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As the world inches agonisingly closer to a potential GFC2, investors everywhere frantically search for safer places to park their cash.  Gold is the place many experts advise us all to go, and indeed has seen price appreciations few would have imagined a decade ago.

Astute investors know investing directly in the companies that mine for the precious metal has advantages over buying the metal itself.  In early 2010, Australian investors had three prominent mining operations from which to choose – everybody’s favorite Newcrest Minerals; Lihir Gold (LGL); and Kingsgate Consolidated (KCN).

In August 2010, NCM gobbled up Lihir at the cost of approximately 10 billion dollars, leaving Aussie investors with only KCN as one of the few alternative gold miners.  With its recent acquisition, Newcrest has become the fifth largest gold producer in the world and was highlighted with a buy recommendation from analyst Shawn Uldridge of William Shaw Securities in last week’s 18 Share Tips column on TheBull.

Before looking into the numbers for NCM and its junior competitor KCN, let us review the bull and bear case for gold mining shares as a safe haven.

First, with the price of gold going ever higher, it is easy to assume that a team of well-trained gorillas could manage a gold mining company and produce a healthy profit.  When the price of whatever it is you produce rises with little direct connection to what you do; what more can you ask?  Bears sagely point out; you still have to get the metal out of the ground at the lowest cost possible.  

Second, the future of global economic growth is uncertain at best and dire at worst.  While the GFC2 predictions would require a perfect storm of events coming together in synchronisation, no one is predicting the opposite.  Search as long as you like, and you will not find a single major economist with a dramatically rosy economic outlook for the next few years.  There are pockets of light – mostly in the Asia Pacific region as well as in Canada – but absolutely no one is predicting robust growth world wide in the near future.

This bodes well for the continued rise in the price of gold.  While the appreciation might moderate and even slow down a bit in the event things improve more than expected, the much anticipated bursting of the gold bubble is not likely to occur anytime soon.

Finally, the share price of gold mining companies has not kept pace with the price of the commodity itself.  In uncertain times, panic selling drags down all shares, with not much concern for their longer term fundamentals.

In short, considering the continued economic uncertainty well into the future, gold still seems to be something every investor would want to have in his or her portfolio.

Now, courtesy of Thompson/Reuters First Call; let us look at how the analyst world views these two Australian gold miners.

For Newcastle, 14 analysts have a Strong Buy or a Buy rating – evenly divided at 7 each.  Four analysts have a hold rating, and none have an Underperform or Sell rating.

For Kingsgate, 9 analysts have a Strong Buy or Buy rating, with 6 at a Strong Buy and 3 at a Buy.  Five analysts have a Hold rating and one rated KCN as underperform.  

How do actual market participants view these two miners?  First, let us look at a share price movement chart for the past year.

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The chart speaks for itself.  As one might expect from a small cap, the price movements for KCN appear more pronounced, even when both shares are moving in the same direction.  You see higher highs and lower lows for NCM compared to KCN.

Now let us look at the market capitalisation and some market valuation ratios for the two companies.

Market Valuation Ratios

  NCM KCN Materials Sector
MC (Market Capitalisation) 30,409 Million 1,178 Million N/A
P/E (Price to Earnings Ratio) 25.47 25.48 12.42
P/B (Price to Book Ratio) 2.21 1.96 1.5
P/S (Price to Sales Ratio) 6.95 5.73 25.25
P/EG (Price to Earnings Growth) 1.3 .12 .59

 

The first comparison that leaps from the page is market capitalisation.  At approximately 30 times the size, Newcastle dwarfs Kingsgate.  For investors who believe in the Peter Lynch principle that big companies don’t make big (share price) moves, KCN has the advantage, especially considering the very attractive P/EG ratio well under the accepted fair value of 1.0.  

Both companies have high P/E ratios in relation to the sector as a whole, indicating market participants are willing to pay more for growth.  As always, these valuation ratios suffer in markets not trading on fundamentals.  For example, the attractive P/EG of Kingsgate may be more a function of recent share price declines than of anticipated fundamental growth.  For a better assessment, let us turn to some actual performance numbers.

NCM vs. KCN – Year over Year Performance

Key Measures NCM 2010 vs. 2011 KCN 2010 vs. 2011
Sales (Per Share in $) 5.78 vs. 5.72 1.79 vs. 1.52
Earnings (Per Share in Cents) 157.6 vs. 147 77.1 vs. 18.1
Dividends (Per Share Cents) 25 vs. 50 35 vs. 15
Net Profit after Tax (Total in Millions) 556.9 vs. 908 73.1 vs. 21.1
Revenue (Total in Millions) 2,802.5 vs. 4,114 175.8 vs. 172.6

 

For both companies, sales per share and earnings per share actually declined between fiscal year 2010 and fiscal year 2011.  The earnings drop at KCN was alarming, and the poor performance is further reflected in their net profit after tax (NPAT).  

In contrast, NPAT for Newcastle increased 63% between 2010 and 2011, as was mentioned by Shawn Uldridge in last week’s 18 Share Tips column.  Total revenue also showed a substantial increase – about 47% – from 2.8 billion in 2010 to 4.1 billion in 2011.

Yet the per share statistics paint a different picture.  Sales per share showed a slight decline, from $5.78 to $5.72.  Perhaps the more surprising number is the drop in earnings per share from $1.57 to $1.47.  Given the increase in revenue and profit, how can this be?

This is a good example of why one should try to look at multiple measures and go behind the numbers for an interpretation.  The simplest explanation here is the acquisition of LGL (Lihir Gold) led to a substantial increase in the number of shares; driving down the per share measures.

Returning to Kingsgate, we find an explanation of their poor performance in the management discussion accompanying the release of their annual financial statements.  As experienced investors of all mining shares know, location of the mines is critical.  Some countries pose a “sovereign risk” and Kingsgate operates in Thailand, where government involvement is cited as the cause of KCN’s decline.

Management claims the issues with the Thai government have been resolved and is looking forward to a return to profitability next year.  If they are right, KCN might be attractive at its current price to investors with healthy appetite for risk.

While Newcrest appears to be a safer play, one has to wonder how much of their recent stellar performance is simply due to the acquisition of a major competitor.

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