Gold producers need to stop piling on debt, S&P warns

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Standard & Poor's is less than impressed by gold miners' attempts in recent years to boost their share prices.

The credit rating agency has already downgraded three major gold producers this year. And in a report released Tuesday, it warned against miners' growing tendency to amass debt as they struggle to boost shareholder returns.

"In fact, some of these companies are taking on unprecedented levels of debt to fund large, risky investments or acquisitions to increase – or even merely to sustain – gold output," the report says.

S&P rates four North American gold miners: Goldcorp Inc., Barrick Gold Corp., Kinross Gold Corp. and Newmont Mining Corp. The companies have a combined market cap of $100-billion (U.S.) and debt of $25-billion; both of these figures, the report notes, have risen significantly higher since gold's rally began about a decade ago.

Among the four gold producers, Goldcorp appears to be the safest. S&P says the Vancouver-based company would not be in risk of a downgrade unless gold prices fell by 50 per cent. The producer boasts a BBB+ rating, and has been able to boost its output and earnings without burdening itself with debt to the same level as its North American peers. It has a ratio of free operating cash flow to debt of nearly 25 per cent – roughly five times higher than its North American competitors.

While Goldcorp's return on capital lags other producers, its growth-by-acquisition strategy has "delivered solid output and profit growth," the report says. It also has the lowest cash costs in its field, S&P says, with EBITDA margins 10 to 15 per cent above its peers.

Like Goldcorp, Barrick's cash costs have been below the industry average, but lower-grade ores in the Toronto-based company's older mines and high costs of labour in South America and Australia have pushed its cash costs for 2012 up by 10 to 15 per cent from last year.

Barrick also has a BBB+ rating, but is the most at risk of a downgrade among the North American gold miners. With the highest debt among its peer group – $14-billion now versus $4.5-billion in 2008, largely thanks to its Equinox acquisition – Barrick has "the least cushion for deteriorating credit measures at the current rating," S&P says. The miner could be downgraded if gold prices fall just 25 per cent, the ratings company says.

Newmont and Kinross, rated BBB+ and BBB– respectively, are in a similar position for a potential downgrade, but S&P says its outlook for the companies is stable so long as they remain positioned to make spending adjustments to keep their credit quality in check.

Thanks to limited acquisitions and a steady asset base, Newmont has had stronger returns on capital recently, S&P says, while only modestly increasing its debt to fund growth. And while Kinross's equity-funded $7.1-billion Red Back Mining Inc. acquisition weakened its share price, it didn't directly effect debt or cash flow, the ratings agency says.

All is not bleak, the report concludes. "Prospects appear favourable for miners to sustain production in the next several years, benefiting from record capex and acquisitions in recent years," it reads. But output is likely to slow down over the next three to five years as gold producers focus on improving returns.

If the miners can slow down expenditures and stop piling on debt, S&P says, their growth might become more sluggish, but they should be able to boost capital returns and keep credit quality in check.