The commodity bull market is in full swing.
Oil, copper, nickel, corn, soybeans –commodities have been on a steady move up over the past few weeks.
The last one to the party has been gold. While the others took off, gold bounced around the $1,800 mark and made me wonder if it was ever going to join in the fun.
But the move we saw Wednesday was reassuring. While not a confirmed breakout, the action of the miners certainly leads me to think it is only a matter of time.
Big moves always start with the biggest miners and that was what we saw this week: Newmont (NEM – NYSE), Barrick (GOLD – NYSE), and Agnico-Eagle AEM – NYSE) were all up huge on Wednesday.
Breakouts from the Top Down
If this moves gains steam we should be in for some fun. The combination of rising gold and depressed mining stocks could lead to a bonanza of mergers.
Mergers always seem to begin after the bottom. I’ve seen it cycle after cycle. No one wants to buy at the top and no one wants to buy when prices are still falling.
Mergers begin after the turn when the bottom is in.
The stock prices of the majors always move first. Then they use their currency (their stock) to buy up smaller fry.
We’re not there yet. Not even close. The big miners have a lot of room to move up first. The big miners are not really that expensive – especially given where the rest of the market is.
Consider the most expensive of the bunch: Newmont. Newmont expects cash flow of a little under $4.5 billion in 2022. That is an 11x multiple. Agnico-Eagle is at 10x. Barrick is only at 7x.
Much of that cash generated by the big-caps is free-cash-flow. Newmont delivered $2.3 billion of free-cash-flow in the first 9 months of 2021. Estimates are for $2.5 billion+ of free-cash-flow this year.
Newmont, Barrick and the rest have cash to spend. If they want to put it to work in M&A, they don’t have to look too far.
Kinross Gold (K – TSX) and Yamana Gold (YRI – TSX) are both large producers trading at far lower valuations.
Kinross, a 2.6-million-ounce producer, is expected to have a $1.50 per share of cash flow this year (consensus estimate), growing to $1.65 next year. With the stock at a little under $6, that is just under 4x cash flow.
Yamana trades at 4.8x cash flow and will produce 1 million ounces of gold (flat -year-over-year). At a $5.50 share price, Yamana has a free-cash-flow yield of nearly 8%.
Acquisitions for survival
But these companies could become acquirers themselves. Yamana is a microcosm of the industry. Yamana has a 10-year growth profile that is essentially flat. To break out of this funk the company has two choices: acquire of be acquired.
Source: Yamana Investor Presentation
The same goes for the group. The eight largest gold producers are expected to grow production by only 4% this year, followed by 5% next year – and that assumes everything goes as planned (this is mining after all).
Source: Analyst Consensus Estimates
These senior miners need acquisitions to grow.
Unfortunately for them, the set-up for acquisitions could be better. But for investors it looks great.
That is because the problem isn’t price. There are cheap stocks out there. It is just that the mining universe has shrunk so far.
Bank of America Capital Markets put together an interesting report last week called “2022 gold M&A outlook: The race to replace gathers pace”.
In the report they made a list of the most attractive small and midcap targets for the large miners:
Source: Bank of America Capital Markets
It looks like a nice list of prospects. But the number of companies on the list far less than the number that have been acquired over the last few years:
Source: Bank of America Capital Markets
Not a great situation for acquirers but a good one for the savvy investor.
But its not all bad news for miners on the hunt for acquisitions. What is working in their favor is that the stock price of the small-fry are trading very cheap.
VICTORIA GOLD – A GREAT FIT FOR A BIG MINER
Take the #1 stock on the list: Victoria Gold (VGCX -TSX). Victoria is a single mine producer in good political jurisdiction. Their Eagle Gold mine, in the Yukon, has been ramping up since the end of 2019.
Eagle did 160,000 ounces of production in 2021. In the third quarter Victoria sold 53,000 ounces at $960 AISC. The Q4 production numbers, which came out two weeks ago, were a bit shy of 50,000 ounces.
Eagle is a cash flow generating machine. In Q3 Victoria generated $32 million of free cash flow from Eagle. With a $950 million market cap and $200 million of debt, the stock is trading at only 10x annualized FCF.
Yet Victoria’s stock price has been hit. It had a high of $19 in November but has fallen to $15 today for the usual reasons – management overpromising on a newly minted mine.
Quite honestly, single mine producers would be better off not saying anything. When they give guidance they just seal the fate of their share price.
At the beginning of 2021 management forecast that Eagle would produce 180,000-200,000 ounces in 2021. Of course that was reduced to the “low end” late last year. To the surprise of virtually no one, actual full-year production came in even lower – at 164,000 ounces.
But here’s the thing. The mine is still hugely profitable. We have two quarters of 200,000-ounce annualized production.
Rolled up into a larger company and Eagle’s bumpy path to sustainable production wouldn’t be under the microscope.
Victoria trades at half the NAV5 of Eagle and Eagle should get bigger yet. There is visibility to at least 250,000 ounces, which Victoria has forecast for 2023 and plenty of exploration upside.
WESDOME – KIENA UPSIDE KEEPS GROWING
#4 on Bank of America’s list is Wesdome (WDO – TSX), a Canadian producer with mines in Ontario and Quebec.
Wesdome is more expensive than some of its peers – it trades at 8x 2022 cash flow. But the premium is justified by the drill results Wesdome has been releasing.
Wesdome produces from two mines: Eagle River, which has been on production for years, and Kiena, which began to ramp up production in Q4.
Wesdome released 2022 guidance last week, forecasting 160,000-180,000 ounces of production, with 40% of that coming from Kiena
Source: Wesdome January 14th Press Release
But the drill results at Kiena are screaming that much higher production is possible.
In May, Wesdome announced a truly phenomenal drill intercept at the Kiena Footwall Zone: 41.2 g/t Au over 51.2 m core length. That is more than an ounce of gold over a length of close to half a football field.
Since deciding to focus on Kiena 3 years ago, Wesdome has delivered press release after press release outlining high-grade ore over long lengths.
Kiena is an old mine that Wesdome is bringing out of care and maintenance. While Wesdome ran the mill at Kiena at ~400 tonnes per day in Q4 2021, that old mill has the capacity to operate at a much higher throughput.
Wesdome’s 2022 guidance for Kiena suggests the mill runs at ~500 tonnes per day as Kiena ramps to commercial production in Q2.
The medium-term plan is to run the mill at 850 tonnes per day. But with the drill results we keep seeing, I have to think the longer-term hope is much higher. The mill capacity at Kiena is 2,000 tonnes per day.
Combine this with recent drill results and it is possible that Kiena becomes much bigger than what is baked into 2022 guidance.
WILL 2022 BE THE YEAR OF GOLD M&A?
In their year-end gold miner note, Credit Suisse pointed out that gold miners were one of the few sectors in the market to “screen inexpensive”.
The bank highlighted that the miners are just plain cheap: “trading at multiple well below the last gold bull market in 2012”.
Like Bank of America, Credit Suisse also expects more M&A. In addition to majors looking to grow reserves, they see more combinations among intermediate producers looking for scale.
What I know is that the number of new gold discoveries that pop up on my watch-list declines every year. And apart from a brief uptick in the summer of 2020, the money going into juniors for exploration has been sparse.
That combination can only mean one thing. If you need to find ounces, you are going to have to buy them.
Time to pay up!