Agnico-Eagle’s Boyd has the answers

Investors in Agnico-Eagle Mines (AEM-T, AEM-N) have two things on their minds these days, said the company’s president and CEO Sean Boyd at the Denver Gold Forum this week.

First, they want to know what Agnico is going to do with all the money flowing into its coffers as a result of the rising gold price. And second, they want to know when the prices of gold equities – which have not increased to reflect US$1,700-1,800 an oz. gold – are going to catch up.

“The answer to the first question is really going to provide the answer to the second question,” Boyd said.

Agnico provided a partial answer to that first question with its $275-million bid for Mexico-focused junior Grayd Resource (GYD-V) announced on Monday.

The Grayd takeover will add 540 sq. km and two projects to Agnico’s landholdings in Mexico, including the La India project, 70 km northwest of Agnico’s Pinos Altos mine – one of the company’s best performing assets. La India hosts 760,000 measured and indicated oz. gold at a grade of 0.88 gram gold and more than 500,000 inferred oz. at 0.8 gram gold, and a preliminary economic assessment in December indicated a nine-year mine life and healthy 51% internal rate of return at US$950 per oz. gold.

The “tuck in” acquisition is early stage, but as per Agnico’s decades-old strategy, it has near-term production potential (within three years), a positive existing economic study and Agnico will own 100% of it. Once in production, Agnico plans to expand the deposit with cheap exploration ounces. The gold miner’s acquisitions over the past five years have added ounces at a cost of US$100 an oz., but Agnico has added reserves at its projects through exploration at an average cost of US$20 per oz.

Grayd shareholders can opt for either $2.80 in cash or 0.04039 of an Agnico share, plus 5 cents. The stock portion of the deal will increase Agnico’s share count by a modest 1.3% – the least amount of equity Agnico has ever issued in a takeover. Agnico certainly has the cash to avoid issuing equity to close the deal (at the end of the second quarter it had $139 million and under the agreement with Grayd, it won’t pay out more than roughly $92 million in cash), but Boyd said that Grayd and other juniors believe in the gold price and don’t want all cash.

While Agnico has always been careful with issuing paper and spending money – the miner with a 54-year history has just 170 million shares outstanding, and focuses on early stage acquisitions that offer large packages and lots of exploration upside – Boyd said he’s starting to see more discipline in the gold sector as a whole in response to shareholders’ concerns.

“I think this goes back historically to an industry that’s had a less than stellar track record on allocating capital and that’s the fear going forward,” he said.

“Looking back over the last twenty years, I think we had an industry that had really no confidence in the product with the massive hedging and the boards of directors clearly had no confidence in the businesses because they were selling away the upside of gold.”

Agnico has never hedged its production.

Times have changed, and in a bullish environment for gold, no one’s asking any longer where the price of gold of going, Boyd said.

And with gold miners’ increasing focus on cash flow and yield, led by Newmont Mining‘s (NMC-T, NEM-N) recently enhanced gold-linked dividend policy, Boyd believes companies will be able to demonstrate going forward that gold mining is a solid business that can sustain a higher yield.

“That’s going to send a strong message that, in the context around the world of a lot of industries struggling, this is one industry that’s actually doing an effective job in a tough environment,” Boyd added, referring to escalating costs.

Agnico is tackling throughput issues that pushed cash operating costs to US$910 an oz. at its Meadowbank mine, in Nunavut, in the second quarter (the mine’s first full quarter of production) and US$850 per oz. at its Kittila mine, in Finland, where it is continuing exploration and will be expanding. Weighted average production costs across its six operations came to US$565 per oz. for the quarter.

As to whether dividends – one of the key themes of this year’s Denver Gold Forum – are sustainable, Agnico’s history shows that it can be. The company starting paying dividends 29 years ago, after gold’s price spike in 1980, and has continued to pay one, even when its margins sank to US$75 an oz. (Margins at today’s prices are upwards of US$1,000 an oz.) The yield on Agnico’s shares peaked in 1989 at 2.5%.

With more and more people looking at the gold industry from the perspective of cash flow, gold miners will have a better chance to compete with gold exchange-traded funds (ETFs) if they embrace that perspective as well.

“If you can’t actually increase your shareholders’ leverage to gold, then you’re not going to do well relative to the ETF,” he said. “So we’ve been very focused over a number of years on our ability to increase our leverage to not only production and reserves, but ultimately that drives cash flow per share.”