The Nut Shell
In a bold move at the end of 2012, Gold Fields (GFI) opted to spin out a number of South African mines into a separate company, Sibanye Gold (SBGL). Gold Fields retained the South Deep mine as its only South African asset along with international assets in the portfolio; and Sibanye Gold was left to fend for itself on the back of three old and labour-intensive mines: the Kloof, Drifontein and Beatrix mines.
Today, the 29th of November, marks the first anniversary of the news release that made this decision public.
The rationale behind the company split was to rid Gold Fields from labour and profitability problems so prevalent with South African operations which had been disenchanting investors. At the time the move was hailed as a template for other large gold miners also based in South Africa and suffering from the same issues.
We believe that the experiment has failed to produce the desired outcome. And we also believe that the experiment has produced a surprise outcome for Sibanye Gold which seems to stubbornly outperform experts' low expectations.
In this article we will take stock of Gold Fields; and provide a valuation of the company one year after announcing the spin-off of Sibanye Gold.
The Company
Gold Fields is a mid-tier gold miner with corporate headquarters in South Africa. Production guidance for 2013 is just shy of 2M ounces of gold which puts the company among the top ten gold miners by gold production.
At a share price of just over $4 the market capitalization at the time of writing is $3B. The balance sheet shows adequate means to pay the bills in the foreseeable future judging by the current ratio of 1.65.
The debt to equity ratio of 0.4 does not sound too bad, although the company's debt has been providing some headaches recently. Of the $2.1B in total long-term debt, $750M matures in 2015 and $1B matures in 2020. The company is reported to have entered negotiations to restructure this debt in order to spread maturities out.
The company reported small earnings of $27M in the first quarter of the year, but followed through with a $129M loss in the second quarter. The third quarter turned positive again, but only just at $9M earnings. In total, earnings are a negative $93M after three quarters in 2013.
The company reported all-in sustaining costs of $1,265/oz and all-in costs of $1,402/oz for the first three quarters in 2013. Just to remind readers of the gold spot price: it has not closed above $1,400/oz for several months.
Impairments worth $129M were also announced as part of the second quarterly report; and the second quarter pain did not stopped there:
"Due to the significant decline in the gold price, the Group has made a loss for the quarter. Management and the Board are also concerned about gold price volatility in the short-term. As a result, the Gold Fields Board has deemed it prudent not to declare an interim dividend."
The chart below bears testimony to the struggle this year has turned out to be so far for Gold Fields. The company has clearly underperformed peers, and maybe even more notably it has also underperformed the abandoned child Sibanye Gold.
One Step Forward...
In August Gold Fields announced the acquisition of three mines in Australia from fellow gold miner Barrick Gold (ABX) in a $300 million transaction. This deal was highly accretive and opportunistic, being timed at the market bottom and boosting Gold Fields' Australian mines to a total of five. Australia now represents Gold Fields' largest regional production centre, with 42% of the group's production. The company had been operating two mines in Australia and expects to gain from synergies through the acquisition of the new assets. Gold Fields paid an exceptionally low price and is expecting significant free cash flow to eventuate from the new Australian assets. Judging from comments made by CEO Nick Holland at the Australia Down Under conference in August further acquisitions in Australia cannot be ruled out.
… one step back …
Labour unrest in South Africa in April and then again in August has led to a test of Gold Fields' strategy of dis-association from South African troubles. After much posturing by competing unions and gold miners alike, a brief strike was enacted, but surprisingly to many, this dispute was resolved within a few days.
Sibanye Gold's share price almost doubled upon realization that labour-related risk was not going to impact the company. Obviously, this risk had been priced in beforehand and Sibanye Gold's share price outperformed peers by a very healthy margin.
Gold Fields' share price, on the other hand, was affected negatively. It almost seems as if investors suddenly realized that despite cutting off most South African assets and 80% of the South African work force, the company was still exposed to the same old issues through ownership of the South Deep mine. This realization was compounded by news of an SEC investigation relating to the Black Economic Empowerment, or BEE, transaction associated with the granting of the mining license for the South Deep operation.
BEE is a program in South Africa designed to enforce the inclusion of black people in the ownership and management of South African companies. In a $200 million deal, a 9% stake of the South Deep mine was handed to a group of black investors. This deal has come under considerable scrutiny since it was revealed that an ANC chairwoman and relatives of ANC leaders were among the main beneficiaries. The deal is also being investigated by the South African police. Following from a review of the matter by the board, Gold Fields has admitted that the deal did not conform with internal standards and CEO Holland waived his 2013 bonus as a result.
… another step back.
Unsustainably high costs at some of the company's mines are another issue plaguing Gold Fields presently. A declining gold price has squeezed margins making it increasingly difficult for Gold Fields to operate profitably. The table below lists production and all-in sustaining costs for the operating mines, except for the newly acquired Australian assets. The diagram below illustrates all-in sustaining costs for the three quarters so far this year.
(click to enlarge)
(click to enlarge)
The one remaining asset in South Africa, South Deep, is still under development. Once it has reached steady state name plate production, it should produce around 750,000 ounces of gold annually. The current mine life is estimated to extend to 2092. The geometry and the nature of the ore body allow for highly mechanized mining techniques and presumably relatively low production costs. Ramping up is currently running behind schedule and contrary to initial projections, the mine will not break even this year. Although decreasing, All-in costs were still reported as $1,599/oz for the September quarter; a long way from profitable.
Labour issues with the local work force didn't stop at the well-known South African battleground for Gold Fields, but has also affected the two mines in Ghana, the Tarkwa mine and the Damang mine. Illegal strikes have cost the company dearly in the second quarter of this year and it remains to be seen if the present calm reached after extensive negotiations can be maintained. Controlling costs at these mines will be all but impossible unless these labour issues can be resolved in a sustainable manner.
Gold Fields has already flagged the possibility of putting Damang under care and maintenance. A decision will be made in the first half of 2014. The Tarkwa mine has been down-sized by closing the heap leach components and gold production will continue from the CIL plant only.
The company has also announced plans to change the price assumption for the reserve calculations to $1,300/ounce from previously $1,500/ounce. This might lead to further impairments towards the end of the year.
Of course there are also bright spots in the company's portfolio. The Australian assets are operating profitably (with the exception of the Darlot mine) and the Cerro Corona mine in Peru is also consistently reporting solid results.
The company has initiated measures to curb costs. The reduction of marginal mining commenced with the closure of the heap leach operation at St Ives in Australia; the withdrawal from mining the low grade Main and Rajah ore bodies at Agnew, also in Australia; and the closure of the South Heap leach operations at Tarkwa in Ghana. Restructuring after separation from Sibanye has led to a 5% work force reduction and to a reduction of corporate costs to $10/ounce. Capital projects and exploration have also been down-sized.
Valuation
In our valuation we have used discounted cash flow, or DCF, models for the Deep South mine, the Tarkwa and Damang mines, the St Ives and Agnew mines and the Cerro Corona mine. For our DCF models we have varied the annual discount between 5% for the Australian assets and 20% for Deep South to account for the variable risk characteristics. Obviously these discount assumptions are personal preferences of your humble scribe.
Furthermore we based cash flow calculations on all-in sustaining costs as reported for the third quarter; and a gold price of $1,300/oz. We considered mine lives as currently stated and production similar to this year's output.
For the Deep South mine we assumed long-term all-in sustaining costs of $1,200/oz and production of 750,000 ounces annually for 40 years.
The three newly acquired mines in Australia were considered with their purchase price of $300M.
The sum-of-parts total was computed to $2.32B. The attached diagram illustrates our results.
Considering market capitalization, debt and cash at hand we estimated an enterprise value of $4.57B or roughly double of our asset value estimate.
To be sure, there are many quite conservative assumptions baked into our asset valuation. Ramping Deep South up to nameplate production, improving the cost structure at the mines in Ghana and realizing the value for the new mines in Australia each would increase our valuation considerably.
The market seems to be optimistic and appears to assume that most of these upside possibilities will be realized. That may be fair enough, but it does not exactly make Gold Fields a bargain at the present point in time.
Meanwhile at Sibanye Gold
Sibanye Gold appears to be coming out of the initial slump that followed the listing of the company early in 2013. Quarterly results have been respectable, labour related problems have been managed better than anticipated and an interim dividend has been declared. In some ways, the spin off has given the company's assets a new lease on life. Cost reductions and near mine exploration have shown first results. A new mine plan will be published later this year and it can be expected to show extended mine lives for most assets. Investors who decided to hang on to their Sibanye shares after the split should not be too disappointed.
The Wrap
The recent deal in Australia appears to represent a great opportunity for Gold Fields. However, problems in labour relations in South Africa and Ghana are not to be under-estimated. The success of the cost cutting program and the ramp up of the South Deep mine are further topics investors will be monitoring in coming quarters. Realizing the value of the Australian operations will also be paramount to justify the current market valuation.
The market seems confident that Gold Field will overcome current challenges and has priced in substantial upside already. Valuation is therefore comparatively high and Gold Fields at $4 per share does not sound like a bargain in the current gold price environment.
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...)
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