During the past three quarters, respected hedge fund manager Seth Klarman’s Baupost Group has accumulated 3.5 million shares, or 4% of the stock, in junior gold producer Allied Nevada Gold (NYSE:ANV). Its stock is up 22.8% in the last year and trades at an incredibly steep PE multiple. Despite this fact, Klarman continues buying.
Klarman is a brilliant man and many investors probably are tempted to follow suit. But before doing so, why not consider a safer option like Yamana Gold (NYSE:AUY)?
Gold Production
In the first nine months of 2011, Allied Nevada produced 69,840 ounces of gold, 16.5% less than a year ago. Fortunately, its average realized price per ounce was $1,543, 29% higher year-over-year. Translated into actual revenue, Allied Nevada grew gold sales in this period by 10.1% to $105.8 million. However, because of delays in equipment delivery to its Hycroft mine, Allied Nevada is behind schedule. As a result, the company will produce 100,000 ounces of gold in 2011, about 15,000 shy of expectations.
According to Allied Nevada, the Hycroft mine has a potential 17 million ounces of gold available over its useful life. From this perspective, a shortfall isn’t a big deal as long as gold prices remain high. However, a 20% drop in the price of gold from current levels around $1,690 an ounce amounts to $5 million in lost revenue and a couple of million in operating income.
Size Comparison
To give you an idea how much bigger Yamana Gold is compared to Allied Nevada, check out Yamana’s silver production for the first nine months of the year. It produced 7 million ounces of silver to the end of September at an average selling price of $36.42 an ounce, generating revenue of $255 million — 2.2 times Allied Nevada’s total revenue for both gold and silver. Size has its advantages.
While Allied Nevada currently mines from just the Hycroft property (although it does have several others in the advanced exploration stage), Yamana has seven mines operating in Brazil, Chile, Argentina and its newest (Mercedes) in Sonora, Mexico. Yamana expects production at its Mexican mine will grow to more than 130,000 gold equivalent ounces by sometime in 2013. In addition to the newly opened Mercedes, it has three additional mines planned in Brazil, all of which should open by the end of 2013. In terms of diversification, there’s no comparison.
Profitability
Both companies are first and foremost gold producers, using what’s referred to in the mining business as cash costs per gold equivalent ounce (GEO), a non-GAAP measurement that tells investors how much they’re making at the site level from their gold production. Other industries call this gross profit. They then subtract their exploration and general/administrative expenses to determine operating profit. So far in 2011, Allied Nevada’s cash cost per GEO is $486 compared to $456 for Yamana Gold, meaning Yamana’s gross margin should be higher.
However, when you look at both their income statements and you include depreciation and amortization in the cost of goods, Allied Nevada’s gross margin is 800 basis points higher at 58%. But if you exclude depreciation and amortization, Yamana’s gross margin is 300 basis points higher at 66% — and if you think about it, it makes sense. Yamana is operating seven mines whereas Allied Nevada is operating just one. The depreciation and amortization charges are naturally going to be higher.
Farther down the income statement we see that in the most recent nine-month period, Yamana’s operating margin was just about double Allied Nevada’s at 43.4%. That too makes sense when you consider where both companies are in the exploration process. Allied Nevada is just four years old while Yamana dates back all the way to 1980.
The two companies so far in 2011 have spent approximately $23 million on exploration. That’s a pittance for Yamana, whose net earnings are 20 times that amount. Put another way, it’s 1.4% of Yamana’s revenue, compared to 20% for Allied Nevada. They are indeed two different kettles of fish.
Bottom Line
If you believe the price of gold and silver will continue to rise and you want to benefit from this increase by investing in a gold producer, then it’s really a matter of preference. On the one hand, you have an established player with many producing mines that also happens to pay a dividend, opposed to a relative newcomer with just one mine open that doesn’t. While I understand Klarman’s interest in the junior gold producer, it doesn’t make it the right choice for the average investor. Forget about Allied Nevada and go with Yamana Gold. It’s the smarter, safer bet.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned stocks.
