Unhedged South African Gold Stocks
Durban Deep (DROOY), Harmony Gold (HGMCY) and Gold Fields (GOLD) are in the top 15 gold producers in the world. Each have recently posted exceptional earnings for 4th Q 2001. Even greater earnings will be forthcoming 1st quarter 2002. Is it safe to anticipate share prices will continue to appreciate? And if so, by how much?
I address the question of how one goes about factoring both a changing price of gold (POG), and changes in currency exchange rates, which were only partially reflected in the last quarterly earnings reports.
During the last six weeks the POG has moved up and in the same period the SA Rand has seemingly stabilized in comparison to the USD. One might posit that share prices have not fully reflected the "sea change" that has occurred for SA gold miners. I share with friends here humble efforts to find the answer to the question, "What valuation may we expect after the release of the next quarterly reports?"
Here is the quantitative analysis performed as part of my due diligence. Perhaps I've made errors. If so, I hope better minds at G-E will spot them and call the question!
Assumptions
1st quarter 2002 will be much like 4th quarter 2001 but with a couple of significant differences. One major change is that 1st quarter 2K2 will have an average POG of $300. Equally important, the US dollar will, on average, equal 11.45 SA Rand. I'm going to assume that production will only equal the best quarter of 2001. I'll use the cost of producing an ounce of gold as reported 4th quarter 2002 in Rand per kilogram as these costs are not exchange rate dependent. I'll also assume that all other costs per ounce will not increase. For this cost component I will use the 4th Q2K1 published amounts stated in US dollars per ounce since some of these expenses are dollar denominated.
The devil is always in our assumptions but we must always make and identify them before we can attempt any serious analysis. One could argue that production will increase due to recent acquisitions, POG will not average $300, the Rand will continue to depreciate or even appreciate, or that production cost will change. Notwithstanding opportunity for error, I looked at each of these companies.
DROOY: Durban Deep has 156.7m shares outstanding. It produced 269K ounces in its best quarter of 2001. It cost the company 55,000 Rand per kilogram production in the 4th Q 2001 plus an additional $4 per ounce in other costs. This company has 14 million ounces of proven mine reserves and an additional 84 million ounces of resources. From this one can calculate that Durban produces .00686 ounces of gold per share annually and they will earn $147 dollars per ounce produced.
That's $1.01 earnings per share annually or $0.2525 earnings per share for the quarter. Durban will surely be able to close its hedge book by (or at) the end of this quarter if they choose. They have already announced a 20% increase in production so I don't think the existing hedge book will negate the probability of achieving the earnings called here. Using a conservative P/E of 10 the value projected for DROOY is $10.10 per share. The share price for Durban has barely begun its move to reflect this valuation.
HGMCY: Harmony Gold has 144.6m shares outstanding. It produced 616K ounces in its best quarter of 2001. It cost the company 63,863 Rand per kilogram production in the 4th Q 2001 plus an additional $20 per ounce in other costs. The company has 32 million ounces of proven mine reserves. From this one can calculate that Harmony produces .01704 ounces of gold per share annually and they will earn $107 dollars per ounce produced at a $300 POG.
This equals $1.82 earnings per share annually, or $0.455 earnings per share for the quarter. This amount would be 2.50 times its 4th Quarter 2001 earnings for a 148% increase. Using a conservative P/E ratio of 10 results in a share price projection of $18.20. Is it any wonder that Harmony stock is already in the "running of the bulls"!
GOLD: Gold Fields has 469.4m shares outstanding. It produced 984K ounces in its best quarter of 2001. It cost the company 55,013 Rand per kilogram production in the 4th Q 2001 plus an additional $20 per ounce in other costs. This company has 96 million ounces of proven mine reserves. From this one can calculate that Gold Fields produces .00838 ounces of gold per share annually and they will earn $131 dollars per ounce produced.
That's $1.10 earnings per share annually or $0.275 earnings per share for the quarter. Using the values assigned above, the projected share price for Gold Fields is $11.00.
Of the three, my projection for Gold Fields seems more suspect. A guess for profit per share would be 20% less than Harmony as this has been a consistent relationship between the companies share price. I've rechecked the math and can't find an error. Perhaps a reader will find a discrepancy. If my calculation is correct, then I would expect every effort is being made by Gold Fields to crank production to achieve a par share value with Harmony. Gold Fields has readily available mining reserves to achieve this objective.
Conclusions
All three of these stocks will show significant earnings improvement in their the next quarterly earnings reports. This prediction is predicated on the validity of assumptions presented. Even as modest reflections of today's reality, we must wonder if these assumptions will hold for the remainder of the quarter? It is my belief that the assumptions presented are very conservative. I serve notice, however, that any and all assumptions can easily make one appear foolish.
I believe that sufficient data and methodology is presented such that anyone may alter the model using their set of assumptions. I urge everyone to model their assumptions and draw their own conclusion.
Either an increase in production or the POG would have dramatic effects on the profit of these companies, as would a dramatic change the Rand exchange rate with the USD. I have constructed a model that allows altering all the variables (POG, cost per Kg in Rand, other cost in USD, $/Rand exchange rate, ounces produced, and shares outstanding), as they will surely change. From the model you can also calculate the effect a dollar increase/decrease in the POG has on share value. This is referred to as leverage. I have not addressed this specifically preferring to defer the subject of leverage to Mr. Hamilton.
I will keep the Gold-Eagle forum posted as new developments alter the forecast presented.
DISCLOSURE
I hold ownership, personally and in various trusts, of all three stocks.
Respectfully submitted for peer review - Your critique is solicited.
Carl Elkins, PhD
torus@ipdi.com
February 19, 2002
CAVEAT: The analysis is not intended as a recommendation to purchase nor meant to be an accurate forecast of earnings or share price. It is only presented herein to stimulate discussion and demonstrate one methodology to factor changes in currency and POG effects on share prices of Unhedged South African Gold Stocks.
Useful conversion data:
1 Metric tonne = 1,000 kilograms
1 Metric tonne = 2,204.623 lbs (not useful for the model)
1 Metric tonne = 32,150.75 troy ounces
1 kilogram = 32.15075 troy ounces
16 avoirdupois ounces = 14.58 troy ounces (not useful for the model)
Email this Article to a Friend 
Also by Carl Elkins
Printer Friendly Version
