Negative free cash flow, the skeleton in the gold sector's closet

Will the world's leading gold miners post any free cash flow for the third quarter of 2009?

JOHANNESBURG - 

If there are beds of roses in the investment world, they could well be found among the pricing levels of specialist gold miners, a global subsector finding it increasingly difficult to produce free cash flows. Historic numbers for the second quarter of 2009 illustrated how it was that only a handful of gold diggers across the world were able to produce free cash flow (FCF).

With miners now facing third quarter reporting season, investors can anticipate another round of crafty marketing, diverting attention from the issue of free cash flows.

Broadly defined as operating cash flow less cash spent on capital expenditure (new and stay-in-business), FCF has become increasingly illusive for gold miners as the underlying gold price has moved from around US$250 an ounce less than a decade ago to recent record nominal figures above US$1,000 an ounce. FCF has also become an awkward topic of discussion.

In conversation with a specialist London-based gold analyst early in September, the following popped up: "don't get hung up on gold companies and free cash flow - an oxymoron!  Just brush that little issue aside..."

Barrick, the world's biggest gold miner by production, value and reputation, posted negative free cash flows (which may be another oxymoron) for the first half of 2009. If cash spent on acquisitions over the past two-and-a-half years is accounted for, Barrick's FCF has been monumentally negative. Like the majority of operating gold diggers, Barrick has funded itself on one or more of rights issues, fresh net debt, or disposals.

On 31 June 2009, Barrick's net debt was US$3.1bn. This excludes the unrealized loss on Barrick's somewhat toxic hedge book, reflected as an impressive US$5.2bn. Barrick reacted to mounting cash flow challenges by raising US$4bn in a rights issue in September.

Earlier this month, Barrick raised a further US$1.25bn in a corporate bond issue. In March this year, Barrick raised US$750m in corporate bonds. This week, Barrick announced the completion or a corporate review that would include the reduction of 80, mainly corporate, jobs, saving around US$80m a year. 

Like other gold diggers, Barrick faces eventual closure of all of its existing mines, and remains under relentless pressure to replace mined ounces, and build new mines. In May this year it announced the go-ahead for the US$3bn Pascua Lama project, straddling high country in Argentina and Chile. The substantial funding required will take years to produce the first incoming cash flows.

While Barrick may well be more the rule than the exception in its attempts to produce genuine free cash flows, it has continued to pay dividends to its shareholders, despite the brutal increase in cash flow pressures.

There are, however, some indications that some leaders in the global gold industry are preparing to take the bull by the horns. In its recent 2009 annual report, South Africa-based Gold Fields, where Nick Holland, the CEO, is a chartered accountant, declared that, "as indicated in the 2008 annual report, it remains a key strategic objective of Gold Fields to reduce notional cash expenditure (NCE) and increase free cash flow".

At Gold Fields, NCE is defined as operating costs (including general and administration costs) plus capital expenditure, which includes brownfields exploration. The NCE per ounce is an important measure, proclaims Gold Fields, "as it determines how much free cash flow is generated in order to pay taxation, interest, greenfields exploration and dividends".

While this may no doubt be the case, the 2009 cash flow statement for Gold Fields shows that while operating activities produced positive cash flow of US$657m, investing activities (mainly capital expenditure) sucked in US$809m in cash. The deficit was financed mainly be fresh net debt. During a period of record dollar gold bullion prices, is this good enough? It must surely say something when Gold Fields states: "We continue to be the only gold mining company to report NCE".

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responses to this article

Savard The metals and mining business needs to come clean with world wide standard accounting practices NCE is a good measure of operating capital and capital needed for growth Free cash flow or net cash flow should be reported always by . .more an honest company (probably better on an annual basis as quarterly expenditures can be extremely luimpy) However, please remember, juniors and midsized miners have more in common with the oil and gas sector than the mfg sector, their job is to find and produce the basic commodities required by civilization and hence an emphasis on growth, not cash on hand. Like oil and gas, as the resource at any particular location declines over time, producers must constantly reinvest to find moree resources. therefor, a companies measure of success is it's ability to increase in size while limiting dilution. However, I also see nothing wrong with developing a trust structure around producing mining assets, milking the cow as it were and paying dividends to shareholders. Overall, I generally like silver better than gold because silver has both an industrial and a monetary use. Because if its industrial use, it is a necessary material required for civilization to maintain it's standard of living. I leave you to draw your own conclusions. RS Calgary, Canada . .less by Rob on October 21 2009, 08:57 Find this comment inappropriate? Report it

x x by x on October 21 2009, 09:01 Find this comment inappropriate? Report it

Negative free cash flow, the skeleton in the gold sector's closet That's why higher gold prices will be seen. If not, producers will stop producing and there'll be a shortage of metal...! by hkm on October 21 2009, 13:36 Find this comment inappropriate? Report it

Problems? Why Now? Perhaps what was written in 1889 in the Great Red Dragon book is pertinent today: "As a rule, persons having gold or silver mines to develop always go to the Money Kings or their agents for the capital to develop them. And the Money Kings . .more never put any money into a mine without having a majority of the stock given them, so as to secure to them its absolute control. They must have the lion's share in any enterprise before they will invest in it. They usually put in one of the original stockholders as their agent and manager; and generally the mine is so managed as to freeze out the other stockholders. A shaft is sunk down upon the "lead;" if it proves to be rich, only the poorer levels nearer the surface are worked, till the outside stockholders become discouraged and sell out their stock cheap: then the mine is worked efficiently. But if, on the other hand, the mine proves to be a pocket, it is puffed in the papers until outsiders have bought the stock; then the true state of things is revealed. Having full control of the mine, they are able, with their agent, to manipulate it as they please; and finally they thus get control of all valuable mines." This would be especially true if the real owners of the mines expect a significant price increase of their "deep storage" holdings. Perhaps they do, as de-hedging indicates. . .less by Edward Ulysses Cate on October 22 2009, 16:37 Find this comment inappropriate? Report it

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