The Comprehensive View of Kinross Gold
Jan 19th 2012 5:08PM
Updated Jan 19th 2012 5:12PM
Someday, shares of Kinross Gold (NYS: KGC) will be worth more than they are today. Of that, I feel certain. But if recent history and the company's latest disappointment offer any guide, this is one vehicle in the gold patch that cannot guarantee a smooth ride.
Kinross triggered a noteworthy selloff of its shares this week by announcing a major review of its project-development plans and an impending non-cash impairment charge relating to goodwill from its $7.1 billion merger with Red Back Mining in mid-2010.
The monkey on Red Back's back
Although the Red Back deal's valuation of the Tasiast project in Mauritania baffled and miffed many industry observers at the time, CEO Tye Burt referenced during a conference call this week the sort of resource expansion that was required to justify the transaction. Burt stated: "Remember that there were 8 million ounces when we acquired it, acquired the asset; now we've done the drilling to define 21 million ounces." Comparing that reference with the last official resource estimate from Kinross, an encouraging resource upgrade for the project appears to be on tap.
I believe it is critical for investors to avoid mistaking the impending goodwill impairment as a signal of the project's failure to broadly meet expectations. Rather, I believe the goodwill charge has more to do with systemic impairment of gold asset valuations throughout the industry, mounting cost pressures, and ongoing tweaks to the mine plan. In a nutshell, Kinross is now contemplating a heap-leach operation to process the "significant tonnage of lower-grade halo material" surrounding the deposit's high-grade core, and the delay of six to nine months inserted into the project timeline relates to the period required to conduct a test heap-leach cycle.
The underlying deposit, meanwhile, remains a gorgeous strategic asset with plentiful room for expansion. Noting the 70-kilometer expanse of the district-scale target, Burt avows: "We believe that Tasiast is much more than a gold mine with expansion potential. It is a world-class emerging gold district that will continue to evolve for many years."
From golden premiums to memorable bargains
In sharp contrast to the pretty penny spent to acquire Tasiast, Kinross snatched the Lobo-Marte project in Chile for a song in 2008. Prior stakeholder Teck Resources (NYS: TCK) was fighting for its very life back during the credit crisis and unloaded most of its gold assets in a hurry. Kinross emerged the clear beneficiary by acquiring Lobo-Marte for just $250 million, or $42 per ounce in reserves.
Kinross paid $1.2 billion for the Fruta del Norte asset that same year when it acquired Aurelian Resources. For the asset's inferred resource (at the time) of 13.7 million high-grade ounces of gold, the deal amounted to less than $88 per ounce. Today, 6.8 million ounces of gold at Fruta del Norte has been converted to proven and probable reserves, carrying an astonishing average grade of 8 grams per ton! The only problem I have with this asset is its location. Having lived in Ecuador for several years, I am wary of the political landscape there. Initial negotiations with the Correa administration set a new precedent within the industry by targeting a 52% piece of the revenue pie for the Andean nation. Kinross is currently seeking more favorable terms, and that process factored into the decision to pause the entire trio of development projects for further strategic evaluation.
When the stakes are this high, get it right
After several years of encouraging Fools to avoid Kinross Gold, I recently changed my tune by adding the major miner to the tail end of my top 10 list of gold stocks for 2012. I am not necessarily regretting that decision, but suffice it to say the odds are now stacked against my pick as a potential sector-outperformer this year.
My investment thesis began with the share valuation and the limited downside risk associated with such a deep-value play. After this week's unexpected drubbing, each of Kinross' 63.3 million ounces in reserves are now valued at less than $180! For comparison, consider that my No. 4 pick -- Goldcorp (NYS: GG) -- possesses a gold-reserve stash of similar scale that is valued at $572 per ounce. What's more, because I believe Goldcorp will deliver with brilliant execution the dreamy sort of production-growth scenario that Kinross just stepped back from; I view Goldcorp itself as substantially undervalued beneath $50 per share.
On the flip side of one of the industry's more tragic trailing stock performances over recent years, then, lies one of the industry's cheapest valuations on a reserve-ounce basis. A look back over a five-year chart shows the road that led to this condition in gory detail:
After a dastardly showing in 2011, Kinross' share performance over the past five years has lagged the benchmark Market Vectors Gold Miners ETF (NYS: GDX) to a troubling degree, recording a 15% decline while rival Goldcorp has yielded nearly an 80% advance. Truly, I find it incredible to see Kinross shares writhing beneath where they stood five years ago, when gold fetched just $635 per ounce! My bullish CAPScall on the stock has been in place since late 2006, and thus far it has served only to remind me of a golden promise unfulfilled. You see, I was a shareholder of Bema Gold when Kinross purchased that stock for $3.1 billion back in 2006, and I had high hopes for the miner's prospects to leverage those high-quality assets (currently Kinross' Kupol and 25%-owned Cerro Casale mines) into one of the industry's leading growth trajectories. Barrick Gold now holds 75% of the Cerro Casale joint venture. Looking over the stronger trailing performance of B2Gold (OTC: BGLPF.PK) -- founded by Bema's management team after the Kinross transaction -- I find myself wishing I had stuck with Bema's people rather than Bema's assets.
But Tye Burt and his team at Kinross may yet prove their mettle. Before pumping $6 billion to $7 billion into its trio of major growth projects over the next few years, Kinross has opted to dial back its timeline a bit in favor of careful planning to remove some execution risk and ensure the optimal allocation of that precious capital. Given what is at stake for the company, I cannot argue with a conservative approach. Although the company is wrestling with rising production costs and other challenges at existing operations, let's not lose sight of the fact that Kinross still expects to produce more than 2.6 million gold-equivalent ounces during 2012. I still view downside risk from present levels as extremely limited, and I consider the shares an interesting prospect for the value-driven gold investor.
- Add Kinross Gold to My Watchlist
- Add Goldcorp to My Watchlist
- Add Barrick Gold to My Watchlist
- Add Teck Resources to My Watchlist
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At the time this article was published Fool contributor Christopher Barker can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of Goldcorp and Teck Resources. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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