Where Next for the Gold Mining Sector?
Charles De Meester
It has been nearly five years now since the peak in the gold price at over US$1,900 per ounce, which was followed by a precipitous decline to a low of US$1,100 at the end of 2015. For most of the large gold mining companies, this ushered in a period of repairing balance sheets. But as the gold price now strengthens in an uncertain political and economic world, what follows for the gold companies?
At Metals Focus, we have been analysing key financial, operating data and investor data on a quarterly basis going back to 2009, for a peer group of the leading global gold companies. We like to think we analyse the data in a unique way, which certainly helps to highlight differences around the main business model for a senior gold mining company. In this article, we will deliberately stay clear of talking about individual companies, but rather the aggregate of their efforts. For potential investors, this might help sway whether to invest in the sector, rather than help decide which company to invest in.
Returning to our original brief history of the sector, equivalent* gold production for the peer group we look at was rising at just under 5% per annum from the beginning of 2009, peaking in the fourth quarter of 2013. Debt was largely the financing agent for the expansion plans that nearly every senior gold mining company was embarking upon. Net** debt peaked at US$32.1bn in the second quarter of 2013. However, the average gold price received by mining companies peaked in the fourth quarter of 2012, and fell by US$300 per ounce within six months. The market capitalisation for the sector did not wait – it fell far quicker and further, in fact by half within nine months. Almost overnight, financial liquidity became paramount. Our preferred measurement of financial liquidity is the ratio of net debt to EBITDA***, less sustaining capital. Our modified ratio peaked at 4.4 in the second quarter of 2013. A ratio greater than 3 is normally deemed dangerous. It certainly galvanised a new sweep of C-suite managers and strategies changed quickly to balance sheet repair and cash flow. This has been the dominant strategy for the last four years.
So how successful has the peer group been and is it now time to switch course? Given that cash flow was the priority, perhaps not surprisingly, production has fallen. From its peak in the fourth quarter of 2013, equivalent gold production for our peer group has fallen by 10%, and gold-only production by 9%. Arguably, this is a reasonably impressive result and shows the “inventory” effect that all senior gold mining companies enjoy. But without investment, the inventory does become depleted. Total capital expenditure for this peer group peaked at US$6.3 billion per quarter at the end of 2012. By the beginning of 2016, this figure had dropped to just US$1.6 billion. All companies cut capital expenditure, some more aggressively than others.
Project capital expenditure, not surprisingly, took the brunt of the cuts, but also sustaining capital expenditure, corporate costs and expensed exploration (that portion of exploration responsible for adding longer term production ounces). This is often where drilling down into individual company data can be useful. We think some companies have over-cut capital savings, making the companies appear, to some extent, more robust cash generators than they are. Total capital expenditure is now rising again, and has reached a level of US$2.2 billion per quarter. But this is still well below a level, in our view, that is required to make production sustainable.
Costs have also been reduced during this period of austerity, albeit quite modestly. Cash costs (before any capital spend) have fallen by 12% from their peak at the beginning of 2013, small when compared to a corresponding 53% drop in the price of oil. Typically, energy costs form a significant portion of cash costs, especially open pit operations. Clearly, a lack of scalability as production reduced has been an issue. It would also appear that labour costs have remained at elevated levels.
What should happen now? Certainly, net debt has been curtailed to more comfortable levels. Using our preferred financial metric, the ratio of net debt to EBITDA***, less sustaining capital is now only 1.5 times, albeit at a time of globally low interest rates.
Cash costs are rising again, up 4% from their low point, but at a slow pace. However, the real issue facing the companies and investors is capital – how much needs to be spent to maintain a sustainable business model? Inventories are running ever lower, not yet critical, but nonetheless lower. The reserve life for this peer group peaked at 27 years at the start of 2013. It now stands at 18 years, some 33% lower in the space of just four years. Investment in exploration and new projects must resume. For some companies, the need is greater than others.
There are two reasons given typically to invest in gold shares; the gearing affect (a 10% increase in the gold price can result in a 20% increase in earnings, assuming all other metrics remain constant) and dividends. Some investors like the idea of a yield, being “paid” to own the gold share. Dividends have tended to be rare in this sector. Even at its peak, yields were much thinner than other diversified mining companies. And right now, as we look at the sector, meaningful dividends still look quite far away.
Reinvesting in the production portfolio will have taken preference, in effect reducing that gearing affect too, by lifting the real cost of production to shareholders. Remember, we are not talking about production increases here, but rather maintaining production, and a sustainable business model.
In conclusion, not all companies in the peer group we analyse are the same, bespoke analysis is always required. But for the peer group that make up our quarterly reporting service, the challenge will be to return to a sustainable business model at a reasonable cost. Investors need to understand this reality. Our peer group review provides an invaluable tool to properly understand the senior gold producer business model, and allows for the bespoke analysis required to distinguish winners from losers.
The Gold Peer Group Analysis is a subscriber-only service, updated each quarter. The Peer Group covers: Agnico Eagle Mines, AngloGold Ashanti, Barrick Gold, Gold Fields, Harmony Gold, Kinross Gold, Newcrest Mining, Newmont Mining, Polymetal, Randgold Resources and Sibanye Gold.
*Equivalent gold production is gold production plus by-product production converted by value to equivalent gold production. *Net debt is gross interest-bearing debt less cash and cash equivalents.
**EBITDA is earnings before interest, tax, depreciation and amortisation. Source: Charles De Meester writing in Precious Metals Weekly, a newsletter published by Metals Focus, www.metalsfocus.com, one of the world’s leading precious metals consultancies. The Metals Focus team specializes in research into the global gold, silver, platinum and palladium markets producing regular reports, forecasts and bespoke consultancy. .
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