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Miners’ Aggressive Debt Reduction Could Impact Future Profits

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Dividend increases to be limited in 2017 – We had hoped to hear of strong dividend growth in 2017, however, we now believe any increases will be limited due to capital allocations to existing property developments and in some cases to further help pay down debt.

Ongoing industry themes – An emphasis on free cash flow over production growth, flat management structure, mine management focused on Net Asset Value (NAV) growth, use of double-digit hurdle rates at conservative gold prices on new projects, partnering with juniors for exposure to Greenfields (a property or project where no previous work has been conducted).

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Market Realist – Dividend payout

Mining companies have shifted their focus to debt reduction by selling non-performing assets, rejecting future capital expenditure, and reducing their workforce. Following these changes, gold miners have achieved financial restructuring and excessive reduction of debt loads. However, this move has limited dividend payouts.

For example, South Africa’s listed gold companies AngloGold Ashanti (AU), Gold Fields (GFI), and Harmony Gold (HMY) boosted profits up to June as the strong dollar (UUP) and gold prices were accompanied by weaker currencies in the countries where they own mines, reducing their operating costs. AngloGold has reduced its net debt to $2.1 billion from $3.1 billion over the past year. Its net debt to adjusted earnings before interest, taxation, depreciation, and amortization (or EBITDA) was 1.44x by the end of June—well below its bank covenants of 3.5x. However, the dividend payout ratio is 0% for AnlgoGold.

Market Realist – Debt reduction implications

Although many juniors are merging to preserve their cash balances, the most active deal flow in recent years came from divestments and rescue deals, with minimal cash changing hands. Gold miners (GDX) (GDXJ) are seeking to generate additional cash to offset underperforming investments and selling non-core assets. So excessive debt reduction via the postponement of future exploration projects and the sale of non-performing assets could impact future profitability.

In the next parts of this series, we’ll discuss the benefits and setbacks of passively traded gold ETFs and actively traded gold funds.

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