Monday, 28 October 2013

Canadian Mining Companies - Is now a good time to buy?

Last week's look at the environmental, social and governance aspects of Canada's largest mining companies found most to be taking such matters seriously. It's a good start but an investor wants to know whether there is money to be made. How are they faring financially and is now a good time to buy shares?

A cyclical industry that is currently out of market favour
Mining, whether of gold, silver, uranium, base metals or fertilizers, is highly cyclical. It is dependent for profits on the big swings in prices of those commodities. Whether for different reasons amongst the different products, currently the whole mining industry seems to be in a down cycle and out of favour in stock markets. The graph below shows the big decline in prices of such stocks, using the example of a few of the companies in our list and a popular ETF that holds a basket of such stocks, iShares S&P/TSX Capped Materials Index Fund (TSX symbol: XMA). Compared to the overall TSX index, which has been relatively flat, the Google Finance chart shows the miners' poor performance for almost three years, since the end of 2010.

Financial stability - some are faring ok, some are hurting
If prices of metals and minerals are down and compressing profits, a company needs to have a low cost structure and sustainable levels of debt. Our table shows good numbers in green and bad in red.

In the two debt columns, we see some bad performers:

  • Barrick Gold (ABX) has a very high level of debt in relation to equity on its balance sheet, much higher than any other company. A recent Globe Advisor column discusses how this makes Barrick very exposed to any further decline in the price of gold. On the other hand, any rise will boost shareholder gains faster. Debt, aka leverage, is a double edged sword. The company is already taking action to curtail the large recent net losses. 
  • Newmont (NMC), Tahoe (THO) and Turquoise Hill (TRQ) have lots of debt in relation to the cash flow being generated and this is reflected in net losses.
  • Goldcorp (G) and Kinross (K) display negative operating margins (operating income divided by sales) i.e. losses from operations that does not include interest or taxes. Both are experiencing substantial net losses, though Kinross is a lot worse off. Until the latest 12 months, Goldcorp had managed to make profits every calendar year. Goldcorp has just reported more problems with its operations and costs. Kinross has had recurring trouble with only four years with profits out of the last seven.
And there are some companies that look good too, with reasonable debt loads, healthy operating margins, consistent profitability, even in current conditions:
  • Agnico Eagle Mines (AEM), Agrium (AGU), Cameco Corp, Eldorado (ELD), First Quantum (FM), Lundin Mining (LUN), Potash Corp (POT), Teck Resources (TCK.B) and Yamana Gold (YLD)
Value - whether stock price is a cheap not an easy thing to assess!
The classic value method of looking at a company starts with looking for a low Price to Earnings ratio (P/E) but with mining, whose earnings can vary tremendously with the price of their gold, silver etc, a P/E may be lowest at the peak of the cycle when the earnings denominator is highest. Conversely, a high P/E may happen at the bottom of the cycle, when earnings are really low and the expectation of better future results justifies a higher price. That may be the case today, where we seem to be more at the bottom than the top of a cycle. Agnico Eagle's P/E of 27.4 may reflect more future earnings growth expectations than over-enthusiastic pricing. Yesterday's huge 17% price jump by Agnico, despite falling profits year over year, suggests expectations are at work.

Price-to-Book may give a better indication of value for more mature companies
Using a company's book value of its assets, which does not change constantly with commodity prices, may help provide perspective, especially where a company has been in business for many years, through several commodity price cycles. Our comparison table above shows in green the companies whose current P/B ratio is either very low at 1.0 or below, or is at the lowest end of the historical price range. On that basis, almost all the stocks appear to be quite cheap and only one - Tahoe Resources - looks expensive.

The whiff of changing sentiment 
Possibly the winds are changing, or at least for some miners. Thursday's quarterly results from Teck were down from the previous year but better than analyst forecasts, which prompted a 3.8% rise in the stock price and a Globe article announcing that mining stocks are on the mend.

Potash facing a new normal of a broken cartel
Potash producers Potash Corp and Agrium face a different future, brought about when Russian producer Uralkali announced on July 30 its withdrawal from the potash selling cartel. Though Potash Corp is still very profitable, it's results are down and it has lost its market darling status of the last many years. The big question for investors is whether this will continue as the new normal, or whether basic demand for fertilizer will restore previous profitability. Agrium is less affected by the potash price drops resulting from the cartel breakup since potash makes up less of its product mix.

Bottom Line - several worth buying, some not
We have sorted our comparison table from the best at the top down through slightly less attractive but reasonable choices based on the information we have compiled. The promising choice list comprises ten companies.

At the bottom of the table, below the blank line, are the six stocks with too much red for our taste. Before making a purchase we would want to read more annual and quarterly reports of the ten good-looking companies, along with analyst commentary to see if there are other problems we have not yet uncovered that are particular to a company that would prevent it from rising in the upward cycle.

Disclosure: this blogger directly owns shares of Potash Corp, and Teck Resources apart from holding virtually all the companies in various ETFs.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

1 comment:

The Blunt Bean Counter said...

Hey CI

Great job as usual. I love your colour coded charts.