AEM:CC - Agnico Eagle: After Delivering A 35% Return I Expect More Upside

2023-04-12 10:49:07 ET

Summary

• Agnico Eagle is well-positioned to thrive in the current environment of rising gold prices.
• The market seems to reward high production growth within the gold mining space as consolidation accelerates.
• Agnico's premier jurisdiction profile and industry-leading margins are not compromised as the company continues to expand production.

Narratives and prejudices often stay in our way in recognizing attractive investment opportunities. They also often result in portfolios becoming too one-sided when it comes to risk.

One such trend has been the religious following of the technology sector as the only source of high future returns. However, having exposure to precious metals has been highly beneficiary for equity portfolios once we account for risks.

The decision to stick with gold miners or having physical exposure to the precious metal is most often one of timing. The former requires some timing skills, while the latter is more appropriate for long-term holders, who don't want to bear the idiosyncratic risk.

The issue of timing could be easily illustrated by comparing returns of Agnico Eagle Mines ( AEM ) and SPDR® Gold Trust ETF ( GLD ) over the past few years.

Although Agnico Eagle delivered an impressive 35% total return since I first covered the stock, success relative to physical gold over the medium to long-term would also depend on the right timing.

Is Now A Good Time To Buy Gold?

For years, I have been writing about the misconceptions around the price of gold and why the precious metal is a good addition to an all-equity portfolio.

While most market commentators focused on the risk of rising real interest rates, I have warned that the relationship between gold and real interest rates is not static.

And here we are in early 2023 with the usual inverse relationship between the two variables now turning into a positive one.

I have already explained in detail why this could happen and why gold should not be seen as a hedge against inflation or geopolitical risk, but as insurance against risks for the existing monetary system.

These risks have been accelerating as of late and it appears that the banking system is unable to support higher interest rates. At the same time, the term premium, which is essential for the proper functioning of the banking system, has disappeared completely. As a result, the yield curve has become the most inverted in decades and suggests that the fixed income market is heavily distorted.

In the meantime, the pending recession would likely require yet another unconventional response, which will most likely distort the market even further.

All that does not necessarily have to be associated with another Great Depression, however, it highlights that the risks for the current monetary regime are unlikely to go away.

Thus, the price of gold appears to have a strong tailwind at its back.

Why Agnico Eagle?

I have recently analyzed the company from a free cash flow and capital allocation perspective and showed why its low cost structure and strong project pipeline make it one of the highest quality businesses in the sector.

Having a strong project pipeline is of great importance as the industry is facing significant consolidation. With scarce growth opportunities, gold miners who can afford to grow organically are preferred by investors.

That is why, we observe a very strong relationship between the capex to sales ratios (plotted on the x-axis) and the share price performance over the past year (plotted on the y-axis).

With the larger peers in the sector increasingly looking to consolidate, companies with a good organic growth profile and highly profitable operations in low-risk jurisdictions will be in high demand.

In addition to higher capital spend, Agnico Eagle's management has been utilizing all available routes to expand production, without compromising its low cost profile. These include recent acquisitions, asset purchases and joint ventures.

The recently announced transaction for Yamana Gold's Canadian assets adds a large exploration and development pipeline in close proximity to Agnico's existing sites.

It solidifies the company's positioning in the strategic area of Quebec, where the company has a long operational history and could leverage existing infrastructure.

Retaining Profitability

While Agnico Eagle is expanding in key strategic areas, the company is not sacrificing its high profitability in the process and remains as one of the most profitable gold miners in the world.

All-in sustaining costs (AISC) have increased materially in the past few quarters, however, as we saw above the price of gold has not been flat either.

Moreover, the costs per ounce were also impacted by operational challenges that according to management are likely to be transitional in nature.

The costs were higher in the fourth quarter. And that is a function of two things. One, it is a function of the full inflationary pressures affecting us. (...)

So, the fourth quarter included those full inflationary pressures, but the costs were also impacted somewhat by some operating challenges .

Source: Agnico Eagle Q4 2022 Earnings Transcript

With all that in mind, the current guidance of declining costs per ounce is achievable, provided that inflation does not spike once again in which case the gold price would likely react positively.

At the same time, the guidance assumes a production growth of between 3% and 10% of the fiscal 2023 which in combination with the relatively flat Capex of $1.4bn would provide an additional tailwind for free cash flow.

Lastly, Agnico continues to trade at one of the highest dividend yields in its recent history.

The 2.8% dividend yield is also relatively safe which would make it far easier for shareholders to ride out a potential market downturn in the coming months.

Conclusion

The case for gold and precious metals has strengthened significantly over the past year. As risk and uncertainty around the existing monetary system increase, gold is likely to retain its value even if interest rates continue to normalize. In this environment high quality gold miners, such as Agnico Eagle, are very well-positioned to continue to deliver superior returns.

For further details see: