Three gold miners that can ride out demand weakness

When gold prices bounce back, these stocks are set to shine.

Vikram Barhat 1 August, 2018 | 5:00PM

As uncertainty roils the stock market and equity valuations get stretched, some investors are taking another look at gold as a safe-haven investment and a stable store of value.

Gold bugs are predicting a strong year for the yellow metal as its attractiveness remains intact for a range of investors around the world. The precious metal started on a strong note, and although it lost some of its sheen in the second quarter, it's predicted to average US$1,360 an ounce this year, up 8% from the year before, regaining its 2013 peak. Further, the demand for gold in China and India -- two of its biggest markets -- has been rebounding.

For now, though, declining gold prices appear to be dragging down stocks of gold producers. On a year-to-date basis, gold has fallen 6%, and the S&P Commodity Producers Gold index is down nearly 8%, while the S&P 500 has gained 6% and the S&P/TSX Composite Index has added 4%, as of July 20, 2018. These declines have opened up attractive entry points for opportunistic investors looking to buy and hold until gold prices start to strengthen, pushing up gold miners' profitability and stock prices.

The leading gold producers are adapting to the twin realities of a multi-year equity market bull-run and weaker investor appetite for gold by paring back their production. To remain competitive, these companies are now focusing on crimping debt and costs, cutting the fat by shedding capital-intensive operations, and tightening spending on exploration and acquisitions. These measures have positioned the following companies well to benefit not only from the seasonal demand in gold's traditional markets, but also for the eventual spike in inflation and stock market gyrations that would send risk-averse investors rushing back to the safety of bullion.

Agnico Eagle Mines Ltd.
Ticker: AEM
Current yield: 1.01%
Forward P/E: 104.2
Price: $55.08
Fair value: $59
Value: 6.6% Discount
Data as of July 30, 2018

 Agnico Eagle Mines (AEM) operates gold mines in Canada, Mexico and Finland. The firm, which also owns 50% of the Canadian Malartic mine, produced roughly 1.7 million gold ounces in 2017. With a focus on increasing gold production in lower-risk jurisdictions, Agnico Eagle's four crown jewel assets will all be based in Canada by 2020.

The miner's portfolio has long been anchored by its Canadian asset, LaRonde mine, whose by-product metals keep costs low. "Agnico Eagle's low production costs are partly driven by credits for revenue from the other metals that appear with the gold," says a Morningstar equity report. "These by-product metals are not intentionally mined for but are nonetheless sold, improving the overall economics of the mine."

Agnico has had to make some tough decisions when higher costs started to hurt its cash flow. For instance, the extreme conditions of the Meadowbank mine, located in the Low Arctic, forced the company to revise the mine plan in order to improve its cash flow at the expense of a shorter mine life.

"This resulted in over $900 million in impairment charges, nearly half of the mine's book value," says Morningstar equity analyst Kristoffer Inton. The impact of impairments on the firm's return on invested capital (ROIC) prompted Inton to conclude that "Agnico's large asset base weighs on its ability to outearn its cost of capital."

In the rising interest rate environment, investment demand for gold is expected to weaken, dragging down near-term gold prices. On the bright side, though, Chinese and Indian jewellery demand could pick up the slack. "Strong preferences for gold in these countries drive high income elasticity, and rising incomes should result in robust jewellery demand growth over the next few years," says Inton, who puts the stock's fair value at $59. "Strong demand will lead to a production shortfall, requiring a higher incentive price to encourage additional mine production."

Morningstar forecasts Agnico's gold production to fall from roughly 1.7 million ounces in 2017 to about 1.5 million ounces in 2018, and to rise back up to 2 million ounces by 2020.

Ticker: G
Current yield: 0.63%
Forward P/E: 45.2
Price: $16.33
Fair value: $21.50
Value: 24% Discount
Data as of July 30, 2018

A leading gold miner with operations in Canada, the United States, Mexico and Latin America,  Goldcorp (G) operates in stable mining jurisdictions. Led by its largest mines -- Cerro Negro in Argentina, Eleonore in Canada and Penasquito in Mexico -- the gold producer has been pushing for rapid production growth through internal development and acquisitions.

Goldcorp's Penasquito mine produces significant gold ounces along with silver, lead and zinc -- by-products that help keep the mine's production costs very low. Although the mine will face low production in the near term, Morningstar forecasts Goldcorp's production to rise from about 2.6 million ounces in 2017 to roughly 3 million ounces by 2021. "Over time, Goldcorp's production, reserves and cost targets are achievable as it rationalizes costs, opens new mines and focuses on exploration to boost gold reserves," says a Morningstar report.

The company has been divesting noncore assets and acquiring development projects as it seeks to achieve 20% production growth, 20% all-in sustaining cost reduction, and 20% higher reserves by 2021.

Inton ascribes the miner's prolific growth to a series of acquisitions that helped fuel production. However, some of these acquisitions were overpriced, as the deals were undertaken amid historically high gold prices. "As a result, it is unlikely that the firm will generate economic returns in excess of its cost of capital, barring a return to materially higher gold prices," says Inton, who recently lowered the stock's fair value from $22.50 to $21.50 following a weak quarterly earnings report.

The short-term weaker investment demand, Inton assures, could be offset by higher demand in Chinese and Indian jewellery markets over the next few years. He cautions, though, that lower gold prices could somewhat blunt the potential upside from strong demand and production ramp up.

However, the company has a stronger ability to generate free cash flow relative to some of its competitors at today's lower gold prices, adds Inton.

Barrick Gold Corp.
Ticker: ABX
Current yield: 1.04%
Forward P/E: 16.6
Price: $14.45
Fair value: $17.50
Value: 17.4% Discount
Data as of July 30, 2018

Toronto-based  Barrick Gold (ABX) is the world's largest gold producer, with mining operations in North America, South America, Australia and Africa (through ownership of Acacia Mining). Five large core mines in North America and South America account for roughly 70% of its gold production.

While the company's entire portfolio operates at all-in sustaining costs below the industry average, Barrick's core mines tend to be even lower cost. That said, the miner's missteps in heavy capital allocation to problematic projects racked up a large amount of debt. "Barrick has spent a lot of capital on assets that are unlikely to open or generate the level of cash flow originally expected," says a Morningstar report, noting the company has spent more than $5 billion on its Pascua-Lama development, before it was placed on care and maintenance, deferring further construction.

As a result, Barrick has lately been focused on strengthening its balance sheet. "In 2015 and 2016, Barrick executed noncore asset sales, royalty streams and other transactions to help drive leverage down to a more manageable level, raising more than $5 billion for debt reduction," says a Morningstar report. An additional $1.5 billion worth of debt was reduced in 2017.

While the company's fortunes, like its peers, are tied to gold prices, Inton asserts its all-in sustaining costs are roughly US$750 per ounce, far below the industry average, placing the company on the lower end of the industry cost curve. In other words, the company can generate positive free cash flow even as gold prices continue to remain low. "The company is slightly insulated to fluctuations in gold price compared with other gold miners," says Inton.

It helps that much of Barrick's exposure remains in stable, mining-friendly jurisdictions, thus its overall portfolio only carries a moderate amount of geopolitical risk, adds Inton.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Agnico Eagle Mines Ltd78.88 CAD0.22
Barrick Gold Corp23.46 CAD-0.59

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Vikram Barhat

Vikram Barhat  Vikram Barhat is a freelance writer.