Friday, September 12, 2008

Agnico Eagle – Focus on per Share Value Creation for Shareholders

Agnico-Eagle (AEM) is an international gold producer, headquartered in Toronto, Ontario of Canada, with advanced-stage projects and opportunities in Canada, Mexico and Finland. The CEO, Mr. Sean Boyd, was in New York City on August 29th to talk about their strategy and growth potential at the Yale Club. There are six major 100% owned gold mines in AEM’s portfolio, all in low geopolitical risk regions:

1) LaRonde mine in Quebec is Canada's largest gold deposit in terms of reserves, with P&P (proven and probable) gold reserves of 5 million ounces, which has generated strong earnings and cash flows for AEM. Current production is about 200,000 ounces of gold but in 5 years it is expected to ramp up to 400,000 ounces.

2) Gold production will begin in this quarter at AEM’s Goldex mine near LaRonde, which holds more than 1.6 million ounces of gold and is expected to produce more than 150,000 ounces of gold next year.

3) In Finland, construction of the Kittila gold mine commenced in the summer of 2006, with initial production expected in the fourth quarter of 2008. This mine has probable reserves of 3 million ounces and is expected to produce 150,000 ounces of gold next year for AEM.

4) Shaft sinking is complete and level development underway at the Lapa deposit, also in Quebec, Canada, with probabe gold reserves of 1.1 million ounces. Production is expected in mid-year 2009 with average annual production of 125,000 ounces.

5) The Meadowbank project in the Nunavut Territory in northern Canada is advancing towards initial gold production in the 1st quarter, 2010, which has probable gold reserves of 3.5 million ounces and is expected to add 360,000 ounces of gold production per year to AEM.

6) Initial gold and silver production at AEM’s Pinos Altos project in Mexico is expected in third quarter 2009. It has probable gold reserves of 2.5 million ounces, 73.1 million ounces of silver from 24.7 million tonnes at 3.2 g/t gold and 92.2 g/t silver. Full annual production is estimated to be around 150,000 to 200,000 ounces of gold.

In general, AEM is estimated to produce around 300,000 ounces of gold this year, about 2/3 from LaRonde mine and the rest from Glodex and Kitila. However, we should see explosive increase in gold production for AEM in the next 2-3 years. Overall, Gold production is estimated to be over 600,000 ounces next year due to contributions from Goldex, Lapa, Kittila and Pinos Altos. In 2010 and beyond, we should see Meadowbank make a big splash by producing likely 360,000 ounces of gold per year alone. The whole gold production for AEM should reach close to 1.4 million ounces of gold at that time, more than quadruple from this year’s estimate of 300,000.

AEM has been careful not to dilute their shares even at the same time they have done several strategic acquisitions. From 1998 to today, period of 10 years, their number of shares outstanding has been up by 2.6 times, but their gold reserves have been growing 12.8 times, preserving and increasing shareholder’s value substantially. With the six mines discussed above, AEM continues to target potential several 5 million oz gold deposits, and strives to grow its reserves further by expanding the mines they currently 100% own and investing early in high quality gold deposits via strategic acquisitions. AEM is spending $65 million on exploration this year, the largest budget in AEM history. AEM has also made strategic investments in Gold Eagle (GEA.TO) and Comaplex Minerals (CMF.TO).

Agnico-Eagle's operating history includes more than 30 years of continuous gold production primarily from underground operations. Since 1972, Agnico-Eagle has produced over 4 million ounces of gold, at the same time as one of the lowest total cash cost producers in the North American gold mining industry. It currently has $7.5 billion market cap, a mid-tier gold producer with ramp-up production in the near future. Agnico-Eagle has traditionally sold all of its production at the spot price of gold, having a policy of not selling forward future gold production, enabling shareholders to participate fully in rising precious metal prices, once this gold bull market resumes. Agnico-Eagle has also paid a cash dividend for 26 consecutive years with current yield around 0.3%.

AEM’s current 2nd quarter earning decreased substantially due to the crash of zinc price resulting less by-product credit thus higher cash cost, and the delay of the Goldex mine production. AEM is capital heavy in 2008, planning to spend $800 million, but will decrease probably 50% every year afterwards. Majority of the financing for this capital expenditure is coming from their cashflow from operations, expanding bank credit facility and cash position.

Overall, with the additional mines into production, AEM is expected to double then double again their gold output in the next 3 years from 2008. With their by-product credits of zinc, silver and copper, the cash cost of gold production is very low, probably around $80 per ounce for 2008. Even if we don’t count those credits, AEM can still produce at less than $300 cash cost per ounce of gold, in the lowest quartile of cash cost producers but with high gross profit margin for a mid-tier gold producer in the industry. More importantly, when gold resumes its bull market, the operating leverage from AEM will provide explosive increase in both revenue and earnings for investors. It won’t surprise me that AEM can double from the current $50 price level to be in 3 digit territory in the next 24 months.

Disclosure: I have been long Agnico-Eagle since November 2007, and I believe Agnico-Eagle is currently undervalued and provides a good opportunity for a diversified mining portfolio for long term capital gain.

Thomas Tan, CFA, MBA

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