Tuesday 31 July 2018 by Asmita Kulkarni Opinion

Panning for Gold

In this note we take a closer look at gold miners and bonds issued by these companies with a relative value analysis

gold

This document has been prepared by FIIG Portfolio Strategy Services. Opinions expressed may differ from those of FIIG Credit Research.

Investment thesis 

Gold is a defensive asset class investors like having exposure to as its performance is typically uncorrelated to other asset classes. For investors that want to have exposure to gold with an ongoing income, there are various USD DirectBonds available, issued by Kinross, Newcrest and IAMGOLD.

Within the investment grade offering, we prefer Newcrest over Kinross. Although the credit fundamentals of the two companies are fairly comparable, there is a major difference. Kinross is in an investment phase, leading to increased leverage over the medium term. On the other hand, Newcrest is deleveraging and expected to produce positive net cashflows after dividends over the same period, resulting in a relatively lower credit risk. Additionally, Newcrest will continue to generate about 50% of its productions from high quality assets in Australia.

Investors looking to invest in HY issuers should consider IAMGOLD, an attractive investment option on a relative value basis. While it is unlikely that there will be an upward credit rating movement due to the ratings being constrained by the jurisdictions it operates in, we note that IAMGOLD has quite a low leverage compared to peers (with cash on hand exceeding debt) and EBITDA in excess of USD300m..

According to company releases, IAMGOLD’s current expansion plans target production reaching 1.2m to 1.3m oz by 2022, with cash cost of production dropping by about 20% over that period. This trajectory of production growth would transform IAMGOLD from being a mid tier player to a position that would place it in the Top 10 gold miners globally, based on 2017 production figures.

Consequently, our two preferred bonds are:

  1. The investment grade Newcrest October 2022 bond with a coupon of 4.2%pa with current yield to maturity of 4.07%pa at a price of 100.50.
  2. The high yield IAMGOLD April 2025 maturity bond with a coupon of 7.0%pa with yield to maturity of 6.26%pa at a price of 104.0.

Background

Gold is a defensive asset class as generally it is considered to be a safe haven investment in times of economic or political uncertainty. On an historical basis, gold prices have not exhibited the same level of volatility as that of other asset classes such as oil, currencies or equities.

Just as oil is seen as a proxy for inflation, as it has a large weighting in the CPI basket, gold, being a physical asset, is broadly seen as a hedge against inflation. This is especially relevant where inflation overshoots expectations. Market participants often use the ratio of gold to oil prices to assess the trend and price movements. As the chart below indicates, this ratio is at one of the lowest levels. This ratio dislocation means oil is relatively expensive compared to gold. This assumes that there will be some sort of mean reversion in the prices. We are not attempting to make a comment on the price expectation of these commodities. Instead we are observing the trend in the price movement of these two assets, which prompts us to take a closer look at bonds related to gold mining.


Source: Bloomberg, FIIG Securities

As a physical asset, gold is a hedge against uncertainty, such as the sentiment caused by the current trade war between the US and China and the US and EU. Recent reports reveal that Russia is no longer one of the top 30 holders of US Treasuries, with speculation that the sovereign will invest these funds in other corporate bonds and gold instead in a bid to diversify investments. Speculation is rising that other countries may follow suit.

Furthermore, China is one of the largest consumers of gold. Hence prosperity of the Chinese economy leads to increased demand for gold. As the chart below indicates, there has been an increased demand for gold bars and coins from China over the past few years. According to the World Gold Council in 2017, Chinese demand for gold bars and coins was 306t, compared to 192t from Europe and 37t from the US.



Source: World Gold Council

A closer look at the miners

For bond investors seeking gold exposure, the following options are available:

  • IAMGOLD-7.00%-15Apr25-USD
  • KCN-5.125%-1Sept21-USD
  • KCN-5.95%-15Mar2024-USD
  • NEWCREST-4.2%-1Oct22 – USD
  • NEWCREST-4.45%-15Nov21-USD

Source: FIIG Securities. Prices accurate as of 27 July 2018 but subject to change

The table below compares some key credit features of the corporate issuers behind the bonds listed above.


IAMGOLD

Kinross

Newcrest

Rating

S&P: B+/Stable
Moody’s: B1/Positive

S&P: BBB-/Stable
Moody’s: Ba1/Stable

S&P: BBB-/Positive
Moody’s: Baa3/Positive

Operating mines*

4 - Canada (14%), Suriname (34%) and Burkina Faso (44%) plus a joint venture in Mali (8%)

8 - US (44%), Russia (22%), Brazil (13%), Mauritania (9%), Ghana (8%) and Chile (4%)

4 -Australia(44%), Papua New Guinea (41%), Indonesia (11%), Ivory Coast (4% - divested in fiscal 2018)

Reserves

Compared to other producers IAMGOLD has relatively low reserves, with proven reserves at 714 koz (less than one year production) and probable at 13,800 koz (15 years). However, this proven versus probable reserve gap is not unusual for a small, mid tier mining company such as IAMGOLD.

Kinross has proven reserves of 9.8m oz, which supports four years of production. However, based on proven & probables, reserves could support up to 10 years.

Newcrest has 65m oz of reserves and 130m oz of resources, providing about 26 years of cover (based on reserves alone)

Production costs

In 2017, the company’s production and all in sustaining cash costs were USD755 and USD1,003 per oz, respectively. This is expected to remain broadly flat in 2018. Including finance costs, the cash cost of production is about USD1,050.

The forecast all in sustaining cost for the year is USD975 per oz. (All in sustaining costs equal production costs, SG&A, sustaining capex reduced by revenue from by product). Considering financing costs represent about USD100 per oz, this gives an all in cost (before expansion & exploration capex) of about USD1,100.

All in costs including expansion and exploration were about USD925 per oz for fiscal 2018, and about USD1,000 per oz when including finance costs.

Leverage

Overall, leverage at 1.5x is much better than the rating might imply but the ratings reflect the company’s relatively small size.

 

Leverage is expected to increase marginally as a consequence, from about 0.6x (at the end of March) to about 1x to 1.5x by the end of 2019, still a relatively low level.

Leverage is about 1.4x at the end of Dec 2017 and expected to go down.

 

* Production percentages based on last full fiscal year and volume figures reported FY17

Conclusion

After considering the credit assessment and relative value of the gold miners, we prefer Newcrest over Kinross, in the investment grade offering. Whilst the credit fundamentals of the two companies are fairly comparable the one major difference is that Kinross is in an investment phase, which will lead to increased leverage over the medium term. Compared to this, Newcrest is deleveraging and expected to produce positive net cashflows after dividends over the same period. Additionally, Newcrest will continue to generate about 50% of its productions from high quality assets in Australia.

Investors with appetite for high yield bonds should consider IAMGOLD, which, in our opinion, provides superior relative value. The current ratings of B+/B1 are greatly influenced by the company’s exposure to jurisdictions in lowly rated countries (both Suriname and Burkina Faso are rated B by S&P) which will inherently maintain some constraints on any upward rating movement.

On the other hand, IAMGOLD presents a very low leverage compared to peers with USD392m of debt at the end of 2017, offset by USD664m of cash and EBITDA in excess of USD300m. Assuming all in sustaining costs including financing of about USD1,100 per oz and production of about USD900k oz for 2018, IAMGOLD would generate cash flows of about USD135m. Given non sustaining capex of USD225m, cash reserves would drop about USD100m, remaining well in excess of current debt.

IAMGOLD’s current expansion plans target production reaching 1.2m to 1.3m oz by 2022, with cash cost of production dropping by about 20% over the period. This trajectory of production growth would transform IAMGOLD from being a mid tier player to a Top 10 gold miner globally based on 2017 production figures.

You may also want to consider such other names as mining services companies Barminco or Ausdrill given their exposure to global gold mines. Please speak to your relationship manager if you would like factsheets or specific pricing around these or any other names.

Note: Please note that we added IAMGOLD to our DirectBond list before the introduction of our current filtering process in September 2017. This bond is on our list incorporating issues not meeting our filters because it is not covered by our third party independent credit research provider.