Commodities | May 15 2019
McKinsey & Company warn that a lack of recent exploration investment threatens a gold reserve crisis, while Macquarie singles out Africa-based miners as solid growth prospects.
-Era of cost-outs leads to a lack of exploration
-Few significant gold finds in recent times
-Oz miners in Africa offering re-rate potential
By Greg Peel
The gold industry has endured a rollercoaster ride in the 21st century to date, with the gold price rising from US$255/oz in 2001 to US$1900/oz in 2011, before falling to US$1050 by end-2015. The soaring price in the noughties prompted global gold miners into aggressive debt-funded M&A programs, note researchers McKinsey & Company.
The near halving of the price from 2011 forced now debt-heavy miners to take hefty impairments and initiate dramatic cost-out programs. Between 2012 and 2017, all-in sustaining costs (AISC) declined by -20% to US$879/oz.
The gold price has since recovered some ground (to US$1300/oz at the time of writing) and the initiatives taken beforehand mean large gold miners are much healthier, McKinsey notes, enjoying stronger cash flows, leaner cost structures and deleveraged balance sheets. But what miners were not doing while engaging in this cost and debt rationalisation phase was investing in high cost, high risk exploration.
The result is gold reserves have declined by approximately -26% to 713moz, due partly to a -70% reduction in exploration spending as miners sought to preserve cash. This raises the uncomfortable prospect, McKinsey warns, of a looming reserve crisis.
During the noughties, miners sought to boost reserves through M&A, with the annual acquisition value peaking at US$38bn in 2011. The average price paid per ounce for acquired reserves in this period was often up to 300% prices a decade earlier. Such value destruction as a result of aggressive M&A means miners today are far more cautious at resorting to this approach to replenish reserves, McKinsey observes, despite price/earnings multiples of potential M&A targets having fallen back to decade lows.
Exacerbating the reserve replenishment challenge has been a lack of exploration success. Only a handful of greenfield projects have delivered significant gold discoveries above 6moz since 2006, and there are long lead-times between discovery and production.
As a result, relying on traditional greenfield strategies may not be the solution for growth either.
Hence, McKinsey suggests, the gold industry finds itself at an inflection point between the past cost-out and balance sheet deleveraging era and today’s need to focus on growth and reserve replenishment. Investors in gold miners looking for improved returns are unlikely to support the traditional means to reserve replenishment — significant M&A programs.
“The future strategic options to drive growth will differ across industry players,” Mc Kinsey suggests, “but all players will need to consider a mix of organic [exploration] and inorganic [acquisition] approaches if they want to return to growth in an economic and sustainable way”.
Out of Africa
ASX-listed West African gold developers Resolute Mining ((RSG)), Perseus Mining ((PRU)) and West African Resources ((WAF)) are trading at a -26% discount in price to net asset value terms to the rest of Macquarie’s gold coverage universe, and a -67% discount in enterprise value to FY21 production terms.
Yet at the same time, each of these developers is expected to deliver some of the highest rates of growth in the sector over a three-year horizon.
An element of geographic (sovereign) risk will always be present, Macquarie admits, but with high-quality geology and projects on the cusp of delivery, the broker sees strong potential for a production-led re-rating in a similar fashion to that enjoyed recently by Gold Road ((GOR)) and Alacer Gold ((AQG)).
The ramp-up of Resolute’s Syama underground project in Mali is expected by Macquarie to reach its planned 2.4mtpa mining rate late this year. Optimisation work at the company’s Ravenswood mine in Queensland is intended to lift production to above 5mtpa. The broker sees Syama delivery as a pivot point, providing significant cash flow fire power to grow the business.
Development of Perseus’ third mine at Yaoure in the Cote d’Ivoire is expected to more than double the company’s production outlook to around 500kozpa by 2022. Yaoure development is fully funded through a mix of debt and cash flow and first production is expected by late next year.
West African’s development of the Sanbrado project in Burkina Faso is well underway, Macquarie notes, the company continues to extend the high grade underground resource, offering the potential for further mine life extensions.
Over time, Macquarie expects the bolstered earnings potential of the three miners to unlock further growth and the maturation of their businesses.
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