As many expected, Donald Trump's presidency is off to a raucous start, and it shows no signs of slowing down. That means, for investors, volatility in the market is just around the corner. And when volatility rears its head, investors turn to gold -- not coins, per se, but gold-mining stocks. Yamana Gold (NYSE: AUY), a leader among gold-mining stocks, is one name that has been drawing attention. Let's look at three tools we can use to help dig through the company's financials to better evaluate the company.
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Image source: Getty Images.
It's about all-in sustaining costs
Dealing in a commodity, miners are at the mercy of the market in determining the price of gold, and they are unable to pull certain levers -- like raising prices -- that most other businesses can. Controlling costs is essential, and when it comes to digging gold out of the ground, there are plenty of costs. Luckily, investors have the all-in sustaining costs (AISC) metric to help guide them.
According to its most-recent annual report, Yamana Gold calculates its AISC based on several factors:cost components of mine sustaining capital expenditures, corporate general and administrative expense excluding stock-based compensation, and exploration and evaluation expense.
Image source: Yamana Gold.
This metric is by no means an exhaustive account of all of the company's expenses. For example, it doesn't include capital expenditures associated with growth projects like mine expansions.
Although the company hasn't released its fiscal year 2016 earnings figures yet, management recently reported that at $914 per gold ounce, preliminary results suggest Yamana achieved its co-product AISC for gold production estimate: between $880 and $920 per gold ounce. In the previous two years, fiscal 2015 and fiscal 2014, the company reported co-product AISC of $868 and $954 per gold ounce, respectively.
Digging for gold and finding the green
When assessing mining companies, it's important to remember earnings per share metrics aren't the most reliable in providing insight into a company's performance. For example, assigning a value to an asset, like a mine, is far from cut and dried. Consequently, companies may take large writedowns on their assets, resulting in skewed earnings figures. In fiscal year 2015, for instance, the company recorded non-cash impairment charges of $2.6 billion. In the company's annual report, management acknowledged that "the largest contributor to the impairment was the writedown of values relating to exploration landand potential ounces."
One thing that can't be massaged, though, is cash flow. Better yet, once we remove capital expenditures, we arrive at an even more desirable figure: free cash flow.Although Yamana failed to report positive free cash flow in fiscal years 2012 through 2014, the company turned things around in fiscal year 2015, when it reported $152.4 million in free cash flow, according to Morningstar. Besides strong cash flow from its cornerstone mines, El Penon and Chapada, management attributed the strong cash flow in 2015 to record annual gold production at three mines: Canadian Malartic, Minera Florida, and Gualcamayo.
Continuing to report positive free cash flow is an essential aspect of the company's strategy to improve its financial health. Having reduced its debt by $286 million in fiscal year 2015, Yamana expects to further reduce it by $300 million by the end of fiscal year 2017 -- something it expects to achieve through the organic generation of cash flow. Ultimately, management is working to reduce its leverage and achieve a net debt-to-EBITDA ratio of 1.5 times to 2.0 times -- something management characterizes as "prudent financial policy and planning."
Although management has articulated a desire to pursue a more circumspect approach to relying on leverage, it's incumbent upon investors to do their due diligence and dig below the surface of management's comments. Management's target of a net debt-to-EBITDA ratio between one time and two times is admirable, but there's a catch: It hasn't provided a time horizon for when the target is to be achieved. Furthermore, Yamana hasn't reported positive EBITDA for the trailing-12-months period -- according to Morningstar it equals negative $2.1 billion. Until the company reports positive EBITDA on a trailing-12-months basis, the ratio isn't as useful.
Examining a company's leverage is important, but when evaluating mining companies, it's imperative to consider their liquidity. Producing millions of ounces of gold in a year doesn't come cheap, so mining companies rely heavily on debt to keep their operations running. But in order to service these massive debt loads, companies must deftly manage their liquidity. Finding millions of ounces of buried gold means little if the company is, likewise, finding itself buried under a mountain of debt.
To assess the company's liquidity, we'll use the quick ratio that is used to calculate a company's ability to pay short-term obligations by subtracting the current inventories from a company's assets and dividing it by the current liabilities. Ideally, companies will have quick ratios above one, reflecting that the company has more than $1 in assets for each $1 of debt.
Clearly, Yamana Gold's quick ratio is a red flag. A ratio of 0.495 is concerning, but when stacked up against Yamana's peers, Barrick Gold, Newmont Mining, Kinross Gold, and Goldcorp, there is even more source of concern. Perhaps we could cut the company some slack if its peers we're sporting similarly low quick ratios, but we don't find that at all. Instead, we find that liquidity -- unlike some of its peers -- is an issue that requires further scrutiny.
When Yamana reports fiscal year 2016 earnings in the coming weeks, there will be a lot to dig through, but assessing the company's ability to report low AISC, generate positive free cash flow, and maintain adequate liquidity are all items that require considerable attention. Likewise, monitoring the company's progress in constructing the Cerro Moro mine is also important as management expects the mine to play a prominent role in the company's future success.
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