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Senior Australian gold stocks face decision time, analysts say

With Australia's senior gold stocks widely held to be fully priced, analysts say the time is right to strike with more M&A over the other attractive option of showering investors with more dividends.

Morgans resources analyst Tom Betlehem said in a client note Feb. 16 that Evolution Mining Ltd. ended the first half of the 2017-2018 fiscal year in an "extremely strong" position, with net debt down 32% to A$321.5 million with 9% gearing, and A$113.4 million cash on hand.

While Evolution, Australia's second-biggest gold miner, just increased its dividend to 3.5 Australian cents per fully franked share despite recording a 10% year-over-year fall in statutory profit, Betlehem told S&P Global Market Intelligence that the market would respond favorably if it chased more assets.

Evolution's management has indicated that the miner will continue to build cash reserves rather than continue to pay down debt, which indicates it may be fluid with potential market opportunities if and when they arise, Betlehem said.

"The rhetoric from companies is that things are fully priced at the moment and they don't want to pay too much, so it's a bit of a stalemate where something has to give — either they return cash to shareholders and start paying huge dividends, or they start buying things," Betlehem told S&P Global.

"Organic growth can only get you so far with that sort of money."

However, he does not expect Evolution to remain idle for too long, despite narrative from the miner suggesting assets valuations are currently prohibitive to M&A.

"In the past they've been rapidly paying down debt to get the leverage they think is appropriate for them — 10 to 15% — and now that they're there, they're saying 'we're happy at these levels,'" Betlehem said.

Equity on hand

Evolution has the loan facilities and readily available equity there if it were to go and buy something, Betlehem said, because "they have a good track record and I think the market would support it, especially how the last two transactions have turned out."

Cowal and Ernest Henry have proved to be highly accretive acquisitions for Evolution, and Betlehem said the timing "appears sound" to further boost the portfolio.

Another top Australian gold producer, Northern Star Resources Ltd., also suffered a drop in profits — 7% — though revenue rose 14% to A$435.3 million, with plans to "capitalize on significant growth opportunities."

With the senior gold producers having such strong cash positions, Betlehem said it was "the logical thing — you'll either see large shareholder returns or some more activity in the M&A space."

Meanwhile, Patersons Securities head of research Cathy Moises said in a February research note that her firm had moved its focus to the emerging developers as "the senior gold stocks within Australia's gold sector look fully priced."

The Melbourne-based analyst told S&P Global that investors have been happier to pay more for the well-performed companies such as Northern Star and Evolution, particularly with the significant amount of confidence in the sector at present.

Market looking strong

With the market "looking stronger than it has for quite some time," Moises said the recent valuations of the "small kids on the block" also reflected "serious potential uplift as they hopefully transition to a more senior status."

Yet those stocks do have a higher risk, which was why Moises chose to focus on three — Kingston Resources Ltd., Geopacific Resources Ltd. and Nusantara Resources Ltd. — because taking a portfolio approach helps investors reduce their risk profile of just investing in one stock.

Moises said the key issue for such juniors was funding, but once that was secured, life suddenly gets a lot rosier, as Gascoyne Resources Ltd. can attest.

Gascoyne was languishing at sub-4 cents per share, and since then has largely traded above 45 cents.

"I wouldn't say it's a bull market, but it's a robust market, and I can't see it stopping in the short term, but we always try to look to the best possible outcome and usually the senior stocks will run ahead of the juniors then towards the end of the cycle the juniors will play catch-up," Moises said.