The confusing signals originating from gold prices, in conjunction with movements in the dollar and the euro, have increased the fear factor for investors. Traditionally, gold rises as the dollar falls, increasing inflationary anxiety.
The recent decreases in the price of gold have confused markets to no end, and the attendant uncertainties regarding precious metals have placed a premium on miners, such as Peruvian miner
Buenaventura
(BVN)
, which has a stake in five metals -- two precious and three base.
The two precious metals, of course, are gold and silver. But BVN also mines lead, zinc and copper. As the following graphs show, although volatility in all five metals has been high, mining in all five simultaneously, as BVN does, provides a great commodities hedge.
The above graphs show that while gold has seen a lot of volatility, the ascension of silver prices has been smoother, and lead and especially copper have been doing quite well recently.
Not a Pure Play
BVN, with a market cap of $8.9 billion, is a small-cap player compared to a competitor like
Newmont Mining
(NEM)
, a Denver-based company that is almost a pure play on gold (it has a minor interest in copper) with a market cap of $20.2 billion. The 51% increase in the price of gold in 2007 did wonders for the bottom line of Newmont, whose earnings increased by 440% over the first quarter of 2008. But BVN's earnings increased by 617% over the same period if the detrimental effect of unwinding a hedge were to be adjusted for and which reduced earnings by $2.08 a share. Including the effects of the hedge led to a loss of 49 cents a share for BVN.
Over the last five years, though, BVN's stock price increased by 80%, compared to a rise of 50% for NEM. Despite this increase in price, BVN is still reasonably valued, with a price-to-cash-flow ratio of 13.64, compared to sector norms of 14.80 and NEM's staggering 33.60.
Smoother Earnings
Gold miners around the world are scrambling to find more and more-productive mines. Both NEM and BVN reported lower gold volumes, with NEM reporting a 4% decline in gold volume sold, at 1.3 million ounces. BVN, mining 403,000 ounces of gold, reported 3% declines in volume, including its equity interest in the extremely fertile Yanacocha mines in Peru, with annual potential capacity of 1.6 million ounces. BVN operates this mine as a joint venture with NEM.
However, besides the gold-mining operations, BVN reported a 12% increase in silver volumes, with a 32% price increase last year. More to the point is the increase in copper production, at 50%, the price of which has increased by 30%. The consistent price increases are partly due to the expanding uses of copper, especially in computer applications, and the possibilities of copper chips over aluminum. BVN also mines zinc, whose sales increased by 23% while prices decreased by 29%.
In short, while BVN is predominantly a precious metals miner, its position in the other three base metals allows it to ride volatility in prices of these metals. In particular, recovery rates for zinc for the company have increased to 69% from 61% in both of its important Peruvian mines.
Favorable Trends
Given the vagaries in gold prices, it becomes especially important for a mining company to be able to contain costs and limit debt. While investors may be able to overlook a one-time hedge loss that diminishes earnings, they are less able to overlook consistent increases in costs or depreciation.
|
Buenaventura |
Newmont Mining |
| Operating margins |
45% |
69% |
| Change in depreciation expense |
27% |
2% |
| Change in operating costs |
17% |
430% |
| Change in net property, plant and equipment |
No change |
7% |
| Net inventory |
19% |
-2% |
| Debt-to-capitalization ratio |
5.30% |
29% |
| Change in cash |
No change |
-18% |
The table at right presents comparative statistics. The debt-to-capitalization ratio for BVN, in particular, is quite low. Also, while operating margins are higher for a company like NEM, its operating costs increased substantially due to the exploitation of mines with increasingly lower recovery rates, especially from the company's copper production.
NEM's debt-to-capitalization ratio, while low compared to other companies, is high compared to BVN's extremely low debt.
I think BVN is a great play on South America, particularly Peru. Mining makes up a large component of the BVL (the Bolsa de Valores de Lima), and BVN is the most important mining company in that country. In a situation where most other mining companies are faltering, I would bet on BVN as a great commodity hedge.
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At the time of publication, Vijayraghavan was long BVN.
Vasu Vijayraghavan was an academic finance professor at the University of Paris who has now turned to a new career as a financial consultant. As an academic, she wrote on corporate governance issues, especially in the European context, and she believes in a long-run and balance sheet approach to stock picking.
Currently, Vasu is working as a consultant for lawyers, doing business valuation. She is a Level II CFA candidate and enjoys writing long/short and earnings calls pieces for TheStreet.Com.
Vasu holds a Ph.D. from the University of Michigan and a B.A. from Harvard University.
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