Evy Hamro the manager of BlackRock’s commodities funds, recently told a room full of investors in London that ‘Gold miners will become a barbarous relic, without change’ after shares of Barrick Gold Corporation (USA) (NYSE:ABX) fell to a 20-year low last week and the company lost its position as the largest gold miner in the world by market cap to peer Goldcorp Inc. (USA) (NYSE:GG).
But how did it get this way? Many people and investors are blaming poor management decisions as not just Barrick, but all the gold miners have expanded rapidly during the decade, spending shareholder cash and diluting their share capital in order in an attempt to win over shareholders during a decade of booming gold prices — destroying value for long-term investors.
| Company | 5-yr Percentage increase in fully diluted number of shares |
| Barrick | 13% |
| Goldcorp | 16% |
| Newmont | 10% |
| Kinross | 81% |
Moreover, the share prices of the world’s five largest gold miners have fallen faster than the price of gold during the first quarter of this year, as rising labour costs, lower ore grades and project budget overruns drain company profits.
| Company | Performance Since The Beginning of the Year |
|---|---|
| Barrick Gold | -43.4% |
| Goldcorp. | -21.9% |
| Newmont Mining | -29.7% |
| Kinross Gold | -45.0% |
| SPDR GLD | -12.4% |
Over the last few years, it appears that the mistakes the miners have made have been masked somewhat by the exciting ride that is the price of gold. Investors have been transfixed by the shiny metal’s move upwards without studying the activities of the miners in general.
Now, the mistakes are coming to light and the miners are paying for it with plummeting stock prices. Indeed, many high profile investors are calling for larger cash returns to shareholders as a way to prop up stock prices, but this could be an unrealistic proposition as margins are coming under pressure in the mining industry.
The projected all-in cost of mining an oz of gold for each of the five main gold miners. What’s interesting here is the fact that although Barrick Gold Corporation (USA) (NYSE:ABX) used to be the biggest gold miner by market cap. its production costs are exactly the same as its smaller rivals, indicating that the company has not been able to achieve the economies of scale it should have as the market leader.
This chart illustrates the falling profit margins of the companies. I have used an average production cost to simplify things. On an individual basis, both Newmont Mining Corp (NYSE:NEM) and Kinross Gold Corporation (USA) (NYSE:KGC) are producing an ounce of gold for an average of $1,150, more than the average I have indicated above, which indicates that their profit margin per oz for this month will be around $300 an ounce — still a good 26% margin.
Balance Sheets have room for expansion
Another proposition could be a wave of takeovers, which is an entirely viable option as all four of the miners above have plenty of room on their balance sheets for leveraged acquisitions. Furthermore, interest on existing debt is already well covered, as shown below.
| Metric | ABX | GG | NEM | KGC |
|---|---|---|---|---|
| Revenue | $14.50 | $5.40 | $9.90 | $4.30 |
| COGS | $8.10 | $3.10 | $5.90 | $2.80 |
| EBITDA | $6.40 | $2.30 | $4.00 | $1.50 |
| Interest Expense | $0.17 | $0.01 | $0.25 | $0.04 |
| Interest Cover by EBITDA | 37 | 230 | 16 | 38 |
| Cash | $2.2 | $1.0 | $1.8 | $2.0 |
| Short-Term Debt | $1.8 | $0.0 | $0.0 | $0.5 |
| Long-Term Debt | $12.0 | $0.8 | $6.3 | $2.1 |
| Net Debt (Cash) | $11.6 | ($0.2) | $4.5 | $0.6 |
| Shareholder Equity | $21.8 | $22.6 | $13.8 | $9.8 |
| Net Debt to Equity | 53.4% | -0.8% | 32.6% | 6.1% |
| Net Debt to EBITDA | 1.8 | -0.1 | 1.1 | 0.4 |
Figures in millions of USD except for ratios
Barrick Gold Corporation (USA) (NYSE:ABX), Goldcorp Inc. (USA) (NYSE:GG), Newmont, and Kinross all have plenty of room on their balance sheets for further borrowing to finance takeovers. Barrick is limited, as the company already has a net debt to equity value of slightly over 50%, but interest costs are covered nearly 40x so there is plenty of room for addition borrowing.
The rest of the miners find themselves in the same position as Barrick Gold Corporation (USA) (NYSE:ABX), with plenty of room to increase borrowing on their balance sheets. However, with profit margins expected to fall this year across the industry, this could constrict free cash available for interest payments.
Out of the four miners, Newmont Mining Corp (NYSE:NEM) finds itself in the most limited position. With a net debt to equity level of just under 33% and a net debt to EBITDA ratio of 1.1, the company is hardly loaded with debt. However, interest costs are only covered 16x by earnings, indicating that the company is paying a higher than average rate to finance its debt. Furthermore, I believe that it could be difficult for the company to raise additional debt for acquisitions without completely constricting its cash flows.
How much would acquisitions cost?
So, Barrick Gold Corporation (USA) (NYSE:ABX), Kinross, and Goldcorp Inc. (USA) (NYSE:GG) have room their balance sheets to attempt a leveraged buyout, assuming of course that competition commissions around the world allow it. But what price would they have to pay to acquire their competitors and could they afford it?
Here are the enterprise, or take over values of each company.
| Company | Enterprise Value |
|---|---|
| Barrick | $34,075 |
| Goldcorp | $23,340 |
| Newmont | $24,037 |
| Kinross | $6,127 |
Figure in millions of USD
It would appear that Kinross Gold Corporation (USA) (NYSE:KGC) is the cheapest miner here and ripe for a takeover by one of its larger competitors. However, Kinross does have one of the highest production costs per oz out of these four miners. Additionally, the company has been running into a lot of production problems, so based on that, I doubt any of the company’s peers would find it an attractive take over target just yet.
Both Newmont and Goldcorp Inc. (USA) (NYSE:GG) have roughly the same enterprise values, although I believe neither of them are suitable takeover targets for larger peer Barrick Gold Corporation (USA) (NYSE:ABX) as, to do so, Barrick would have to roughly triple its net debt — taking debt to equity to 150%!
Having said that, Newmont could be a good acquisition target for Goldcorp. Goldcorp Inc. (USA) (NYSE:GG) has no debt currently and a leveraged acquisition of Newmont would only put the company on a net debt to equity level of 100% — high but sustainable.
Conclusion
Overall, gold miners are under performing and they need to turn themselves around before shareholders abandon them altogether. Increasing shareholder returns or a wave of acquisitions would help the sector, but if gold prices drop further, it could be time to jump ship.
The article Where Next for Gold Miners? originally appeared on Fool.com and is written by Rupert Hargreaves.
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