Including Australian gold miners in the Focus Portfolio offers several advantages.
Their long-term performance, diversification benefits, and potential for outperformance in a rate-cut environment make them an attractive investment at this point of the cycle.
The Key Reasons to Hold Gold Miners
1. Precious Returns
Australian gold miners have demonstrated strong long-term performance. Over the last 10-20 years, these miners have outperformed the ASX 200, with leverage to the gold price while capitalising on Australia's rich gold reserves and favourable mining conditions. Their ability to preserve value and deliver positive returns over extended periods reflects the growth potential offered by ASX-listed gold miners.
2. Diversification
Gold miners exhibit a low correlation with the ASX 200, presenting an excellent diversification opportunity. Due to their unique characteristics and industry-specific factors, the performance of gold miners tends to be independent of the broader market. Including Australian gold miners in our portfolio can potentially enhance risk-adjusted returns through diversification.
3. Tail risk protection
Gold and gold miners serve as effective hedges against tail risk events and periods of significant market downturns. In times of economic uncertainty, geopolitical tensions, or financial crises, investors seek the safety of safe-haven assets like gold. The gold mining industry's historical resilience during market stress makes Australian gold miners an attractive option for hedging against adverse market conditions and protecting portfolios from downside risks.
4. End of tightening in sight
After retracing significantly in FY22, gold has been a solid performer in FY23, although it has pulled back off its highs in the past few months. The prospect of the Fed pausing and then cutting should drive some further upside in the $A gold price over the next 6-12 months.
Why Not Just Hold the Commodity?
In addition to the benefits of holding the commodity, investing in gold miners provides distinct advantages that differentiate them from simply holding gold. These benefits include:
1. Production and exploration growth
Gold mining companies offer the potential for production and exploration growth. As they develop and expand their mining operations, they can increase their gold production over time, increasing revenue without relying on the gold price. Higher production coupled with a higher gold price can be a powerful combination. This growth potential allows investors to participate in the mining company's success as it increases its output and enhances profitability.
2. Operating leverage
Gold miners exhibit operating leverage to the price of gold due to their fixed cost base. Therefore, an incremental increase in the gold price directly impacts their bottom line, resulting in a proportionally larger boost in earnings for gold miners. This leverage results in gold mining companies, on average, outperforming the price of gold itself during a gold bull market.
However, it is important to note that operating leverage works both ways, and during a bear market or declining gold prices the profitability of gold miners can be adversely affected.
3. M&A activity
The gold mining sector has witnessed increased M&A activity, driven by larger mining companies seeking growth through acquisitions. This presents potential opportunities for investors in gold miners. Smaller mining companies could be acquired by larger players looking to increase their production capacity or access promising mining assets.
Alternatively, gold miners could engage in acquisitions to expand their operations and increase production. This M&A activity can create value for shareholders through synergies, increased economies of scale, and enhanced operational efficiencies.
The Key Things we Look for in a Gold Miner?
- Focus on selecting gold miners in tier one jurisdictions.
- Prioritise companies with size and scale for financial strength and potential market dominance.
- Look for gold miners demonstrating production growth to capture the upside of rising gold prices.
- Emphasise strong future cash flows for sustainable returns and the ability to reinvest and create value.
Our Top Pick - EVN Preferred over NST
We have made the strategic decision to replace Northern Star Resources (NST) with Evolution Mining (EVN) in the Focus Portfolio, as we believe EVN now presents a more compelling investment opportunity. EVN stands out due to its attractive valuation metrics, better production growth, and its exposure to copper.
Adding Evolution Mining (EVN) +2.5%
Evolution Mining (EVN) is a prominent gold mining company operating in Australia and Canada. In Australia, their key mines include Cowal in New South Wales, Mt Carlton and Mt Rawdon in Queensland, Mungari in Western Australia, and the recently acquired Ernest Henry copper-gold mine in Queensland. The 2022 acquisition of Ernest Henry has added a significant copper component to EVN's portfolio.
Internationally, EVN expanded its operations by acquiring the Red Lake gold complex in Ontario, Canada. Red Lake, known for its high-grade deposits, presents a substantial growth opportunity. With operations spanning Australia and Canada, EVN has established itself as a leading gold mining company with a diversified resource base and strategic geographical presence.
1. Stronger production growth
EVN has superior medium-term growth prospects to NST. The gold production forecasts indicate that EVN is expected to exhibit higher production growth compared to NST from FY23 to FY26. During this period, EVN's gold production is projected to increase at a compound annual growth rate of approximately 6.6%, while NST's stands at around 5.2%.
EVN’s production growth is expected to come from Red Lake (Canada) moving from ~125kozpa in FY23 to ~300kozpa by FY27, and expansion in Mungari (WA), which could produce ~200kozpa in FY27 from ~130kozpa today. Recent capex on Cowal is expected to bear fruit in FY24 and beyond.
2. EVN valuation and cash flow superior to NST and NCM
EVN looks better value using a few different metrics. EVN currently trades on a 5.5x FY24 EV/EBITDA, representing a more favourable valuation compared to NST, which is trading at 6.1x times. This valuation discrepancy suggests EVN offers investors an opportunity to acquire shares at a relatively cheaper price.
EVN has superior expected cash flow metrics. This is due primarily to the amount of capex NST still has over the next few years. EVN is now past its peak capex (in FY23) and expected to benefit from a higher free cash flow over the next 2 years.
3. Copper option
Another noteworthy aspect of EVN is its exposure to the copper market through the Ernest Henry mine. Approximately 20% of EVN's revenue is expected to come from copper production, a similar percentage to that of industry giant Rio Tinto.
Evolution acquired 100% legal ownership of the Ernest Henry asset in January 2022. This resulted in Evolution’s copper production increasing significantly, lowering the group’s all-in sustaining cost (AISC) per ounce, and cementing Evolution’s position as one of the lowest-cost gold producers in the world.
This exposure to copper provides EVN with additional revenue diversification and potential commodity upside.
The evolving landscape presents an increasingly attractive medium to long-term outlook for copper, as the market experiences a shift towards a structural deficit with the energy transition.
Read about our views on copper in Digging Beneath the Surface – Australia’s Copper Giants
4. Long life, high quality mines
Both EVN's key assets - Ernest Henry and Cowal - are regarded as high-quality assets with the potential for additional value creation.
EVN has a material % of copper revenue since Ernest Henry's acquisition in 2022. We anticipate further enhancements, including incremental growth opportunities through latent mill capacity utilisation from new independent ore sources.
Cowal is strategically positioned as a cornerstone within EVN, set to reach approximately ~320kozpa in FY24, and steadily ramping up to steady state production by FY26 out to FY40. These assets serve as the fundamental drivers of long-term value for the stock.
5. Capital management (over time)
At the core of EVN's business strategy is a commitment to disciplined capital allocation and operational efficiency. Over the past 12 years, EVN has had a successful track record of portfolio optimisation through a disciplined approach to M&A. The portfolio over time has grown from a ~7Moz mineral resource in 2012 to ~30Moz mineral resource in 2022.
Along the way, EVN has divested the lower-margin operations and acquired high-quality assets to increase group margins by lowering group AISC. A key part of the strategy since 2012, the ex-CEO, Jake Klein, now sits as executive chair and remains an important cog in the business.
What has Deterred us in the Past?
Gearing - while it is important to note that EVN's gearing level currently stands at 30%, the company's strong cash flow generation is expected to facilitate de-gearing over the coming years. By FY25, it is projected that EVN's gearing will decrease to around 20%, reflecting improved financial stability and reduced reliance on debt.
CAPEX – FY22 and FY23 were periods of high capex for EVN. Now past its peak and returning to a more normalised level, we believe EVN should be back on the market's radar.
Labour cost-related downgrade (June 2022) – while the resource sector was not immune to the labour pressures last year, EVN was badly hit by shortages. This was more pronounced as EVN was going through a period of high capex. With labour shortages becoming less of an issue, and EVN past its peak of capex, we do not see this as a material issue at present.
Written by
Rob Crookston, Equity Strategist
Rob is an experienced research analyst with a background in both equity strategy and macroeconomics. He has a strong knowledge of equity strategy, asset allocation, and financial and econometric modelling.
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