It was a difficult 18-month extension for the Gold Mining Index (GDX), as the ETF slipped more than 30% from its highs. While some of this weakness is related to the gold price (GLD), another reason is inflationary pressures, which have taken out profit margins for some miners. However, not all miners are created equal, and some have been flushed out with shower water. In this update, we’ll look at three excellent candidates for buying and dipping.
The preferred way to find out about gold prices is through GLD or GDX, the latter offering more leverage. This is because producers can see a significant increase in their margins when the price of gold moves higher. However, while GDX offers diversification with over 50 properties, this diversification is an Achilles heel. This is because 70% of miners are not worth owning, which results in the worst producers with their margins slashing dragging the index lower.
The way to make superior returns is to own the best producers/franchises in the sector and buy them at the right price. There are many names available at the right price when it comes to quality names, but three of them stand out as having superior fundamentals, attractive dividend yields, and solid growth. These three names are Agnico Eagle Mines (AEM), Wheaton Precious Metals (WPM), and Alamos Gold (AGI). Let’s take a closer look at the three companies below:
Starting with Agnico Eagle Mines, the company is set to complete its merger with Kirkland Lake Gold (KL) in the next two weeks, making it one of the world’s largest gold producers. The combined entity is expected to produce approximately 3.4 million ounces of gold in FY 2022 on a conservative basis and could grow to be a producer of 4.5 million ounces by FY 2028. This represents 33% growth from current levels, well above the growth rate production for its peer group, with companies like Barrick anticipating minimal production growth over the next several years.
(Source: Company filings, author chart and estimates)
The source of this sharp increase in total production comes from organic growth at existing mines and the anticipation of new projects emerging online, including Upper Beaver and Santa Gertrudis, two forward projects in Canada and Mexico. Within the portfolio, Detour Lake is expected to steadily increase to more than 850,000 ounces per year ( 2021 production: 712,000 ounces), while annual Macasa production is expected to grow to 400,000+ ounces (FY2021: production ~ 210,000 ounces).
The exciting part about this growth is that not only is the company expected to see a meaningful increase in production, but the additional growth is expected to come from higher-margin assets. These include Upper Beaver, which should produce less than $850/oz with byproduct credits, Santa Gertrudis, which should also produce less than $850/oz, and Detour Lake, which costs are expected to fall below $775/oz. ounces when the production profile is higher.
Finally, Macassa will likely see costs fall below $650/oz once production exceeds 400,000 ounces per year. Hence, Agnico’s growth should be accompanied by higher margins, with a potential increase in the price of gold benefiting margins even more. Based on Agnico’s current portfolio of operations/development projects, the company’s combined net present value (5%) on mining assets comes in at more than $23 billion, well above the current market value of $21 billion.
With AEM typically driving a significant premium to NAV, I see a rise to over $70.00 per share. The bonus is that AEM has one of the most attractive dividend yields in the industry, and currently pays an annual dividend yield near ~3.00%. Finally, the company should be nearly debt-free by the second quarter of 2022, providing ample scope to supplement dividends with share buybacks to return capital to shareholders. Therefore, at the share price of $47.00, I see a significant rally from current levels, and plan to continue building on weakness.
The second name on the list worth paying attention to is Wheaton Precious Metals (WPM). This broadcasting company helps finance producers/developers with upfront payments for the delivery of a portion of the production over their lifetime in the mines. The company has a market capitalization of $17.5 billion, has an attributable production profile of more than 740,000 ounces, and expects to see an average production of more than 825,000 ounces of gold equivalent annually over the next five years.
(Source: Company files, author chart)
Due to the extremely high profit margins due to the flow model (Capacs-Lite model), the company is not affected by inflationary pressures and has much lower risk than its peers. However, the company benefits greatly from new discoveries and expansions in its partner projects, which enhance the company’s attributable total production and long-term revenue (longer life of the mines). Therefore, WPM is one of the best ways to play in the sector for investors who want to be exposed to the sector with minimal risk
If we look at the WPM valuation above, we can see that the stock has historically traded at 35 times earnings and yet is currently trading at only 27 times the FY 2023 earnings estimates. This is a very reasonable valuation, especially given that the price of gold is sitting at lows Much higher than it has been on average for the past seven years when WPM had a P/E of 35. Based on what I believe is a fair P/E that is closer to 36, given that WPM has profit margins of over 75%, I see a fair value of the stock Closer to $52.00 per share. Therefore, at $38.00, this looks like a low-risk entry point into the stock.
The last name on the list is Alamos Gold (AGI), a mid-tier gold producer with three mines, two of which are located in Canada and one in Mexico. The stock has seen a sharp sell-off over the past 18 months due to the falling price of gold and the rising costs of the Molatus project in Mexico. However, the company is set to transform over the next few years, growing from a 480,000-ounce product at $1,150 an ounce to a 750,000-ounce product at a cost of less than $850 an ounce.
(Source: Company files, author chart)
This makes Alamos one of the best sector-wide growth stories, and will help the company become one of the highest-margin producers in the segment in 2025, which should translate into a higher stock multiplier. For those unfamiliar with the story, this growth is expected to come from a major expansion of a high-quality Island Gold mine in Ontario and a new mine, Lynn Lake, in Manitoba.
Based on 396 million shares outstanding, AGI currently trades with a market capitalization of $2.62 billion, which pales in comparison to the estimated net present value (5%) of $3.9 billion. With the current share buyback program in place that should reduce the number of shares further and help provide support at current levels and a dividend yield of 1.0%+, I see this as a low risk entry point into the stock. Based on the 1.1x P/NAV multiplier, I see a fair value of $11.00 per share, or more than 60% above our 18-month price target.
In over a decade of trading in the gold sector, I don’t remember the last time the sector was hated, except for nearly the lowest levels of a secular bear market in 2015. The difference this time around is that the average miner generates significant free cash flow is more disciplined With allocating capital, and having a strong balance sheet, this makes this a very low risk entry point into the sector to diversify one’s portfolio. Based on AEM, WPM, and AGI being quality companies at a reasonable price, I see this as a buying opportunity for all three.
Disclosure: I LONG GLD, AEM, AGI
Disclaimer: Taylor Dart is not a registered investment advisor or financial planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation in connection with any securities transaction. The information in this writing should not be construed as financial or investment advice on any subject. Taylor Dart expressly disclaims all liability with respect to actions taken based on any or all of the information in this writing. Given the volatility in the precious metals sector, position determination is critical, so when buying precious metal stocks, transaction sizes should be limited to 5% or less of an individual’s portfolio.
WPM shares were trading at $38.67 a share Friday afternoon, down $0.34 (-0.87%). Year-to-date, the WPM is down -9.92%, versus a -8.11% rise in the benchmark S&P 500 over the same period.
About the author: Taylor Dart
Taylor has over ten years of investing experience, with a particular focus on the precious metals sector. In addition to working with ETFDailyNews, he is a senior writer on Alpha Search. Learn more about Taylor’s background, as well as links to his recent articles. more…
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