3 Undervalued Gold Miners Poised to Take Advantage of The Rebound In Gold

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The sharp correction in the gold price since the start of 2013 has seen gold miners fall into disfavor with investors, with many of the major miners touching new 52 week lows. Already for the year to date, the Gold Bugs Index -- which measures the performance of the 30 largest gold miners -- has plunged 43%. As a result, there are a number of potential bargains now hidden in the gold mining sector.

Finding Bargains Among Gold Miners

Essentially, any investment in a gold miner is a leveraged play on the price of gold bullion. Accordingly, for mining equities to outperform bullion, miners need to generate strong net operational cash flows. In order to do this, they need to generate a solid margin per ounce of gold produced, by keeping production costs low. 

This means that initially, investors need to identify those miners with low production costs. These are measured in two ways: total cash cost per ounce, or all-in sustaining cash cost per ounce. The first method only takes into account the direct costs of producing an ounce of gold, whereas the second includes all direct and indirect costs. As a result, the second method is a more accurate assessment of the costs associated with producing an ounce of gold. 

A considerable number of the major gold miners – as illustrated by the chart below - have a total all-in sustaining cash cost per ounce in excess of $1,000. As a result, with gold now trading at around $1,343 per ounce, these miners are making a thin margin per ounce produced.

<img alt="" src="http://g.fool.com/editorial/images/59824/all-in-sustaining-cash-cost-per-ounce-220713_large.png" />

Source data: Each respective company's Q1 2013 financial reports.

This emphasizes the importance of choosing to invest in gold miners that have a low all-in sustaining cash cost per ounce. The three lowest as illustrated by the chart are Barrick Gold (NYSE: ABX), Yamana Gold (NYSE: AUY) and Eldorado Gold (NYSE: EGO). Each of these companies also has solid production and growth prospects, allowing them to take advantage of any rebound in the gold price.

Barrick Gold

Barrick is the world’s largest gold miner, offering investors a combination of geographically diversified mine assets, economies of scale, and a promising exploration program. Of late, it has been dogged by a range of project development issues, in particular regarding its Pascua-Lama mine on the Chilean and Argentine border.

Barrick has already invested around $5 billion in the development of the mine, but has been stymied by Chile’s environmental regulator, which recently stopped construction and imposed sanctions over environmental concerns. This has now seen the commencement date of the project delayed from 2014 to 2016, and will more than likely see Barrick forced to write down around $5.5 billion against the value of this asset.

But the sharp decline in Barrick’s share price has seen the company trading at a level well below its fair value. This is highlighted by Barrick's enterprise value of four times its EBITDA, and its price, which is around four times its operating cash flow per share. All of this makes Barrick appear to be an exceptional value, particularly in comparison to its peers.

Eldorado Gold

Eldorado recently announced that it has slashed its exploration budget by almost half, had deferred the Kisladag mine expansion and reduced capital expenditure by almost a third. The company made these changes to ensure its future profitability in an environment where the outlook for gold is uncertain. This leaves the company well-positioned to considerably reduce costs, improving the margin it makes per ounce and allowing it to preserve its operational cash flow and profitability.

Surprisingly, despite the collapse in the gold price, Eldorado was able to boost gold revenues by 19% year over year for the first quarter 2013, on the back of higher sales volumes. The company expects production to grow through the remainder of 2013, allowing it to maintain sales and revenue despite a softer gold price. It also leaves Eldorado well-positioned to take advantage of any unexpected rebound in the gold price.

But Eldorado does not appear to be particularly cheap, despite its share price being down by 46% since the start of 2013. It is trading with an enterprise value of eight times EBITDA and a price that represents 16 times its operational cash flow.

Yamana Gold

Yamana appears to be the best-positioned of the major gold miners, with its low all-in sustaining cash cost of $856 per ounce. But the company has recently reported a rash of disappointing results, which have seen profitability and operational cash flow plunge. This includes reporting that first quarter 2013 operational cash flow had fallen by more than half, despite production increasing by 4% over the same period.  

Despite this, Yamana appears marginally undervalued, trading with an enterprise value of seven times EBITDA and a share price that is nine times operational cash flow.

Furthermore, gold production at Yamana’s flagship mine El Penon grew by 9% year over year for the first quarter of 2013, and it is expected that production at this mine will continue to grow. This certainly bodes well for increased profitability, on the back of Yamana having cut its exploration budget and capital expenditures for 2013. It also positions the company well to take advantage of any unexpected rebound in gold prices.

Foolish Bottom Line

All three miners present a credible opportunity for investors seeking exposure to gold and are trading at bargain basement prices. Both Yamana and Eldorado have particularly positive outlooks, while Barrick being the most under-valued. But investors need to be aware of the impact that the forthcoming writedowns on the Pascua-Lama project will have on Barrick's share price. 


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