October 01, 2021
The gold priced edged up 0.2% to US$1,751/oz, after dipping earlier in the week, as equity markets declined, with the market considering the outcomes of an expected Fed taper, while a giant merger, between Agnico-Eagle and Kirkland, was announced.
This week we look the valuations of the top four gold stocks over the past decade to get some idea of the range of multiples over the cycle and conclude that gold stocks are not looking particularly expensive, especially if we factor in a rise in the gold price.
Gold rose 0.2% this week to US$1,751/oz, even after dipping earlier in the week, as
the market continues to consider the outcome from a potential taper to stimulus by
the Fed that could start as early as next month. Gold first took a moderate hit this
week with Fed comments to the US Congress not indicating any changes to the plan
to begin a taper soon. However, gold rebounded later in the week as the market
apparently began to factor in that a taper could potentially lead to severe declines in
equity market, given several valuations metrics for the S&P 500 that are near all-time
highs, driving investors back into the relatively safety of gold. Overall, we expect to
see inflation continue at a higher than expected levels and a gradual Fed taper, but
enough that equity markets could take a major hit, with both of these supporting gold.
This week saw one of the most major mergers in the gold sector in many years, with Agnico-Eagle Mines and Kirkland Lake Gold to combine, and continue operating under the Agnico-Eagle name. This will create a third giant producer, with a combined production in 2020 of 3.43mn oz Au, nearing the level of industry leaders Barrick, at 4.50mn oz Au, and Newmont at 5.96mn oz Au (Figure 4). The combined market cap of the merged company would be around US$29.1bn, compared to US$40.8bn for Barrick and US$42.8bn for Newmont. Based on the average return on equity from 2015-2020, with Kirkland Lake at 12.1% and Agnico-Eagle at 3.4%, the combined entity would have had an average return of 6.0% over the period, without considering any cost reductions from the combination. This would put it significantly above the returns of Newmont, at 3.6%, and Barrick, at 0.1%, which is quite low because of some difficult years early in this five-year period, at the bottom of the cycle.
With the largest gold producers in focus after the news of this major merger, this
week we look at the valuations of the big four gold companies, Newmont, Barrick,
Agnico-Eagle and Kirkland Lake, over the past decade to gauge where multiples are
relative to the overall cycle. These companies set the tone for the industry given their
huge size, and their valuations are indicative of overall sentiment for the segment. In
general, the metrics point to a sector that while not severely undervalued, is certainly
not overly expensive, especially taking into account a further pickup in the gold price.
Where we are in the valuation cycle for the market leaders can have a substantial effect on the junior gold miners. When the majors have strong cash flow and high valuations, it increases the potential for acquisition-related money to spill out across the industry, eventually reaching down to the junior miners. Conversely, when these companies pull back on investment in a downturn, the flow of capital making it to the juniors tends to slow to a trickle or dry up.
It is also not just the absolute levels that are important, but also the trend, as valuations that are high but trending down are obviously not great for investors, while valuations that are low but trending up can be. Overall, valuations have certainly picked up off industry lows in 2015 but have not reached excessive levels at all. To gauge these levels specifically we use four metrics, price to sales, EV/EBITDA, price to earnings and price to book, to give us a full picture looking at the valuations from different angles of the income statement and balance sheet.
The first ratio is Price to Sales, measured as the company's market cap over its
revenue. With this metric only focusing on the topline, it obviously excludes important
detail on costs and profits, but is sometimes used in industries that have no profits,
for example, early-stage companies, and when an entire industry is in a cyclical
downturn and many companies have negative earnings.
Starting near the peak of the previous cycle, the Price to Sales ratios of the top four gold producers reached their highest levels of the past decade in 2010 (Kirkland's ratios are shown only from 2017, its first full year trading). They declined to lows in 2015, a combination of; 1) a major fall in prices, with Newmont and Agnico-Eagle down about 50% at their lowest point in 2015, and Barrick down over 70% (Figure 5), and 2) a significant -22% decline in revenue, from an aggregate US$21.9bn in 2010 for Newmont, Barrick and Agnico-Eagle to US$17.1bn by 2015 (Figure 6).
Prices started to pick up from 2016, and based on the average so far over 2021, Newmont surpassed its 2010 levels by 38.9% and Agnico-Eagle by 9.3%, but Barrick still lags its 2010 level by -42%. This drove a rise in the price to sales multiples across the group through to 2020, although only Newmont has risen above its 2010 levels, with Barrick and Agnico-Eagle still below. The forward multiples for 2021E and 2021E are down from 2020, and do not look expensive in a historical context, with the exception of Kirkland, which has seen premium because of the merger with AgnicoEagle. Importantly, looking at the revenue forecasts, the market is pricing in only a gradual rise in gold prices, which means that there is considerable room for gold prices, and therefore sales and earnings, to surprise to the upside.
EV/EBITDA is a ratio of the enterprise value to the earnings before interest, tax,
depreciation and amortization. The basic concept behind this is to measure the cost
of purchasing an entire company, relative to how much cash it is generating. The EV
incorporates both the market cap and the net debt of the company, or what it would
cost to buy the entire company, in contrast to the market cap used in the price/sales,
price/earnings and price/book ratios, which only includes the equity. EBITDA is used
to measure mainly the cash generation of the company before considering
differences like; i) capital structure, which leads to different levels of debt and interest
payments, ii) tax rates, which can differ across countries, and iii) accounting decisions,
which can affect depreciation and amortization levels.
The EV/EBITDA ratio for Newmont, as with the Price/Sales ratio, has picked up from 2010 to 2020, as the company has seen an improving operating performance over the decade, with the ratio for Agnico-Eagle and Barrick trending down (Figures 8, 9). The forward multiples for 2021E and 2022E are down from 2020 on forecast gains in EBITDA, and do not look overly expensive in the context of the last ten years.
While another common metric is price to earnings, we do not chart this, as the numbers are not meaningful through the cycle lows from 2013-2016, with earnings either negative for many companies, leading to a negative PE, or earnings very low, creating extremely high PE readings (Figure 10). However, we still can consider the aggregate PE ratio, as combining the companies' data reduces the volatility somewhat, as shown below when we compare the gold sector to the S&P 500.
Another metric is the price to book ratio, measuring the market cap over the assets of the firm minus the liabilities, or the book, what would be left for shareholders if the firm was liquidated and all its liabilities were paid off. While we have seen the two ratios above rise for Newmont from 2010-2020, its price to book actually came down considerably from 1.8x to 1.1x, although it is back to 1.8x on a forward 2022E P/B. The P/B for Barrick came down to just 0.8x in 2020, and is at 1.0x for 2022E, with a P/B below 1.0x considered quite inexpensive. Kirkland spiked to 4.6x P/B in 2019, but on a forward 2022E P/B multiple is at 2.1x, inline with Agnico-Eagle at 2.2x.
The price to book multiple is often reflective of differences in the return on equity of companies. We can see this in the premium for Kirkland, which led the top four for average ROE from 2018 to 2020, and has a relatively high P/B, Barrick, which had the lowest P/B of the group, and the lowest returns, and Newmont, with reasonably high average returns and a moderately high P/B (Figure 12). Agnico-Eagle has a high P/B given its average returns just below zero from 2010-2020, but this may have been boosted by the merger with high ROE Kirkland.
In addition to relative valuation levels between the top four gold we can also consider
their valuations versus the S&P 500. We use an aggregate of the market cap of the
top four over the combined sales, earnings and equity, or book (EV/EBITDA is
excluded given there is no readily available EBITDA measure for the S&P 500). For
Price to Sales, gold stocks were far ahead of the S&P 500 in 2010, declined below it
briefly in 2015, and then climbed above it (Figure 13). However, for the 2021 estimate,
the two have converged, suggesting no major overvaluation for gold stocks versus
the broader market, especially if we consider a potential rise in the gold price.
As we noted above, the PE is distorted by the negative or low earnings from 2013- 2016 for the top four, but the more recent 2019-2021E aggregate P/E shows gold stocks as considerably less expensive than the S&P 500 (Figure 14). The P/B ratio shows a large and widening gap between the S&P 500 over the gold stocks. However, this metric is skewed because much of the gain in the S&P 500 is from tech stocks, which have much lower book values. Their assets are more intellectual property and systems creation, which do not show up in the book value, in contrast to the large physical asset bases of many larger industrial companies (Figure 15).
The producing gold miners were mostly down this week even as gold ticked up, offset by broader selling in the equity markets (Figure 16). The biggest news by far was the merger of Agnico-Eagle and Kirkland Lake, creating a gold producer almost near the size of giants Newmont and Barrick. Eldorado reported an operational update from three projects, and Centerra filed an application for urgent measures on its arbitration on the Kumtor Mine, with concerns of operational damage after it was seized by the Kyrgyz government and is being operated by the state-owned gold refining monopoly. Iamgold announced its commitment to achieve negative greenhouse gases by no later than 2050 and appointed Kevin O'Kane to its Board of Directors (Figure 18).
The Canadian juniors were mixed as gold edged up, with many holding up well even under the pressure of the decline in equity markets later in the week (Figure 17). For the Canadian juniors operating mainly domestically, Pure Gold closed its C$23.0mn bought deal offering, New Found Gold reported results from rock samples at the new â€˜Big Daveâ€™ zone 2 km north of Lotto, and began trading on the NYSE American Exchange. Tudor Gold reported drill results from the Goldstorm and Eureka Zones of the Treaty Creek project, and Probe Metals reported an expansion of its drill program at Monique and drill results (Figure 19). For the Canadian juniors operating mainly internationally, Novo reported the first results of its reverse circulation drill program from the Tagla Tagla gold project, which is 110 km north of its flagship Nullagine project (Figure 20)
Disclaimer: This report is for informational use only and should not be used an alternative to the financial and legal advice of a qualified professional in business planning and investment. We do not represent that forecasts in this report will lead to a specific outcome or result, and are not liable in the event of any business action taken in whole or in part as a result of the contents of this report.