Note: The following True Vine Letter was originally published as Premium content on December 22, 2020. I am publishing it here as a sample of what Premium offers. I strive to write not about everything there is to know but the most important things to know for potential investments. You can learn more about the Premium service here.

Introduction 

I am a student of history and always find it helpful for putting current events in context. In this phase of my life I have little time for reading so I listen to audiobooks while doing other things. I am currently going through Carl Sandburg’s Abraham Lincoln: The Prairie Years and The War Years which I intentionally selected for perspective on a deeply divided nation.

The referential wisdom of history is always speaking concerning the present. I am hearing it saying now that we are living in a time of heightened mass hysteria. This mass hysteria has been used to justify reckless levels of government borrowing and central bank money creation. As I wrote about in The Truth On Investing, debt and inflation create deceptive economic environments. The rampant speculation in various stocks that we are currently seeing is the fruit of this.

Gold and silver are akin to the “God” of the economy—an everlasting, never changing, standard of truth. Gold is shining brighter nowadays in the midst of mass hysteria and ever increasing debt levels that can only be repaid, if ever, by inflating them away.

I am continuing my analysis of gold and silver producers, specifically looking for a few that can generate good levels of free cash flow to pay dividends. Lately, I have been thinking about dividend paying gold producers as savings accounts at (real money) banks that do or can potentially pay much higher levels of interest than what is currently available elsewhere.

Agnico Eagle

In many ways, Agnico Eagle (AEM) is similar to Kinross Gold (KGC). Here are the ways that stand out for me:

• both have 7 to 8 major mines

• both will produce in the 2 to 2.5 million oz. per year range in the coming years

• both are expected to increase production by about 20% over the next several years

• both have similar cost structures - overall All-in Sustaining Costs (AISCs) for both are about $1,000 per oz.

• both have between 55 to 60 million ozs. of combined gold Reserves & Resources

Despite the fact that Kinross is currently producing about 20% more gold than Agnico Eagle (Kinross is on the high side of the 2 to 2.5 range), the market value of Agnico is almost twice that of Kinross.

Investors are paying a significant premium for Agnico. Why? The following 2 slides provide the answer:

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source: Kinross Gold Investor Presentation

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source: Agnico Eagle Investor Presentation

It simply comes down to jurisdiction. The bulk of Agnico’s production comes from Canada and the rest comes from Finland and Mexico. All of these are sound mining jurisdictions.

For reference, the following Agnico presentation slide shows the location of their producing mines:

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source: Agnico Eagle Investor Presentation

Investors are paying a significant premium for Agnico because of its geographic footprint which is mostly in Canada. I get it. If you are going to own gold in the ground, you do not want it to be stolen. Because of this, the stock currently trades for 24 times my 2021 earnings estimate assuming $1,800 per oz. gold.

What Investors are Missing

I put together a detailed financial model for Agnico expecting to see more robust results and projections than what I ultimately concluded. It turns out that over the last 7 years the company has paid an effective cash tax rate of over 40%. For reference, management is guiding between 40% and 45% for 2020. Moreover, Agnico has almost $1 billion of deferred income and mining tax liabilities. So not only has the company been paying an average annual income tax rate of 40%, but this does not include an additional $1 billion they still owe. When I take the increase in deferred income and mining tax liabilities from 2014 to 2020, add it to the cash taxes they paid from 2014 to 2020 (7 years) and divide by the total earnings before taxes (EBT), I get an effective tax rate of almost 50%! Perhaps these “safe” jurisdictions are not as safe as investors think they are.

What I’d Pay

Agnico is going to have to get a lot cheaper for me to get interested. I’m talking like 50% cheaper than the current $72 price tag. Assuming a 42.5% long-term effective tax rate, an $1,800 per oz. gold price, and gradual production increases, I see Agnico earning roughly $3 per share in 2021-22 and growing the dividend enough to yield 3% to 4%. The high tax take is a drag on free cash flow that will make it difficult for the company to grow earnings at a fast enough rate to warrant the current valuation. I see a multiple in the low double digits as being more realistic.

In their quest for safe jurisdictions, investors are not considering all angles when it comes to Agnico. Government expropriation comes in multiple forms. Investors are paying too much for this stock.

Keep in mind that I don’t necessarily expect Agnico to move to my price target. My base case is that investors will continue to overpay for years and end up with poor returns from the stock unless the price of gold keeps moving higher. I have my valuation disciplines and I am sticking to them. In the quest for sound money I am not going to forget sound valuation principles.