How to value Nord Gold ahead of its IPO

“The timing of the proposed Nord Gold flotation on the London and Moscow stock exchanges is interesting as gold tries once more to crack the $1,900-an-ounce barrier and investors ponder whether inflation is going to make a comeback or not,” says AJ Bell Investment Director Russ Mould. “Gold thrived during the 1970s, when inflation was rampant (although it could be argued that stagflation was the problem then), and then fell right out of favour in the early 1980s after the Paul Volcker-led Federal Reserve clubbed it into submission with brutal interest rate increases. The tide turned again after 2000, since when the precious metal has outperformed even the S&P 500, as gathering Government budget deficits and then record-low interest rates and Quantitative Easing have persuaded some investors to abandon ‘paper’ money and ‘fiat’ currencies in favour of ‘real’ assets.

 
Source: Refinitiv data

 
Source: Refinitiv data, FRED - St. Louis Federal Reserve database

 
Source: Refinitiv data, FRED - St. Louis Federal Reserve database

“Any investor thinking about Nord Gold must therefore first take some sort of view on the gold price. Inflation will be one key influence over sentiment toward gold and government deficits and spending another.

“At the moment, the classic cycle of higher commodity prices, higher factory gate prices and higher consumer prices looks to be playing out, although sustained wage increases may be needed for inflation to really entrench itself. That is far from certain, given the rise of automation and current levels of unemployment, while record levels of global indebtedness are inherently deflationary as interest must still be paid and the borrowed money eventually returned (at least in theory), diverting cash away from what could be productive investment and spending.

“The inflation debate is therefore likely to rage for some time.

“What seems more certain is politicians’ desire to spend, either to fund what they view as vital, planet-saving projects, support the economy during the pandemic or simply curry favour and buy votes. Austerity is a vote-loser. Granted, the issue of taxation and who should pay more and by how much is gathering pace, but whether it is enough to fund ambitious spending programmes in the USA, for example, remains to open question, even if the Republicans seem unwilling to embrace all of President Biden’s projects. A British Prime Minister whose own personal financial arrangements seem unorthodox at best is unlikely to be a good bet as someone willing to apply rigorous checks and balances toward other peoples’ (taxpayers’) money.

“A vindication of central bankers’ view that the current inflationary spike is transitory, or an unexpected tightening of monetary policy, or a new round of tax-rises and hair-shirt fiscal policy could all stop gold in its tracks, and by implication make gold mining stocks less appealing. 

“But accelerating inflation and more fiscal and monetary stimulus could yet see gold bugs enjoy a sustained spell back in the limelight.

“That would then leave fans of the precious metal looking to buy either physical gold, directly or indirectly via tracker funds, active or passive funds that are dedicated to investing in precious metal miners, or individual miners.

“Picking a company that is literally sat on top of a gold mine is, however, not as easy as it sounds, as the recent share price and operational woes of Resolute Mining and Centamin would attest. Investors therefore need assess Nord Gold just as carefully as they would any other gold miner – and that is before they decide whether owning a share of a Russia-base miner is something which they feel comfortable, for either ethical or economic reasons, given the pressure that the US continues to bring to bear on Moscow both politically and economically.

“Key factors to study include the following when it comes to assessing gold mining shares:

•    The miner’s status. Some miners are producing gold, some are exploring a site and some are prospectors that may have no more than a licence to mine and are still doing preliminary geological work. The more mature the miner, the less risky it will be. Although the greater gains could be had among the juniors if one makes a big discovery or starts to ramp-up production the risks here are enormous and the scope for something going wrong and share price losses considerable. Investors also need to assess the miner’s management team and whether it has the right skills and local connections and a decent track record.

•    Geopolitical risk. “Resource nationalism” can be an issue, should a local government decide it wishes to keep more of its mineral riches for itself and impose higher taxes or take away a licence.

•    Operational risk. Mines rarely run smoothly and their location – in the desert, the jungle or mountains – and issues such as local labour skills and availability and even the weather must be taken into account.

•    Financial risk. Many miners take on a lot of debt when they first develop a mine. If something then goes wrong, or the gold price falls, this can then potentially put them into financial difficulty. Equally, if the gold price soars, profits could fly and cash flow mushroom so paying down the debt adds to earnings growth via lower interest payments. 

•    Cost base. This will be a reflection of the factors above and investors need to focus on the all-in sustaining cost (AISC) of a miner or mine’s gold production per ounce, not the cash cost, especially as this takes into account the payment of interest on any debt. The lower the AISC the better as this offers more upside when gold prices rise and more downside protection if gold prices fall.

•    Valuation. During the gold price boom at the start of this decade, analysts would typically value explorers and developers at 0.5 times to 1.0 times net asset value (NAV) per share. They would value emerging producers at 1.0 times to 1.5 times NAV; and 1.5 times to 2.0 times NAV for mid and large-cap producers. Some analysts will use a blend of NAV and earnings multiples, using price/earnings (PE) and EV/EBITDA (enterprise value to earnings before interest taxes depreciation and amortisation) ratios, based on near-term earnings forecasts. However, a more scientific approach will focus on a detailed discounted cash flow (DCF) model that provides a net present value (NPV) of future cash flow streams, based on certain assumptions regarding the gold price and the miner’s cost base. The more mature gold producers may also pay a dividend so yield could be another valuation metric.

“When it comes to valuation, investors will be able to compare Nord Gold to a number of miners who are already listed on the London Stock Exchange.

Source: Company accounts, Marketscreener, consensus analysts’ forecasts

“They will also be able to benchmark Nord Gold against leading gold miners who are listed in the USA and that are the main constituents of the HUI Gold Bugs Index, which is dutifully followed by many tracker and exchange-traded funds.

Source: Company accounts, Marketscreener, consensus analysts’ forecasts

“It would be logical to expect Nord Gold to come with a discount rating on earnings and book value and a premium on yield, because it is less of a known quantity, and some investors may have governance concerns, owing to the company’s Russian background – and Nord Gold’s target of a $400 million dividend payment in 2021 suggests that management recognises this.

“Even if the plan thereafter is to distribute a large portion of free cashflow as dividends, Nord Gold stresses a record of dividend payments that stretches back to 2013, as well as its plan to grow last year’s annual output of one million ounces of gold by one fifth in the next five years, thanks to higher production at the Gross mine in Russia and two mines in Burkina Faso.”