Is AngloGold Ashanti Worth the Risk?

Source: Thinkstock

Source: Thinkstock

AngloGold Ashanti (NYSE:AU) has been one of the worst performing gold mining stocks over the past several years. Its performance was so bad that at its trough in December, the company’s stock was actually lower than where it stood back in 2000 when the gold price was around $300/ounce! There are numerous reasons for this underperformance.

  1. The bulk of the company’s production is in Africa, and much of it is in South Africa. Mining investors hate investing in South Africa and the stocks of the companies that operate here are serial underperformers.
  2. The company saw production costs soar. At one point, in 2012 the company’s quarterly production costs reached over $1,500/ounce! This doesn’t include things like interest payments, manager’s salaries and other corporate expenses.
  3. The company’s production has been declining. Production collapsed from nearly six million ounces annually in 2006 to less than four million ounces annually in 2012.
  4. The company hedged a lot of its gold production, and it took a huge loss when it finally stopped doing so back in 2009.

In short, everything that could have gone wrong with a gold mining company went wrong with AngloGold Ashanti. Nevertheless, there are signs that the company is turning around. Of the four criticisms I list above, the only one that still seems to be an issue is the first one. The company still has about a third of its operations in South Africa, and another third is in the rest of Africa.

But otherwise, the company has been cutting production costs, growing production, and it is no longer hedged. Given these points, is now a good time to bite the bullet and buy shares in AngloGold Ashanti?

The numbers presented by the company certainly are compelling. In 2014, the company is providing the following projections:

  1. Production of 4.2 million to 4.5 million ounces versus 4.1 million ounces in 2013.
  2. Cash costs of $750/ounce to $790/ounce versus $830/ounce in 2013.
  3. All in sustaining costs of $1,025/ounce to $1,075/ounce versus $1,174/ounce in 2013.
  4. Corporate costs of $120 million to $140 million versus $200 million in 2013.
  5. Depreciation and amortization of $800 million; the same as in 2013.
  6. Interest and financing costs of $250 million versus $200 million in 2013.

Given these numbers, the company’s projected 2014 earnings at $1,300 is still negative, as the added costs above all in sustaining costs come in at about $285/ounce, which means that using the conservative $1,075/ounce AISC figure we get a total production cost of $1,360/ounce before taxes. But if we start figuring in a higher gold price we start to see the company’s appeal. For instance, at $1,700/ounce gold the company will earn $340/ounce before taxes, or $1.43 billion — not bad for a $7 billion company. If the company trades at just 10 times its pre-tax earnings, its shares can double if the gold price rises just $400/ounce, or 31 percent.

If gold doubles to $2,600/ounce, then the company’s pre-tax earnings per ounce will be $1,240, or $5.2 billion — at 10-times pre-tax earnings we see an awesome gain of 600 percent. Not only will the company’s annual cash flow give the shares a lot of leverage to the gold price should it rise, but the company has a lot of gold — over 200 million ounces!

But while there is a lot of upside potential in AngloGold Ashanti shares, keep in mind that there is a lot of risk here. We have seen that the company has had some serious issues in the past controlling its costs and growing its production. While it is projecting that it will be able to do these things risk-averse investors will want to see it before they believe it. Furthermore, there is the pressing issue of mining in South Africa, which has been plagued with political and labor issues. Given these concerns, AngloGold Ashanti is not for the faint of heart, but you are well compensated if you are willing to take the risk.

Disclosure: Ben Kramer-Miller has no position in AngloGold Ashanti.

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