We’re now more than two-thirds of the way through the Q2 Earnings Season for the Gold Miners Index (GDX), and despite a solid H1 report, AngloGold Ashanti (AU) has tumbled more than 25% from its recent highs. While a correction was not overly surprising, given that the stock was getting ahead of itself short term above $36.00, a near 30% haircut for the stock looks overdone, especially given that the stock is now trading below 9x FY2021 annual earnings per share. Based on the company’s recent margin expansion, industry-leading earnings growth, and relative undervaluation, I see the current correction as a low-risk entry for investors.
AngloGold Ashanti released its Q2 results earlier this month and reported quarterly gold production of 753,000 ounces, down 6% from the 801,000 ounces produced in Q2 2019. Given the lower gold sales and headwinds from COVID-19, we saw costs jump as well, with all-in sustaining costs coming in at $1,015/oz, 4% above the industry average last year. However, while we saw softer performance year over year, it’s worth noting that gold production should have been up 3% year over year if not for COVID-19. Unfortunately, the 74,000 ounces that were estimated to be lost in Q2 derailed this plan, while also tacking on $53/oz to all-in sustaining costs. Therefore, while the headline results certainly aren’t that exciting, it’s worth putting them in context, given the temporary closures and reduced operations.
(Source: Company Presentation)
The good news is that, while production slipped year over year, the average realized gold price soared to $1,707/oz, an increase of 31% year over year. This allowed AngloGold to generate $173 million in free cash flow in Q2, a 122% increase year over year. Meanwhile, adjusted EBITDA soared to $622 million, up 63% from the $382 million reported in Q2 2019. These figures represent exceptional growth, especially considering the unprecedented challenges the company faced due to COVID-19. It’s also worth noting that while all-in sustaining costs increased, all-in sustaining cost margins improved more than doubled, from $306/oz to $692/oz. Let’s take a closer look at the quarter below:
(Source: Simon Dawson, Bloomberg.com)
While AngloGold Ashanti wasn’t hit nearly as hard as other miners by COVID-19 closures in H1 2020, the company is tracking a little below its FY2020 production guidance mid-point of 3.18 million ounces, with H1 production coming in at 1.47 million ounces. Fortunately, due to lower fuel costs and weaker local currencies, costs are tracking below the guidance of $1,070/oz, as they came in at $1,031/oz in the first half of the year. The most significant contributor in the quarter for AngloGold was the company’s Geita Mine in Tanzania, which produced 173,000 ounces in Q2 at cash costs of $478/oz. This was a massive improvement from the 133,000 ounces produced at cash costs of $771/oz last year, with the stronger results driven by higher tonnes processed and higher grades from the Nyankanga Pit.
Meanwhile, the company’s newest Obuasi Mine also had a solid quarter, though we have seen some construction delays due to COVID-19. The good news is that the full ramp-up to Phase 2 is expected by Q1 2021, and Obuasi should be able to reach its 4,000 tonne per day target by mid-year latest. Currently, Phase 2 is 68% complete. Assuming AngloGold is able to meet these estimates, the mine will produce 375,000 ounces of gold in FY2021 and help to drag down AngloGold’s all-in sustaining costs. This is because Obuasi is one of AngloGold’s lowest-cost mines, with projected costs of $775/oz at the mid-point, 25% below the company’s FY2020 $1,070/oz cost guidance.
(Source: Company Presentation)
While many investors write off AngloGold as it’s a high-cost Tier-2 producer, and there are many to choose from in the sector, it’s worth noting that the high-cost part of this equation is likely to change. As we can see in the chart below, AngloGold’s average all-in sustaining costs from Africa came in at $934/oz in the first half of 2020, but the company has divested or reduced operations at its highest cost assets, as it sold Mponeng and SA Surface to Harmony Gold (HMY).
The below chart’s lower pane is the current look at AngloGold’s Africa operations after they’re divested, and it’s clear that we have a much lower-cost asset base by H2 2021. This is because we had two $1,300/oz plus cost operations in Mponeng and Morila, with SA Surface also relatively high cost at over $1,100/oz. If we add Obuasi into this picture once it ramps up to full production, we’ve got a cost base in Africa closer to $850/oz, down 7% from the H1 2020 costs of $934/oz as the only real high-cost operation will be Siguiri. Therefore, I believe that AngloGold should have no problem bringing its costs down below $985/oz long term on a consolidated basis. This would remove its status as a high-cost producer, with costs more than 5% above the industry average. Let’s take a look at AngloGold’s growth metrics below:
(Source: Company Presentation)
As we can see from the chart below, earnings estimates for AngloGold have been climbing recently, with annual EPS estimates surging given the higher gold (GLD) price. If we look at the chart below and compare the July estimates (blue line) vs. current estimates, we can see that analysts were forecasting FY2020 annual EPS of $2.31 just over a month ago, and estimates have since risen to $2.58. Meanwhile, the yearly EPS estimates for FY201 have also risen at breakneck speed, jumping from $3.09 to $3.42. Therefore, while AngloGold pulled back over the past month, the valuation has improved both from a lower share price and a rapid rise in earnings estimates. Generally, positive earnings revisions are a very bullish sign, one of the reasons the company is ranked 10th from a Quant rating standpoint in the table below.
(Source: YCharts.com, Author’s Chart)
(Source: Seeking Alpha Premium)
If we look at the earnings trend below, these bullish earnings revisions have significantly improved the picture here, with annual earnings per share [EPS] set to increase by over 40% this year. This earnings growth is not only well above the sector average, but it’s even more impressive coming off a year of 145% annual EPS growth [$1.80 vs. $0.73). If we look ahead to FY2021, the earnings trend shows that growth is expected to maintain its rapid rise, with FY2021 estimates of $3.42. Assuming the company meets these estimates, this would translate to a compound annual EPS growth rate of 67%, one of the top-5 highest earnings growth rates in the Gold Miners Index (GDX). Typically, the best-performing stocks in the market maintain 25% plus annual EPS growth rates each year, and given that AngloGold is set to grow annual EPS by 43% and 33% in the next two years, I would expect funds to be lining up to buy the stock on dips.
(Source: YCharts.com, Author’s Chart)
One thing to be careful of is robust earnings growth that’s missing revenue growth or margin expansion, but in AngloGold’s case, we’ve got both. During H1 2020, revenue was up 24% over the same period last year, and we’ve also seen significant margin expansion. As the chart below shows, with all-in sustaining cost margins increased by 900 basis point in H1 2020 vs. FY2019 levels (37% vs. 28%). However, these margins were based on an average gold price of $1,662/oz, and we’re currently sitting above $1,900/oz. Based on a high likelihood of an average realized gold price of $1,840/oz or higher in H2, we should see all-in sustaining cost margins improve to 40%, even if we come in at the high end of cost guidance ($1,100/oz). This would translate to a 300 basis point improvement sequentially from H1 to H2 2020, which confirms that the strong earnings trend above is sustainable.
So, how’s the valuation at current levels?
If we look at the chart above, we can see that AngloGold Ashanti is currently trading at just 13.19x forward earnings, a very attractive growth rate for a stock that’s ranked among the top-150 growth stocks in the US market currently. Typically, growth stocks that are enjoying 30% plus annual EPS growth trade at a forward earnings multiple of 20 or higher. If we compare AngloGold Ashanti’s forward earnings multiple to its peers, we can see that the stock is undervalued on this metric as well. As the above chart shows, million-ounce gold producers in Tier-2 and Tier-3 jurisdictions are trading at an average forward P/E ratio of 16.66 vs. AngloGold at 13.19. Therefore, if AngloGold Ashanti were to close the valuation gap between the current share price and its peers, it would move to a share price of $35.15 ($27.90 x 1.26). While this doesn’t mean the stock has to head there in a straight line, I believe the fair value of the stock is, assuming the gold price stays above $1,850/oz.
Some investors may agree that the fundamentals are compelling, but they’ve been scared off by the recent 30% correction. While the correction has certainly been violent, it’s essential to put it in context. As the chart above shows, this has been a deep correction; but it hasn’t even put a dent in the long-term picture. This is because the quarterly breakout occurred at $24.00, and the stock remains well above this price currently. Obviously, there are no guarantees, but I would argue that this suggests that the correction is merely to remove the overbought condition we had going into August and is not a failed breakout, which would be a much more bearish development. Therefore, as long as the bulls can defend the $26.25 level, I see this correction is providing a low-risk opportunity for investors to start a position in AngloGold.
(Source: Company Website)
AngloGold Ashanti has seen a significant fall from grace the past month, but the fundamentals have continued to improve during this decline. While the recent CEO departure and weaker gold price have weighed on the stock, I do not believe either of these things has put a dent in the long-term picture. Based on the AngloGold’s industry-leading earnings growth rate, continued margin expansion, and relative undervaluation, I see this current correction as an opportunity for investors to start a position in the stock. It’s certainly possible the stock could still have a little further room to drop on the downside, but at less than 9x FY2021 annual EPS estimates ($27.90 / $3.42), the reward to risk has shifted back to favorable at current levels.
Disclosure: I am/we are long GLD, AU. 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: Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.