Newmont Mining Corp is one of the world's largest gold miners. And while there are many risks a miner like this faces, a single risk will have a disproportionate impact here, a fact that's doubly true over the next couple of years. If you are looking at Newmont, you need to understand this risk and why it's more important than ever.
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Newmont Mining is basically fully exposed to the price fluctuations of gold because it doesn't hedge against gold prices. And gold makes up roughly 90% of the miner's top line, so it's a big deal. That's not strong enough... its THE big deal. When gold is trading hands at high prices, Newmont's revenues and earnings will be high. When gold is falling and/or trading at low levels, Newmont will quickly feel the pain.
This is doubly true because mining is an expensive process. And while you can cut costs, they can only go down so much. Last year, Newmont was able to trim its all-in sustaining costs, the amount it costs to mine an ounce of gold, by about 10%. However, it thinks production costs will sit at the $1,000 an ounce or so plateau for the next couple of years. That means the big variable on the top and bottom lines will be gold prices. So, when it comes to Newmont, the price of goldis the biggest risk, and opportunity, to watch.
A look beyond gold...
That said, part of the reason why the company's costs are set to flat line is that it is investing in new projects to help offset declining production from older mines and the natural depletion of its mines over time. That's gold again, in an indirect way, since less gold coming out of the ground means less revenue on the top line. And if depletion isn't faced head on, eventually there'd be no gold at all. This issue is far more obvious when gold prices are low, crimping profit margins.
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So, when thinking about costs, there are some bigger-picture risks to consider like the age, quality, and cost of operating mines.Essentially, as a mine ages it generally costs more to operate and ore grades often decline over time, making the mines less productive. In addition, as gold is pulled out of a mine, Newmont has to find new sources to replace it -- gold is naturally occurring, and each mine only has just so much gold that can be economically recovered.
But then, there's also the issue of the projects Newmont undertakes to offset declines at older mines. Right now, Newmont is working on six projects at or near existing mines. While expansions at existing facilities has a higher probability of success, all projects come with execution risks. And building a new mine from scratch is particularly expensive and risky.
Newmont's Minas Conga project is a prime example. This mine project is pretty much on hold because it faced political and public opposition in Peru. The opposition was so strong that Newmont just gave in and called it quits, at least for now. It the project doesn't start up again, every penny sunk into it will have been for naught.
Source: Lands Department, Survey of Lands Branch, Photographic Branch, via Wikimedia Commons.
That said, if Newmont doesn't invest for the future, then it is doomed to a slow death. Indeed, if it runs out of gold to mine from lack of investment, it basically has no business. So, new projects are important risks to take. In some ways, it would be a bigger risk if Newmont chose not to take such risks, which means you should keep an eye on the company's plans here to make sure they are doing enough to keep the business stable or, better yet, growing.
A difficult environment
And, of course, Mining is a very dangerous activity. It's why miners talk so much about their safety records. No one wants to have employees die. And because mining is so dangerous, it's highly regulated. So, Newmont has to deal with lots of regulations and inspections. That's good on one level, but it exposes the company to the risk of changing regulations. Safety equipment, training, and monitoring cost money. The more money spent on such things, the less a miner earns. A rule change could require costly changes throughout the company. Low gold prices exacerbate the issue, since there's less profit floating around to absorb added costs.
And when all of the preventative measures put in place still can't stop an accident, there's another set of problems to deal with. For example, if an employee does die on the job, even if it was an unfortunate and unavoidable accident, it can lead to lawsuits, increased regulatory scrutiny, changed work patterns, lost equipment, and more. And if a mine event is large enough, like a cave-in or flooding, it can simply stop production for a period of time -- or indefinitely, if the disaster is really material. Luckily, these aren't everyday occurrences, but they are important aspects of the business to be aware of. And with gold prices at relatively low levels, any work stoppage would hit hard.
Bonus Round: Money makes the world go round
Although Newmont is a giant miner with plenty of access to capital, another risk you need to consider here is financing. The company's debt has been trending higher over the last decade, on both an absolute and relative level. While it's doubtful Newmont will have trouble coming up with cash to fund its operations and expansion efforts, debt is something to watch.
Since interest expenses don't change with the price of gold, more debt just makes it that much harder to turn a profit. And there is some level at which getting access to more capital becomes troublesome. Newmont isn't likely near that point, which is why this is a "bonus" risk, but it should be something you think about because of the huge up-front costs of mine projects.
Don't fret... too much
At the end of the day, most of these risks are just part of doing business for a gold miner like Newmont. And when you boil it down, the biggest risk is still the price of gold. That's particularly true since Newmont doesn't hedge its gold price exposure. So, while you should keep an eye on everything here, you should pay really close attention to gold if you own Newmont shares.
The article The 1 Major Risk That Could Bring Down This Gold Titan 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.
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