Valuations for capital-intensive industries
The EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) valuation multiple is a good measure for capital-intensive industries. It helps investors compare companies with various capital structures.
The above chart compares gold miners’ EV to forward EBITDA to the EBITDA margin from 2017. EV is the total market value of a company’s debt, equity, preferred shares, and minority interests, net of cash and equivalents, and investments in associates. EBITDA is a fundamental measure for the company’s stakeholders. Based on an investor’s risk appetite and various gold price scenarios, investors could consider the following possibilities.
Companies with higher financial and operational leverages outperform companies with lower leverages in times of higher gold prices. But for fundamental investors, the best strategy might be to invest in miners with healthy balance sheets, increasing production profiles, low costs, and good cash flows.
While Goldcorp (GG) checks almost all the right boxes for senior gold miners, its recent production and cost performance disappointed the Markets. Most of the issues, however, are transitory in nature. Its recent acquisition highlights that management is focused on growth. It’s probably as a reflection of all these positives that the stock is trading at a forward EV-to-EBITDA multiple of 9.1x. That’s the highest among senior miners. More positive catalysts would be needed for the stock to rerate any further.
Newmont Mining (NEM) has a multiple of 8.6x with an EBITDA margin of 43%. A higher gold price leverage and declining financial leverage have been the main drivers behind its significant rerating since the beginning of 2016. Its EBITDA margin estimate has also increased considerably on the back of its impressive cost-cutting efforts. This positions it well for the volatile metals price environment. It also provides a further upside in case gold prices (GLD) (IAU) keep recovering.
The financial leverage for Barrick Gold (ABX) has been a cause of concern for investors. Despite having the highest EBITDA margin of 50%, it’s trading at a multiple of 7.4x, which is lower than Goldcorp and Newmont. Although investors may still be concerned about Barrick’s high leverage, management’s focus on reducing leverage could act as a positive catalyst. Going forward, the execution of project development could be key for Barrick. This could lead to a further upside for the stock.
While Yamana Gold’s (AUY) valuation multiple has improved since the start of 2016, it would take consistent operational improvements for the stock to rerate further.
Kinross Gold (KGC) is trading at the lowest forward multiple of 5x. However, investors should note that its EBITDA margin estimates are also the lowest among the peer group at 40%. This is mainly due to its higher unit costs and lower grades. Its unstable production profile and geopolitical risks are also factors weighing on investors’ minds.
Barrick and Newmont account for 6.2% and 6.7%, respectively, of the VanEck Vectors Gold Miners ETF (GDX).
What’s your risk appetite?
Investors with a high risk appetite often invest in gold miners (GDX) (GDXJ) and leveraged ETFs such as the ProShares Ultra Silver (AGQ) and the Direxion Daily Gold Miners Bull 3X ETF (NUGT). Investors who prefer a low-risk environment may want to invest in physical gold or ETFs that track gold prices such as the SPDR Gold Shares (GLD) and the iShares Gold Trust (IAU).