Double hedge with gold miner Endeavour

You’d think there’d be little need to talk up gold in an Olympic year. Especially when inflation is climbing around the world. But it seems the rules around investing in gold are changing. In July, US investors sold out of the precious metal as inflation numbers ticked up, despite the yellow metal’s long-time status as a hedge against rising prices. 

There was stronger interest in Europe and Asia, according to World Gold Council data, but overall it’s been a flat year. But while record gold prices in 2020 delivered high profits and strengthened balance sheets, gold miners’ share prices have fallen this year. Gold bugs have watched on as companies extracting other metals have smashed through earnings expectations, set new dividend records and seen superior share price gains. 

However, as the economic pressures that sent iron ore and copper surging are falling back – thanks to the Chinese government slowing down its stimulus and trying to cut the prices of the key industrial metals to protect growth numbers. Meanwhile, if traditional investment rules reassert themselves, gold miners should be in a strong position to claw back to the high points of last year. 

Ahead of the interim results season for gold companies, RBC Capital Markets analyst Tyler Broda said the non-North American gold miners were trading on similar enterprise value/cash profit (EV/Ebitda) ratios to the diversified miners and pointed out the possibly divergent narratives: “Considering the potential benefits to a portfolio from gold’s theoretical positive reaction to a stagflationary environment, we see this mispricing as highly anomalous”. 

At the same time, Canadian gold miners have flocked to London to find investors with more of an appetite for the metal. This trend started a few years ago. Bigger and bigger miners have added a London presence to their Toronto listings. The two largest to make the jump are Yamana Gold (AUY) and Endeavour Mining (EDV), while this week prospective Romanian miner Euro Sun Mining (Can:ESM) said it was coming to the “most dominant capital market for mining stocks” to help raise the cash to build a gold and copper mine. 

There have been some bumps in the road for new listings this year. Nord Gold, the major Russian miner, pulled its secondary float plan in June because of “uncertainty and volatility in the resources sector”, which it attributed to central banks flagging rises in interest rates. That volatility was apparent in the gold price falling in June. In the weeks after Nord Gold announced its intention to list in London, the price fell by about 6 per cent from over $1,890/oz to $1,779/oz. 

Endeavour was more committed to its London shift, given its multi-year plan to move its primary listing from Toronto, but just happened to arrive in the midst of this gold price rout. Investors have stuck with it so far. Since June, when it listed at 1,705p, the miner’s share price has bounced between 1,550p and 1,815p at the start of this month.

A new Endeavour

Of course less than two months of trading is hardly representative of what shareholders can expect from Endeavour in the future. The company itself is at a completely different scale than it was a year ago, as well, with two major acquisitions recently completed.

The quarter-by-quarter production changes in the past year show this well. In the first quarter of 2020, Endeavour’s output was 172,000oz. By the September quarter, it was 244,000oz and then by the June quarter this year it was above 400,000oz. The all-in sustaining cost (AISC), a common cost metric that includes exploration to replace mined gold in the reserve, stayed level at under $900/oz. 

Endeavour managed to buy two other large gold miners in all-share deals when the gold price was at or near a record high. The deals were struck with West Africa-focused Canadian companies, after failing miserably at merging with Centamin (CEY) at the end of 2019. 

There was a reason the deal with Semafo, its first big purchase, was possible in the middle of a bull market which may otherwise have made the target's offer-price expectations unattainable. In 2019, a terrorist group killed 39 of its workers in Burkina Faso, following another deadly attack in 2018. 

Endeavour handed Semafo investors 0.1422 of its own shares for each share they owned, equivalent to C$1bn (£570m), gaining around 250,000 ounces (oz) a year of gold production. Endeavour later surprised investors with another big deal, buying Teranga Gold in another all-share deal, making the new company two-thirds Endeavour and one-third Teranga, also bringing in Barrick as 4 per cent shareholder. 

Barrick chief executive and industry leader Mark Bristow showed his support for Endeavour in a June investor day appearance, saying the miner had superseded the “Randgold brand”, referring to the former London favourite he ran until it merged with Barrick. 

Inflationary

Gold miners are of course hit by inflation as a result of rising costs as well as in theory benefiting from it through the price of the metal. But there is an idea of a two-speed environment that could mean a win-win for Endeavour. 

Bernstein analyst Danielle Chigumira said “a scenario where developed country inflation accelerates more than developing country inflation” was on the cards, specifically pointing at Barrick as benefiting given its lack of Canadian and Australian operations, where inflation has been running 4-5 per cent. 

Endeavour also fits this bill as an Africa-focused operator. Chief executive Sébastien de Montessus says the company is in a more advantageous position given its recent mergers. “We went through a massive renegotiation with the Semafo acquisition and then with the Teranga acquisition on all our main key contracts on the supply chain and logistics side,” he said, adding the company had locked in prices for between six months and two years. There is some risk that costs could rise due to the reliance of several of Endeavour’s mines on oil-powered generators, although this is the minority of the company’s assets. 

The company has five mines guided to produce more than 100,000oz in 2021, ranging from Sabodala-Massawa at over 300,000oz to Wahgnion at around 150,000oz. Its smallest mine, Karma, with 80,000-90,000oz of gold production forecast for this year at a high-end estimate AISC of $1,300/oz, is up for sale. 

Where inflation could hit the company is in its next stage of development. This won’t be acquisition-based after a hectic two years of activity, but through expanding Sabodala-Massawa and developing two new mines: Fetekro in Cote d’Ivoire and Kalana in Mali. Each will cost around $300m and add 200,000oz (Fetekro) and 150,000oz (Kalana) a year to Endeavour’s production. 

The forecast internal rates of return (IRRs) for both are well above the miner’s 20 per cent hurdle rate, at 33 and 49 per cent, with Kalana coming out on top, although de Montessus pointed to higher steel prices as headwinds for both projects. More detail will come in the upcoming definitive feasibility studies, usually the last work the company will do before building a new mine. 

These will take some time to impact Endeavour’s production – consensus forecasts see output falling 2 per cent on 2021 to 1.41moz, before climbing in 2024 to 1.54moz. At the same time, Endeavour’s AISC will stay under $900/oz, which is impressive for a miner putting hundreds of millions into new projects. The risk to profits is therefore the gold price tumbling (although most of the mines will stay profitable below $1,400/oz, just as plenty did pre-2020), as well as further attacks in Burkina Faso. 

The conversation around inflation being transitory or not will likely continue as it keeps ticking up. Even iron ore and copper falling – as many analysts see happening soon – will not have a huge impact on inflation given oil’s strength and other pressures post-pandemic. Gold is a traditional hedge against falling prices that is not yet moving despite growing evidence of inflation, but another few months of punchy price rises should see this change.

Last IC View: Hold, 16 June 2021, 1,660p