The first six months at Gold Fields have been less than easy for CEO Mike Fraser. By his own admission the first quarter “wasn’t a good start”, headlined by a one-fifth output decline. That was in May. A month later, Gold Fields cut its full-year production forecast by as much as 220,000oz to between 2.2-million and 2.3-million ounces — about 10%. Gold Fields’s shares fell by a similar amount on the day.
The primary reason for the cut was the culmination of a series of delays at Salares Norte, the company’s $1.1bn, 400,000oz per year project in Chile’s high-altitude Atacama Desert. The project’s targeted production had already been cut last year, which forced it to extend the ramp-up into a winter that came early and caused the mine’s pipes to freeze.
“There has been a lot of disappointing news on Salares Norte. When I joined that was something I knew I had to deliver on,” Fraser tells the FM. A baptism of ice, you might say.
Salares Norte is a critical cog in keeping Gold Fields’s production steady at about 2.5-million ounces a year — a level Fraser says sustains a price-to-NAV that keeps heavy-hitting investors in the share. Salares Norte is also the group’s only major growth project of note. Its problems, however, raise uncomfortable questions.
“Salares was earmarked to deliver much-needed growth in the Gold Fields portfolio,” says Arnold van Graan, an analyst for Nedbank Securities. “The delay in output would not only trim the near-term growth prospects but would also raise questions about the longer-term production profile, in our view.”
Van Graan believes Salares Norte could weigh on Gold Fields’s valuation for some time. The company also has downgraded production at South Deep, its South African mine. Fraser says the problems at South Deep aren’t completely resolved either. All eyes then on the group’s interim results announcement due out in July.
There has been a lot of disappointing news on Salares Norte. When I joined that was something I knew I had to deliver on
— Mike Fraser
“We don’t need to rebuild our credibility, but we’ve hurt ourselves a bit,” admits Fraser. “Where we got into trouble is we should not have been ramping up in winter.
“What could I do differently? In December I should have said: ‘Let’s not attempt to do this in winter as we are cutting it fine.’ Maybe we should have bitten the bullet and said: ‘Let’s wait until after winter.’ That’s maybe what we should have done.”
Full marks for fronting up, but it means the pressure is on to recover well and quickly. While Fraser doesn’t think shareholders are doubting his technical ability — not yet, he jokes — Gold Fields is desperately in need of some good news. The hope is that Salares Norte’s ramp-up, when it resumes, will surprise on the upside. It’s worth noting Fraser’s point that this is cash flow delayed, not lost. As of April, there was a stockpile of ore at the mine’s processing plant worth 520,000oz in gold ready to be produced.
So far analysts are keeping faith.
Gold Fields has traded at a premium in the past owing to its good project execution, cost control, and earnings predictability. RMB Morgan Stanley analysts have gone underweight the stock — saying they expect it to trade in line with peers (rather than above them) — but they also think a good recovery of Salares Norte will give a lift to earnings before interest, tax, depreciation and amortisation, and hasten the degearing of the balance sheet.
“Despite recent gold price appreciation, Gold Fields has underperformed its peers on setbacks with respect to Salares Norte’s ramp-up delays, subsequent guidance revision, in addition to operational volatility,” says Raj Ray, an analyst for Canadian bank BMO Capital Markets. “We believe the market now has better visibility on the potential operational risks and with the stock valuation now more in line with peers.”
Shares in Gold Fields have traded disappointingly so far this year, up barely 2% and only 4.5% higher in the past 12 months. In this regard, they have traded a bit like their North American peers such as Barrick Gold and Newmont. Analysts say the improved gold price over the past two years has been quickly followed by mining cost inflation, which has narrowed margins. That may be changing, however, especially as the gold price is tipped to remain elevated.
“Equities have been under a cost squeeze, which has eroded margins. I think we are near the end of that,” says George Cheveley, portfolio manager of asset manager Ninety One’s mining funds in London. “The latest gold price improvement has not been matched by inflation. But investors are wary,” he adds.
They are wary because historically the counters haven’t tended to allocate capital well. Cheveley thinks gold producers have come out much stronger as a result of the investment disaffection they have faced. There is also a growing awareness that the gold price improvement is here to stay. Driven by dedollarisation in China, where its central bank has been aggressively buying gold, bullion has gained about 31% in three years and 65% over five years.
“The gold price has taken more than 10 years to move through the $2,000/oz level, but the market is not entirely sure it’s for real,” says Jim Rutherford, a former nonexecutive director of Anglo American and now a nonexecutive at Centamin, a UK-listed gold producer operating in Egypt. “Unappreciated,” he says of gold equities, adding that gold producers are far more disciplined than in the past.
Not all are convinced, especially with regard to South African shares — which may now have peaked and could be falling just as their North American counterparts, including Gold Fields and AngloGold Ashanti, head northwards.
“Our commodity strategist sees support for the gold price strength, premised on ongoing physical market demand, with an uptick in financial flows as we move towards rate cuts,” says RMB Morgan Stanley.
“However, South African gold producer all-in cost margins sit close to all-time highs, and, as we have previously highlighted, at this point in the cycle upward pressure on unit costs/capex often typically begins to offset additional margin upside.” South African stocks such as Harmony Gold “appear fair to fully priced”, the bank adds.
— Direction of gold
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.