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The Gold Stock Strategist analyzes leading junior gold producers and major gold mining companies.

Comments are welcomed!

Thursday, July 2, 2009

How Do Gold Miners Stack Up Mid-Year 2009?

There are several ways to value large gold producers. One of the conventional methods is to use “price to earnings” ratio calculations, commonly referred to as “PE”. This method of analysis is the one of the most basic valuation techniques. Lower PE ratios suggest a company is undervalued relative to competitors. PE ratios are best used as a “first cut” in due diligence to see how the market is valuing gold mining companies relative to others in the industry.

As the table below (sorted by 2010 PE ratios) shows, current PE levels in 2010 for 14 major and mid tier gold producers elegantly break down into two groups—those above a 20 PE and those below.

Three out of five of the most undervalued companies based on PE ratio are South African gold miners. This is not surprising because of higher operational risk and political risk involved with mining in South Africa. There continue to be miner deaths reported this year in South Africa and investors are still stinging from power generation disruptions last year.

Peruvian gold and silver miner Buenaventura (BVN) is relatively undervalued. The Company closed its hedge book back in February 2008, stumbled on low grade ore at their Yanacocha project, and reported negative earnings in Q4 2008. More recently, work stoppages and protesters at their Orcopampa mine have stalled production. An operationally smooth second half of 2009 would help boost Buenaventura share prices going into 2010.

Lihir Gold (LIHR), an Australian gold miner, is also relatively undervalued using PE ratios. This is probably in large part due to a long history of operational challenges at their world class Lihir Island mine (below sea level) in Papua-New Guinea.

The two largest gold producers in the world, Barrick Gold (ABX) and Newmont Mining (NEM) are surprisingly relatively undervalued for conservative investment plays in the gold mining industry. It remains curious that Barrick and Newmont are lagging in PE valuation. Both companies are projected to increase production at a faster rate than other gold miners listed above with the exception of Agnico-Eagle (AEM) and Randgold (GOLD). Fast growing mid-tier gold miners like Agnico-Eagle and Randgold appear to have gotten a little ahead of themselves relative to other company valuations based on PE ratios for 2010.

Goldcorp (GG) is in a slower growth phase going into 2010 than in past years. It has several world class mines throughout North and South America. Goldcorp is also the most overvalued company in the table with a projected PE ratio of 44 for 2010. Of course, longer run investors like Goldcorp’s aggressive plans to expand gold production by about 50 percent over the next few years.

Kinross Gold (KGC) Kinross has producing mines in Russia, Chile, Brazil, Nevada, Alaska, and Washington State. The Russian mine is high grade. Investors are concerned about political risk in Russia. Kinross is in a consolidation phase after considerable growth in production and with $800 million cash on hand is probably looking to make an acquisition to expand its production profile. The share price has had a nice run recently, driving Kinross’ PE valuation higher.

Mid tier producer Yamana Gold (AUY) is coming off the heels of a sale of three high cost mines to Aura Minerals (ORAUF) in early June. Yamana received over US$200 million and may have sold the properties below market value. Despite the controversy, Yamana increased their “war chest” by 200 percent with this deal. The Company is rumored to be on the lookout for acquisitions with a lower cost profile than the assets just sold. The share price could lag until an acquisition is announced. That is unless, of course, a larger gold producer decides to add Yamana’s mostly Brazilian assets to its portfolio of properties.

Companies to watch closely are the high cash cost miners like Harmony Gold (HMY), IAMGOLD (IAG), Gold Fields (GFI), Anglo-Gold Ashanti (AU), and Randgold. These companies will likely have higher earnings growth than the other miners if the price of gold jumps above $1,000 an ounce in the second half of this year. Higher cash costs translate into greater leverage to changes in the price of gold. Companies with higher cash costs per ounce have higher cash flow growth rates than companies with lower operational costs when the price of gold rises. Likewise, high cost producer cash flow suffers more than low cost producers when the price of gold declines.

El Dorado Gold (EGO) has the lowest cash costs of all the companies in the table at about $270 per ounce. As a result, El Dorado has higher quality earnings because it is less sensitive to the price of gold. El Dorado’s producing mines are in Turkey and China and present some political risk. Nevertheless, investors who like low cost producers find El Dorado attractive. That may be one reason why it has a 26 forward PE ratio for 2010.

We have seen a recent price run up over the past couple of weeks for many gold mining stocks. Despite this run up in share prices, several companies are sporting PE ratios under 20 for 2009 and 2010. A rise in the price of gold over $1,000 an ounce in the second half of 2009 would move the share prices higher for many large gold producers.

Second quarter earnings season is upon us. Keep your eyes on the larger gold producers. Companies that beat expectations this quarter by driving down operational costs could show significantly higher share prices in the second half of 2009 and into 2010.

Disclosure: No positions

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