Agnico Eagle (AEM) reported Q4 2019 results and left investors scratching their heads as to why the stock tanked a whole 15%. The company delivered what looked like solid numbers with record gold production and also guided for higher production for the next 3 years. AEM hiked its dividend by 14%. Most precious metal mining companies don’t even know what that word (dividend) means. Hence, a dividend hike is about as rare as a pink unicorn in this sector. So why the big tank?

Data by YCharts

The lowered guidance is significant

AEM said that it now expects full-year production of 1.87 million gold ounces compared with its previous outlook of 1.95 million gold ounces. The production is going to be lower due to more conservative mining plan in the West mine area at LaRonde. AEM did maintain its 2021 guidance, although it moved around plenty of expectations among its different mines.

In 2019, the company essentially used up all its operating cash flow on capital expenditures.

Source: AEM Q4 2019 financials

While that production cut is small, it is likely to not be offset on the expense side at all. As such, it is a $128 million decrease in free cash flow based on today’s gold price. Depending on the price of gold, AEM may not generate free cash flow in 2020.

Source: AEM presentation February 2020

Valuation

AEM is a mining company that breaks down its capex into “sustaining” and “growth” as has become the trend in the precious mining space. This is illustrated above in the graph showing the stark difference between sustaining and total capital deployed. We generally have a very high degree of skepticism towards this as many companies fail to even keep production flat despite spending all their cash flow on sustaining and growth projects. AEM is a rather different breed and has actually increased production meaningfully over the last decade.

Source: AEM presentation February 2020

That said, even if we completely disregard their growth capex numbers and focus on free cash flow before growth capex, we do see that AEM is not extremely cheap.

ChartData by YCharts

At a $12 billion market capitalization, AEM is trading at about 30X free cash flow before growth capex. While it is one of the rare ones where we can actually compute a multiple, it is certainly not cheap. What is equally important here is that the multiple is very vulnerable to small changes in the price of gold. At 20% lower price of gold, free cash flow before growth capex would largely evaporate.

All-In Sustaining Costs around $1,000/Oz

The company reported its AISC measure at $938/oz for 2019 which is expected to move up in 2020 before coming down again in 2021.

AISC for the full year 2019 were $938, compared to the most recent guidance of $875 to $925 per ounce. AISC for 2020 are expected to be between $975 and $1,025 per ounce. The higher AISC in 2020, when compared to 2019, is largely due to higher total cash costs.

Source: AEM Q4 2019 financials

AISC does, however, ignore interest expenses and capitalized interest. Even so, considering that AEM is one of those rare companies that delivers growth with its growth capex, we do think the $1,000 AISC is a good number.

The non-diluting gold company

Just kidding. There are no gold companies that they do not dilute their shareholders. AEM just like most other gold mining companies loves issuing shares.

ChartData by YCharts

Some of that is necessary as recruiting the right people for this field is rather difficult. Impressively, AEM has leveraged the price of gold, at least since the turn of the century, something most other gold companies cannot say.

ChartData by YCharts

The results are even more impressive when you take into account the small dividends.

ChartData by YCharts

Conclusion

Near-term drop aside, AEM might be one of the safer ways that investors can take a leveraged bet on gold prices. The key issue will always be whether they can trust the company’s judgement on what are sustaining costs vs. what are growth costs. In addition, estimating total reserves is a big judgement call and costs of mining in later years can move up rather rapidly. Gold companies do currently have the best of all worlds where the US dollar is strong, gold prices are high and oil prices are low. The combination of this keeps cost of mining down.

ChartData by YCharts

Should that trend reverse, we will see significantly lower cash flow for companies like AEM. We remain neutral on this name, although we do recognize that it is possibly one of the best, if not the best, in a group of rather large serial money destroyers.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints. TIPRANKS: HOLD

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2020-02-15