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Patricio Kehoe
Patricio Kehoe
Articles (164) 

Not Everything That Shines Is Gold

September 06, 2013 | About:

After reaching a three-month high, gold prices fell once again following the announcement of a possible strike on Syria. Considering investors are already skeptical when it comes to gold mining firms, due to their cyclical nature, Yamana Gold Inc. (NYSE:AUY) and Eldorado Gold Corp (NYSE:EGO) have a lot to prove.

A Potential Buy

Yamana Gold, founded in 2003, operates gold and silver mines in Brazil, Argentina, Chile and Mexico. The firm also produces copper at its Chapada mine, yet gold is its strong suit, at around 80% of total production. Although Yamana has grown primarily by acquisitions, the strategy has shifted in recent years towards generating more internal growth. It comes as no surprise that Donald Smith & Co. and Ray Dalio from Bridgewater Associates have decided to increase their stake in the company by 70.53% and 380.62%, respectively.

Yamana's attractive portfolio of silver and gold mines in the Americas is situated at the low end of the industry cost curve, giving the firm an edge over competitors. In addition, the production of copper makes the firm less vulnerable to sudden drops in gold prices. Looking forward, the firm has several advanced projects in the pipeline, with Pilar, C1 Santa Luz, and Ernesto mines going live by the end of 2013. The acquisition of Cerro Morro in Argentina in June 2012, an exceptional asset with ultrahigh grades and shallow depth gold-silver deposits, will serve as further stimulus. The company´s growth potential is exciting, yet there are certain concerns regarding funding, which could bring about financial risks in the near future.

Due to recent acquisitions, Yamana Gold has incurred increasing levels of debt, reducing its financially strength. Nevertheless, revenue continues to soar due to increased production. Yamana is currently trading at 3.9 times its sales, resulting in a 65% price premium to the industry average. In accordance with the firm's great growth potential and the smart acquisitions it has made, I feel optimistic about this stock.

A Low-Cost Producer[b][/b]EIdorado Gold is a global mining company with assets in Turkey, China, Greece and Brazil. By producing over 650,000 ounces of gold in 2012, at a cash cost of $554 per ounce, the firm has achieved one of the lowest production costs amongst its industry peers. Due to low cash cost of its operations, and the long lifetime projected for its mines, Eldorado Gold has a narrow economic moat. Van Eck Associates Corporation seems to have recognized the firm’s potential, as it recently purchased over 7 million shares.

Eldorado´s expansion plans for its flagship asset, Kisladag in western Turkey, will improve the mine’s economics further, bringing its potential future production forward. Also, the Efemcukuru mine will be reaching full capacity over the next year and producing at even lower unit cash costs than Kisladag. In addition, Eldorado obtained further operations in Greece and Romania, through the acquisition of European Goldfields in 2012. These mines, along with the firm’s assets in China, will be responsible for increasing gold output even further. However, certain geopolitical risks must also be factored into the equation. Dealing with the Chinese government is not always predictable. Furthermore, declining gold prices could seriously affect Eldorado’s finances.

In spite of expansion projects and acquisitions, Eldorado has maintained its debt in check and continues to boost its revenue. The financially stable Eldorado is currently trading at 5.1 times its sales, entailing a whopping 112.5% price premium to the industry average. The Canadian gold producer is bound to have a great future, yet due to the high price premium I would hold on this stock for now.

It’s All About the Long Term

Despite the troubles gold mining companies are facing, some firms have managed to bolster their income by producing at low costs and thus staying below current gold prices. Yamana and Eldorado are outperforming their industry peers, as their current price tag suggests. Hedge funds such as Donald Smith & Co. and Van Eck Associates Corporation seem to have be on the same page, as they both decided the price premium was worth paying, due to the firms’ growth potential.

About the author:

Patricio Kehoe
A fundamental analyst at Lone Tree Analytics

Rating: 4.5/5 (6 votes)


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