Description

Yamana Gold, AUY

In recent years gold mining has been an effort in disappointing production and ever rising cash costs, not to mention meddling governments adding to costs or uncertainty via changes to royalty rates. Yamana Gold is a budding senior producer (1.2MM oz per year, $10B mkt cap) that has been successfully navigating these waters and growing production and, along the way, roughly meeting guidance for cash costs. AUY is diversified with eight mines, their assets are mostly in countries with favorable and stable mining policies and they’re executing on plan.

Gold mining stocks have underperformed the commodity due to:

1. Problems maintaining production
2. Cost escalation
3. Poor capital allocation

Yamana has superior assets, management, and capital discipline, and the company has avoided the issues that plague the industry. However AUY trades at a similar multiple to peers.

1.       Yamana has a strong growth profile

High production growth in 2013 (+27%) and 2014 (+11%) as three new mines are added to their portfolio. Management has a track record of executing on production guidance, which sets AUY apart from its peers.

                         2006   2007   2008   2009   2010   2011   2012   2013E   2014E    2015E

Production (oz) 314     577       983   1,026 1,047  1,102   1,201   1,520     1685     1750

Cash Cost        294      285       384      366   465     486       516      546      

Yamana has industry low costs, earning gross margins in excess of 70% at today’s gold prices. In addition, Yamana’s growth in cash cost per ounce has been well below peers, but in any case has been within guidance so one can model it without material surprises. 

Yamana’s assets are mostly in countries with stable governments including Chile (45%), Brazil (25%), Argentina (20%)(not perfect), and Mexico (10%). Cost escalation is a serious issue in politically unstable countries such as South Africa because of mining strikes and difficulty sourcing skilled labor.

3.       Yamana has a plan for returning capital to shareholders

Following the completion of its growth capex in 2014, Yamana will significantly increase its dividend. I model a run-rate free cash flow yield of 11.3%. At a payout ratio of 70%, AUY will yield 7.9%, well-above peers.

Yamana’s CEO Peter Marrone has said in conference calls that 2.0MM ounces of annual production is the maximum ideal size for a gold miner because it provides a base of assets large enough to scale fixed costs yet is also small enough that maintaining production is feasible. As gold miners become larger than this, it becomes increasingly challenging to maintain production because new projects must be massive to move the needle. In addition, smaller mines are easier to contain costs and meet production guidance.

Based on Marrone’s comments and management’s guidance Yamana will stop growing at 1.75MM oz and begin returning capital to shareholders.

Valuation (under $1,550 gold price assumption)

1.       As management continues to execute on its growth plan, Yamana’s CFPS should increase 24% to $1.98 in 2014 under a $1,550 gold price scenario. At peer P/CFPS multiple of 9.0x, AUY is worth ~$17.80 on 2014 numbers, or about 29% of today’s closing price. 

2.       At a stable, long-term dividend of $1.09 (70% payout ratio on FCF) and a 6% yield AUY is also an $18 stock.

3.       Gold could go down. Gold could stay roughly at this price. However, it is worth noting that gold could go back up. Perhaps the weakness in gold is due to the financial world beginning to leave crisis mode. I honestly don't know. But if it is and the world economy is beginning to stablize, then all this money printing may begin to lead to inflation which could be the trigger for the next upward move in gold. If so, AUY is strongly levered to that upside.

Note:

Yamana’s cash flows are leveraged to the gold price.

1. Yamana is growing from a junior miner into a senior miner. Senior miners tend to have lower multiples because they struggle to maintain ounces of production. If Yamana is compared to senior miners, it could hurt the multiple.

Catalyst