Disappointment Brings a Bargain Buy
Kitco Commentaries | Opinions, Ideas and Markets Talk
Featuring views and opinions written by market professionals, not staff journalists.
Adrian Day of Adrian Day Asset Management looks into the results reported by a triad of companies, including one whose stock fell sharply and that he now considers a strong buy.
Osisko Gold Royalties Ltd. (OR:TSX; OR:NYSE, US$9.73) fell sharply following its fourth-quarter results. Three factors contributed to this: higher G&A (general and administrative) costs; a reduction in 2018 guidance; and most important an impairment charge on the Eleonore royalty it owns. The charge, of $89 million, followed mine-owner Goldcorp reducing its long-term production estimate to 400,000 ounces a year (down from 600,000), a lower but achievable target.
There remains considerable upside in the mine, both from improved operations and exploration. Osisko emphasized that it could reverse the charge if operations improve or the mine life is extended. It should also be noted that the mine remains in ramp-up. Osisko received 6,390 ounces from the mine for its royalty last year but, even with the reduced guidance, expects 7,920 this year and 8,800 thereafter. The mine will generate increased cash flow for Osisko going forward.
The higher G&A expenses were attributable primarily to costs related to the Orion transaction last summer, and Osisko expects a reduction in stable-state G&A going forward. The reduction in production guidance was due primarily to delays in Lydian's Armenian mine, on which Osisko holds a royalty, and only a temporary reduction.
Good news as well
There were plenty of good things about the results, including record gold ounces and revenues. The foundational royalty on Canadian Malartic set a new record, while exploration is underway at brownfield deposits.
The balance sheet remains strong, with an increase in cash to $334 million; a securities portfolio valued at $364 million; and long-term debt of $464 million. Osisko also has $250 million of unused firepower available.
The nearly 10% decline in Osisko's stock price is overdone, and the valuation discount too great. The stock is trading on a price-to-NAV basis at a discount of 36% to its royalty peers. Osisko is a strong buy here.
Goals Remain but Progress Slow
Goldcorp Inc. (G:TSX; GG:NYSE, US$12.95) has reiterated its 20/20/20 plan to lower costs, increase production, and increase reserves by 20% over five years, even though not much progress has been made to date. Byproduct credits will drive lower costs, but despite higher base metals prices, Goldcorp has kept its year-ahead cost guidance flat, an indication that cost pressures are coming back.
New mines (Borden, Coffee), ramp-ups (Eleonore, Cerro Negro), and expansion (at Penasquito) make the production target doable. Execution will be the key to achieving the goals and to the stock price.
Goldcorp trades at modest discounts to peers, but given the weaker balance sheet—$2.6 billion of debt against cash of $186 million—as well as lower-return projects, a discount is justified. We are holding.
Ares Turns the Corner
Ares Capital Corp. (ARCC:NASDAQ, US$15.92) continues to make progress in digesting the huge American Capital acquisition and toward fully covering its dividend again. Indeed, the company says the transition year after the ACAS acquisition, "is now behind us," and the tone of the recent conference call was more optimistic.
Most importantly, Ares has a large pool of carry-over income, because it outearned its dividend over the years prior to the ACAS acquisition. This is currently $0.81 per share, "a big number." Management indicated it wants to be sure of sustained progress before raising the dividend.
The net asset value (NAV) was up slightly, to just over $16, and there was a reduction in companies on nonaccrual (just 3.1% at cost). The company is also on a roll with new investments of over $1.5 billion (including a $900 million block of senior loans in its Ivy Hill unit). With the new investments, debt-to-equity increased to a still comfortable 0.7x, while there is plenty of availability on its credit line.
Though the company did not say so, I suspect we will see an increase in the quarterly dividend later this year, or, at least, another bonus dividend; the last bonus dividend was paid in early 2015, before GE exited from a SSLP joint venture with Ares.
Trading just below book, with a yield of 9.6%, Ares is a buy for long-term income investors. We also suspect that, with the ACAS acquisition behind it, we should start to see some capital gains as well.
Adrian Day, London-born and a graduate of the London School of Economics, heads the money management firm Adrian Day Asset Management, where he manages discretionary accounts in both global and resource areas. Day is also sub-adviser to the EuroPacific Gold Fund (EPGFX). His latest book is "Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks."
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1) Adrian Day: I, or members of my immediate household or family, own shares of the following companies mentioned in this article: Osisko Gold Royalties and Ares Capital. I personally am, or members of my immediate household or family are, paid by the following companies mentioned in this article: None. My company has a financial relationship with the following companies mentioned in this article: None. Funds controlled by Adrian Day Asset Management hold shares of the following companies mentioned in this article: Osisko Gold Royalties, Goldcorp and Ares Capital. I determined which companies would be included in this article based on my research and understanding of the sector.
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