Investors are hardly in the mood for risk.
And when risk appetite wanes the “principal/agent” issue rises to the forefront pushing investors to favour cash in their own hands rather than being left at the disposal of management.
The principal/agent problem arises when principals (the shareholders) hire agents (company management) to act in their best interests but aren’t privy to the same information that management is and thus can’t be sure that they are truly acting in their best interest.
With the current volatility in the markets pushing investors to put a premium on generating more secure income, the failure of the mining sector as a whole to distribute cash to investors in an adequate way is being reflected in the senior producers suffering the lowest price-to-earning ratios since 2008.
The issue has also been on display through the scorn heaped upon recent big acquisitions by major players such as Barrick Gold and Kinross Gold. In the case of Barrick it resulted in the ouster of its chief executive, while in the case of Kinross, it has resulted in a share price more than cut in half since the time of its big acquisition.
The fortunes of the two companies are symptomatic of a change in the general mood of investors. It was only a few years ago that shareholders implicitly endorsed management’s pursuit of ever more production growth via acquisitions. Now, however, those same investors are asking when and how more cash flows will be distributed directly into their pockets.
Also framing the issue is the rising popularity of ETFs. It is no secret that the poor performance of gold miners relative to the price of gold has coincided with the increased popularity of ETFs. The investment vehicles make it easier for investors to play the price of gold directly without having to fuss over poor decisions by management.
Such competition means management needs to focus now more than ever, on the one big advantage that gold companies have over physical gold — their ability generate income for investors. While gold bars are lauded for their ability to hold value, no one has yet seen one that spits out cash for those that hold them.
And while any responsible management team has to weigh the advantages of pushing cash out to shareholders against holding on to it to generate more wealth for those same shareholders via growth and greater efficiencies, it is clear that the big boys in the game are getting the message as most of the major producers having increased dividends over the last 12 months.
With all the attention on dividends, however, the second form of distribution is often left out of the conversation. So while markets overall have been trending more towards share repurchases over dividends over the last decade, the mining sector has been slow to warm to the strategy.
This is somewhat surprising given that share repurchases offer a few distinct advantages over paying dividends.
The first is that a repurchase doesn’t come with the same commitment to continually spit out cash to investors. Repurchases can be a one time deal, thus freeing up future cash flows for any needs that may arise at a later date.
Another advantage of a buyback is that a company can satisfy its acquisition itch at a minimal cost. That is to say that when management decides to buy its own shares it is acquiring liquid assets and it is doing so without paying any sort of premium or subjecting itself to shareholder votes or legal costs.
The other often noted advantage of a share repurchase occurs on the psychological front. A buyback is generally read as a signal by investors that management is confident in the company’s future share price.
And while the trend has been towards dividends in the mining industry some miners have shown a partiality to the share buyback strategy.
Miners that have recently announced share repurchases include Hecla Mining, Pan American Silver and Potash Corp, which did a massive $2 billion repurchase of its own equity after BHP Billiton’s attempted takeover was thwarted.
And there are rumblings that BHP itself will announce another modest repurchase in the coming weeks. The company has been known to use the tactic in the past.
The most recent miner to show faith in its own stock is Coeur d’Alene Mines, which announced a repurchase of up to $100 million of its common equity. Based on its recent closing price, that will likely work out to the purchase of 5.3 million, or roughly 6% of its shares outstanding.
Such moves are a good sign for the industry. And if the senior producers continue to strive to find the right balance between shareholder distributions and cash flow retention, perhaps those once lofty price multiples will return, and the trend towards ETFs will lose much of its luster.
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