IAMGOLD Is Very Vulnerable At Today’s Gold Price

Last week, Canadian gold miner IAMGOLD (NYSE:IAG) reported disappointing third-quarter results, in which revenue and earnings missed analyst expectations. Revenue fell by 28%, primarily due to lower gold sales at the Westwood and Rosebel gold mines and further weakness in the selling price of gold. IAMGOLD is producing negative free cash flow and no profit because of its high cost structure. We recognize the company has achieved cost savings at Essakane and Rosebel this year, but costly ramp-up issues at Westwood continue to eat into its balance sheet. IAMGOLDs net cash position has decreased by $43 million to $148 million since the second quarter.

The slump in gold prices cut deep into the companys financials

IAMGOLD registered third-quarter revenue of $207.6 million, down 28% compared to a year ago, and fell short of analyst estimates by $7.7 million. Two primary factors contributed to lower revenue results. The first is lower gold sales at the Westwood and Rosebel gold mines that caused revenue losses of $39.4 million and $18.9 million, respectively. Westwood produced and sold only 2,000 ounces, compared to 35,000 ounces last year, mainly because of a third seismic event that occurred at the underground mine in late May, as we reported here. Of late, the company has focused on rehabilitation and underground development, therefore limiting mining and production activities for the last few months.

Figure 1: IAMGOLD attributable gold production for the third quarter. Source: Corporate presentation

As for the Rosebel gold mine, the company reported decreasing production and gold sales because of lower grades and mill throughput. These poor results, coupled with higher sustaining capital costs raised all-in sustaining costs just above $1,100 per ounce. Last quarter, IAMGOLD discussed the importance of cutting costs at Rosebel to ensure its long-term viability in the challenging gold market. It managed to reduce all-in sustaining below $1,000 per ounce at Essakane. It now wants to achieve the same success at Rosebel. Why is this such an important task now? How does the company plan to do it?

IAMGOLD expects hard rock material passing through the Rosebel mill to increase to approximately 80% by 2018. Hard rock costs more to mine and process compared to softer saprolite and transitional rocks. Last month, the company announced plans to reduce its employee base by 10% to cut labour costs. Additionally, it announced plans to acquire the rest of Euro Resources (OTCPK:EROFF) for euro;24.9 million (US$27.5 million) in order to eliminate the costly royalty fee pinned to Rosebels cost structure, as we reported here. We expect to see Rosebels all-in sustaining costs cut below $1,000 per ounce in the first half of 2016. Like Rosebel, the Sadiola gold mine produced 19% less gold ounces because of lower head grades.

The Essakane gold mine achieved record production of 107,000 ounces, up by 29% compared to last year, offsetting the lower sales from Westwood and Rosebel. The mine benefited from higher grades and mill throughput as the company recovered additional ore from the Falagountou deposit. The increase in production and sales contributed to lowering all-in sustaining costs to $922 per ounce. The satellite pit is 8 km southeast of the Essakane main pit, and IAMGOLD estimates there is enough ore material at Falagountou to take it through the end of the year.

Figure 2: IAMGOLD all-in sustaining costs performance relative to the price of gold. Source: Corporate presentation

The company increased Essakanes attributable gold production guidance from 360,000-370,000 ounces to 365,000-380,000 ounces to reflect the increase in high-grade production realized to-date. Weak production performances at Westwood over the last few months led to a decrease in gold production guidance from 60,000-70,000 ounces to 55,000-65,000 ounces. Overall, IAMGOLD expects to produce between 780,000 and 815,000 ounces at all-in sustaining costs of $1,050-1,150 per ounce in 2015.

The second and most obvious factor contributing to lower third-quarter revenue, profits and cash flow is the decreasing gold price. The selling price of gold declined by 12% and contributed to $27.7 million in revenue losses in the quarter. Gold prices have plunged sharply this month on growing speculation that the US central bank could raise interest rates for the first time since 2006 at next months FOMC meeting. Signs of low unemployment, economic GDP growth and inflation nearing the Federal Reserves 2 percent target mean a December rate hike could be on the table.

Gold loses investment appeal in a rising interest rate environment because the metal is non-yielding asset. As a result, investors would feel more inclined to get out of gold investments and place their bets on stocks and bonds when rates begin to rise. Therefore, we expect gold to sell off in the event of a US rate hike. This is bad news for gold producers and streamers (for example, Royal Gold (NASDAQ:RGLD) and Sandstorm Gold (NYSEMKT:SAND)). IAMGOLD produces gold at a unit cost around todays gold price, so pullbacks in the price of gold makes it harder for the company to generate free cash flow to service capital requirements, growth plans and debt.

The company is seeing negative free cash flow and no profit because of its high cost structure. Adjusted earnings loss was $46.9 million, or -$0.12 per share, missing analyst forecasts by $0.03 per share. We recognize that it has achieved cost savings at Essakane and Rosebel this year, but costly ramp-up issues at Westwood continues to consume cash on the balance sheet. IAMGOLDs net cash position has decreased by $43 million to $148 million since the second quarter. There is very little potential to generate sufficient cash flow, with all-in sustaining costs at $1,027 per ounce and gold predicted to trade lower than todays $1,080 market price. This is why it is so important for IAMGOLD to focus on cutting operating and capital costs without disrupting production rates.

We cant do anything about the price of gold. It is out of our control and we cant do much about the sentiment. But what we can do is work and continues to focus on our costs. So, thats what we are going to continue to do. We are going to focus on cash preservation. We are going to make sure that balance sheet stays strong, Steve Letwin, company president and CEO, said to investors on the Q3 2015 conference call.

IAMGOLD has made it clear that it does not plan to use the cash proceeds from the Niobec ($504.1 million) and Diavik royalty ($56.8 million) sale to purchase any of its debt ($635 million) at par next year. Instead, it plans to spend $300 million of the cash proceeds to fund capital expenditures at its existing mining operations and another $170 million related to capital leases, settlement of hedges and smaller organic acquisitions (Monster Lake, Euro Resources).

Initially, there was discussion about the company entering the active metals and mining acquisition market through the purchase of AngloGold Ashantis (NYSE:AU) 41% stake in the Sadiola gold mine. IAMGOLD showed interest, but later shot the idea down, as the market was too challenging. There are not too many cash flow-generating mines at todays gold price, according to the company. IAMGOLD would rather invest in its own improving the companys assets organically.

We are much better off investing in our own assets organically improving our cost structure and maximizing revenue because we just cant seem to find anything out there that we can add to our portfolio right now that is going to be generating cash as opposed to using cash, Mr. Letwin said on the call.

IAMGOLDs overall cost structure is a concern in todays gold environment. High costs put the balance sheet at risk, as seen by the decelerating net cash position. The company needs to implement further control costs, particularly at the Westwood gold mine. A revised mine plan due in January 2016 intends to provide a life-of-mine update on Westwood. The seismic event has limited production growth and inflated production costs to negative-yielding cash flow levels. Any changes to significantly cut costs and increase productivity will be viewed as a huge positive by the market. The stock trades well below working capital and book value per share, but it does not scream a buy in our view. We expect IAMGOLD to post negative profit and free cash flow returns by year-end as declining gold prices cut deep into its financials.