Many investors are interested in the mining and metals sector but struggle with how to properly value these companies. Unlike typical stocks, miners have unique attributes that require a different framework for valuation. This article will provide a step-by-step guide for investors on how to value mining companies based on their resources, costs, gold price assumptions and other key factors.
Assessing Resource Potential
The starting point in valuing a miner is understanding the resource potential of their deposits. This means estimating the total ounces or pounds of gold, silver, copper or other metals within a company’s projects. The larger the resource, the more potential value the miner has. Investors can find resource estimates in technical reports, investor presentations and other materials published by the company.
When looking at resources, it’s important to consider both quantity and quality. Having a large low-grade deposit may be less valuable than a smaller high-grade one. The concentration of metals (grade) along with total size determines how much can ultimately be extracted profitably. Investors want to see significant resources with grades above the industry average.
Modeling Production Outlook
The next step is modeling the potential production profile of a mining project. Technical studies like Preliminary Economic Assessments (PEAs), Pre-Feaibility Studies (PFS) and Feasibility Studies (FS) will outline production estimates over the expected mine life. How much metal can be mined per year and the total lifetime output determine potential revenues. Higher production equals greater value generation.
It’s also key to look at expected all-in sustaining-costs (AISC). Costs encompass everything from mining to milling to overhead. The lower the AISC per ounce or pound, the more profit the operation can generate at a given metal price. Cheaper assets have higher margins and are inherently more valuable. As with grades, investors want to see AISC well below industry averages.
Choosing Gold Price Assumptions
One of the most important assumptions in valuing miners is the long-term gold or metal price forecast. Most technical studies sensitise NPVs at varying prices. A $1,500/oz gold assumption will result in a much lower valuation versus $2,000/oz gold. Investors need to build a price deck forecasting where they see metals trading over the next 5-10 years.
In today’s environment, many experts see gold averaging $1,800-$2,000/oz or more over the next decade given high inflation and global uncertainty. Silver also looks poised to outperform base metals. Choose assumptions reflecting your macro views, but also consider using conservative estimates to provide a margin of safety.
Calculating Net Asset Value
With resources, costs and gold prices in hand, investors can now estimate a miner’s net asset value (NAV). NAV sums the discounted future cash flows of each project to arrive at a valuation. As the example conversation showed, a rising gold price dramatically increases NAV due to the inherent leverage.
Always focus on NAV per share, not total NAV. Two miners with a $500 million NAV aren’t equal if one has 100 million shares outstanding and the other has 500 million. NAV per share lets you compare values across companies. Generally, miners trading at steep discounts to NAV per share represent good opportunities. Estimating Full Value PotentialIn addition to NAV, investors must also estimate the ultimate value potential of a miner. During bull markets, miners often trade at sizable premiums to NAV as gold prices rise. This is the full value potential.
Assessing Other Key Factors
NAV and value potential get us most of the way there, but other factors are relevant too. Financing risk is critical – does the miner have the balance sheet to fully fund projects or will repeated equity raises dilute shareholders? Operating jurisdiction is also key – assets in mining-friendly regions like Canada or Australia are worth more than emerging markets with higher risk.
Finally, investor sentiment around a company can impact valuations. Highly followed miners often trade at higher earnings multiples. This “brand value” should be considered in separating miners with world-class assets from ones with mediocre projects.
Using Cash Flow Multiples
An alternative approach to NAV modeling is applying cash flow multiples typical of producers. In the mining sector, larger diversified miners often trade around 5-6x cash flow. Take a junior miner’s projected cash flows, apply a 5-6x multiple, and discount this back to today to get a valuation target. The downside is that projected cash flows are highly dependent on metal price forecasts. Cash flow estimates can swing wildly based on $1,000/oz differences in long-term gold price assumptions. Nevertheless, multiples can provide a reality check against NAV valuations.
Apply These Tools to Value Miners
Valuing mining stocks requires going beyond typical valuation metrics. By following this guide, investors can take a rigorous approach including estimating resources, modeling cash flows, choosing conservative metal price assumptions and assessing value potential.
The key is using these tools to identify miners trading at steep discounts to fair value. Quality juniors with world-class assets trading at fractions of NAV offer the best risk-reward. Conduct thorough valuations combining both NAV modeling and cash flow multiples to find the most attractive opportunities. Stay disciplined on bids and be patient for the market to eventually recognize value.
Applying rigorous valuation techniques allows gaining an edge on Wall Street. For investors willing to dig deeper into the fundamentals, the mining sector offers a potential goldmine of alpha. Now is the time to take advantage by uncovering the most undervalued metal stocks primed for gains as the bull market continues unfolding in the years ahead.
