- Some major miners have underperformed the gold price for a decade
- London miners and royalty companies could provide better value
Last month, explosives and chemicals company Orica (AU:ORI) doubled its exposure to the North American gold industry by buying a fellow sodium cyanide manufacturer.
The logic is sound: cyanide is used to extract gold from rock, and behemoths such as Barrick Gold (US:GOLD) and Newmont (US:NEM) are unlikely to cut back on their use of the chemical any time soon. They even run a mine complex together: Nevada Gold Mines, which has triple the entire production of London's top gold producer, Endeavour Mining (EDV), at around 3mn ounces (oz) a year. It needs a lot of cyanide. London-listed Capital Limited (CAPD) has also expanded its operations from Africa to the US through two contracts with Barrick, having initially worked with the mining giant in East Africa.
But where services companies see opportunity, investors see negative returns, even with the gold price at record levels. Barrick has underperformed the price of bullion on a 10, five and three-year basis, even when accounting for dividends.
Smaller miners have also traded behind the metal, although they have done better than the biggest operators. Centamin (CEY) has largely tracked the VanEck Gold Miners ETF (GDX) over the longer term, but is well ahead on a two-year basis.
Orica and Capital, which provide drilling and laboratory services, have had far better returns than miners, although Capital’s free cash flow had been mediocre until 2023.
But Orica's $640mn (£502mn) cyanide deal could come at a time when the major gold miners make some hard decisions and ultimately land Orica with a lot of expensive infrastructure. Overall, however, the reasoning makes sense, given the reports emerging from the BMO Mining Conference at the end of February.
One BMO analyst reported broad “frustration” among investors with equity performance given the rise in the gold price, while another participant told Investors’ Chronicle the mood around the majors themselves was outright negative. Juniors and mid-cap attendees had a much better reception.
“Larger [gold] producers continue to evaluate portfolio optimisation, while companies undergoing expansions look to de-lever balance sheets upon delivery of growth projects promising elevated free cash flow,” said BMO analyst Alexander Pierce after the conference.
This is seemingly too ‘jam tomorrow’ a mindset for investors, given costs have been rising for years.
The VanEck Gold Miners ETF has dropped from an average forward price/earnings (PE) ratio of 22 times a year ago to 16 times now. Its top two holdings are Barrick and Newmont, with fellow miner Agnico Eagle (CA:AEM) and royalty companies Franco Nevada (US:FNV) and Wheaton Precious Metals (WPM) rounding out the top five.
Meanwhile, forecasts for Barrick’s 2024 dividend payout have dropped a quarter in the past six months, leaving its forward yield below 3 per cent. Over in the bulk mining world, forward yields are close to 7 per cent despite the expected huge cuts in payouts compared with 2022.
There are two schools of thought on what happens next. One notes there is no guarantee that shares in gold miners, particularly the majors, will rise in tandem with the gold price. The other thinks now may be the time they finally turn it all around.
Digger dilution
A decade ago, Barrick produced 6.3mn ounces (oz) of gold a year at an all-in sustaining cost of $864. In 2023, the company produced 4mn oz at a cost of $1,335 an oz. Newmont has grown far more, through the acquisitions of Gold Corp and more recently Newcrest Mining, but has a flat organic gold output (at 5.2mn oz) and a higher all-in sustaining cost of $1,444 an oz. Barrick's decline is evident in its near-decade low enterprise value (EV) to Ebitda (earnings before interest, tax, depreciation and amortisation) ratio of 6.4 times.
To conclude the number collage, there is a very simple measure of what Barrick shareholders are getting – production in oz per share: In 2014, this was 0.0054 oz per share, and in 2023 it was 0.0023oz. Investors are getting less for their cash.
Some see improvements coming down the line, however. Bernstein analyst Bob Brackett says Barrick has shifted its focus to organic growth, sacrificing absolute production levels for in-house development. This comes well after Mark Bristow took the chief executive chair via the Barrick/Randgold Resources merger. But Randgold was a top developer of mines, and shareholders benefited through dividends and share price appreciation.
“Looking into 2024, there are multiple studies that will enhance its organic growth engine and play as catalysts [to the share price],” Brackett says.
These include the Reko Diq copper and gold project in Pakistan, which will be difficult to build, and the ramp-up of the Lumwana super-pit in Zambia from 2027. But headaches remain – multiple in-development mines are behind schedule or running at a higher cost.
There is also an eyebrow-raising idea, as per one RBC analyst, that Barrick management is considering nuclear power for the Donlin mine in Alaska. “The asset features substantial resource inventory of 39mn oz at high grades of 2.2 grammes per tonne, although its refractory ore requires high power consumption for autoclave processing,” says Josh Wolfson of RBC. “Barrick is still evaluating a solution for this, noting potential opportunities available from nuclear power generation.”
The probability of Barrick being able to build a nuclear power station in the wilderness in which the Iditarod sled race is run every year is probably similar to the (centigrade) temperature in that part of the world over winter.
Where else to go?
We are more bullish on London’s crop of mid-cap miners despite the more concentrated risk that stems from backing companies with fewer mines in operation.
Outside that cohort, the royalty companies provide a solid mix of exposure to gold and higher cash flow than the miners, given their low fixed costs. Wheaton Precious Metals, mentioned above, has a London listing and has far outperformed Barrick and Newmont in share price terms recently. It does fail slightly on the cash flow argument, however, with a run of acquisitions last year knocking it into a $462mn outflow for FY2023, as forecast by Peel Hunt. The broker sees this bouncing back to $745mn in 2024, and the Ebitda margin has been steady around 70 per cent in recent years.
Capital also has a solid growth story, and capital spending shouldn’t blow up returns this year despite the new Barrick contracts. Peel Hunt forecasts capex of $46mn this year, down on 2023.
There is no guarantee the gold price will stay high but given its performance in the face of what are usually headwinds – a strong US dollar and high interest rates – it might be smart to have a few investments that are proven cash generators tucked away.
