Consolidation does not lead to a goldmine

Investors would be wise to view the growing M&A activity in the Australian gold space as a business opportunity.

Consolidation is the name of the game in play in Australian gold mining today, and while it can be a stockbroker’s picnic, it can also create more losers than winners.

The current center of speculation about a rush of mergers and acquisitions (M&A) activity in the gold sector is the historic mining center of Leonora in Western Australia – the site of some fabulously rich mines, but also a place where a lot of money went to die, and where I lived briefly during the nickel boom decades ago.

For investors with a high risk tolerance and a willingness to trade quickly, the consolidation game can be very profitable if they can get in and out, and that’s not always easy with some of Leonora’s potential players who are not not traded for days.

Thin volume

Low volume is the first warning sign that all of the companies mentioned in some of the most exciting tip sheets and websites are not worth looking into again, as they are not so much small caps as microscopic ones with a market capitalization lower than the value of my house.

Buying a stake in a mining minnow might be possible, but don’t expect to be able to sell easily.

In theory, the gold assets around Leonora are poised for consolidation as major player in the region, St Barbara (ASX:SBM), is under pressure, not so much from its main asset, the super-deep Gwalia mine. , more because of problems elsewhere.

An overpriced 2019 acquisition in Canada (Atlantic Gold) has stalled pending government permits.

The Simberi mine in Papua New Guinea has underperformed, leaving the 125-year-old Gwalia mine to do the heavy lifting – and that’s another clue to Leonora’s overall problem, as mining ore from ‘a 1.6 kilometer deep mine is expensive and gets more expensive the deeper it goes.

Rising costs

Costs are another index of risk in the consolidation game and even though it is claimed that a merger can reduce operating costs, it does not always work as costs increase rapidly, such as a 42% increase diesel and 68% of contractor load and haul rates. consumes revenue and efficiencies.

Then there is the question of who will lead the consolidation of Leonora. St Barbara’s management argues that it should be the company in charge, as it is the largest gold producer in the region, with substantial ore processing capacity and a large building.

St Barbara, however, is challenged by a highly successful team of mining professionals using Genesis Minerals (ASX:GMD) as Leonora’s consolidation vehicle, with a deal being offered earlier this month for the player of financially strained Leonora Dacian Gold (ASX:DCN).

Genesis is led by Raleigh Finlayson, who previously ran the highly successful Saracen Minerals which merged with Northern Star (ASX: NST) to create a world-class gold mine with the Kalgoorlie Superpit as its main asset.

Other potential M&A players

After Leonora’s two main players, there’s a cricket team of down-to-earth hopefuls, an old mine or two (the area has been mined since the 1890s), exploration plans, a bit of… money in the bank and a claim to be part of the game.

Smaller potential consolidated Leonora beneficiaries include Kin Mining (ASX:KIN), Saturn Metals (ASX:STN), Red5 (ASX:RED) and Mt Malcolm Mines (ASX:M2M) – all have lower share prices today today when the first contract (St Barbara and Bardoc) was finalized in April.

St Barbara and Genesis have a Leonora takeover/merger under their belts and confirmed earlier this month (July 4) that there is bigger play in the works as they look to “unlock synergies exploitation and development in the region”.

St Barbara’s management team would love to be on top of the action, but investor momentum is behind Genesis, especially given Finlayson’s track record.

If a St Barbara/Genesis merger emerges from their discussions, the guiding principle of investing will kick in, sell the bidder and buy the target, because in most mergers the buyer overpays, convinced that value can be created from cost savings and growth potential.

The consolidation of Leonora begins with the acquisition of Bardoc

The first phase of Leonora’s consolidation began late last year with St Barbara’s share-swap acquisition of Bardoc Gold, a deal that valued Bardoc at $157 million, but did not nothing done for St Barbara shareholders as their company’s share price falls.

Ended in mid-April this year, St Barbara’s share price fell 37% from $1.47 at the time to last selling at $0.92.

Genesis, Leonora’s other potential consolidator, didn’t fare much better with its share price down 34% over the same period, from $1.82 to $1.19 – a drop influenced by a issue of shares to raise new capital and its agreement with Dacian.

If Leonora’s consolidation game was as attractive as some of her promoters claim, it’s unlikely the potential leaders would both have fallen so heavily.

What seems to be happening is that investors recognize the twin challenges of a falling gold price and rising costs – a diabolical squeeze on earnings.

Rather than being seen as a means to achieve growth, the story of consolidation is more about surviving in a hostile environment, ready to win when the price of gold rises, which it will, but will not. don’t ask when.

Commodity prices fall as costs rise

Former Rio Tinto (ASX:RIO) chief executive Jean-Sébastien Jacques warned last week of what he called “a price/cost squeeze nightmare scenario,” with commodity prices falling as costs rise.

The Australian The paper’s mining reporter, Nick Evans, was on the same page as Jacques in an article published earlier this month, which warned that the costs of gold mining, as reported, were sometimes misleading.

Its opening paragraph says everything you need to know about the issue of all-in sustaining costs (AISC) – they are, according to Evans: “largely bullshit, and retail investors who rely on them are wrong” .

As a catchy comment for potential investors, it doesn’t get much better than this and while bordering on exaggeration, there is reason to argue that AISC’s cost estimates aren’t as accurate as they should be. be given the lack of inclusion of interest expense on debt and a company’s ability to treat certain operating costs as growth capital.

Besides rising costs, there’s the issue of falling gold, the metal at the center of Leonora’s consolidation push.

Gold is down 12.5% ​​from US$1,976 an ounce since the completion of the Bardoc merger to the last price of US$1,727 an ounce.

Locally, a fall in the Aussie dollar (or a rise in the US dollar to be more precise) saw the price of Australian gold drop just 5% from $2,666 A/oz to $2,553 A/oz – a modest move, reflecting an exchange rate that fell from US75 cents to US67c.

“Season of confessions” imminent

Costs are absolutely critical to what happens next in Leonora’s consolidation game and while they can’t be seen as clearly as the fall in the price of gold, they do their corrosive work on earnings with the soon-to-be-coming “confession season” in the form of annual corporate earnings statements with a June 30 closing date.

St Barbara, despite being more than twice the size of Genesis on the stock exchange ($734m vs. $298m), reported encouraging production numbers for the prior year – boosting production by gold of the group by 40% to 280,746 ounces with the lion’s share of Gwalia.

Until the July 27 earnings release, St Barbara’s profitability is unknown, although Macquarie Bank in a July 8 research note reported a loss for the past 12 months. However, the analyst updated his buy hold advice with a 12-month stock price target of $1.10.

Much more will be reported over the next few months on the consolidation of the gold sector, but investors would be wise to view the process as a trading opportunity, as it is not so much about making money, but rather avoiding losses and achieve economies of scale to recover from them. a difficult and inflationary commodity market.

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