The next Northern Star?

While gold has disappointed over the last five years, what is often missed is that in Australian dollar terms it is up nearly 25% in the same time frame. With currency and other factors supporting it, the Australian gold sector has left the others behind.

Leading local names have shot the lights out, such as Northern Star which is up 9-fold in half a decade. We recently asked two managers familiar with the theme, James Miller  from Firetrail Investments and Justin Braitling from Watermark Funds, to get their view of the sector’s prospects and to nominate the next junior to watch.

Notably, they both selected the same small cap stock which is emulating the Northern Star model and displaying some remarkable metrics already. Tune in or read the transcript for the full story. 

Transcript

Ben Clark: Welcome to Buy, Hold, Sell. I'm Ben Clark, and today we're going to be talking about gold. It's been one of the few shining lights in the market lately with the stock market correction in place. To see if it's going to continue, we're going to talk to James Miller from Firetrail, and Justin Braitling from Watermark.

So guys, I thought I'd start with a bit of an overview. James, let's start with you. How do you see the overall health of the gold sector at the moment? Australian gold equites have been very strong versus offshore. Is there a reason why?

James Miller: Yes, absolutely. When you think about Australian gold equities, you've got to think about the Aussie dollar gold price. You've seen rates rise in the U.S., U.S. dollar going up, then typically the gold price is negatively correlated to that. But with the Aussie dollar falling as well, you've seen Aussie dollar gold up this year while U.S. dollar golds down. So Aussie dollar golds been a pretty good space to be.

Ben Clark: Yep. And Justin, can you add anything to that, the state of balance sheets in the gold space at the moment, costs of production? Are we in a good space to look at investing in the area?

Justin Braitling: Well, I think that's one reason why the Australian names have performed so well. The Canadian and North American gold miners have got themselves into quite a bit of trouble in recent years. They had bought back a lot of their gold books when investors wanted them to provide exposure to gold, and they levered up their balance sheets in the process, they under-invested in mine development, and they really struggled to grow. So, you would have seen executives of Newmont and so forth talk about peak gold.

Ben Clark: Yep.

Justin Braitling: There have been very few new large discoveries in recent years. And so those businesses are looking very mature, they're running out of reserves, and their stocks have struggled. The Australian companies, on the other hand, there have been some really well-managed companies like Northern Star and Evolution.

They've picked up distressed assets from those Canadian miners. They bought them cheaply, they've added a lot of value to those mines, extended the life of those mines. Cut costs, and really created a lot of value for their shareholders. You would have seen Northern Star and Evolution up between 5 times and 10 times over the last four or five years. I mean, there have been spectacular stories.

Ben Clark: Absolutely. James, I'll come back to you. So, just in terms of Firetrail's approach, do you look at gold first and think, "We like the look of it, or we like the defensive attributes," and then filter down to underlying gold stock? Or, is it the other way around? Are you looking for a story specifically, and then gold adds to it?

James Miller: It really is about the stock specifics for us. We analyse gold stocks just like we would any other stock. It's a thing about valuation. So we'll look at the company, we'll look at management, do our research on modelling, and then think about, "Where's your free cash flow? Where's your enterprise value to EBITDA there?" Typically, you can do that on a variety of gold price scenarios, but on spot gold is one way to do it then. You've got to think about those stock specifics.

Thinking of the gold price itself, that's something that can really do your head in, so look for stock specifics in the company, look for those regions, those areas where management can really add value to companies. Evolution, Northern Star, even Aurelia Minerals recently, management's added great value to existing companies.

Ben Clark: Yep. Absolutely. So Justin, and the reason I asked that question was when I was doing some numbers, the largest gold stock in Australia, Newcrest, has given a rolling one year return of minus 4%. The second largest, Northern Star, has gone positive 18%. So it seems you can get the call on gold right, but you can get the call on the stock wrong. Is that how you look at it from a bottom up perspective?

Justin Braitling: Absolutely. I mean Northern Star, five or six years ago had a couple of years of reserves. They bought Jundee well, extended the reserves of that mine, continued to add on acquisitions, Pogo more recently. And they just keep doing it again and again and again. I think the emphasis there is on management. You really need good management to run these businesses. They're not easy to manage, a mining operation, unless you're running Escondida or the Pilbara. You know, these are difficult operations typically. You got to keep your costs down, you got to be frugal with your capital, and you've got to add value wherever you can.

Ben Clark: Okay. Well, let's put you on the spot. So with the sector in good shape, a bottom up story is something that you do look for. Is there one that you could single out, and also just give us maybe an idea of what the criteria was that led into you pulling the trigger on them and buying it?

Justin Braitling: So we really like Aurelia Metals. They operate in the Cobar Basin in the western district of New South Wales. You know, the Cobar Basin's been around for a long time as a copper gold district. Glencore have a mine there. And Aurelia has been running Nymagee for many years. A couple of years ago, a new CEO came in, Jim Simpson, and has done a great job in restoring the value in those two mines that they operate.

More recently they've acquired the Peak Mine from New Gold. Now New Gold, like Barrick, got itself in a lot of trouble and it's been forced to sell the crown jewels. And this mine cost $500 million to develop, they bought it for $58 million, it's basically already paid itself off within a couple of months. And the real trick is here, Jim actually used to run the Peak Mine. So you know, he knows where all the little hidden seams are and they've been mining the channels seam with grades north of 10% in recent months. And again they're paid off ... paid the acquisition very quickly.

So you know, they'll buy, it'll be a replay of what Northern Star did with Jundee, with what Evolution did with Cowal. They're going to put more feed through the mill, they'll buy other mining operations along the strata length there in the Cobar Basin. They'll drive the cost down and create enormous value to their investors.

Ben Clark: Okay. And James, putting you on the spot as well, is there one that you like in this space?

James Miller: I'm like Justin there. We look for where management teams are adding that value. I'm going to agree with Jim there. Aurelia it's a great story and I'll put some more metrics around it. This company and with the acquisition of Peak Mines recently, it's got a market cap of about $600 million. Over the next year we estimate free cash flow will be about $150 million, that's 25% of their market cap back within a year. So that's a great metric when you look at that and you look at two times into enterprise value to EBITDA, there's no doubt it's a cheap name, plenty of growth still to come with a great management team as well. That's one we like as well.

Ben Clark: Okay. That's great. Well, it can be tough spotting the little nuggets of gold out there, but Aurelia sounds like it's one you should be checking out.