Monday, February 19, 2018 at 1:05:53 PM GMT+10:00
Around the Markets - metals and mining / Gold
Trent Allen, Metals and Mining Analyst at Citi and Jim Copland, Portfolio Manager at IFM Investors lead a gold sector discussion with Jake Klein, Executive Chairman of top performing gold miner Evolution Mining ASX:EVN
Trent Allen was a Top rated metals and mining analyst in the 2017 East Coles Equities Markets awards
Evolution Mining was ranked 1st for Earnings Quality in the 2017 East Coles Corporate Performance Awards - Metals and Mining
00:19 Trent Allen, Citi – Introduction
01:07 Jake Klein, Evolution – Evolution and background on Australian gold sector
02:48 Trent Allen, Citi – Evolution and performance of ASX200 gold companies
03:22 Jake Klein, Evolution – Global investors and trust in the Australian gold sector
04:20 Jim Copland, IFM – History of M&A in Australian gold sector
05:34 Jake Klein, Evolution – geological maturity of Australia’s gold sector
07:31 Jake Klein, Evolution – technology enhancing Australia’s gold sector exploration
09:33 Jim Copland, IFM – Investor perspective on allocation of free cash in gold sector
10:52 Jake Klein, Evolution – prospering through the cycle
12:47 Jake Klein, Evolution – relevance of M&A to Evolution and the gold sector
15:03 Jim Copland, IFM – production versus financial focus in gold company analysis
15:36 Jake Klein, Evolution – building investor confidence with asset portfolio
17:02 Jim Copland, IFM – gold stocks versus other sectors
18:39 Trent Allen, Citi – North American investors’ perspective on Australian gold stocks
19:39 Jake Klein, Evolution – rebuilding trust with North American investors
20:44 Jim Copland, IFM – Paulson paper and gold stock value destruction
21:44 Jake Klein, Evolution – gold stocks and value for global investors
23:22 Jim Copland, IFM – Jake Klein leadership
23:54 Jake Klein, Evolution – shareholder support
24:41 Jake Klein, Evolution – gold price
25:21 Jake Klein, Evolution – Evolution short-term focus
Trent Allen: [00:00:19] Hi I'm Trent Allen a metals and mining analyst with Citigroup here in Sydney. I'm here with Jim Copland who is a portfolio manager at IFM investors where he has given us his board room today [00:00:30] for this event and Jake Klein who's the Executive Chairman of Evolution Mining. Evolution won an award from East Coles in 2017 for Best Earnings Quality of a metals and mining company, against some stiff competition at the moment too. So a good award. Now, we just thought we'd talk a little bit about Evolution and the gold sector in general or just start by asking Jake a question, perhaps you can tell us how Evolution Mining was founded and [00:01:00] how he sees the company at the moment in terms of its outlook?
Jake Klein: [00:01:07] Thanks Trent. Evolution was really founded with a view that Australia had kind of gone off the map with respect to gold, global gold investors. You have to go back to the early 2000's and most of Australia's gold production, I think 75%, was owned by foreign companies at the time and there wasn't really a mid-tier sector and the mid-tier [00:01:30] sector is the best space to be. So there was a little bit of serendipity to the forming of evolution in 2011 because of course in 2012, 2013 the gold price rolled over and I think it's well known now the value destruction that occurred globally in the gold sector. I think the top 13 global gold companies wrote off, impaired $85 billion of m&a that they'd done as the cycle [00:02:00] and the gold price rose to 1800 of course went back to its current levels around 1250. But that's been the huge opportunity for the Australian gold producers and Evolution's been one of them and we've grown ourselves into a genuine global mid-tier. We're in fact I think last quarter Evolution and two of our peers in the Australian gold sector were the lowest cost gold producers globally. So that's a huge change. There's been a real renaissance in the Australian [00:02:30] gold sector. 26% of Australia's gold production has changed hands in the last five years and that's created I think 7 ASX listed gold companies with now a market cap of over a billion dollars and our relevance relative to international gold companies I think is growing.
Trent Allen: [00:02:48] Sure well I mean the ASX gold companies have outperformed the ASX200 in the past 12 months I mean the 200 put on around 8 or 10 per cent and the gold index for the ASX has gone up by 23 [00:03:00] percent. Evolution has done 30%, so it's been a great performance. You've outperformed the global gold companies so they've fallen by 4 per cent over the same period, even though the gold price has gone up by again around 8%, so Australian gold producers are they in a better position than their global peers what explains that outperformance in know your mind?
Jake Klein: [00:03:22] Well I think there's been a number of factors. I mean obviously the Australian dollar has gone down and that's helped the gold price but our free cash [00:03:30] flow per share has grown enormously and I think on every metric you look at free cash flow per share, reserves per share you see Australian gold producers I think doing better than the Canadian peers. The challenge which we have is that the global interest in the gold sector is relatively low at the moment, you know, you are seeing the synchronised growth thematic who needs to own gold and I think in the downturn when gold rolled over and we [00:04:00] lost all that impaired all that value we lost the trust of generalist investors. Jim you may have some view on that but we have to regain the trust that we are a very profitable dividend paying company and that we are not a highly speculative investment.
Jim Copland: [00:04:20] What's interesting Jake about that point you made about 25% of Australian gold production changing hands in recent years is if you go back to the late 90's and remember [00:04:30] when the majors Barrick, Newmont, Placer Dome even Goldfields and Anglo Gold from South Africa without exception bought assets in Australia and 75 percent of those Aussie gold mines went into foreign hands around that time. The currency was about 50 cents then and there was also that valuation arbitrage which we say today where North Americans trade at 2 times NPV using a 5 percent discount right versus the Australians trading at 1 times NPV at 10 percent. [00:05:00] So that valuation arbitrage opened up and they took advantage of it. Well fast forward a decade and they haven't really made a go of the Aussie operations it seems like falling back into Australian owned hands has given those assets the love perhaps that they deserve and I guess the other point to make is that you know a lot of the challenges of the industry in terms of cost, in terms of CapEx in terms of all of the issues that we've wrestled with on a daily basis I really [00:05:30] do think that the Aussie gold sector has learnt some of those hard lessons.
Jake Klein: [00:05:34] I think so I mean we certainly are you know producing probably the highest margin gold production in the world you know our average EBITDA margin per ounce is 53%. I think one of the sort of perceptions that we also need to get over is that Australia is mature from a geological perspective and our story and our history of our acquisition of Cowal I think is illuminating in that regard because Cowal [00:06:00] as you know Trent is you know the E42 ore body which is the main ore body that we're mining and all our reserves are in that ore body. It's really a 6 million ounce ore body if you take out what's been mined from there. But if you go back in the discovery history of Cowal it was discovered by North Jia Peka in the late 80's early 90's and then a whole series of events really conspired in our view to mean that when we acquired it in 2015 there [00:06:30] had really been very little exploration done on one of the most prospective areas in Australia from a copper / gold perspective 25 years yet it was owned by the world's largest gold producing company, so I think we've got to debunk the myth that Australia is mature from a geological perspective.
Trent Allen: [00:06:51] I mean how do you think about exploration? The perception is, right or wrong, that there are no more easy gold deposits [00:07:00] in particular to find. That the days of Lassiter tripping over something sticking out of the ground are gone. Do you think that's the case? I mean I've seen plenty of projections that Australian gold production might peak at around 20, 21, 22 and after that if it's to sustain the current rate of production it relies on exploration. So how do you think about exploration? Is it easy or is it getting harder, do you have to look deeper? And what's your budget also for exploration [00:07:30] over the next.
Jake Klein: [00:07:31] We spend about $60m a year in exploration it's a core part of any gold company's business. We have a bunch of geologists always out in the field in case they do trip over a deposit but I think we've got to rely on the fact that now you know the surface of Australia has probably been reasonably well explored. So you now need to look at depth and I think one of the most interesting things that has occurred in the sector is that there may be a real confluence of events between technology and capacity [00:08:00] for companies like ours to fund the use of that technology. So 3D, 4D seismic surveys which definitely give you a below surface view of the structures below surface which you would have never been able to identify without the use of that technology. It's been used very successfully in the oil industry for many decades but it was always too expensive for gold companies. It's now available to hard rock companies so I think you're going to see more discoveries. I think you would have seen that [00:08:30] slide that we show on Mungari which is 20 kilometres away from Kalgoorlie. Kalgoorlie would have to be one of the most explored and well-endowed areas in Australia's gold history and yet if you look at the number of holes that have pierced below 100 metres or 200 metres it's very sparse. So yes Australia may have been reasonably well explored at surface but take 100 metres off that and it's got a lot of prospectivity.
Trent Allen: [00:08:58] Now you mentioned your [00:09:00] budget is around 60 or so. Which brings me to everyone's favourite subject of cash, for miners in particular. The average free cash flow yield of an Australian gold miner at the moment is around 10% and a dividend yield sort of pushing up towards 3%. So I guess my question is and maybe I'll ask Jim instead what do you like to see miners spend their cash on? Is it exploration or deleveraging [00:09:30] or what do you think? Do you want to see some more capex spent?
Jim Copland: [00:09:33] It's quite simple. We just want everything really. Exploration as Jake said is a core part of the business. You can't have a sustainable company without doing exploration but one of the beautiful things I think about the industry today versus again 10 years ago is that these cash flow yields to me appear to be sustainable and that's a function of again good commitment to exploration. [00:10:00] Those are important dollars to spend. Dividends I think are also important because, and you know more about this than I do Jake, but sitting around the boardroom talking about allocation of capital, the dividend discussion is always going to be, really focus your mind, I imagine on how you do ultimately allocate capital to acquisitions versus exploration versus construction CapEx etc. So to me as an investor I think that you know obviously we like everything. I would hasten to add don't [00:10:30] listen to investors all the time because one week we want growth, the next week we want dividends. You've got to run a real business. But you know one of the reasons we are in this industry today as investors is because they're doing a fantastic job. It's sustainable. Regardless of the gold price outlook in US dollars, we think even at current prices it's a good investment as a sector because it's being well run.
Jake Klein: [00:10:52] Yeah Jim I agree with you. One of the things I've told our team to do is get a good set of earplugs because we do get a lot of free advice. [00:11:00] A lot of it is very welcomed. And it's and it's well intentioned but fundamentally we need to create and deliver a business that prospers through the cycle. That is not dependent on the gold price being higher and accepting that we operate in a very volatile sector and we need to be focused on margins and cash flow and investing appropriately. We can't, you know if you look at the traps which gold companies fell into previously there was huge value destruction on m&a, geopolitical [00:11:30] risk has blown investors out of the water. Then there have been things which are clearly which we must be accountable for, you know operational misses and capital misses. But again going back to Cowal, this was in 2004, 2005 when Barrick built the mine, one of the things which meant that they didn't spend money on exploration is that initially the mine was meant to cost $400 million to build. It ended up costing $700 million. That's just poor allocation of capital, and as an industry I think that's why we've [00:12:00] lost generalist investors and that's what we've got to demonstrate that we have got better at, and certainly something that Evolution's very focused on. You know we've got to demonstrate that we are not dependent on the gold price going higher. We are not dependent on luck for discovery but we run a business that is both sustainable and very high margin.
Trent Allen: [00:12:21] So how do you think about m&a? I mean Evolution's got a great track record of it. You acquired your Kalgoorlie assets from La Mancha and you used [00:12:30] that to leverage straight into the Cowal acquisition. More recently your Ernest Henry acquisition from Glencore which seemed like a great deal and came out of the blue. Do you think Evolution's got a good DNA in terms of m&a or is it something you're not thinking about in the near term? Are you finished for now in that sense?
Jake Klein: [00:12:47] I think what we do and we've stayed true to this since we formed Evolution in November 2011 is we've said that we want to improve the quality of the portfolio, we don't want more than six to eight assets but we [00:13:00] want to continuously improve the quality of the portfolio. To us that means mine life and all in sustaining cost which ultimately gets to cash flow. In order to do m&a you need in our view a motivated seller, or if you don't have a motivated seller you need a geological view which is much more challenging but it's also a way of adding value. You may pay full value for a million ounces today, but your geologists believe that there's 2 million ounces. Those [00:13:30] to us are the only two ways you can really deliver value to our shareholders from m&a. Now we were fortunate to live through a period where other groups were less fortunate and needed to sell assets and deleverage. Glencore was one, Barrick was another and we were able to put together deals which suited them but definitely gave us what we wanted in improving the quality of the portfolio. Are there motivated sellers around today? Difficult to see. The industry is in good shape. People [00:14:00] have repaired their balance sheets, so I'd say that m&a from that perspective is probably lower likelihood for us now, then we need to go to well is there something that looks geologically very interesting and that is an area where our discovery team is focused on, but I think we've got to get out of the cycle where people perceive ounces, production [00:14:30] ounces as important and hitting production targets so we'd very much like not to have you know guidance on ounces produced. We'd much rather have guidance on cash flow and reserves per share and that type of more genuine fundamental value than potentially what leads to growth for growth's sake and saying that we're going to sustain production forever.
Trent Allen: [00:14:55] Okay. How would you view that as an investor, Jim? That shift from production focus to [00:15:00] more financial focus guidance.
Jim Copland: [00:15:03] Yeah, I think it's refreshing, Trent. I mean you've been following the industry for a long time and it used to be those production targets and costs. And as analysts we always love those things because you can check them into your model and throw in a gold price and there's your number that comes out the other end but you know to be a little bit more thoughtful about it and actually to reflect the nature of the business which is inherently risky and unpredictable in terms of the commodity price, and mining is, you know, its [00:15:30] quarter in quarter out, there's always something going on.
Trent Allen: [00:15:33] I think we want both.
Jake Klein: [00:15:36] But that's why you need a portfolio, and that's what we have. You know we have six assets, you know often in a quarter some assets almost certainly some assets outperform and some assets underperform but generally we've been able to meet guidance for all the years, six consecutive years. And I think that builds investor confidence. And you know let me give you an example of where I think [00:16:00] you know selling some things is also as important. We sold Edna May recently. It was an asset which had an 18 percent EBITDA margin, our average was about 50% per ounce. So we are producing less gold but we're actually producing more cash flow. That's got to be a better outcome for investors.
Jim Copland: [00:16:19] Yeah.
Trent Allen: [00:16:20] I was just going to ask Jim, how do you, well it used to you would buy a gold company for the portfolio and then there was everything else. But does it become [00:16:30] a choice now between Evolution and an industrial, considering the earnings are of such good quality, and we're talking about long term, relatively high free cash flow and dividend yields, has it become an alternative for others?
Jim Copland: [00:16:42] Yeah. Yeah that's a good question. I think firstly and when you look at the gold sector, Evolution's doing a fantastic job and I think it's fair to say there's a good sense of camaraderie as well as competitiveness among the top players in the Aussie gold industry. You know you all go to the same conferences and [00:17:00] you know.
Jake Klein: [00:17:01] All have a beer together.
Jim Copland: [00:17:02] All have a beer together and compare notes, but you know Northern Star's another example, St Barbara's doing a great job, Regis has been open pit operator specialist for years. Saracen's coming up the curve too. So first of all there's a choice there, and then when you do look into as a more generalist investor, for the first time again in the last couple of years, I do think you can actually look at that dividend yield and go that's not just going to disappear tomorrow, that actually [00:17:30] could be around for a few more years. What am I going to invest in in this market? I think the other equities are expensive. I'm not sure about how sustainable the other commodities are in terms of copper, nickel, EV, materials. Gold hasn't actually run too hard. I think it's a good sustainable business in the downturn and God forbid the gold price does run, you're sitting in a good safe place.
Jake Klein: [00:17:54] But I do think that's the area that we have to focus on, is getting generalist investors [00:18:00] to really view gold companies as sustainable, profitable, dividend paying companies. We've lost their trust. We need to regain it and we're only going to do that by delivering.
Jim Copland: [00:18:13] Can I ask Trent, both of you know this better than I do, offshore investors, North Americans, used to like growth and not like dividends and hate hedging and the generalists weren't really going there. Australians probably are a bit more conservative, but is there any change in that North American [00:18:30] attitude toward those metrics, you know in terms of the attitude to the Australian gold industry, because I do think it is looking a lot more sustainable now than it used to.
Trent Allen: [00:18:39] Well what we've noticed is that North American investors in particular, they'll still pay for a long reserve life. So I think they're focused more on NPV and mine life. I mean before, I mean 10 years ago, 15 years ago investors all wanted resource growth. So that's what, didn't [00:19:00] even seem to matter if a company was in production. So long as they had a lot of gold on the ground now, but now, and I think whereas in Australia there's been more of a focus at least until recently on near term cash flow. So to me that's the big difference between the two. But I think they're starting to meet in the middle now, which is ideal. Somehow we have to close that gap in terms of discount rates where as you were saying that in Australia I've always used 10% for a gold company or 5 or [00:19:30] 10, whereas North Americans will use zero to five. It just depends on what your view is of the risk free rate and what the cost of capital is.
Jake Klein: [00:19:39] And we certainly get a sense from US investors or North American investors, gold investors that you know, there's still the perception that you're just squeezing the lemon from former assets that you bought from majors. There's unlikely to be new discoveries and that. But I think there will be. I think, you know Northern Star's showing that they [00:20:00] are discovering new ounces. We've taken our average mine life from just over five years to now nine years on a reserve life basis. So these are the changes which, you know, North American investors are starting to notice but we still have some time to really convince them to reorient their portfolio more towards Australian gold producers.
Trent Allen: [00:20:21] Speaking of portfolios and when you talk about m&a in terms of the ASX listed companies acquiring things at the asset level [00:20:30] or maybe each other eventually but do you think larger of some of the global majors might start to look this way in terms of what they'd like to do? Talking about low cost, relatively long mine lives.
Jim Copland: [00:20:44] Could I jump in just really quickly on that. You've got a much better answer, Jake, but I'll get my bad answer out first, and that is, you were both probably at Denver this year when Paulson did that paper about the industry since 2010 and how the gold price was up 20 percent [00:21:00] and the aggregate share price of the top 10 producers also was a negative, I'm not sure that number was but it was a big negative, and at the same time the CEO's had collected tens of millions of dollars in salary. Where's the value in that investment? So, and a lot of that value destruction that Jake talked about was written off. So you know, I think for me, once bitten, twice shy. I think having regard to that, the North Americans will probably be a little bit more wary about coming [00:21:30] back here albeit that that valuation arbitrage has opened up again and the cost curve is as attractive as it was back in those days. I just feel that they'll be a bit more cautious this time.
Jake Klein: [00:21:44] I think that's right, I mean Paulson's, you know, it's hard to argue with a lot of what they said. You know we as an industry in a sector were guilty. The only pushback I have and I know Marcelo well and he's actually a shareholder of [00:22:00] Evolution, and a happy shareholder, is that you know you get what you ask for as investors. The whole mantra when the gold price was going up was "we want growth" and gold companies delivered that in spades. They did terrible m&a deals which ultimately resulted in $85 billion in impairments. So you know we need to be cautious that we don't get back into that trap where investors go well you guys are running a really good business, you're making good margins, good cash flow, you're paying dividends, [00:22:30] but we're the catalysts, because that runs the risk that you know companies then start to get back into the "well we better grow". You know we have piles of investment bankers’ presentations on my desk saying “you know you should merge with XYZ company”, and when you say "well, why?", you know "well it will increase your relevance". I'm not sure you need more relevance. You know, we're exposed and we're getting traction with some of the largest gold funds in the world. I don't think we need more traction. [00:23:00] I think just going back to, you know, will Australian gold companies start to come onto the radar screen of Canadian corporates or other corporates. The best example or anecdote I heard last week when I was at ‘Mine's and Money’ in London was “there's still too much scar tissue”. So probably not.
Jim Copland: [00:23:22] I mean I do think yeah don't listen to the investors and a good thing is I think you can nod and smile and take it all in, but I [00:23:30] mean one of the things Jake's always been good about is being very self-critical or at least analytical about the industry and its mistakes and owning them and then talking about what to do differently, and I think that's why the last couple of years in particular for the industry has been so successful and so again it's like voting, you know, you get the politicians that voters vote for and you know….
Jake Klein: [00:23:54] But ultimately Jim, I mean it's you know it's important for us to have shareholders like yourselves who long term understand [00:24:00] the strategy because if you take sort of the marginal buyer in gold they come as quickly as they go. So really that creates a lot of volatility which frankly we don't want. We want a group of shareholders who actually understand the business, who believe in the strategy, who recognize that this is a highly volatile commodity that we're producing and that there are going to be highs and there are going to be lows, but do you have a business that can prosper through that and that's ultimately the shareholder [00:24:30] base that we want.
Trent Allen: [00:24:32] You can't really pick the gold price, you can only pick the best company as an investor, so I guess that's why Evolution finds such favour.
Jake Klein: [00:24:41] Well I mean I think, Trent, you know things which we do to try and prevent ourselves getting into that trap is we do all our long term planning off a 1500 Australian dollar gold price so it's now 1660 so as one of our general manager, site general manager, said "Every dollar above 1500 we have to treat as a prisoner", but we have [00:25:00] to accept that it's not always going to be above 1500, we hope it is, and the other thing is you know, thinking about where do you go from here. You know, I think we have just got to stick to the mantra of profitability.
Trent Allen: [00:25:18] So what's coming up for you guys over the next couple of months.
Jake Klein: [00:25:24] I think for us it's really just consistent delivery. We're certainly starting [00:25:30] to get some real discovery enthusiasm around Cowal, we've drilled some holes that I said earlier that it's really very underexplored. We've got drill rigs operating across all our sites but ultimately we just want to deliver low cost gold safely, profitably and then discover more ounces.
Trent Allen: [00:25:51] I'd [00:26:00] just like to thank Jake Klein for his time today, I'm sure the quality earnings will continue to flow from Evolution Mining. Also Jim for hosting us in his office today and thanks from me as well, and from Citi.