Choice of mining method
The method used to value a mining company depends on the stage in the mining life cycle the company’s currently in. For early-stage companies, since the reserve life and grade et cetera aren’t known, the ideal way would be to use the relative multiples for the comparable companies. But for companies that are in the substantially advanced stages of exploration or production, you could use net asset value.
We’ll discuss each of these methods in detail in this part and the next part of this series.
Net asset value or NAV
This method calculates the present value of a gold mining company’s future cash flows. There are a number of estimates you have to make for each of the mines, like the long-term gold price, cash costs, and the production rate. After calculating cash flows, a discount rate is applied to bring the cash flows to the present date. This discount rate should include various risks, like financial risk or country risk.
When not to use NAV
You shouldn’t use the net asset value method when gold prices are very volatile or when it’s very difficult to get a reasonable long-term price for a commodity like gold. The long-term price assumption is one of the key assumptions for this valuation method.
There are other drawbacks this method suffers from. It’s quite difficult to capture the country, geological, and economic risks in a single discount rate number, which can have a significant impact on a company’s valuation.
Advantages over the multiples method
This method is superior to many other methods. It’s also helpful when multiples for comparable companies aren’t available. It takes into account quite a lot of fundamental concepts for a company, like its reserves, mine-life, and cost structure. Multiples-based methods don’t account for these concepts.
But along with valuation metrics, investors should look at other factors like the business, assets, and key drivers for gold prices before coming to a conclusion regarding investment in gold stocks like Goldcorp Inc. (GG), Barrick Gold Corp. (ABX), Newmont Mining Corporation (NEM), Agnico Eagle Mines (AEM), and Yamana Gold (AUY) or gold-backed ETFs like the SPDR Gold Trust (GLD) and Gold Miners Index (GDX).