(Kitco News) - Even with record-high gold prices, the mining sector has struggled to attract investor attention. According to some analysts, one reason the mining sector continues to lag behind the precious metals market is that companies have done a poor job of allocating capital and rewarding shareholders.
Equity analysts at BMO Capital Markets suggest that while mining companies have learned some lessons from the previous bull market, there is still work to be done in effectively allocating capital as gold producers see record margins and free cash flow (FCF).
“In our opinion, while there have definitely been some positive changes, there remains a level of ambiguity in terms of capital allocation priorities and policies that needs to be addressed more decisively—specifically with regards to capital returns—in light of record gold prices and expected FCF strength,” the analysts wrote in a note.
BMO analysts noted that the biggest hurdle for gold companies is allocating capital to support growth and future production. They added that past cuts to exploration budgets have created a suboptimal growth outlook for the sector.
While reinvestment into exploration is necessary, BMO commented that determining how much capital should be allocated will not be straightforward.
“We agree with gold company management that reinvestment capital needs to increase to at least maintain current production levels, especially given the inflationary environment. However, the overall business environment—capex inflation and a scarcity of quality projects in favorable jurisdictions—is still not ripe for undertaking larger growth projects,” the analysts stated. “Furthermore, in terms of segmentation, we believe the intermediate and junior gold producer space offers better organic growth opportunities than the senior gold producers.”
BMO analysts also pointed out that mining companies face a challenging decision regarding balance sheet improvement. While mining companies have made significant progress in deleveraging from the massive debt levels accumulated in the early 2000s, the question remains whether improving balance sheets and paying off debt should be a priority in the current environment.
“One can understand the sector’s tendency toward continued deleveraging given the challenges faced over the past decade with high debt levels, but from a purely financial and cost-of-capital standpoint, maintaining zero or very low levels of leverage is not necessarily the most optimal structure,” the analysts commented. “We believe that continued deleveraging should be less of a priority for gold companies compared to business reinvestment or capital returns.”
Finally, BMO analysts observed that one factor keeping investors out of the mining sector has been a lack of returns on investment. Even with record-high gold prices, investors feel they aren’t seeing enough returns on their capital.
“We believe the gold sector, and specifically senior gold producers, could do more in terms of both policies and the quantum of capital returns. We also believe that supplemental returns could take the form of buybacks, where the gold sector seems to lag materially behind broader market trends,” the analysts said.
