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Salares Norte is a game-changer for Gold Fields - Seeking Alpha

Monday, 9 November 2020


Gold Fields had a solid first half operationally, with gold production up marginally year over year despite COVID-19 related headwinds.

While the stock was previously getting expensive on a valuation basis in July, the fact that gold has found a floor near $1,800/oz has pushed earnings estimates significantly higher.

Meanwhile, the company has made a positive construction decision on Salares Norte, a project that should transform Gold Fields into a low-cost gold producer.

While I see better opportunities among Tier-1 jurisdiction gold producers, the competitive dividend yield and strong earnings trend make the stock a buy on any dip below $10.60.

It's been an exciting year for investors in the Gold Miners Index (GDX), which is especially true for investors in Gold Fields (GFI). The stock has massively outperformed its peers this year with a 95% return year to date, driven by increased gold production, and a positive construction on the massive Salares Norte Project. While I previously highlighted the stock as a Sell above $12.60 in Q3, earnings estimates have continued to climb, with the gold (GLD) price barely pulling back. This has improved the stock's valuation considerably. Therefore, while I continue to see better opportunities among Tier-1 jurisdiction miners, Gold Fields' competitive dividend yield and strong earnings trend make it quite attractive below $10.60.

Just over three months ago, I wrote on Gold Fields and discussed that any rallies above the $12.60 level would be an opportunity to book some profits. The stock headed above this level briefly before pulling back nearly 20% from this level as the Gold Miners Index made new 60-day lows just before the Presidential election. However, while the decision to take profits above $12.60 might have been correct in Q3, the company's earnings estimates have climbed rapidly since after a strong first half operationally, with the Gruyere Mine picking up the slack for minor COVID-19 related headwinds. Let's take a closer look below:

As shown in the table above, it was a solid first half for Gold Fields with attributable gold production of ~1.09 million ounces, up from ~1.08 million ounces in the year-ago period. While a less than 1% increase in gold production is nothing to write home about, it's important to note that this occurred during a year with unprecedented headwinds for the sector, with many mines unable to operate at full capacity and some mines shut down altogether. Two of Gold Fields' mines were affected in the period, with South Deep in Africa and Cerro Corona in Peru both seeing lower gold production. Fortunately, the company's new 50%-owned Gruyere Mine in Australia picked up all of the slack.

Given the slightly higher gold production combined with a much higher gold price, Gold Fields generated ~$1.64 billion in revenue in H1 2020, a 26% increase from the ~$1.30 billion in revenue during H1 2019. This translated to a massive increase in net mine cash flow, which grew 300% year over year from $80 million to $320 million. Unfortunately, costs did come in higher on a year-over-year basis, with all-in sustaining costs of $987/oz in H1 2020 vs. $891/oz in the year-ago period. However, this included a $20/oz headwind from COVID-19-related costs, higher sustaining capital, and a lower copper price, which led to lower copper credits to help bring down all-in sustaining costs. Therefore, I don't see any reason to be alarmed by the slight escalation in costs. It's worth noting that the company has maintained its cost guidance mid-point of $960/oz, which will come in below the industry average.

Finally, given the strong cash generation, we saw a sharp decrease in both net debt and the company's net debt-to-EBITDA ratio. As shown above, net debt decreased to $876 million at the end of H1 2020, excluding lease liabilities, or ~$1.24 billion when they are included. The latter figure was down more than $420 million year over year from ~$1.66 billion in the same period last year. Assuming similar cash generation in H2 2020, we should see net debt, including lease liabilities, fall below $1 billion, which would significantly improve the company's leverage ratio relative to other million-ounce gold producers.

Gold Fields has traditionally been thought of as an African gold producer, but it's important to note that African gold production makes up barely 40% of its portfolio. This means that the company's peers are names like AngloGold Ashanti (AU), Kinross Gold Corp. (KGC), which have a mix of Tier-1, Tier-2, and Tier-3 jurisdictions in their production profile. Therefore, Gold Fields should be closer to the multiples for these two companies, and not near the compressed multiples of names like Harmony Gold (HMY) which is a strictly Tier-3 gold producer. Let's take a look at the company's earnings trend below:

Gold Fields has seen a massive increase in annual earnings per share (EPS) estimates since July, with the current earnings trend shown above and the previous earnings trend (July 2020) shown below. As we can see, FY2020 estimates have climbed by more than 50% from $0.48 to $0.76, and FY2021 annual EPS estimates are up from $1.18 to $1.58. This has significantly improved the company's earnings trend, as FY2020 annual EPS estimates are now expected to grow by over 250% year over year ($0.76 vs. $0.20), and be followed up by another year of triple-digit growth in FY2021 if the company meets next year's forecasts ($1.58 vs. $0.76). These are incredible growth figures, making Gold Fields a top-150 growth stock currently in the US market with expected back-to-back years of triple-digit earnings growth and a compound annual EPS growth rate of over 100% from FY2019 to FY2022 estimates ($1.62 vs. $0.20).

However, it's important to note that the growth is not done here, with the company recently approving the Salares Norte Project in Chile, a massive gold project with the potential to produce up to 450,000 ounces of gold for the first five years and 350,000 ounces per year over the mine life. The initial capex for the project is certainly not cheap at ~$834 million, but Gold Fields has secured ample funding for the project without significantly increased its net debt due to its impressive cash generation with higher gold prices.

The benefit to Gold Fields from Salares Norte is extremely significant, and while it's one of the most expensive undeveloped gold projects worldwide, it's also one of the lowest-cost ones. As the chart below shows comparing large-scale gold projects, Salares Norte's all-in sustaining costs are projected to come in at $545/oz, nearly 50% below Gold Fields' current cost profile. This should lead to Gold Fields becoming a low-cost producer among its peers once the project achieves commercial production in H1 2023, as Gold Fields will see a 20% increase in its annual gold production at 45% lower costs (H1 2020 costs: $1,087/oz). Assuming these projected costs are met, Gold Fields should have no problem becoming a sub-$900/oz producer, while simultaneously improving its jurisdictional rank. This is because Chile is a high Tier-2 jurisdiction and will further dilute its reliance on African gold production. Let's take a look at the valuation following the recent jump in earnings estimates:

As shown in the chart below, there is a wide range in valuations across the sector, with the largest gold producers like Agnico Eagle Mines (AEM), Newmont (NEM), and Barrick Gold (GOLD) commanding the highest multiples. Currently, the median forward P/E ratio for million-ounce gold producers across all jurisdictions is 13.3, and Gold Fields is sitting at 10.7, a 20% discount to the peer group. I would argue that this a fair valuation, given that Gold Fields is a Tier-2 gold producer with an average production profile relative to the group and slightly higher costs. However, once Salares Norte comes on-line, there's no reason that Gold Fields shouldn't command a slight premium to the average name in the group. Therefore, while the valuation isn't overly attractive at current levels, it certainly is not a headwind anymore given the sharp increase in annual EPS estimates.

If we look at Gold Fields from a dividend yield standpoint, it's also near the middle of the pack, with a dividend yield of 1.65% vs. a peer average of 1.50%. This is good news for shareholders, especially if we see a slight increase in the annual dividend rate at year-end as Gold Fields makes up for its reliance on African gold production with a higher yield than its peers. Currently, the company pays a much more attractive yield than its peers reliant on African gold production. This is because both Barrick Gold and AngloGold Ashanti have dividend yields below 1% as well. However, B2Gold does have Gold Fields beat with an industry-leading yield of 2.29%.

While valuation was previously a significant headwind as we entered Q3 for Gold Fields, the strong first half operationally and massive bump in earnings estimates has improved the valuation here. At a current forward P/E ratio of 10.7 and with Gold Fields on track to deliver two consecutive years of triple-digit earnings growth, I would argue any drop near the October lows would make the valuation attractive again. Therefore, while I currently see more attractive opportunities out there in safer jurisdictions like Kirkland Lake Gold (KL), any pullback below $10.60 for Gold Fields is a low-risk buying opportunity.

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