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Aim's golden nuggets

Alex Newman sifts through London's small-cap gold miners to find where the real value lies
Aim's golden nuggets

On 7 November, investors waved through Randgold Resources’ (RRS) merger with Barrick Gold (US:ABX). Barring the unexpected, those shareholders will find their shares trading in New York and Toronto when markets reopen in January. In London, the FTSE 100 will have lost what may be the world’s premier gold company.

By several measures, Randgold has proved to be one of the success stories of modern African mining, marrying high-quality ore bodies with strict capital discipline and what chief executive Mark Bristow repeatedly cites as a “social licence to operate”. At present, the company requires a 20 per cent internal rate of return, at a long-term gold price of $1,000 an ounce to merely sanction a project. It’s that sort of approach that has helped Randgold shares generate a compound annual growth rate of 23 per cent over two decades, excluding dividends.

Otherwise, investors aren’t exactly spoiled for choice at the top of the sector. In a scathing assessment of large gold miners’ historic record, hedge fund investor John Paulson found Randgold to be the only large-cap gold stock that matched the return of physical gold, and as one of just two to have delivered a long-term return on investor capital. Barrick’s 53 per cent negative total shareholder return between 2010 and 2017 was less impressive. 

For UK investors, a few large-cap precious metals stocks will remain. Mexico-based Fresnillo (FRES), the world’s largest silver miner, may no longer boast the excellent mineral grades of its past, but it is well-run and growth-oriented. 

Just outside the blue-chip index, Russian gold and silver miner Polymetal International (POLY) manages to balance a lofty debt pile with strong dividends, thanks in large part to its low-cost portfolio. It was also the only global gold stock other than Randgold to post a positive return, per Mr Paulson.

Then further down the food chain, there are two struggling African players: Centamin (CEY), whose largely open-pit-focused Sukari mine in Egypt has missed several forecasts this year, as well as Acacia Mining (ACA), which remains embroiled in an existential stand-off with the Tanzanian government. The latter could soon go too: the executive team of New Barrick, which owns 64 per cent of the group, has flagged the possibility of either buying out Acacia’s remaining shareholders, or selling the company to a third party.

Top to bottom

Although mining mergers have a chequered history, there’s often strong strategic rationale for combinations. While production has continued to climb since the financial crisis, grades have steadily fallen, reserves are being depleted, and discoveries continue to thin. In many cases, purchasing untapped reserves (which is essentially what Barrick is doing by acquiring Randgold) now looks cheaper than the alternative, which is to commit increasingly large chunks of time and capital to sourcing new projects.

Indeed, the watchword is now consolidation. A recent survey from consultancy EY found that mining executives expect more dealmaking in 2019, and cited the new Barrick tie-up as a potential motivator to other industry participants to increase volume via mergers and acquisitions (M&A). The new venture’s executives telegraphed as such, when they signalled their intent to spin off its lower-margin (non-tier-one) mines to mid-tier players.

But while the top of the market looks set to thin, where does that leave London’s gold minnows – the well from which Randgold was sprung?

In short: in alright shape, thanks. Yes, the Alternative Investment Market (Aim) continues to carry its fair share of ever-hopeful exploration candidates, but there are also several well-run, profitable companies in the space, which either return substantial dividends to shareholders, or have a viable growth story. In this piece, we will look at a handful of London’s smaller gold stocks, panning for signs of operational quality, rather than promises of game-changing discoveries or world-conquering M&A.

 

Panning for gold

Gold mining equities, like most resources stocks, tend to be driven by commodity prices. That was evident when gold prices fell below $1,200 an ounce earlier this year – a level that tested many companies’ ability to break even on an all-in sustaining cost base.

But as Randgold’s history has showed, gold companies do not need a $1,300-an-ounce long-term price to generate earnings, pay dividends and grow (either through exploration or acquisition). That said, a good starting point is evidence of production, however limited that may be.

Given the turbulence in the gold price in the past few years, one approach is to look beyond gold stocks’ net profits and multiples, and to focus on operational quality. To do so, I have leaned on Algy Hall’s adaptation of accountancy professor Joseph Piotroski’s F-Score system, which applies a series of tests to a company’s recent financial information to judge whether operational improvements have helped to boost profits and cash generation. It’s not a perfect test, not least because some of the companies above our £20m market capitalisation floor do not yet produce gold. Nonetheless, the F-Score system is a useful, if broad, test of capital-intensive companies. The criteria are as follows:

■ Positive profit after tax, excluding exceptional items.

■ Positive cash from operations.

■ Profits after tax excluding exceptional items up on the previous year, which could be a signal that a company may be in recovery mode and in the process of rerating.

■ Cash from operations higher than profit after tax, excluding exceptional items, which indicates an ability to convert accounting profit into actual cash.

■ Gearing (net debt as a percentage of net assets) down on the preceding year, which suggests that the company has not had to look for external sources of finance.

■ The current ratio (current assets divided by current liabilities) up on the preceding year, which suggests that the company's ability to service upcoming financial obligations is improving.

■ No new shares issued over the past year, which again suggests that the company has not had to look for external sources of finance.

■ Gross margins have risen in the past year.

■ Improving capital turn (turnover as a proportion of net assets), which suggest greater productivity.

 

Company Name

TIDM

Market Cap

+ve net inc

Rising net inc

Op cash > net inc

+ve op cash flow

Falling gearing

Current ratio up

No new shares

Gross margins up

Improving capital turn

F-Score

Anglo Asian Mining

AIM:AAZ

£85m

9

Highland Gold Mining

AIM:HGM

£471m

X

8

Centamin

LSE:CEY

£1,078m

X

X

X

6

Polymetal International

LSE:POLY

£3,337m

X

X

X

6

Avesoro Resources

AIM:ASO

£220m

X

X

X

6

Trans-Siberian Gold

AIM:TSG

£41m

X

X

X

6

Shanta Gold

AIM:SHG

£34m

X

X

X

6

Acacia Mining

LSE:ACA

£689m

X

X

X

X

5

Fresnillo

LSE:FRES

£6,026m

X

X

X

X

5

Randgold Resources

LSE:RRS

£5,674m

X

X

X

X

5

Serabi Gold

AIM:SRB

£22m

X

X

X

X

5

Petropavlovsk

LSE:POG

£208m

X

X

X

X

X

4

Caledonia Mining

AIM:CMCL

£84m

X

X

X

X

X

4

Hummingbird Resources

AIM:HUM

£65m

X

X

X

X

X

4

Orosur Mining

AIM:OMI

£17m

X

X

X

X

X

4

Pan African Resources

AIM:PAF

£155m

X

X

X

X

X

X

3

Chaarat Gold

AIM:CGH

£90m

X

X

X

X

X

X

X

2

Ormonde Mining

AIM:ORM

£28m

X

X

X

X

X

X

X

2

Galantas Gold

AIM:GAL

£20m

X

X

X

X

X

X

X

2

Greatland Gold

AIM:GGP

£36m

X

X

X

X

X

X

X

X

1

Source: S&P Capital IQ, data retrieved on 15 Nov 2018

As the results show, company size and higher F-Scores don’t correlate perfectly. Several measures – such as new shares issued, improving gross margins and de-gearing – were consistently failed regardless of market capitalisation. As a result, five of the top seven stocks in the list hail from the junior market.

To add to these operational metrics, it's worth screening for a few valuation tests, including a forward price/earnings ratio, enterprise value to operating earnings, strong interest cover and price to book value. Below are the results for those stocks with an F-Score of at least five, and a profile of four of the highest-scoring Aim-listed gold stocks:

 

Company Name

TIDM

Fwd PE

DY

EV/EBIT

P/BV

ND/EBITDA

5x interest cover

Acacia Mining

LSE:ACA

10

-

-

0.78

-

X

Anglo Asian Mining

AIM:AAZ

-

3.1%

13

1.24

0.07

Avesoro Resources

AIM:ASO

-

-

-

0.00

1.81

X

Centamin

LSE:CEY

13

10.3%

5

1.12

-

Fresnillo

LSE:FRES

18

3.8%

11

2.62

0.10

Highland Gold Mining

AIM:HGM

9

8.1%

8

0.80

1.23

Polymetal International

LSE:POLY

10

4.9%

12

3.20

2.17

Randgold Resources

LSE:RRS

24

2.6%

15

2.00

-

Serabi Gold

AIM:SRB

11

-

-

0.41

-

X

Shanta Gold

AIM:SHG

3

-

9

0.43

1.14

X

Trans-Siberian Gold

AIM:TSG

10

6.1%

11

0.69

0.59

Source: S&P Capital IQ, data retrieved on 15 Nov 2018. Gaps may reflect a lack of forecasts.

 

On the up

The gold price may have bounced around this year, but shares in Anglo Asian Mining (AAZ) have tended to move in one direction. Partly because of this track record, the only miner in our screen with a perfect F-Score has started to pick up a decent following among Aim investors.

The group counts three mines at its processing facilities in Western Azerbaijan, and benefits from low all-in sustaining costs of just $604 an ounce (oz), thanks in part to its copper by-products. In the past two years, these low costs and expanding operations have produced something of a virtuous cycle for both earnings and the balance sheet. As of September, the company had swung to a net cash position, whereupon it announced a maiden dividend of 3¢ a share – a figure broker SP Angel reckons could double in 2019. Balancing this commitment against the need to boost its reserves is the next challenge.

A developing story

Highland Gold (HGM) screens well whichever way you look at it. From the perspective of asset risk, it is also about as strong as you’re likely to find, provided your risk appetite extends to Russian resources companies. And with three mines in operation, another three in development and three exploration properties, the group also has a growth story.

Central to that story is development of the 100 per cent-owned Kekura open-pit and underground mine in the prolific Chukotka region, which Highland expects to enter commercial production in 2020, just in time to replace slimming output from the ageing Belaya Goro and MNV mines. This high-wire transfer of the production base may help to explain the shares’ discount to book value, but investors can at least refer to a rising dividend as a sign of management reassurance.

 

The income case

There’s one good reason why Trans-Siberian Gold (TSG) may be beneath the radar of many resource investors. This year, the owner of the high-grade Asacha mine in Russia’s far east is on course to hit production guidance of 36,000-40,000 oz of gold, just shy of the 57,000 measured ounces sitting in its reserves estimate at the end of 2017.

In other words, investors are reliant on a fast conversion of Asacha’s indicated and inferred reserves to extend its mine life. So long as investors are comfortable with this picture – and based on the past few years of production, there’s little reason to doubt Trans-Siberian can keep it up – then the compensation is a dividend policy that has returned $12.8m to shareholders in the past two years.

 

A high-risk turnaround

The classic image of gold panning – sifting through the muck for any signs of brightness – is a fair analogy for Shanta Gold (SHG), the cash-strapped operator of the New Luika mine in Tanzania. Arguably a casualty of the country’s protracted showdown with Acacia Mining, Shanta has been forced to swallow both rising VAT receivables and higher royalties, while managing a swollen debt pile and improving the life of its asset. Such austerity has brought some benefits: expensive contracts were exited and Shanta has sensibly cut its historic preference for ex-pat management. And despite the tricky operating environment, net income has risen and cash conversion has remained robust.

But keeping the lights on and holding up production has proved a challenge, as third-quarter results underlined. Lower-than-expected mine grades led to a drop in full-year output guidance to 80,000 oz, from a range of 82,000-88,000 oz, while expected all-in sustaining costs have been lifted to $750, from a range of $680-$730.