When it comes to mining, margins are king. And today, with the price of gold hovering at nearly $1,600 (£1,030) an ounce, the margins on gold mining have rarely been this good. True, costs are on the rise, but some producers - such as Russia-focused Highland Gold - have managed to contain them better than others and are now reaping huge benefits.
- Low-cost gold producer
- Gold poised to benefit from further QE
- Minimal financial risk
- Discount to book value
- Strategic investor pulled out
- Russia risk
- Largest mine winding down
Highland produced 184,000 ounces of gold last year from its three mines in eastern Russia at cash operating costs of just $594 an ounce - below the $657 an ounce averaged by two dozen of the world's largest gold miners - resulting in a healthy gross profit margin of over 50 per cent. And while costs for 2012 are expected to rise slightly, so too might the price of gold. Another round of quantitative easing (QE) by the US central bank is looking increasingly likely later in the year and that would be seriously good news for gold, which acts as a traditional hedge against inflation and mitigates the risk of fiat currencies being debased by money printing.
Indeed, the past two rounds of global money printing have helped push gold from around $750 an ounce in late 2008 to a peak of just over $1,900 an ounce last September. During this time, many gold mining equities performed strongly - and as the chart below shows, shares of highly leveraged gold producers such as Highland even outperformed the rising price of bullion at times.
Yet there has been a reversal of this trend this year. While the price of gold has actually risen slightly in 2012, shares of junior gold miners and risky resource stocks have come under extreme selling pressure, with the global economy - and thus demand for commodities - cooling once more. Certainly, shares in Highland have fallen by more than most. The departure in February of strategic investor Barrick Gold - the world's largest gold miner and a widely-touted potential bidder for Highland - sent the shares tumbling. Then, in April, the company announced it had missed production targets as a result of deteriorating ore grades and weather-related delays.
However, having halved in value since January, the oversold shares appear to be in the early stages of recovering some of that lost ground. They are certainly cheap enough, trading at a hefty discount to book value and, at 5.3 times trailing 12-month earnings, have the lowest PE ratio of their peer group.
Yet Highland remains in solid financial and operational shape. The company has a cash-rich balance sheet, no gold hedges and plans to ramp up production to between 200,000 and 215,000 ounces in 2012. A strong pipeline of projects in prospective growth areas of Russia and the CIS adds to the attraction.
HIGHLAND GOLD (HGM) | ||||
|---|---|---|---|---|
| ORD PRICE: | 111p | MARKET VALUE: | £358m | |
| TOUCH: | 110-111p | 12-MONTH HIGH: | 217p | LOW: 94p |
| DIVIDEND YIELD: | nil | PE RATIO: | 5 | |
| NET ASSET VALUE: | 137p | NET CASH: | $91m | |
| Year to 31 Dec | Turnover ($m) | Pre-tax profit ($m) | Earnings per share (¢) | Dividend per share (p) |
|---|---|---|---|---|
| 2008 | 149 | -111 | -72.0 | nil |
| 2009 | 165 | 87 | 24.2 | nil |
| 2010 | 244 | 144 | 37.6 | nil |
| 2011 | 300 | 132 | 31.9 | 5.0 |
| 2012* | 341 | 142 | 34.0 | nil |
| % change | +14 | +8 | +7 | - |
Normal market size:3,000 Matched bargain trading Beta: 0.78 *Numis Securities forecasts £1=$1.55 | ||||
Admittedly, Highland's main MNV gold mine - which produced 144,000 ounces last year or 78 per cent of the company's gold output - is scheduled to wind down in 2016 unless Highland can extend the mine life. To that end, the company is currently completing surface drilling in areas around the open pit. It is also advancing a number of near-term development projects to fill in the eventual loss of production. For example, construction of a processing plant at its Belaya Gora mine will complete by the year-end and recently acquired LLC Klen, a Russian company that controls the Klen gold deposit, should start production in 2015.
True, Highland's shares could see further selling if the company misses production targets again or political issues in Russia flare up. But Highland's financial backers are very well connected - the largest minority shareholder is Chelsea football club billionaire owner Roman Abramovich. And it's worth noting that Barrick's decision to exit its investment was mainly because the major miner is ridding itself of non-core assets. Barrick actually acquired its initial position in Highland in 2003.
