Reasons to Avoid AuRico Gold
AuRico Gold (NYSE:AUQ) reported its fourth-quarter and 2013 earnings figures on Monday. The shares fell more than 6 percent in response. True, the gold price was down a little more than 1 percent; however, gold mining stocks held up fairly well, with the Market Vectors Gold Miner ETF (NYSEARCA:GDX) falling less than 1 percent and the Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ) actually rising slightly.
I think this fall in price reflects some real issues at the company. Further, while the stock has performed roughly in line with its peers so far this year to date, I suspect that we will see the shares underperform long-term.
The company reported operating cash flow of 7 cents per share, or $17 million, and it reported a loss of $106.4 million due to write downs (a common occurrence for gold miners in this environment). While the company bragged that it made a significant step forward in commencing underground production at its Young Davidson mine in Canada, it has yet to demonstrate that this mine is going to be economically feasible when we take all costs into consideration.
The company already suffered from razor-thin margins with its fourth-quarter all-in sustaining costs coming in at $1,232 per ounce. As was expected, the company’s costs rose in the fourth quarter as a result of the added cost of bringing the Young Davidson underground operation online. Still, we saw all-in sustaining costs come in for the year at $1,181 per ounce. While this makes the company profitable on an operating basis, we need to take a step back and view this figure in a broader context.
AuRico Gold has a market capitalization of $1.17 billion, with $140 million in cash and $170 million in long-term debt. It produces around 200,000 ounces of gold on an annual basis and it plans to increase this figure to about 300,000 ounces per year by next year. With this valuation and production level, AuRico gold shares are intrinsically overvalued unless the company produces with incredibly low costs.
For instance, if it wants to trade at 20 times 2015 cash flow, then with gold at $1,300 per ounce and 300,000 ounces of production, the company needs to generate about $200 per ounce of gold produced. With taxes, this means that the company needs to generate a pretax profit of about $300 per ounce, and therefore the company needs to bring costs down to $1,000 per ounce from around $1,200 per ounce.
This is no easy feat. Now consider that a stock trading at 20 times cash flow is pretty expensive. If we start to bring this multiple down, we see that the company needs to start generating a lot more cash than it currently is in order to justify its current valuation. This seems to be incredibly unlikely, especially since — as the company’s fourth-quarter and full-year figures demonstrate — costs are rising.
While the market apparently has extremely high expectations for the company regarding its production growth and its cost of production going forward, investors need to keep something else in mind. Last year, the company instated a fairly aggressive program whereby it instituted a dividend and repurchased its own shares. The company bought back nearly $300 million worth of its own stock between $6 and $8 per share. With the stock trading under $5 per share, this seems like a waste.
This apparent waste becomes more acute when we consider that the shares of many small gold mining companies collapsed in value last year — in many cases, we saw company’s shares fall 75 percent or more. This means that this $300 million could have gone toward a far more producing source, and I can’t help but conclude that the company mismanaged shareholders’ hard-earned capital.
With that being said, we have a company that is trading at a rich valuation. While it has some near-term growth, it still has an issue containing production costs. This means that unless the gold price rises dramatically, the shares trade at a very rich valuation relative to expected cash flow even after the anticipated production expansion.
And if this wasn’t bad enough, the company’s management has a history of poor capital allocation that may be repeated in the future. Therefore investors should avoid AuRico Gold shares, and I think more aggressive traders may even consider taking a short position, especially if it is hedged by long positions in other, higher-quality mining companies.