A Canadian Gold Miner with Upside
01/08/2013 6:00 am EST
Miners have had a hard time keeping up with the price of the metal they mine, but this company is coming back from a unique year and has legs where others are stuck in the mines, notes Tom Slee in The Canada Report.
Here is our top pick for this issue. Prices are as of the close of trading on Friday, Dec. 14.
Type: Common stock
Trading symbol: AEM
Current price: $53.45
Entry level: Current price
Risk Rating: Higher risk
Recommended by: Gavin Graham
Background: Gold mining stocks have been lagging the price of the precious metal badly over the last 18 months. Goldcorp (GG), which has recently overtaken Barrick Gold (ABX) as the most valuable gold miner in terms of market capitalization, was down more than 20% over the last 12 months, while the iShares S&P/TSX Global Gold Mining ETF (XGD) is down 22% over the same period.
Gold bullion, by contrast, has been flat over the last year but has risen by 50% over the last three years while the gold mining ETF has fallen by the almost the same percentage!
Obviously, anyone considering buying companies that have lagged far behind the metal they produce needs to believe that the bull market in gold will continue. If it does, mining companies offer a leveraged play on the price of the metal. They have underperformed so badly they now seem likely to produce returns at least equal to those from owning gold itself, and probably substantially higher.
The re-election of President Obama has confirmed that there will be no change in policy at the US Federal Reserve, now undertaking its third round of quantitative easing. Mario Draghi at the European Central Bank has confirmed his willingness to conduct unlimited market operations, effectively promising to create limitless liquidity by purchasing Eurozone government bonds. The Bank of Japan has just issued an unprecedented joint statement with the Ministry of Finance, which states it is ready to expand the money supply to avoid deflation and, by implication, weaken the yen to help Japanese exports.
With this concerted effort by the leading central banks to create more liquidity and weaken their currencies in an effort to stave off a new global recession, it is not surprising that precious metals are holding their own. The surprise is that they are not stronger, but it should be remembered that gold ran up to its all-time high of $1,875 an ounce in September last year but then dropped back to $1,523 in June of this year. That was a decline of almost 19%, close to the unofficial definition of a bear market, which is 20% or more. It has since rebounded to just below $1,700.
With gold likely to continue to do well, I suggest that readers take another look at a major Canadian gold miner, Agnico-Eagle (AEM), which was a previous Canada Report recommendation.
The business: For several years, Agnico, under its experienced management team led by long-term CEO Sean Boyd, was regarded as one of the most attractive companies in the sector.
Using the cash flow from its long life, low-cost La Ronde underground mine in Quebec, which began operations in 1988, Agnico expanded dramatically in the last five years.
During that period, it brought four new mines on stream including the Kittila mine in Finland, now its largest gold deposit, the Pinos Altos mine in Mexico, its largest producer, a mine at Lapa in Quebec, and its Meadowbank operation in the Canadian Arctic in Nunavut. That these mines came on stream on time and approximately on budget was a major positive, as was the fact that they were all located in politically stable countries with long histories of mining development.
Therefore, the reaction when Agnico stumbled last year was rapid and brutal. The first blow, in the spring of 2011, was a fire at Meadowbank, which curtailed production. That was followed by the complete suspension of operations at its Goldex mine in Quebec in October owing to unsafe ground conditions. These operational failures were regarded as a major disappointment from a management team that had built up a reputation for delivering results.
Agnico eventually wrote off Goldex completely (gross cost $303 million). Then, in a bigger blow to its asset value, the company wrote down more than half the value of its Meadowbank mine at a gross cost of $907 million. The reason given was that the additional reserves it had anticipated finding hadn’t materialized, meaning the mine only has a six-year life. Investors fled the stock in droves and the share price plummeted more than 60%.
Subsequently, the share price recovered to the current level of $53.45 as investors have overcome their initial unhappiness and Agnico has continued to run its remaining mines in its usual efficient manner.
Why we like it: Agnico’s goal is to move back into the industry’s lowest cost quartile after their missteps last year and to do so by growing reserves and production in mining friendly regions. Their three favorite jurisdictions are Mexico, Ontario, and Quebec, although they would consider looking at opportunities in Northern Europe and potentially South America.
While management is always ready to look at potential acquisitions, they have been very disciplined in terms of issuing stock to pay for new opportunities, as shown by the fact that they only have 171 million shares outstanding after being in operation for 55 years.
With an investment grade credit rating, having raised $600 million in 2010 and $1.2 billion in available bank lines, the company has the firepower to make an acquisition, but it would almost certainly be a smaller operation with an attractive resource.
This would give Agnico the chance to add value through exploration and mine building. RBC has estimated the company is selling around 1.1 times its net asset value, which is below its historical average of 1.5-1.8 times.