Kinross Gold Is Trading at a Discount


At first glance, Kinross Gold (NYSE:KGC) appears to be a miserable investment. If you look at the chart, you’ll see that the shares have lost four-fifths of their value since peaking above $25 per share in 2008. If you look at the company’s financials, you will see several large write-downs in the hundreds of millions or even billions of dollars. You will also see a discontinued dividend. But these prima facie warning signs mask underlying strength that make this stock ideal for contrarian investors who are looking for an inexpensive cash-flow generator going forward.

Like many gold mining companies, Kinross Gold was hit particularly hard by the recent correction in the gold price. In fact, shares of Kinross have sunk to their lowest level since 2002. But while many investors are viewing this as a warning sign, I think a lot of the company’s bad news is behind it, and the company’s 80 percent discount to its 2008 high is a rare buying opportunity.

Kinross has suffered from many of the problems that have plagued the major gold miners that strived to produce as much gold as possible without much concern for the cost of extracting this gold. As a result, while Kinross grew, production costs grew, as well. Even as the price of gold was rising, the company wasn’t meaningfully increasing is profits. As a result, the company was hit especially hard as the price of gold began to fall in 2011 while the cost of producing gold remained elevated. Much of the gold that Kinross’s management believed to be economical to mine in fact wasn’t.

Falling gold prices served as a reality check for Kinross’s management, who took swift and drastic action in 2013. First, the company abandoned its Ecuadorian Fruta del Norte project in June due to a punitive taxation regime. Second, the company ceased production at its La Coipa project in Chile due to low gold prices. Finally, management downgraded several million ounces of mineral reserves to mineral resources, meaning that it no longer believes that they are economically feasible to mine given the current gold price environment. This led to a 40 percent decline in total gold reserves from December 31, 2012, to December 31, 2013. Furthermore, all of these actions led to billions in write-downs.

But while the company has fewer producing mines, it is actually increasing gold production.  This is due to increased production at its Paracatu mine in Brazil, its Tasiast mine in Mauritania (West Africa), and new production from its Dvoinoye mine in Russia. Furthermore, management has cut costs dramatically. By reclassifying several million ounces of gold reserves as resources, the reserves that are left to mine are higher grade and therefore cheaper to mine.

The end result is that Kinross is prepared to generate a lot of free cash flow in 2014, even with the gold price where it is. Management expects to produce 2.6 million ounces of gold with all in sustaining costs between $950 per ounce and $1,050 per ounce. At $1,300 per ounce gold and $1,000 per ounce production costs, this means that the company will generate $780 million in pretax cash-flow — not bad for a $6 billion company. Further, if the gold price rises even modestly to $1,600 per ounce (not even a 25 percent rise) then this free cash flow will double.

Ultimately, many gold mining companies have reacted to the lower gold price environment by claiming that they are concerned with producing higher-quality ounces (aka ounces that generate free cash flow) as opposed to a higher quantity of ounces. However, not every mining company devoted to this new philosophy has actually followed through with it. Even if they have acted, few companies have done so as aggressively as Kinross. This new approach will allow Kinross to generate cash flow and profits even if the gold price remains depressed, and it will augment the company’s profits going forward as the long term bull market in gold continues.

Nevertheless, investors have pretty much ignored Kinross’s advancements. This means that Kinross is a company that is not only inexpensive on a quantitative basis, but Kinross’s adaptive management team is trading at a discount, as well, and therefore Kinross Gold shares are currently a “buy.”

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