Ed Bowie is an investment manager at Altus Capital Ltd., a London-based
company which invests primarily in precious metals and natural resources. Last
summer, Altus said the resource sector was experiencing “natural selection.”
The worst companies and least knowledgeable investors were set to leave the
space.
In Altus’ most recent letter to shareholders, Ed explained how senior
mining companies failed to create shareholder value when the price of gold was
on the rise. They were overly optimistic about the future prices of the metals,
misrepresented the true costs of their operations, and were careless with debt
and shareholder capital.
As a result, the gold mining industry suffered tremendous write-offs and
losses throughout 2013. Billion-dollar acquisitions were abandoned. Share
prices sank to new lows. And many management teams and CEOs from the boom years
were thanked and excused by their boards.
Because they frequently under-reported the costs of mining, shareholders
overestimated the profitability of these companies and governments demanded
greater taxes and other social rents because these mines were perceived as
highly profitable.
“During the course of 2013 senior mining companies attempted to
re-ignite investor confidence with a collective apology for their past
misdemeanors,” says Ed. Although substantial external downside risks remain in
the sector, the most competent and well-run of the major miners are now
becoming much more attractive, he says. As he points out, some major mining
companies are increasing their output and becoming more profitable.
For instance, Endeavour Mining Corp. acquired Avion Gold Corp. in the
third quarter of 2012. At Avion’s Tabakota mine, Endeavour doubled the number
of tons mined per day, reduced the head-count of high-salaried expatriates, and
switched from contract mining to an owner-operator fleet. These improvements
reduced costs from $1,250 to around $850 per ounce of gold.1
OceanaGold Corp. commissioned the Didipio project, located in the
Philippines, in the second quarter of 2013 and over the last year has become
one of the lowest-cost gold producers in the world. The company as a whole
still had a net loss of $47.9 million for the year after it recorded the
decrease in value of its reserves as a $77.6 million-dollar loss due to lower
gold prices.2
Randgold Resources Ltd. has avoided big write-downs associated with
lower gold prices because it maintained a gold price assumption of $1,000 per
ounce. Other tier-one producers had increased their assumed gold price to
$1,500 per ounce. When the gold price fell below that number, many of their
reserves became too expensive to mine and had to be taken off their books.
Meanwhile, Randgold has increased its production in 20133without having to reduce
reserves.
Ed warns that major miners may well disappoint shareholders in the near
term. Volatility in the gold price this year could mean mining companies could
struggle to generate profits, he says.
Nonetheless, some mining companies appear to be correcting their bad
behavior, by reducing costs and making new acquisitions that stand to be
low-cost, profitable operations. Some may take advantage of low prices to make
acquisitions while most early-stage projects are selling at record lows.
Asanko Gold Corp.’s recent acquisition of PMI Gold Corp. is an
encouraging signal that M&A activity could take off, he adds.
“Valuations remain extremely compelling and further M&A activity is
anticipated, particularly by larger-cap companies seeking to fast-track the
replacement of less economic ounces in their resource inventory.”
Ed concludes: “After two years of cutting overhead, fire sales of
certain assets and optimizations of mine plans using realistic price and cost
assumptions, the new leaner and cost-driven companies are much better
positioned to deliver substantial returns.”
Large mining companies are hardly out of the clear, because many mining
operations are barely profitable or even losing money at the current gold
price. Nonetheless, well-run major mining companies could improve margins and
acquire potentially profitable new deposits, which could surprise investors to
the upside going forward.
1http://www.endeavourmining.com/i/pdf/Financials/2012YE.pdf
3http://www.randgoldresources.com/randgold/action/media/downloadFile?media_fileid=17754
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