SBM July 6, 2016
In January 2015, with SBM trading at $.19, I felt that it could go to $ 3.19. This was based on the turnaround in cash flow generation. Based on an Australian gold price of $1640, I thought that cash flow from the Pacific operations could go from a $110 million deficit of 2014 to potentially a $60 million surplus. Gwalia was projected to go from a cash flow surplus of $140 million in 2014 to a surplus of $220 million. With estimates for administration and exploration of $50 million, free cash flow prior to debt would be $230 million. These projections as a whole proved to be quite accurate. It was a simple deduction that a company generating these cash flow numbers was worth a lot more than the $94 million dollar market cap. the market was valuing SBM at the time.
So what is SBM worth today? With gold rising in price to $1840, and net debt down to $88 million as of June 30, 2016 (and going to a net cash surplus by Dec 2016), a valuation of $4.50 plus seems reasonable. Free cash flow could exceed $300 million prior to debt and taxes in 2017. However, this may be simplistic, and complicated by the two factors. Firstly, SBM continues to be undervalued compared to other gold companies. Secondly, the economic policies of the central banks may have created an opportunity to be invested in gold and quality gold miners.
In the aftermath of the 2008 financial crisis, central banks thought that they could bring the world economy back to sustainable growth by lowering interest rates, raising asset prices, and increasing debt levels. Central banks have accomplished these policy objectives in a spectacular manner, yet sustainable growth appears illusive.
Earnings of companies in the S&P 500 have decreased 4 quarters in a row, with the June 2016 quarter expected to be the fifth. Many of these companies have increased debt levels over the last few years. Yet the S&P continues to trade at elevated Price/Earnings and Price/Sales ratios. The combination of more debt, less profit, and elevated valuations pose a risk to current investors.
In the bond markets, over $11 trillion now trades at negative interest rates. These investors are guaranteed to lose money, even with full repayment.
Real estate markets have high debt levels, high valuations, and weak income growth. As with the S&P 500, this poses a risk to present investors.
The banking system is weak with investors and deposit holders exposed to bail-ins. Global debt levels have increased by about $100 trillion since 2008. Debt repayment is dependent on income, yet debt has increased dramatically relative to income. There is the risk of substantial defaults.
Gold investments represent about 1.5% of financial assets. Given the financial risks of the 4 main investment groups, a re-rating of gold and quality gold companies is a distinct possibility.
Globally there are relatively few quality gold stocks. Many of these companies have high production costs (a product of decreasing gold grades), and high debt levels. SBM, with low production costs, and soon to be no net debt appears to be an attractive investment, with a distinct possibility of being re-rated.
For example, Yamana Gold (YRI) claims it is a “True Value Proposition”. For the year ending Dec 2015, YRI struggled to generate free cash flow, and relied on a share issue and streaming agreement. The March 2016 quarter saw free cash flow improve to US $56 million ($75 million Aus), which is similar to the free cash flow earned by SBM in the March quarter. Market cap is Aus $7178 million or 416% above that of SBM. Now YRI has gold reserves of 15 million ounces compared to 4 million for SBM, but it costs YRI more to extract these ounces. Over the last year, SBM generated more free cash flow than YRI. As of Mar 2016, YRI had net debt of US $1.7 billion (Aus $2.27 billion) compared to net debt of Aus $88 million for SBM as of June 2016.
Over the next 12 months it is likely that the share price of SBM will benefit from two re-ratings. The first re-rating will be the result gold and gold stocks rising relative to stock markets, bond markets, real estate markets, and bank deposits. The second re-rating will arise as SBM’s market cap rises relative to other gold companies.
Where these two re-ratings take SBM is pure speculation, but a price above $10 per share is possible.
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