PwC: Gold Equities Reached Breaking Point in 2012

Gold equities reached their breaking point in 2012, according to PricewaterhouseCoopers’ (PwC) 2013 Global Gold Price Report. Last year, increasingly frustrated investors doled out severe punishment to gold miners, making it clear that they were rapidly losing faith in the ability of these companies to deliver value. But PwC projects a turnaround and believes that gold miners are positioned for a promising 2013 if they can prove they are worthy of investment.

Gold miners’ trouble with investors largely stems from the trend of chasing growth.

CEOs have spent billions on risky acquisitions and capital-intensive projects in the last several years, PwC explains in the report. Since gold prices have been high, those mining the yellow metal have not been pressured to defer projects and slash capex spending to the same degree as miners in other sectors. That means gold companies have had much more leeway to pursue projects while making promises to cut costs.

However, many of these projects have ultimately turned out to be failures. Some could not be completed within the set time frames and budgets, while others put forth lower-than-expected production. Still others largely failed to create the shareholder value sought by investors.

PwC blames mining executives’ poor decision making on their efforts to appease shareholders who want greater exposure to rising gold prices.

“If we look back two, three, four years ago, many investors’ focus was on increasing gold production,” said Jamie Sokalsky, president and CEO of Barrick Gold (TSX:ABX,NYSE:ABX,LSE:ABG), in an interview with PwC. “They rewarded miners who touted significant production growth. And for the most part, shareholders ended up getting what they asked for — miners making investments to grow for the sake of production growth,” he continued.

A new day has arrived. Investors and companies are now switching their focus from growth to cash. As that happens, they are looking less at the top line and more at the bottom line — specifically free cash flow per ounce, PwC notes in the report.

To convince investors that they have changed, gold miners are reportedly set to display better judgment in employing capital as they switch to strategies that prioritize the rate of return.

PwC found that senior gold companies generally have strong cash positions. An analysis of 46 of the largest TSX companies revealed that over half have cash reserves in excess of $500 million. And the vast majority of all the participants surveyed see gold prices increasing this year. None foresee the price of gold declining.

But strong gold prices have been a source of irritation for gold equity investors. That’s because as metal prices have gone up, gold stock prices have lagged.

To correct this divergence, 60 percent of the participating companies expressed plans to institute cost-management programs.

All the senior miners surveyed said they will continue to use their hoards of cash to pay dividends this year, and 80 percent reported plans to increase the dividend they pay. All of the seniors will also continue to use cash for exploration and development.

The number of junior and mid-tier gold miners who will use cash for dividends is set to increase from 20 percent last year to 28 percent in 2013; half of this number also expressed intentions to boost the amount of profit distributed to shareholders. 89 percent of these small and mid-sized companies plan to use cash for project development and 83 percent will spend on exploration activities.

Participating seniors did not spend their cash on share repurchases in 2012 and none expressed plans to do so this year. Eight percent of the junior and mid-tier participants engaged in share buybacks last year, but only 6 percent have such plans for 2013.

Seniors are obviously flush with funds to make acquisitions, but PwC does not expect a flurry of deals. Twenty percent of senior miners pulled out cash for acquisition activities in 2012 and the same number reported plans to do so this year.

However, 33 percent of junior and mid-tier companies have acquisition spending in their plans for 2013. That’s double the number this group spent on mergers and acquisitions in 2012, the PwC report states.

Only 20 percent of senior miners will look for additional financing this year, and most of them plan to turn to the equity markets.

By contrast, the smaller companies have more aggressive investment plans, with over 70 percent expressing that they will be on the prowl for financing. Over half of these junior and mid-sized companies will seek funding through debt. More than a third hope the equity markets will provide funding, while 11 percent hope to secure offtake agreements or streaming deals.

The damage that has already been done must be undone or compensated for before significant benefits can be enjoyed, states PwC’s report. But change is reportedly already underway. And now, after the flood of headlines chastizing them, gold companies are starting to rally, the firm said.

Securities Disclosure: I, Michelle Smith, do not hold any equity interests in any companies mentioned in this article.

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