Value On Offer In Australian Gold Sector

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This story features RED 5 LIMITED, and other companies.
For more info SHARE ANALYSIS: RED

 – Gold price remains well supported
 – Australian gold equities have underperformed gold price
 – DJ Carmichael sees opportunities in the sector
 – Preferred stocks are low cost and with M&A potential

By Chris Shaw

While the gold price is nearly 20% below its record high of US$1,921 per ounce in September of last year, DJ Carmichael notes global financial market uncertainty continues to support the metal price. The elevated gold price is a positive for ASX-listed producers, as margins are high and cash on hand is increasing.

Despite a solid margin outlook and strong margins, Australian gold equities have underperformed spot gold of late. DJ Carmichael's numbers suggest over the past 12 months spot gold has fallen by around 7% in US dollar terms, while a simple average for listed producers in Australia shows a decline of 17% over the same period.

For DJ Carmichael this can be explained by the fact gold equities are equities, as the market in general has struggled when investors adopt a risk-off mentality. As well, investors now have more options with respect to gaining exposure to gold given the emergence of Exchange Traded Funds or ETFs.

This has meant gold producers have lost their traditional premium to net present value (NPV), as DJ Carmichael notes the market at present is generally ignoring any premium to NPV. For this reason, the broker suggests investors steer clear of mid-tier gold plays trading above NPV in the current environment.

The combination of growing cash reserves and solid operating margins has seen a pick-up in merger and acquisition activity among Australian gold plays. As examples, DJ Carmichael notes this month Silverlake Resources ((SLR)) and Integra Mining ((IGR)) announced a merger, while Saint Barbara ((SBM)) and Allied Gold Mining (ALD)) announced a similar proposal in June.

The focus of current M&A activity appears to be the creation of mid-tier producers, which for DJ Carmichael implies output of 400-500,000 ounces per year. One surprise is a lack of M&A activity among companies with operations in West Africa.

DJ Carmichael suggests this trend is unlikely to last much longer, as asset prices are depressed at present and companies continue to look for growth options. Potential targets in the broker's view include Perseus Mining ((PRU)) and Gryphon Minerals ((GRY)), the former as it moves to full production in Ghana and the latter given large resource holdings in Burkina Faso. At the same time, DJ Carmichael suggests both companies could be on the lookout for acquisitions of their own.

There are opportunities elsewhere as well, DJ Carmichael seeing Red 5 ((RED)) as a potential target given low cost operations in the Philippines and a solid outlook with respect to mine life. Beadell Resources ((BDR)) is a near-term producer operating in Brazil and is a potential target of North American companies given this location and a growing resource base in the view of DJ Carmichael, as is Troy Resources ((TRY)) for similar reasons.

Australia is also throwing up some options, as DJ Carmichael notes Doray Minerals ((DRM)) has operations in the highly prospective Murchison province in Western Australia. Ramelius Resources ((RMS)) is already producing in the region and could gain synergies by taking over Doray according to DJ Carmichael, as the move would provide high grade feed for the recently commissioned Mt Magnet gold plant.

With respect to where value lies among Australian gold plays, DJ Carmichael notes on an enterprise value per ounce of production (EV/oz of production) values have declined in recent months. As an example, Newcrest's ((NCM)) EV/Resource is now $140 per ounce, down from $180 per ounce six months ago.

On such a basis the standouts among the larger producers are Kingsgate Consolidated ((KCN)) and Resolute Mining ((RSG)). Among the smaller producers the standouts are Dragon Mining ((DRA)), Ramelius and Unity Mining ((UML)).

At current levels DJ Carmichael sees value in the Australian gold sector, but with stocks in the sector struggling when investors adopt a risk-off approach the broker's preference is for companies at the lower end of the cost curve and those with M&A potential.

This generates a preferred stock list for DJ Carmichael among Australian gold plays. The list is made up of the producers and near-term producers Beadell, Kingsrose Mining ((KRM)), Perseus, Red 5 and Troy Resources, along with Newcrest as a large scale, multi-mine operation.

Of the six, DJ Carmichael only offers coverage of Kingsrose, which is rated as a Buy. One attraction is Kingsrose is the lowest cost producer on the Australian market with a cash operating cost of around US$260 per ounce. 

Exploration activity continues as Kingsrose attempts to boost reserves and resources, while production should be boosted in coming months with the Talang Santo mine coming online. Improving cash flows suggests Kingsrose is likely to look for growth via acquisition, while DJ Carmichael notes the company has commenced dividend payments with a maiden 4c per share payout announced last May.

DJ Carmichael has a price target on Kingsrose of $1.56, which compares favourably to a current share price of around $1.10. Given a market capitalisation of less than $200 million Kingsrose is not widely covered, none of the brokers in the FNArena database offering research on the company.

Among the remainder of DJ Carmichael's preferred list, FNArena Sentiment Indicator readings stand at 1.0 for Beadell and Troy Resources, 0.9 for Newcrest and 0.7 for Perseus. None of the brokers in the database offer coverage on Red 5.

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