Is this Giant Gold Miner Digging Too Deep a Hole?

By Markets Fool.com

Newmont Mining Corp started life as something akin to a mutual fund for investments in mining companies. That was until activist investors got hold of the company. Fending them off has had a notable impact on the company's balance sheet -- in a liability kind of way.

Continue Reading Below

More than the parts
The company, which first sold shares to the public in 1925, started life as a way for its founder to bring together mining assets under one roof. It was a little like a mutual fund. By the 1980s, it was producing 28 different products from facilities around the world. However, Wall Street believed that the sum of Newmont's parts was worth more than the whole.

That led to a series of activist investors trying to break the company apart, or buy it so it could be sold for its pieces. Newmont was able to fend off the attacks; however, there was a cost. It paid a $33 per share special dividend worth a total of roughly $2.2 billion in 1987. It was funded largely with debt, requiring the sale of assets over the next two years to pay down the bill.

Source: Public domain, via Wikimedia Commons.

That's one of the main reasons why the company today is focused on gold, and to a lesser extent, copper. In fact, for 12 years, the company was only mining gold. It didn't return to the copper market until the turn of the century.

Continue Reading Below

While debt has ebbed and flowed during the years, it remains a notable issue today. A quick look at the balance sheet shows that long-term debt, at nearly $6.5 billion, is the largest entry on the liability side. It's a number that's been trending roughly higher during the past decade on both an absolute and relative basis. For example, a decade ago, debt made up a little less than 20% of Newmont's capital structure. At the end of 2014, that number stood closer to 40%.

While the corporate raiders aren't responsible for the company's debt today, they certainly sent Newmont down a vastly different path -- and one that was laden with IOUs. Debt isn't unusual in the gold mining industry. Building a mine costs a lot of money up front, while the gold pulled out takes years to show up on the revenue side.

At Barrick Gold Corporation, for example, debt makes up about half the capital structure. However, at much smaller Royal Gold, Inc USA, debt makes up only about 12% of the capital structure.

A limiting factor
If you looked at those three companies, and had to determine which one could best weather weak gold prices, Royal Gold would have to get points for having less debt. The size of Newmont and Barrick would give them clout with lenders, but it would be better to just not have lenders, like debt-free competitorFranco-Nevada Corporation. Franco-Nevada's operations don't have to absorb any interest expense while Newmont had to deal with $361 million worth of interest expense last year. And that number is over three and half times what it was 10 years earlier, even though debt as a percentage of the company's capitalization only roughly doubled over the same span.

That's no small issue for a company like Newmont that has no pricing power -- its top line is dependent on often volatile commodity prices. Taking on too much debt could quickly be a problem if gold prices were to fall below the cost of production.

Debt also becomes an issue on the growth side of the ledger. With so much debt on the balance sheet already, a large merger or acquisition could become troublesome. So, too, could spending on new mines or mine expansions if they can't be funded from cash generated by the miner's operations. Every new piece of debt adds to the cost of running the business, making it that much harder to turn a profit. This isn't an issue to lose sleep over, at least not right now, but it's one to make sure you watch.

Newmont Nevada Gold Mine. Source: Uncle Kick-Kick, via Wikimedia Commons.

A unique entry
Although not a particularly big deal, there's another item among Newmont's liabilities that's worth understanding: "reclamation and remediation liabilities." This figure is normal in the mining industry, and represents the costs that Newmont expects to pay for returning mines to their natural state after they're done. It's the second-largest number you'll see under liabilities.

This is an expense that the company has to pay based on environmental and safety regulations. However, it's worth noting that a rule change can lead to changes in this expense.

It's worth keeping an eye on the number for large changes. Regulation shifts, or unexpected events at a single mine, could be behind such changes; either way, you'll want to understand why a big change happened, because it could have a long-term impact on the company's finances.

Watch, but don't worry
At the end of the day, Newmont's biggest liability isn't out of line with similarly sized competitors. And the rest of its liabilities are pretty straightforward. There's nothing here that suggests you need to worry about what's going on at Newmont. However, you should be aware of the company's debt, and what it could mean for the future of the company.

The article Is this Giant Gold Miner Digging Too Deep a Hole? originally appeared on Fool.com.

Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.