Why Gold Fields Is a Bellwether for the Industry
Gary is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Gold Fields (NYSE: GFI) is one of the most prepared gold miners to face the volatile realities now inherent in the sector, and it has taken the right steps and incorporates the right outlook, whether the price of gold falls or rises.
The company has spun off some of its assets in South Africa, continued to cut all-in production costs, is targeting higher ore grade areas, lowering the size and costs of potential acquisition targets, and is looking to diversify into other commodities to spread the risk.
We'll focus on the production costs in this article, as along with the price of gold; it's the major catalyst - positive or negative - gold miners face. Among costs to be addressed are wages, ore grades, and the best way to make acquisitions to eliminate costs on the front end.
As for wages, Gold Fields spun off some of its projects in South Africa because the mining wages there are among the highest in the world, accounting for 40 percent of all costs. I like that because it reveals the miner isn't in love with its projects and won't punish shareholders by holding on to them past their useful purpose. Compare that to Harmony Gold (NYSE: HMY), which has 93 percent exposure to South Africa, and you can see how much better the future looks for Gold Fields after spinning off the high-cost, high-risk projects of KDC and Beatrix operations in South Africa into a separately listed company, Sibanye Gold Limited (NYSE: SBGL).
In contrast to Gold Fields, which is highly diversified geographically, Harmony Gold and Sibanye Gold don't have that luxury. Other than its Hidden Valley Project in Papua New Guinea, Harmony operates totally in South Africa. That means 40 percent of production costs is paid out to workers; among the highest in the world.
Instability in the power grid, high wages and production costs, radical unions, and defensive cost strategies make the two miners inferior to Gold Fields. Sibanye has tremendous resources (all in South Africa), but producing them at high costs makes them very risky.
Notional Cash Expenditure
When taking into account what Gold Fields calls notional cash expenditure (NCE), which includes the capitalized costs for projects in its growth portfolio, and is the real cost of its gold production, it was able to lower that number by 2 percent in the first quarter from $1,355 an ounce to $1,291 an ounce. That's not insignificant, as any cost taken out of the equation is extremely important in this gold price environment. It's still a little high, but it's headed in the right direction.
Investors need to know that Gold Fields is one of the few gold miners that report 'real' all-in costs. When you hear it report its actual costs, you can count on it being very close to the real numbers.
Reducing Capital Expenditures
Another step taken by Gold Fields to cut costs was to lower capital expenditures. In its latest earnings report CEO Nick Holland said the company cut greenfield expenditure from $130 million in 2012 to $80 million in 2013. Near-mine expenditure was slashed from $65 million in 2012 to close to $28 million in 2013.
The most obvious question there is whether or not Gold Fields will hurt future growth. It's not going to because the accompanying strategy is to focus primarily on smaller mining areas with higher ore graded, which are less expensive to work.
To coincide with its acquisition strategy, Gold Fields is looking at smaller, targeted areas having high ore grades. Specific price targets range from $200 million to $250 million. While the miner is open to projects valued at as high as $500 million, it would have to fit very exacting criteria for it to acquire one of them.
The reason for searching for better ore grades is cost savings. As grades get lower and digging locations farther from the mill, the cost of production remains the same or rises no matter how much gold is brought back per ton. So there are higher wages, more fuel use, more vehicle repairs, and an increase in road repairs. All of this with less gold being brought in per load.
This is why Gold Fields and Holland are looking for very specific projects which can be profitable in a potentially low gold price environment. Projects too spread out will cost far more to produce, even if it has more resources in it.
In the view of Gold Fields, the new mining realities are a company must forego large, spread out projects in order to acquire less-impressive, but more profitable ones.
Gold Fields is doing everything it needs to do to effectively compete in the tough gold mining market. Since it can't do anything about gold prices, it's doing the most important thing, which is to cut costs in a way that the company can continue to grow and be profitable.
What investors in gold miners must do is research and find out the real all-in costs of each mining company, as it is usually several hundred dollars more than what is usually identified as 'cash costs' by the companies. Don't just focus on mining activities, but every penny the company must spend to mine an ounce of gold. That is the real cost of doing business, and not knowing that can be the difference between a good long-term investment and a huge loss.
The good news is the World Gold Council and other miners are working on a metric that can be used by miners which gives the most accurate all-in costs miners incur. While that is a good step, it's very important we do our own research to figure out what it is really costing to get an ounce of gold out of the ground.
Gary Bourgeault has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!