Should You Buy Sibanye Gold?
Back in 2013 when gold miners were starting to realize that they needed to eliminate risk in all of its forms — risks related to costs, exploration, and geopolitics — one of the largest gold miners, Gold Fields (NYSE:GFI), spun off a new company in order to eliminate geopolitical risk from its portfolio. This new company is Sibanye Gold (NYSE:SBGL).
Sibanye Gold consists of three of Gold Fields’ South African gold mines. The latter company kept one South African gold mine — its tremendous South Deep Project, while shifting its emphasis towards its projects in Ghana, Peru, and most importantly, Australia.
The decision was based on the fact that South Africa is a risky place to mine. This is especially true of Gold Fields’ former projects, which are deep underground mines. These are the mines that have dangerous working conditions that workers protest against, and as a result, these mines have a higher risk of shutting down than most others.
In spinning off Sibanye Gold and in making subsequent moves into Australia, I think Gold Fields made itself a more intriguing investment, although as an investment it is not without risk.
But what about Sibanye Gold? Aside from the glaring red flag of operating in South Africa, there seems to be a lot to like about this company. As an investor in gold miners, I want global exposure. While I overweight companies that operate in lower risk mining districts, I am comfortable putting small amounts of money into companies that operate in riskier mining districts assuming that I am being paid to take this risk.
Sibanye Gold falls into this category. While it certainly isn’t for widows and orphans, there is enormous potential upside in this stock. Sibanye Gold has markedly outperformed its peers since going public in February 2013. Its stock is up nearly 30 percent while the broader sector, as measured by the Market Vectors Gold Miner ETF (NYSEARCA:GDX), is down nearly 40 percent during the same time period.
Nevertheless, Sibanye Gold is still a relatively inexpensive company with 1.5 million ounces of estimated production this year, over 75 million ounces of gold resources, and just a $1.75 billion valuation.
Furthermore, the company has done an excellent job of lowering its production costs, which came in at just $1,043/ounce before taxes in the six months ended December 2013. That amounts to over $250 million in annualized post-tax profits assuming South Africa’s corporate income tax rate of 28 percent. That’s a lot for a company trading with a valuation of just $1.75 billion, especially considering that the S&P 500 trades at over 20 times earnings.
Investors are right to be concerned that Sibanye Gold is operating in South Africa, but this fact in itself should not preclude you from investing. It simply means that you should pay less for the company’s expected earnings going forward.
But if you are going to invest in a mining company operating in South Africa, Sibanye Gold is a particularly good way to go about doing this. The fact that the company operates solely in South Africa gives it a uniquely insightful perspective with respect to the regulatory environment and workers’ demands. I think this eliminates a lot of the risk of operating in South Africa. We see this, for instance, in the company’s new two-year labor contract that increases wages. This keeps workers happy and more productive, and it also fixes labor costs in the near-term, which eliminates an element of uncertainty.
Thus, while I don’t think that Sibanye Gold should trade at the same valuation as, for instance, Agnico Eagle Mines (NYSE:AEM) — which operates in Canada, Mexico, and Finland — 7 times 2014 earnings seems to be too cheap to ignore. Even if we take into consideration that production will fall if the company fails to expand its mining operations (all of the company’s mines will see slowly diminishing production otherwise), the company still trades at a relatively low valuation with respect to its 2015 or 2016 earnings, which should be around $200 – $225 million. But in all likelihood, management will be able to keep up its current production levels.
Given these points, Sibanye Gold is an intriguing investment at the current valuation. Nevertheless, when it comes to high risk investments such as these, I think the best strategy is to wait for a pullback. High risk investments often have to digest negative news, and we often have situations in South Africa where the government does something that investors perceive to be anti-business and capricious, or where miners decide to strike or to threaten to strike. One little story gets blown way out of proportion, and investors sell anything related to mining in South Africa. While Sibanye Gold has avoided this scenario for the time being, it will almost certainly repeat in one form or another in the future. Sibanye Gold shares will fall, and I think the smart money will be buying.