As many corporate issuers brace for slowing economic growth, the gold sector is regaining its shine after several lackluster years. Gold prices--the key driver of issuer cash flow and credit measures--have sharply increased recently to a high not seen in more than six years. Merger and acquisition (M&A) activity has also picked up in 2019--led by Barrick Gold Corp. and Newmont Goldcorp Corp.--and has contributed to S&P Global Ratings' improved sentiment for the sector.
What Do Higher Gold Prices Mean For Our Ratings On Gold Producers?
In the near term, we expect reduced downside rather than wholesale upgrades.
This rise in gold prices is in the early stages and we expect future price volatility linked to market sentiment. In addition, we are waiting to see to what extent (if any) issuers respond to the improved gold market outlook. Reactions could include a resurgence in capital-intensive growth investments and/or heightened shareholder returns that could come at the expense of balance-sheet strength. Jurisdictional risk remains an overhang for some gold producers, namely from unstable operating conditions (such as taxation and permitting) or social considerations, and could intensify with new development projects.
Furthermore, improving historically weak returns on capital remains a key challenge as sustainable cost reduction has proven elusive for most miners. While we can't rule out future upgrades, for now we believe a measured approach is warranted. And at present, we do not envision widespread positive rating actions within the sector over the next 12 months.
|Gold-Focused Issuers Rated By S&P Global Ratings|
|ICR||Outlook/CrediWatch||Business risk||Financial risk||SACP||Domicile|
Newmont Goldcorp Corp.
Barrick Gold Corp.
China National Gold Group Co. Ltd.*
Newcrest Mining Ltd.
Kinross Gold Corp.
Zijin Mining Group Co. Ltd.
Shandong Gold Group Co. Ltd.*
China Gold International Resources Corp. Ltd.*
AngloGold Ashanti Ltd.
Gold Fields Ltd.
Yamana Gold Inc.
Zhaojin Mining Industry Co. Ltd.*
Sibanye Gold Ltd.
Eldorado Gold Corp.
New Gold Inc.
|Ratings as of Oct. 21, 2019. *ICR influenced by sovereign linkage. ICR--Issuer credit rating. SACP--Stand-alone credit profile.|
Ratings Upside Transcends Prices
We recently revised our gold price assumption to US$1,400 per ounce (/oz) in 2020 and 2021--a US$100/oz increase (7.7%) from our previous quarterly price review in July 2019 (see "S&P Global Ratings Cuts Copper And Zinc Price Assumptions And Lifts Those On Nickel And Gold," published Oct. 9, 2019, on RatingsDirect). Prices are a fundamental component of our forecasts used to assess the financial risk profiles and liquidity of our rated issuers. The increase in our price assumption improves our forecast credit measures for gold-focused miners. In most instances, projected adjusted debt-to-EBITDA ratios fall in line with levels in our upside rating scenarios; we were already forecasting an increase in earnings and lower net debt related to free cash flow (we net at least 75% of cash to derive our adjusted debt estimates) in 2019. Our higher gold price assumption accelerates this trend; therefore, we estimate a steeper year-over-year decline in leverage in 2019 among our higher-rated issuers (see chart 1).
Prospective Cost Profiles And Asset Quality Are Key To Our Rating Assessments
Notwithstanding the deleveraging, our ratings incorporate the expectation for volatility, particularly at this early stage of the upturn in the gold cycle. We typically require sustainable strength in credit measures, usually for at least a year, with high prospects that this strength will continue before we take a ratings action. In addition, we also consider cash returns for reinvestment to defend or enhance business drivers, such as reserve lives, asset breadth, and cash production costs, before contemplating upgrades. In particular, this applies to entities rated near or at investment-grade ('BBB-' or higher). This measured approach reflects our experience with gold cycles.
Gold prices have been highly stable relative to most commodities over the past five years, averaging close to US$1,250/oz (and trading in a narrow range) before the recent spike. In contrast, historical prices fluctuated significantly. Interestingly, gold prices in late 2019 have broken from their historical inverse relationship with the U.S. dollar, with both climbing to near-decade highs.
S&P Global Ratings' gold price assumptions are higher than they have been in several years, but we can't rule out meaningful declines in the future. The vast majority of rated issuers lack meaningful commodity diversification or hedge positions that add downside risk exposure when the cycle turns. Gold hedging is rare among rated issuers (equity investors want exposure to price upside) and typically is only employed to provide price certainty during material project construction (see chart 2 and 3).
Cost Improvement Has Proven Elusive, Even At Higher Production Rates
In the past several years, we have witnessed rising costs among many of our rated issuers despite a sectorwide focus on efficiency initiatives. Sustainable cost improvement has been difficult to achieve: unit cash and all-in sustaining costs (AISC) have slowly climbed since 2015 amid relatively stable gold production for most higher-rated issuers. The majority of issuers are now focused on increasing the value of production rather than gross gold output (a departure from past cycles).
We believe cost stabilization is more likely than material improvement. Rising costs for labor (usually about in line with inflation), consumables, and energy, as well as the impact of lower grades that accompany reserve depletion, are key impediments. Aging mines require higher capital intensity to sustain production. As unit costs migrate higher, issuer profitability and cash flow become increasingly sensitive to lower gold prices.
Newmont Goldcorp and Barrick's M&A/joint venture transactions have led to higher output and hold the promise of significant efficiency gains. Beyond synergies, both companies are also likely to improve the value of their produced ounces through asset sales over the next couple of years. However, we assume the extent of unit cost improvement to be relatively modest over that time frame. For example, we estimate Newmont Goldcorp's cash costs will improve by less than 10% over the next two years, despite adding substantial lower-cost ounces from the company (an increase of over 40% based on 2018 results). Barrick has also guided to higher year-over-year unit costs in 2019 despite acquiring Randgold Resources early in the year. Clearly, higher production does not guarantee unit cost improvement. Other than Newmont Goldcorp and Barrick, issuer production across our rated portfolio is estimated to remain generally flat. Newcrest Mining Ltd. (Cadia) and Kinross Gold Corp. (Tasiast) announced expansion projects at existing mines, but we don't envision a material change in consolidated output over the next few years (see chart 4 for gold production).
EBITDA Margins Will Improve, But Returns On Capital And Free Cash Flow Are Key
We estimate that margins will sharply improve in 2019 for all issuers, led by higher average gold prices and generally stable operating costs. For most, this should also translate into higher free cash flow generation that strengthens financial flexibility and effectively alleviates any near-term rating pressure. But gold mining is a capital-intensive business: The sustainability (and certainly growth) of mined production requires high ongoing investments to mitigate reserve depletion.
We estimate AISC across the sector at about US$1,000/oz on average (lower for most higher-rated issuers; see chart 5). Add discretionary spending for future growth initiatives, much of which is aimed at developing new (or expanding existing) assets to offset depletion from maturing mines, and breakeven cash flow approaches about US$1,200/oz--about in line with average prices over the past five years. We can see this from historically low ratios of free cash flow-to-debt--in the mid-single-digit area (on average) for most issuers--and negative in certain instances related to project spending. While average prices have slowly risen in the past few years, so have AISC.
As a consequence, returns on capital have been weak. For the larger players (Newmont Goldcorp, Barrick, AngloGold Ashanti Ltd., Kinross Gold Corp., Newcrest Mining, Gold Fields Ltd., and Yamana Gold Inc.) return on capital has averaged just below 6% (and lower if we account for the significant write-downs incurred by certain issuers over this period). In our view, returns at this level are sufficient to cover debt servicing costs (which have come down due to debt repayment) but do little to increase free cash flow and improve enterprise value (see chart 6).
Gold prices have been sluggish over this period, but capital expenditures have also been relatively restrained. None of our rated gold companies has embarked on massive expansion projects that result in a step-change in investment and output, as we have seen in the base metals sector. At this point, we assume markedly higher free cash flow and returns on capital in 2019, spurred by higher prices and generally stable capital expenditures. However, for us to contemplate rating upside for investment-grade gold producers, we would likely require a track record of free cash flow and double-digit returns on capital (see chart 7 for cumulative free cash flow).
There Are No Upgrades On The Horizon Just Yet
S&P Global Ratings is in no rush to raise ratings across the gold sector in response to its more favorable price assumptions.
Prices have historically fluctuated, and we incorporate the potential for volatility into our ratings. There are also several other factors to consider beyond stronger estimated credit measures linked to higher prices, which could very well prove to be temporary. In particular, the industry is capital-intensive and must contend with ongoing cost inflation, which has contributed to low returns on capital for many issuers. In addition, we are interested to see if, and to what extent, companies adopt new strategies beyond debt repayment should prices remain near strong levels.
Non-investment-grade gold producers could become candidates for an upgrade if higher prices translate into stronger cash flow available to complete projects that positively affect the value of output. We view this as unlikely within the next 12 months. We don't expect to raise our ratings on most of our investment-grade gold universe, at least not for the next few years, in the absence of sustainably stronger returns on capital.
S&P Global Ratings Cuts Copper And Zinc Price Assumptions And Lifts Those On Nickel And Gold, Oct. 9, 2019
This report does not constitute a rating action.
|Primary Credit Analyst:||Jarrett Bilous, Toronto (1) 416-507-2593;|
|Secondary Contact:||Donald Marleau, CFA, Toronto (1) 416-507-2526;|
|Research Assistant:||Nicole Jiang, Toronto|
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