AuRico Gold - Still Free Cash Flow Negative

Introduction

In this article I'll have a closer look at AuRico (AUQ) which has reported its Q3 financial results and has declared commercial production at its new Young-Davidson gold mine in Canada. I will provide my view on the financial statements and the balance sheet, and I'll look forward to the company's expected production rate. This will result in my investment thesis at the end of this article.

My view on the financial statements

In the third quarter of this year, AuRico produced almost 49,000 ounces of gold at an all-in sustaining cash cost of $1210 per ounce. The company generated $54.3M in revenues which resulted in an adjusted net profit of $800,000 for the quarter. Keep in mind this adjusted profit statement is capitalizing the revenue generated by the underground part of the Young Davidson mine.

As I've written in several previous articles, it makes more sense to look at the cash flow statements of mining companies instead of at the pure bottom line, as those cash flow statements might give a much better impression of the quality of the underlying assets.

So when we look at the cash flow statements, we see the company generated $24.3M in operational cash flow, which isn't bad at all. Unfortunately AuRico also spent in excess of $80M on capital expenditures, and there was a total net cash outflow of $69.6M (as the company also purchased 'investments' and paid a $9M dividend to its shareholders), meaning the company is still free cash flow negative. I understand AuRico's decision to pay a dividend, but I'd prefer the company to cut it as long as it's free cash flow negative. It doesn't make any sense to pay dividends if the cash flow is insufficient to cover it.

My view on the balance sheet

As of at the end of September, AuRico had a very healthy working capital position of $181.6M, which is a big drop from the $648M working capital at the end of 2012. The company's current ratio is a very decent 2.72 (keep in mind a ratio higher than 1 means the company has sufficient current assets to cover its current liabilities).

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At the end of the third quarter, AuRico's book value per share was $7.70, which means the company is currently trading at a discount of 49% to its book value. However, as I said before, investors in the mining sector shouldn't rely too much on the book value of companies. There are also some things on the AuRico balance sheet which are bothering me a bit. I'm not fully convinced about the $303M value for 'goodwill and intangible assets' on the balance sheet as it's not very clear where this amount of goodwill comes from.

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Another thing which really surprises me is that AuRico was able to increase the book value of its mines by an average 9.3%, despite the huge drop in the gold price since December 2012. I understand the value of the Young Davidson mine increases because it has started commercial production, but I'm really surprised to see a mining company increasing the book value of its mines by several hundreds of millions of dollars…

Outlook

AuRico tries to be a shareholder friendly company as it paid almost $30M in dividends and bought back its own shares for cancellation for a total amount of $300M. However, I'm not convinced a free cash flow negative company should do these share buybacks and dividend payments as long as there's no light at the end of the tunnel.

As AuRico will still be free cash flow negative in 2014, it might be wiser to save its cash position in case more rainy days are ahead of us. I also think these millions could be spent better, as this is definitely a buyers' market whereby cash-rich companies can acquire mining assets on the cheap.

Using a gold price of $1300/oz, AuRico will generate $0.28/share in free cash flow in 2015, and that's where the potential value of this company is. Using a 6% free cash flow yield as starting point, AuRico should be worth $4.75 by the end of 2015 (based on a gold price of $1300/oz).

Investment Thesis

AuRico still is free cash flow negative, and will remain in the negative territory throughout 2014. The positive takeaway is the fact that the company still expects to be free cash flow positive by 2015, so speculators should definitely take a position in AuRico if they believe in the continuous strength of the gold price.

However, I still think it isn't wise for the company to pay a dividend in a free cash flow negative stage, and I'd like the management team to change the dividend formula from the current policy which calls for a payout of 20% of the operating cash flow. I think a dividend policy based on the free cash flow would be safer and more fair.

It could be interesting for speculators to write a P4 March 2014 at $0.50 or a P3 June 2014 at $0.20. I might be interested in AuRico, but only at the right price, so I'm considering writing a P3 January 2015 for an option premium of $0.50. If the management indeed generates $0.28/share in free cash flow in 2015, I'm taking a position at a ratio lower than 11 times the FCF. And if I don't get the shares assigned to me, thanks to the high option premium I will have had an annualized yield of 14.8% while I'm waiting.

Source: AuRico Gold - Still Free Cash Flow Negative

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

Additional disclosure: I currently have no position in AuRico, but might write a P3 Jan 2015 as explained in this article.

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