Gold Returns and What To Look For

Gold mining stocks offer another vehicle for investors looking for exposure to gold. When gold is on the rise it can provide an improved rate of return for a mining company. A properly run mining company can expand margins, profits, and free cash flow as it benefits from higher selling prices. Individual companies are riskier for investors as they can be subject to company specific issues on the production and balance sheet side. Mining companies also offer an ‘optionality’ to gold prices meaning a savvy stock picker can find a greater rate of return in a miner compared to gold.

Newmont Corporation (NEM) is the largest gold miner in the United States by market cap at $51 bln trailing only BHP Biliton and Rio. A recent merger with North America rival Goldcorp helped boost this valuation. NEM was founded in 1921 and has been publicly traded since 1925 giving it a long history of reliability. Newmont is the only gold producer listed in the S&P 500 Index. It is anchored in favorable mining jurisdictions in North America, South America, Australia, and Africa. This is key when taking into consideration geopolitical risks.

Newmont can act as a hedge against the market as it holds a beta of -0.1% against the S&P. A beta of 1 means that a stock mirrors the volatility of whatever index is used to represent the overall market (i.e.- the closer to 1 the closer it moves with the market). A negative beta, such as the case of Newmont, indicates an inverse relationship to the market. This makes sense as gold will usually find safe haven buying if the stock market is under pressure from some exogenous force. This would lead to interest in gold miners as the economics behind mining will be more enticing.

NEM finds itself as an enticing destination when investor sentiment enters this realm. J.P. Morgan recently initiated the stock with an Overweight based around the idea that it has stable production and declining costs which is a rare find in a gold industry that can struggle to replace reserves. A look at its first quarter earnings from 2020 showed NEM producing 1.5 mln attributable ounces of gold which was up 20% year over year. NEM reported cost applicable to sale (CAS) of $781 per ounce which was up 11% y/y due to lower ore grade mined at certain mines. The All-in sustaining costs was $1,030 per ounce. This difference allowed NEM to generate $939 mln of cash for continuing operations. NEM was able to boost its dividend by 79% to $1.00 annually. While not a dividend play, the yield of 1.5% does add a layer of income for investors looking to offset the volatility risk. The move highlights NEM’s confidence in the business environment it is operating.

Mining is a heavy debt laden business due to the upfront cost of operations. A good mining company needs to be able to manage its balance sheet to maximize profits and returns. NEM ended 1Q20 with $3.7 bln of consolidated cash and approximately $3.0 bln of borrowing capacity on a revolving credit facility, totaling approximately $6.6 bln of liquidity. NEMs net debt to pro forma adjusted EBITDA was 0.7x which is very respectable. S&P rates NEMs debt at BBB which is tied with Barrick Gold for tops among major miners.

Newmont may look expensive, but investors should remember that gold miners are more likely to track gold prices than valuation. A better way to view the valuation of gold miners is by looking at annual pre-tax cash flow. A historical average for trading around this metric is 11x. NEM is trading at 11.7x which is generally in line with historical average even though gold is hitting 7-year highs in prices. This could suggest a premium should be placed on this well-run miner.

Investors need to address the desired returns they are looking to achieve while managing risks. But for those looking for levered optionality in their gold trades then NEM represents a compelling case. Gold is up approx. 12% year to date while shares of NEM have been able to run 44%. There is greater risk to picking an individual company but the right decision can help an investor outpace her gold ambitions.

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