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[the cork]

Why Kinross Is A Long-Term Winner
http://seekingalpha.com/article/400731-why-kinross-is-a-long-term-winner?source=email_portfolio&ifp=0

by: Samuel Zeifman February 29, 2012
(special thanks to investor15)

In a market where everyone is chasing yield, people are forgetting about the rich long term opportunities that are available. When considering the shares of Kinross, (KGC) one must seize the opportunity to invest at this opportune moment. The fact that Kinross just raised the dividend by 33% is an indication of where the company is going.

Whether you bought Kinross shares today or seven years ago, the price remains the same. The only change is that today, the spot price of gold is around $1730, where seven years ago the price was $550. Thus we have seen a tripling of the price of gold, yet the price of Kinross shares remains at either below or above book value levels (depending on how you value goodwill). The main argument against Kinross is higher costs relative to competitors. However, the fact that every investor is aware of this known data presents a great buying opportunity, as this news has been overly factored into the price.

Kinross' shares have been hit with a goodwill impairment charge in Q4 2011 where a $2.9 billion dollar write down was booked. Kinross is undertaking questionable negotiations in Ecuador (which may fail), and faces general market and operational risks. The argument for this article is that when you take into account all of the negative information and apply it to Kinross, the company represents an amazing buying opportunity.

It is only a matter of time before there is an increase for the demand of gold. In the past, investors have poured money into physical gold and gold-backed exchanged traded funds (ETFs), thus the gold miners have not had the investment that they will soon receive when earnings start coming through on today's gold price.

"Gold producers are heading for an "inflection point" triggering a rally," Barrick Chief Executive Officer Aaron Regent said in an interview. "They have been punished as investors decided the shares should no longer trade as a proxy for physical gold," he said.

"The growing popularity of gold-backed exchange traded funds, or ETFs, which include the $73.3 billion SPDR Gold Trust, probably have taken away some of the capital that previously was invested in companies such as Toronto-based Barrick," Regent said. Investors have shunned gold producers choosing instead to hold physical metal and ETFs after gold advanced in 11 successive years and touched a record in September.

Kinross has developed an asset base to 10 operating gold producing mines, and although average cost per ounce of gold is higher than competitors, Kinross still makes substantial sums of money per ounce of gold. In 2011 Kinross had a margin of $965 per ounce of gold sold. In 2011 average production cost of gold was $636 per ounce. This cost might go as high as $700 per ounce this year.

According to Tye Burt, President and CEO, "Our ten operating mines are generating strong cash flow. Tasiast remains our first development priority in a measured and prudent plan for capital allocation and growth designed for long-term value and financial strength."

The profit margin for Kinross is an important metric because costs are the key reason why shares have traded flat in the last 7 years while competitors have had explosive stock price increases. (See chart above.) With a higher cost of extracting the gold, margins were tight with the gold price less than $1,000 per ounce. With gold at today's prices, Kinross has had record revenue and operationally has never produced so much gold. Producing 2.8 million ounces per year, and earnings which will add about .80 cents a year per share, make Kinross a great value play.

Kinross is mining a significant amount of gold. Kinross mines 2.8 ounces compared to Goldcorp's 2.5 million ounces in 2011. The difference is that Kinross has costs on each ounce three times higher than Goldcorp, and trades at a price four times lower. That said, when gold starts to appreciate, Kinross will continue to see record earnings.

If you examine the book value for Kinross before the goodwill impairment charge Kinross took in Q4 2011, Kinross had an excessively large amount of goodwill in relation to total assets in comparison with other similar gold miners. (See chart below.)

After a thorough investigation valuating gold companies, I have reached the conclusion that goodwill in gold producers' balance sheets doesn't have nearly the same amount of "pull" as in other industries. Companies who had a higher relation of goodwill / assets traded at significant discounts and Kinross fits this model. (See chart below.) Nonetheless, the $2.9 billion dollar non-cash goodwill impairment charge (which caused the stock to drop about 20%) could be expected. However, the price of the stock is now trading at or near book value when you factor in the current goodwill of the stock which according to my chart is $11.21.

If you strip out goodwill entirely from the balance sheet you still come up with a book value of $8.20. This is on a mid cap established gold producer with 10 operational mines earning .80 cents a year. Just the earnings without any cash in the bank would justify the current price. When goodwill is factored you have a stock trading below book value. Looking at Kinross from a financial perspective, earning $.80 cents this year, with a stock price at near or below book value, creates a great value play. In either case with or without goodwill the valuation looks great.


RELATIVE VALUES
(Before Kinross' $2.9b Goodwill Charge)

RELATIVE VALUES
(After Kinross' $2.9b Goodwill Charge)



Icing On The Cake

If you were to define conservative management you would say the name Kinross, and I don't blame management for a second. Management continues to be highly criticized for the Red Back acquisition which was done to purchase the Tasiast mine. At the time the mine was expected to have 8-9 million ounces of gold and since the studies have come in, Kinross is saying the gold deposits are looking more like 12 million. Despite this, the street is still ripping management apart for over-paying for this asset.

Tasiast is what is going to keep Kinross strong into the future. Kinross has excellent current production (2,610,373 ounces of gold in 2011) and is adding capacity through expanding the Tasiast mine. Last quarter Kinross produced 55,000 ounces of gold with the expectation of that number going to 75,000 ounces a quarter starting this year. If we round off production at Tasiast at an approximate average of 80,000 ounces per quarter going forward, that gives Kinross an extra 320,000 ounces of gold per year. This represents an 11.4% increase of current operations of 2.8 million ounces.

With what Kinross is mining right now, and the additional reserves that Tasiast will deliver, over the next year, Kinross will be adding approximately 11.4% more gold to earnings through this asset. Tasiast is a world class deposit that people aren't paying attention to. Some believe that Kinross took a 2.9 billion dollar goodwill write down to reflect the lower value of the Tasiast mine. However, the reason Kinross took this impairment charge is because of the run up of the price of Kinross shares which caused the price of the Red Back deal to increase substantially.

This price increase was attributed to the "goodwill" section of the balance sheet and has now been properly reflected. The difference can be seen on chart #1 versus chart #2. The reason for the write down was not an inferior mine, but market conditions which ran the price of the acquisition up when Kinross stock was rising. In summation, Kinross has a world class mine that has more gold than expected, and the share price appreciation caused the write down, not the quality of Tasiast.

The reason that I suggest that Kinross has conservative management is because all of the future forecasting is based on $1,250 as the price of gold. Even through the price of gold is $1750 Kinross uses $1,250 as the future gold price.

If management had projected the price of gold to be in the mid-range between $1250 and $1750, say $1450 per ounce, there would not have been a goodwill charge. This was stated on the Q4 investor question and answer period available on the Kinross website.

This is how sensitive Kinross is to the price of gold. With higher than average costs which might hit $700 per ounce, a selling price of $1250 only leaves $550 profit per ounce. That is less than 2011 profits of $965 per ounce. I feel that gold is not going to $1250 leaving only $550 profit per ounce. (1250 - 700 = $550)

I feel that gold will stay at current levels or appreciate. Thus, gold projections at $1250 are overly conservative and if gold stays at $1750, margins will be $1050 not $550. $550 margins (not $1050 margins) is how management is calculating goodwill on the balance sheet. Therefore, if gold stays at these levels Kinross will earn solid money from a diverse geographical combination of ten operating mines, and benefit from additional future production and site increases with a focus on Tasiast.

In conclusion, Kinross is trading at an excellent valuation as described above. Kinross earns good money at about $.80 cents per year with a world class brand new young operational mine (Tasiast) which is just starting to come online. This mine will most likely increase total production by around 11.4%. This means if you buy this stock now and you sit and wait until the earnings come through, the dividend rolls up, and for all the reasons you would buy gold, Kinross will be a winner. Not to mention that at these crippled prices Kinross is ripe for a take-over. The only issue is that Kinross is too big to get swallowed.

Disclosure: I am long KGC.