Today we are going to explore how to evaluate gold companies using the Gold Investor Pro report
SmallCapPower | March 22, 2017: In Part 2 of our three-part series, we are going to explore how to evaluate gold companies using the Gold Investor Pro report. If you missed the opportunity to view Part 1, here it is.
Valuation ratios are used by investors to estimate the attractiveness of an investment and get an idea of its value, as well as compare it against its peers in the market. Since looking at the financial statements of a company can cause many investors to suffer from information overload—there are just so many different financial values—we have simplified the evaluation process by extracting relevant data such as revenue, EBITDA, free cash flow, etc. in our ‘market data’ Excel sheet for you to perform your analysis. Additionally, we have included some of our own valuation multiples to help guide you, which will be explained in further detail below.
View the Gold Investor Pro: Top 34 Gold Companies Analyzed
A well-known investment valuation ratio is the P/E multiple, which compares the current price of a company’s shares to the amount of earnings it generates. The purpose of this ratio is to give users a quick idea of how much they are paying for each dollar of earnings. However, most junior miners have yet to report any earnings, as they focus on exploration for new mine deposits and invest in drilling campaigns to expand their mineral resources—increasing their asset value. As a result, although P/E may be useful for producing gold companies, it would not help evaluate development or exploration-phase stocks.
In Part 2, we will explore valuation ratios such as enterprise value per ounce of gold (EV/Au oz), enterprise value to EBITDA (EV/EBITDA), and lastly, price to NAV (P/NAV). This will allow us to compare the performance of each company against its industry peers in our Gold Investor Pro Report to find those stocks that may be undervalued.
Enterprise Value Per Ounce of Gold (EV/Au Oz)
A key measure that investors should consider when valuing a gold miner is its enterprise value per ounce of gold in the ground (in-situ). This allows investors to see how much they are paying per each ounce of gold in the ground, therefore making a quick and simple comparison to current gold prices. Obviously, the lower this multiple is, the more attractively priced the company. What we like most about this valuation metric is that it can be applied to all gold companies with a resource & reserve estimate, from exploration to production.
Before we go into any further detail, it is worth defining what enterprise value is and compare it to market capitalization. Whereas market capitalization is simply the share price multiplied by the number of shares a company has outstanding, a simple calculation of enterprise value (EV) is to take market capitalization and ADD debt, and SUBTRACT total cash and cash equivalents. Don’t worry, we have already calculated EV for you! It can be argued that EV is a more accurate representation of a company’s value as it is the value you would have to pay to acquire a company outright (paying off its debt holders, while netting the acquired cash). Since mining is a capital-intensive industry, EV allows us to compare apple-to-apples as to the financial health of a miner and whether it is undervalued in comparison to its peers.
As for our calculation of total gold ounces, we have calculated adjusted gold-equivalent ounces (Au Eq. adj.), converting silver and copper into gold equivalents, as well as using “confidence” probabilities to respective categories of resource/reserve (assigning 90% to P&P, 50% to M&I, and 10% to Inferred). Below, in the ‘Reserves & Resources’ Excel tab, we show you how to filter for the gold companies with the lowest EV/Au.Eq. adjusted value. A low multiple may mean the market does not recognize the true value of a company’s gold reserves, implying it is undervalued! As you can see in Figure 1, Argonaut Gold Inc. (TSE:AR) has the lowest EV/Au.Eq. value of $25.50/ounce compared to Gold Standard Ventures (CVE:GSV) which trades at $1,124.00/ounce.
Figure 1: Using Excel to Filter for EV/Au.Eq.
Enterprise Value to EBITDA (EV/EBITDA)
Unlike the price-to-earnings (P/E) ratio, the EV/EBITDA multiple is unaffected by a company’s capital structure, and it allows us to include unprofitable miners within our evaluation as well.
EBITDA refers Earnings Before Interest, Taxes, Depreciation and Amortization. It allows us to evaluate a company’s performance without having to factor in financing decisions, accounting decisions, or tax environments. This is very important considering different mining companies operate in different jurisdictions with their own tax and interest rates. Comparing the earnings of a company in Canada to another in Brazil would be like comparing maple syrup to coffee beans. In short, EBITDA allows us to compare the operating performance of each gold company on the same scale.
The EV/EBITDA ratio tells investors how expensive a stock is per dollar of its EBITDA. As you may have guessed, exploration companies that have no revenues and thus are higher risk, will have negative EBITDAs, meaning to say that this valuation multiple can only be compared amongst EBITDA-positive producers.
Similar to the ‘filter’ method on Excel used for EV/Au Oz. above, we employ the same method for EV/EBITDA below. As you can see, Teranga Gold Corp. (TSE:TGZ) has the lowest enterprise multiple of 2.3x, followed by Timmins (TSE:TMM) at 3.9x, and Centerra Gold Corp (TSE:CG) at 4.3x.
Figure 2: Using Excel to Filter for EV/EBITDA
Price to Net Asset Value (P/NAV)
The quality of a company’s assets is arguably the most important factor influencing the success of a mining company. The last valuation multiple that we will present is P/NAV, which calculates the premium or discount investors pay per the intrinsic value of a miner’s assets.
Although we include the Price (market cap) for each of the companies in our Gold Investor Pro report on the ‘Market Data’ Excel sheet, the NAV calculation will require independent research. Simply put, the NAV of a company can be calculated by adding up the NPVs of each of the companies mining assets, and subtracting out its net debt. This can be done by discounting the mining asset’s cash flows, or for our purposes, can be found within a mine’s NI 43-101 Technical Report (usually found on SEDAR filed under “technical reports” such as NI 43-101 and pre-feasibility or economic feasibility studies). More often than not, the NPVs of a company’s assets can be found in news releases and corporate presentations. Once the NAV is calculated, divide the market cap of the company by this number.
A rule of thumb in the mining industry is that the benchmark P/NAV is 0.7x. The discount usually represents the fact that a Net Asset Value calculation is prone to many assumptions (such as the price of gold, operating costs, and life time of mines, to name a few), as well as the very likely possibility that a mine’s operations may be delayed (or never started for that matter). In theory, every company should trade at 1.0x NAV (since NAV is the intrinsic value of the company), but the discount is more appropriate in the mining industry due to its excessive risk profile.
As an example, we will calculate the P/NAV of Lundin Gold Inc. (TSE:LUG), which has a market cap of US$279mm (as depicted in the ‘Market Data’ Excel sheet). The company has one large key asset called Fruta del Norte in Ecuador, and we will search for the NI 43-101 Technical Report for this asset. It is worth noting that a company may have multiple technical reports for each asset, so be sure to use the most current. If a company has more than one asset, we will have to repeat the process for each property and sum up the net present values of the company’s assets. We were able to find the NPV of Fruta del Norte on Lundin’s corporate presentation, but we will perform a search on SEDAR as well.
Figure 3: NPV of Fruta del Norte
SOURCE: Corporate Presentation, March 2017
On the SEDAR website, we will do a company search for technical reports in the past decade and then go through each of the NI 43-101 reports (NOTE: these files are usually larger than 5,000 kb, so ignore smaller files). Once you have found the correct report, view the economic analysis on the table of content or perform a search for ‘NPV’ using your browser (Control + F). As you can see in the clip below, we found the before-tax NPV of the Fruta del Norte technical report to be US$1,283 million. As mentioned before, we will seek before-tax inputs to ensure we are comparing apples to apples! Since this is Lundin Gold’s only asset, this is also its net asset value or NAV. As a result, Lundin Gold Inc. is trading at a P/NAV multiple of 0.22x, which is well below the industry average of 0.7x, implying that it may be undervalued.
Figure 4: Navigating SEDAR to Find NPV of Mining Projects
When analyzing gold companies, no single multiple or valuation technique will isolate the best stock in which to invest. Instead, a collaborative approach must be adopted, where we employ qualitative measures, valuation calculations, and a financial analysis.
Stay tuned for the third part of our ‘Excel How-to’ series where we examine key financial ratios to compare companies against their industry peers. We will sift through the data to find those companies with solid balance sheets that are best positioned to deliver healthy returns to shareholders.
In the end, we will have one of our leading research analysts provide his own expert valuation as to which gold stocks are likely to outperform their industry peers!
