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Gold Fields: Strong Outlook But Prices Indicate Caution - SeekingAlpha

Tuesday, 20 August 2019

Summary

  • The H1 2019 earnings report showed strong results and potential for operational improvements through expected ramp-up of Gruyere by H2 2019.
  • With a recent debt refinancing scheme, GFI has improved its liquidity profile.
  • The $1.8 BB debt has a prolonged maturity profile but remains a key concern for management.
  • The decisionto build on South Deep operations was not an optimal one and increases challengesfor management.
  • The stock may testsupport at or near $5.

Until recently, Gold Fields (GFI) has shown strong price performance in the recent bullish gold run. The company's fundamental strength stems from its healthy gold production that's likely to enhance going forward, thanks to the Gruyere mine that delivered its first production in Q2 2019. On the flipside, GFI's significant LTD and safety concerns at the deep underground operations at its South Deep mine are the key issues facing management. A broader view (that incorporates both fundamental and technical performance indicators of GFI) suggests that the stock could move above $6 during H2 2019, a caveat being that gold prices must remain strong.

Gold has gained more than 16% since mid of May 2019, and GFI has followed suit with a ~70% climb (from $3.59 to $6+), demonstrating a correlation factor of ~4.5x. Historically, GFI has shown a correlation between ~5-8x with a bullish gold market, and the below-average correlation we are seeing here points towards certain risk factors.

It came as a shock to investors that despite a continued gold price hike and following a solid Q2 earnings report, the stock dropped by ~10% intraday. In my view, the market has not responded favourably to GFI’s plans to increase its operational dependence on the SD mine (read: South Deep) in South Africa. In terms of underlying resources, this mine is very attractive as it’s expected to contain ~37 Moz and 66 Moz in gold reserves and resources respectively. Nevertheless, the negative tags associated with the mine are much stronger. For reference, SD yielded AIC of $1,992/oz during Q2 2018 and this was way above the average realized gold prices during that quarter, which means that SD has so far been a drain on GFI’s cash assets, and has also affected its overall operating margins. Plus, SD operations have a history of being unsafe, and the company recently reported another casualty at this underground mine.

Such incidents often ignite union strikes and attract undue attention from the authorities. Investors were hoping that GFI would exit South Africa by disposing of the SD mine to de-risk its asset portfolio and improve overall AIC. The company’s plans to expand its operational footprint at SD were a setback for investors and this explains the sharp intraday decline despite a strong H1 2019 report. My take is that given the rising gold prices and Q2 AIC of $1,275/oz ,GFI could steer this mine towards profitability through increased automation, and this could eventually create a sustainable stream of cash flow generation. Nonetheless, this will require time and effort on part of management and patience on the part of investors.

GFI is fundamentally strong, and has recently emerged from a phase of high capex spending that has enabled it to commence production at its Gruyere project, and also improve the mining prospects at Damang. Besides, it has transformed its net cash flows from negative to positive and seems set to build on this trend, going forward. Gruyere is a new addition to GFI’s asset portfolio and is expected to add between 75-100 Koz in annual gold production in a safe mining jurisdiction (Australia). The mine is in the ramp-up stage and is expected to reach its nameplate processing capacity of ~8.2 Mtpa by year-end (Figure-2). With positive cash flow generation, GFI is well-positioned to fund the mine’s expansion capex. The added production potential would definitely help in a bullish gold market.

However, despite its strong fundamentals, a couple of recent strategic decisions have made investors wary of GFI’s management. The company reported net debt of ~$1.8 BB at the end of H1 and had recently raised ~$ 1 BB in fresh debt that was used to pay $250 MM of loan notes maturing 2020 and part of its $1.29 BB debt under the Credit Facilities Arrangement. With this settlement, GFI has effectively spread its debt maturities over the next decade (Figure-3).

The problem is, GFI also disposed of its 20% non-core investments in Maverix Metals (MMX) and Red 5 for a total of ~$88 MM (sold at a profit) to reduce its debt burden. MMX is a gold royalty and streaming company that’s fast-advancing its diversified portfolio of gold/silver assets (Figure-4). As MMX increases its royalty interests in mining properties, GFI forgoes the opportunity to benefit from the situation.

The problem is, GFI also disposed of its 20% non-core investments in Maverix Metals (MMX) and Red 5 for a total of ~$88 MM (sold at a profit) to reduce its debt burden. MMX is a gold royalty and streaming company that’s fast-advancing its diversified portfolio of gold/silver assets (Figure-4). As MMX increases its royalty interests in mining properties, GFI forgoes the opportunity to benefit from the situation.

Moreover, instead of selling the MMX property for ~$68 MM, GFI would have done much better to consider the disposal of the SD mine that poses certain challenges (as discussed earlier) and requires management to prove its skills to convert it into a profitable mine. Had management gone for disposal of SD mine, they could have bagged significantly greater cash that would be enough to pay a sizable portion (if not all) of its towering ~$1.8 BB debt.

Meanwhile, gold continues to rise in the wake of a continuing trade war, concerns over the Fed’s monetary policy, and recessionary fears. Gold’s technical picture shows it will likely find resistance at $1,550/oz (Figure-5). However, contrary to its historical mirroring of gold, GFI may suffer from bearish sentiments for a while, and may well find support at or near $5 (Figure-6).

Although GFI’s management has maintained full-year production guidance between 2.13-2.18 Moz of gold, the next two quarters are important as we shall see how management’s plans at the SD mine will turn out. Also, the timely ramp-up of Gruyere's processing capacity by year-end will support the momentum in share price that was triggered by a bullish gold run.


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