All eyes are on last week's meeting of the Federal Reserve Open Market Committee. The market is expecting a 25 basis point rate increase (with the Fed Funds futures putting 85% odds of that) and then a pause. I concur, but expecting an 80 bps decline by the end of the year (as per the futures) is aggressive. The gold market is on hold, awaiting the possible rate hike and commentary around it; bonds are down, anticipating the rate hike, while the stock market seemingly is ignoring it.
Gold ran up strongly in March around the last meeting and the supposed Fed pivot. It was not a pivot, however, and the market, as I have said, moved too far, too fast, on overly optimistic assumptions of what lay ahead.
Now, in recent weeks, several Fed spokesmen have called for higher rates, hence gold's slow retreat from early April highs. More important than the rate increase will be the commentary surrounding Fed Chairman Jerome Powell's press conference. We expect a pause in rate hikes after this one, depending, as always, on the economic news before the next meeting.
Powell may attempt to sound hawkish, emphasizing that inflation is the Fed's main priority, but can't ignore the growing signs of a slowing economy nor signs of trouble in the banking and insurance sectors. Gold will latch on to these signs of a Fed pause, and we expect after the meeting, gold will find a bottom and move back up. This week, given the optimism that could be dashed and the uncertainty around the meeting, we are buying little this week.
We fully expect to be buying again soon. In truth, though gold is down US$50 from its mid-month peak, it has been holding up well and not wanting to give up gains readily.
Ares Can Withstand a Slowing Economy
Ares Capital Corp. (ARCC:NASDAQ) reported weaker earnings for the first quarter due to lower origination fees and modest balance sheet deleveraging. Credit metrics also worsened slightly, continuing a trend of the last few quarters, but they remain above the company's 15-year average and the BDC sector's average.
It was not all bad (modestly bad), however. Core earnings (from loan income) were up 36% year-on-year, driven by higher interest rates on new investments. Earnings remain comfortably in excess of the dividend. The company's NAV increased, to US$18.45 a share, while the Return on Equity remains high, increasing to 12.7%.
After the deleveraging, the debt-to-equity ratio is below 1.1 times, which is very low, giving the company lots of dry powder for new investments.
Going forward, the company expects origination fees to stay low in what it sees as a slow transaction environment. The first quarter of the year is usually the slowest, but this one was slower than normal. However, the company still sees lots of potential deals; the number it looked at this past quarter was up by 14%.
Longer term, the turmoil in the banking sector means banks are constrained in making new loans to the benefit of the BDCs.
Alternative Lenders Are Different From Banks
Ares maintained its quarterly dividend — equating to over 10% on an annual basis — and has US$1.19 per share in spillover income, the equivalent of 2 ½ times its regular dividend payout, providing ample cushion to supplement any weak quarters.
It is trading at a 5% discount to NAV, and the company has a share buyback program in place for use when the discount widens too much. Ares stock, along with other BDCs, fell from earlier highs amid the banking crisis in March. But most BDCs, including Ares, have important characteristics that distinguish them from banks; most importantly, they employ far less leverage, and they match the duration of their assets and liabilities (what an idea!). Most of their debt tends to be fixed rate, while their loans are mostly variable.
So while the stocks will tend to be volatile, the better companies are well-positioned to survive and even profit from an economic downturn. Ares can be bought here for long-term investors looking for yield. For those who already own it, however, we would look to add to positions below US$18.
Agnico Does It Again!
Agnico Eagle Mines Ltd. (AEM: TSX; AEM:NYSE) reported better-than-expected first-quarter results, with operations, production, costs, and earnings all exceeding expectations. Production was up 2%, quarter of quarter, in contrast with most other large miners that saw quarterly declines.
Indeed, all operations exceeded expectations, except Fosterville in Australia. Earnings of 58 cents per share beat analyst consensus of 48 cents. Total cash costs of US$804/oz were below the full-year guidance of US$840-$890 and among the lowest of the large miners.
Agnico has about half its 2023 diesel exposure hedged at 80 cents per liter, lower than current prices and lower than its 93 cent/liter guidance for the whole of 2023. Diesel is one of the largest components of operating a mine, and the price has moved up over the past two years.
The company has long had a successful hedge program (on costs, not gold) and a strong record of cost management. In recent quarters, the weak Canadian dollar has helped local operations as well. The first quarter will likely be the weakest of the year for Agnico, given that it acquired the other 50% of Malartic only on the last day of the quarter.
It is on track to meet its full-year guidance. If Agnico exceeded expectations, it is also true, as I pointed out in February (Bulletin #852), that Agnico tends to be conservative in providing guidance. It is also optimizing its assets, including its recently acquired assets (from Kirkland and Yamana).
The next several months should bring more announcements on its plans. Agnico is our favorite among the large miners, with top management, a deep bench, world-class assets in low-risk jurisdictions, a strong balance sheet, and now an abundance of growth opportunities.
If you are underinvested in the gold space, you can buy Agnico. But for additional purchases, we are holding now.
Strong Guidance for the New Pan American
Pan American Silver Corp. (PAAS:TSX; PAAS:NASDAQ) released its 2023 production and cost guidance following its acquisition of (most of) Yamana. Gold production is forecast at between 870,000 and 970,000 and silver at 21 million to 23 million, at All-in Sustaining Costs (AISC) of US$1,275-1,425/oz and US$14-$16/oz, respectively.
Cash costs are expected to be in the range of US$975/oz and US$1,100 for gold, and US$10 to US$12 for silver. Pan America uses a different methodology for costs than Yamana. Similarly, because of accounting practices, Pan American's reported AISC will be higher than it was for Yamana.
Guidance for the newly acquired mines is for the nine months of Pan American ownership but the full year for the legacy mines. Pan American expects production for the year to be back-ended, particularly for some mines.
CEO Michael Steinmann said he was excited about many of Yamana's operations. Its four operating mines — Jacobina, El Penon, Cerro Moro, and Minera Florida — account for 32% of the combined silver and 47% of the combined gold production, with "tremendous opportunities" on projects for expansion and brownfields exploration, adding that the acquisition was accretive.
Pan American also gained many greenfields projects that it will be evaluating, together with its own exploration properties, in the coming months. He noted that the combined entity was on track for US$40 million to US$60 million in annual synergies.
Divestments Can Further Strengthen Balance Sheet
The combined company has cash of just over US$500,000, with US$425,000 remaining on its credit facility. It acquired long-term debt with Yamana, notes due 2027 and 2031, bringing total debt to just over 10% of equity, still a low figure, though Pan American has eschewed debt in the past. Interest rates on the notes are low, at 4.6% and 2.6%.
It is also expected that the company will make one or two disinvestments, though it gave no details, or indications, saying they were evaluating all assets now. Using Yamana's listing, Pan America has now moved to the New York Stock Exchange from Nasdaq. The combined entity, now even more focused on Latin America and with operations in a large number of countries, has the potential for synergies as well as optimization of some operations, with significant capital spending being planned for some.
The balance sheet remains very strong, notwithstanding the acquisition of debt from Yamana. On a valuation basis, it is undervalued on an asset basis, though it ended 2022 on an abnormally high cash-flow multiple, expected to come down this year.
We are holding, given near-term uncertainty in the gold price, but will be buying again.
Nestle Successfully Maneuvres Turbulent Seas
Nestle SA (NESN:VX; NSRGY:OTC), which reports more frequently now than it used to, said quarterly sales increased by 5.6% to Sfr 23.5 billion, while foreign exchange decreased sales by 4%; net acquisitions increased sales by 0.3%. Organic growth exceeded a healthy 9%, with broad-based contributions across regions and categories.
It confirmed its full-year outlook for organic sales growth between 6% and 8% and margins of 17% plus. By product, Purina PetCare was the largest contributor to growth, driven in particular by its premium pet brands. Confectionary and infant nutrition both grew by double digits. Water, prepared foods, and ice cream were the weakest.
Most regions had double-digit growth, with the Greater China region lagging again at only 3%. The company continues to face cost inflation but said that portfolio optimization and what it calls "responsible pricing" helped to offset cost pressures.
Nestle has largely held on to consumers in its premium products, with limited trading down, as it has limited price increases. In new ventures, it announced the creation of a joint venture dedicated to frozen pizza in Europe.
Strong Balance Sheet, Diverse Operations, and Reasonable Valuation
With operations and sales in over 100 countries and a broad mix of products, it is always to be expected that some areas will perform better than others. Nestle has done a good job of increasing sales and continually optimizing its portfolio of products. The balance sheet is strong and returns high (ROE of almost 20%).
Its guidance for the year seems a little conservative on caution over costs. The valuation is generally within its historical range, with a yield of 2.6%, well off the lows but still below its long-term average.
We are comfortable holding this global blue chip. Nova Royalty Corp. (NOVR:TSX.V) has moved up since our recommendation at the end of March (see Bulletin #857).
Although, as discussed in the subsequent bulletin, it traded under our CA$1.45 limit that morning, we recognize that many of you will have missed it. So we are raising our buy limit to CA$1.62.
TOP BUYS THIS WEEK, in addition to the above, include Altius Minerals Corp. (ALS:TSX.V), Midland Exploration Inc. (MD:TSX.V), Lara Exploration Ltd. (LRA:TSX.V), and Hutchison Port Holdings Trust (HPHT:Singapore). Because we remain cautious about the near-term gold price around this week's Fed meeting, we are not buying much in the gold sector now.
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