in second quarter 2013, a 60% year-over-year decline; and $0.07 in the third quarter, for a 56% drop, the payout ratio is currently a sustainable 32%. Cash flows from operating activities also indicate that the dividend is maintainable; however, IAMGOLD has been losing cash overall since December 2012.
While the dividend is not guaranteed, IAMGOLD remains in a decent financial state. Per current data, cash, cash equivalents and bullion at market value are valued at $535.9 million (specified as $361 million cash; $179 million in bullion which adds up to $540). Semi-annual dividend payments have been very close to $47 million. There is sufficient cash on hand to continue paying stockholders while gold’s prices are low.
Cash flows are also needed for continuous exploration and development of production. The company has 376.6 million issued and outstanding shares, which is virtually unchanged since 2012. IAMGOLD plans to pursue acquisitions which is expensive and time consuming. However, in light of current resources, dilution for the above reasons is not immediately worrying.
There are several variables in IAMGOLD’s outlook. Assumptions are based on an average realized gold price of $1,350 per ounce (the London Bullion Market Association currently lists a per ounce gold price of $1,309), Canadian $ / USD exchange rate of 1.00, $ / Euro exchange rate of 1.30 and average crude oil price of $95 per barrel. Hedging activities are carried out in order to mitigate these risks.
Partially because of an increase in hard rock drilling, cash costs are expected to go higher through this year and into 2014. Higher grade gold and productivity improvements are cited as “offsetting factors.”
There is $650 million in debt outstanding that does not mature until 2020. However, the Altman Z-Score is in the distress range at 1.69 and may indicate concern.
GuruFocus’s Valuation Box provides several metrics that immediately make a case for value. Currently, parameters that support investors at the share price at $4.61 include:
· Tangible book value of $8.99 per share.
· An intrinsic value of $5.99, partially based on a discounted cash flow (“DCF”) projection of $8.85.
· A Graham number of $9.56.
· A Peter Lynch value of $9.60.
There are specific issues for those wishing to use a DCF valuation. Management uses a low discount rate in its own calculations: 5.75% to 9%. If we plug a median 7.38% into the Fair Value Calculator, the output result is $13.30, as compared to the more conservative $8.85 obtained through a 12% rate. The rate should be representative of the time value of money, and be based on a sum of Cost of Debt (“COD”) and Cost of Equity (“COE”).
The company has issued $650 million in notes that pay 6.75% per annum. Cost of debt multiplied by debt to total capital serves to approximate COD without attention to taxes. Remembering from above, there is $536 million in cash and bullion. Our before tax cost of debt is [ 6.75% * ( $650 / $536 ) = ] 8.18%. The specified third quarter normalized effective tax rate is 38%, our COD is [ 8.18% * ( 1 – 38% ) = ] 5.07%.
Cost of equity probably involves the most questions here. The expected return on the investment is central to arriving at it. Further, gold’s changing price is an important consideration. While methods for valuing the company vary, the stock has at least two attributes that may lower its COE:
1. IAG has had a Beta of only 0.55 since 2011, meaning low variation in returns in comparison to the S&P 500 over the preceding five years.
2. IAG’s high dividend payment.
The share price is currently $4.61. If we are looking for an 18% return through an investment, subtracting a 5.42% dividend yield can mean that we seek 12.58% in capital appreciation. To be cautious, one half of the yield is removed from calculations here so that a 15.29% gain in stock price is the target. If we multiply 15.29 * Beta of 0.55, the result is 8.41%. Adding COE and COD (8.41 + 5.07) we arrive at a discount rate of $13.48%. To be conservative, $0.50 in yearly EPS is assumed, lower than the $0.60 TTM figure, and then we obtain a Fair Value of $6.57 and a 30% margin of safety.
Given that inflation has been low for some time — perhaps a reason for the declining price of gold — a view may be accepted that it is to rise, eventually, amid a highly uncertain economic environment. Gold has traditionally been considered as a means of protection against inflation. The Federal Reserve targets a 2% rate but forecasts less than 1.2%. If prices actually go up, there is a chance of gold, and IAG, appreciating more rapidly than other investments. However, adjusting for inflation may require returns at a higher rate than prices rise change.
Gold is also used to hedge against tail risks, or situations that can result in a drastic change in investments’ value. As we never know where or when a catastrophe might occur, the precious metal has been viewed as insurance. There has been no clear shift away from gold’s identity in this regard and it should support IAMGOLD’s valuation.
Stephen Letwin has been president and CEO since November 2010, providing a decent time frame for his evaluation. His prior posts have been with energy corporations such as TransCanada and Enbridge. Unfortunately, though shareholder friendly, IAMGOLD has been underperforming.
The share price is down 75% under current leadership, while the dividend has gone up 56%. Records show shares of IAG trading at similar values until November 2011. A correlation can be observed with the Market Vectors Gold Miners ETF (GDX), which is down 59% since November 2010. The stock’s lack of performance in regard to the ETF is a concern.
Chairman of the Board William Pugliese has been with the company since inception. The board serves to check management and maintain fiduciary responsibilities to shareholders. With the results shown above, a rubber stamp should not be given here.
In addition to issues that are sensitive for virtually all mining companies, such as striking workers, IAMGOLD’s international operations involve other considerations. Specific to management, the company has given up 3.3 million ounces of gold in exchange for only $30 million in stock because of an inability to navigate the Ecuadorian political landscape and tax system in 2012.
If not for the safety of the company’s yield and multiple compelling valuation metrics, an activist presence may be needed, if not welcome. Of gurus who hold positions, including Ray Dalio, Jean-Marie Eveillard and John Paulson, none are identified with an activist investment model. However, their collective presences should result from due diligence and add some confidence to others reviewing the stock who may not consider management to be a strength.
There are positives. Acquisitions have had favorable results, an example is the purchase of the Côté Gold project in the second quarter 2012, which remains an attractive asset for the company’s long term production. There is also ongoing achievement on the $100 million cost cutting plan, and production that meets guidance.
There has been no significant and recent insider buying or selling activity.
Impairment charges, or an abrupt decline in fair value, on mining operations are a concern. IAMGOLD tests annually, on Dec. 31, at a minimum. With gold currently near $1,300,
“The average short-term gold price assumption used in the first five years of the impairment assessments was $1,425 per ounce (December 31, 2012 – $1,615 per ounce) and the long-term gold price assumption used was $1,400 per ounce (December 31, 2012 – $1,400 per ounce).”
If management’s expectations differ from values realized in the future, impairments can arise. Gold prices are materially lower than the figures used; however, the company “Concluded that the recoverable amounts of its cash generating units exceeded their carrying amounts as of June 30, 2013 [when gold was near $1,200/ounce].” Impairments may be a worry if the price of gold drops 20%.
Regarding perhaps the most important matter: according to Goldman Sachs in a Sept. 24 report, important drivers for the price of gold include demand in India and China for jewelry, bars and coins, which have compensated for outflows at central banks and ETFs in the first half of 2013 (graphic below: “1H2013 – actual”). The investment bank says that because of these factors, it forecasts gold at $1,144/oz in 2014. Bank purchases are forecast to decline 38% this year.
A follow-up story, that might be viewed as partially off target, from Goldman’s London branch describes an even lower price target of $1,050.
Again, the company actively hedges as mitigation against considerable ongoing risk. Other causes for concern include the cost of oil needed to carry out mining activities, geology, changing exchange rates; and legal, geographic, and political issues in foreign jurisdictions. Oil and foreign exchange dangers should be more easily controllable.
During the third quarter Conference Call, an analyst raises a question about IAMGOLD”s lack of sustainable free cash flow. CFO Carol Banducci forecasts it turning around next year in response. It is not currently a favorable situation.
Though current data shows him as an IAG shareholder, even Paulson has unwound his paper gold holdings.
Lastly, niobium’s usage is tied to production of steel. There are uncertainties in the steel market, which is supported by the Chinese government. Feelings vary, however, there are several ghost cities there that have been described as the largest housing bubble in history during a 60 Minutes episode. While caution may be indicated, niobium is currently a stable and growing aspect of the company and margins have expanded.
Gold is precious for several reasons. During 2013, its price decline has affected to value of companies that produce it. IAMGOLD is a multinational corporation in the middle of the situation. As its shares are down substantially because of this matter, they can be shown to be undervalued in several ways. Prices can rise over time and IAG pays high dividends to those with the patience and willingness to wait it out.
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