Research Notes
Polyus Gold: already too expensive
| 17.02.09 |
We are resuming our coverage of the Russia’s biggest gold producer, Polyus Gold. The company holds the world’s fifth largest gold reserves and should the investment program be successfully completed, could double its production levels by 2014. However, favorable price trends in the market are a crucial condition for the capital investments efficiency.
Upside factors:
- Large mineral resource base. The company holds gold reserves of 72 million ounces, which are unjustifiably valued cheaply. Investors value Polyus Gold reserves at USD 61 per oz, against the average relevant price for peers of USD 250.
- The large amount of liquid assets and healthy balance sheet limit the company’s exposure to the negative implications of the global financial crisis. More than USD 1.3 billion at the company’s disposal is, on one hand, a guarantee of its stable financial position and, on the other,offers greater opportunities in the merger & acquisition market.
- Increased demand for gold miners’ names in the face of the financial crisis. The deepening financial crisis has triggered a surge in demand for gold, which has propped up global prices. Another key factor fuelling investor interest in gold miners’ shares is their low correlation with a stock market’s performance in a time of instability. At present, the average market value of gold-mining companies’ shares exceeds 20 P/E 2009. Our fair price for Polyus Gold, estimated under a peer group method, stands at USD 36.3 per share as of year-end 2009.
Risks for the company and shareholders:
- The lack of a long-term fundamental value. The investment component of demand for gold is exposed to wide fluctuations. Amid expectations of a slackening demand for gold on the part of jewelers, this gives us grounds to believe the average yearly price of gold will not rise above USD 1,000/oz in upcoming years, even if US inflation accelerates, as expected. In light of this, we set the target price for Polyus Gold, calculated under a DCF method, at USD 14.6 per share as of year-end 2009, down by more than 50% from the current market level.
- Production costs growth. Between 2003 and 2008, gold total production costs surged from USD 130 to USD 520/oz, or at an average annual rate of 32%. The miner’s current expenses are already close to the upper limit of the average cost range for the industry. To remain competitive, the company needs to urgently tighten screws on its expenses.
- A large-scale capex. The vast resource base enables the company to boost production levels, which, however, cannot be done without hefty capital investments. The company’s investment program requires over USD two billion in 2009 through 2015, which may dramatically limit cash flows for shareholders.
We underscore the company’s large-scale resource base as a key competitive edge. However, we do not currently see an effective way that would allow the company to transform this advantage into adequate cash flows for shareholders. As a result of our valuations, based on a peer group method and a DCF model, we assign a SELL recommendation on Polyus Gold common shares, with a USD 25.5 year-end 2009 target price.
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Sectors: Metals, Non-Ferrous MetalsCompany: Polyus Gold Company