Gold Fields Is Increasing Production, Decreasing Costs

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Gold Fields (NYSE:GFI) is one of the more misunderstood gold mining companies. It has a reputation of being a South African miner with high production costs and no production growth. And to a large extent, this was true until very recently.

With the fall in gold prices last year and concerns over mining in South Africa, Gold Fields’ management radically revamped the company’s portfolio. It spun off all but one of its South African assets into a new company, Sibanye Gold (NYSE:SBGL). It also purchased additional assets in Australia from Barrick Gold (NYSE:ABX). In doing so, the company greatly reduced its geopolitical risk. Now, the company gets more than 40 percent of its production from Australia and just 16 percent from South Africa.

In addition to this shift toward low-risk mining jurisdictions, the company has been doing an excellent job lowering costs. Seven out of the company’s eight mines were operating so that they would be profitable at the current gold price. The company expects its all-in production costs to come in at $1,150 per ounce this year. This means that the mine will be comfortably profitable at the current gold price.

Furthermore, the company is growing is production to 2.2 million ounces, according to its latest guidance, released on Thursday. This means that at the current gold price, the company’s pretax cash flow will exceed $350 million. That’s not bad for a company that has a valuation of just over $3 billion.

Going forward, the company should be able to continue to grow production. Its one unprofitable mine — the South Deep project in South Africa — is currently seeing a production ramp-up, which is costing the company money. But in the end, it should be a worthwhile endeavor. Right now, the mine produces more than 300,000 ounces of gold annually, with costs coming in at $1,436 per ounce. Going forward, production should more than double here. By 2020, the mine will produce nearly 700,000 ounces of gold at $800 per ounce. That’s $350 million in annual cash flow before taxes.

The mine also has an incredible reserve base, exceeding 30 million ounces. This makes it one of the largest gold deposits in the world. At 600,000 ounces of production per year, the mine can produce for over 50 years. The company’s one South African asset that investors are so concerned about is actually arguably its best long-term mine, and this fact offsets, to some extent, the political risk of mining in South Africa.

The company is doing an excellent job of executing a turnaround that is going to create a lot of long-term value for shareholders. But this value isn’t going to be reflected in earnings figures immediately. The South Deep mine is still a high-cost producer as the company continues to develop the asset in order to prepare it for more production. Also, the company has a fair amount of debt — over $2 billion. Servicing this debt is going to hurt the company’s profits.

Thus, while the stock is outperforming its peers for the year, it is still very depressed at just $4 per share, whereas it exceeded $25 per share in 2006. Investors are likely to remain skeptical of Gold Fields until it starts to generate more cash flow. But for those who have seen the company’s changes, there is reason to become confident that management will be able to execute its long-term goals. Such investors should consider taking a long-term position now.

There are certainly risks in doing so. Not only can the gold price remain depressed, but the South Deep project can be subjected to capricious government action. If either of these things happen, Gold Fields will wind up being a lousy investment. But if they don’t, the upside potential is incredible. In a few years’ time, the company’s production will be 2.5 million ounces annually, with production costs under $1,000 per ounce. Even if the gold price remains at $1,300 per ounce, the company can generate $750 million in annual pretax cash-flow — not bad for a company valued at $3 billion.

Given these points, Gold Fields is an intriguing investment for more aggressive gold investors, although keep in mind that it is not for everybody.

Disclosure: Ben Kramer-Miller has no position in Gold Fields or in any other stock mentioned in this article.

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