We reiterate our Buy rating on Kinross Gold (TSX: K, $7.91) based on valuations that we believe are quite compelling as the stock trades at its lowest levels since 2005. Concurrently, we are lowering our price target to $13, from an earlier target of $16.

Kinross is now trading well into the single digits after falling below the $10 level earlier this year for the first time since the market panic of 2008. The company has lost about a third of its market value so far this year, and ranks No. 52 on the 64-member TSX Global Gold index in terms of YTD performance.

With Kinross having lost more than 60% of its value since it completed the $8-billion acquisition of Red Back Mining about 1½ years ago, it is clear that the deal has been anything but positive for the company. The stock had plummeted in January after Kinross said it would take a non-cash charge primarily relating to the goodwill recorded for its Tasiast mine in relation to the acquisition of Red Back Mining. Kinross recorded a non-cash goodwill impairment charge of $2.94 billion when it reported Q4 and fiscal 2011 results on February 15, of which $2.49 billion was attributable to Tasiast.

The company's Q1 results released last week revealed lower production and spiralling costs, offset to some extent by its unchanged guidance for the rest of the year. It produced 604,247 attributable gold equivalent ounces (GEO) in Q1, down 6% from a year ago, due to expected declines in grade at Kupol and an increase in processing lower-grade stockpiled ore at La Coipa, as well as production that was below plan at Tasiast. (A less favourable gold equivalent ratio - 51.82 compared with 43.51 eyar ago - also had an impact on production). Production cost of sales per GEO surged 36% to US$742/oz, from US$545 a year ago, due to increased processing of lower-grade ore, and higher power, labour and contracting costs. 
   

Revenue rose 11% from a year ago to US$1036.6 million due to a higher realized gold price, which rose 24% to US$1,644/oz. Higher gold prices resulted in margin per GEO increasing 15% to US$902 despite rising costs. Adjusted operating cash flow fell 14% to US$339.7 million or US$0.30 per share, while adjusted net earnings rose 16% to US$203.1 million or US$0.18 per share. Reported net earnings plunged almost 58% to US$105.7 million or US$0.09 per share. The decrease in net earnings was mainly due to an increase of US$110.3 million in deferred tax liabilities (a non-cash item) as a result of an increase in the corporate income tax rate in Ghana from 25% to 35%.  

Operating earnings in Q1 fell 5% to US$313.2 million. The biggest contributors to operating earnings were Kupol (US$96.2 million), Paracatu (US$66.0 million) and Maricunga (US$64.9 million). The Tasiast mine had an operating loss of US$6.1 million, compared with operating earnings of US$26.2 million a year ago, due to a 27% decline in production. Kinross said the drop in output at Tasiast was due to the leaching metallurgy being affected by a high proportion of near-surface fine material and a clay-like substance called felsite. It also said that the issue is being resolved and production is expected to improve in the second half of the year. 

Figure 2 shows operating metrics for Kinross' various mines. The biggest increase in per-ounce production cost of sales of 70% occurred at the Tasiast mine in Mauritania and La Coipa in Chile due to output declines combined with the leaching issue noted earlier at Tasiast and significantly lower grades at La Coipa (0.56 g/t of gold compared with 0.83 a year earlier, and 38.78 g/t of silver compared with 75.64). Kinross expects grades and production at La Coipa to improve in the second half as processing shifts from stockpiled ore to ore from the Can Can and Ladera Farellon pits. Per-ounce production cost at the Kupol mine in Russia also 50%, although it was among the lowest-cost of Kinross' mines, due to sharply lower output caused by a scheduled decline in grade and lower mill throughput. Kinross noted that performance metrics remained strong and Kupol is expected to meet production and cost guidance.  

Figure 2: Kinross' Mine Metrics   

Source: www.kinross.com

Kinross left its outlook unchanged, with production of 2.6 - 2.8 million GEO expected in 2012, with production cost of sales per GEO forecast at US$670 - $715. On a by-product basis, the company expects gold production of 2.5 - 2.6 million ounces of gold and 7.5 - 8.0 million ounces of silver, at an average production cost of sales of about US$620 - 665 per ounce of gold.

Capital expenditures for this year are forecast at US$2.2 billion. Capital expenditures in Q1 were US$534 million, more than double year-earlier capex of US$256 million, due to project-related expenditures at the Tasiast, Paracatu and Dvoinoye mines.  

The feasibility study for the Dvoinoye mine was completed in Q1 and the Kinross Board has approved full construction funding. This is a high-grade mine (average gold grade expected to be 17 g/t and silver grade 21 g/t) that is located about 100 kilometres north of Kinross' existing Kupol mine in the Chukotka region of Russia. The mine is expected to produce about 1,000 tonnes of ore per day, which will be shipped by truck to the Kupol facility. Total life of mine gold production is expected to be about 1.1 million ounces, with 1.14 million ounces of silver.

Kinross' Russian operations are expected to become very significant contributors to revenues and earnings going forward, and Dvoinoye and Kupol results will be reported on a combined basis. Annual gold production from Dvoinoye is expected to average 215,000 - 250,000 ounces of gold for the first three years of production; combined with Kupol's average annual production of 435,000 - 470,000 GEO during this period, the region is expected to produce about 650,000 - 700,000 GEO annually from 2014 to 2016. Dvoinoye is forecast to have a mine life of seven years, and is on track to deliver first ore to the upgraded Kupol mine in the second half of 2013. Capital expenditures for Dvoinoye are estimated at US$370 million, which includes about US$175 million for infrastructure construction and upgrades to Kupol, which is being upgraded to process 4,500 tonnes of ore daily. Capex and commitments for the project at end-Q1 were US$206 million, or 56% of total expenditure.

Tasiast is of course the other big focus for Kinross. It has accelerated mining activity at the deposit, with mine production forecast to increase to about 90 million tonnes this year from 50 million tonnes in 2011. The company also reports progress in its other major growth projects, Fruta del Norte in Ecuador and Lobo Marte in Chile, although these currently a lower priority than Dvoinoye and Tasiast.

While the $2.5-billion goodwill write-down confirms that Kinross paid too much for Tasiast, the situation may be redeemed to some extent if it makes a prolific new discovery in the area. The company expects to allocate about US$80 million in exploration expense this year for Tasiast, with its efforts focused on finding new ore shoots along the 8-kilometre mine corridor and on satellite ore bodies in the district.

Given that 60% to 70% of the company's costs are denominated in US dollars, it has the following sensitivities -

·        A 10% change in foreign exchange could result in an impact of about US$5 in per-ounce production cost of sales.

·        A US$10 change in the price of oil per barrel could result in an impact of about US$2 in per-ounce production cost of sales.

·        The impact on royalties of a US$100 change in the price of gold could affect per-ounce production cost by about US$4.

Kinross has a solid balance sheet, with shareholders' equity of US$12.5 billion compared with total debt of US$1.6 billion. Cash and investments amounted to almost US$1.5 billion at end-Q1, down by US$280 million at December 31, 2011, due to cash used in purchasing fixed assets. Working capital amounted to US$1.65 billion at March 31, with the working capital ratio at 2.34:1.

Analysts' opinion is divided on Kinross, with 13 rating it as a Buy or equivalent, 9 as a Hold, and 1 Sell rating. Average EPS estimates have come down in recent months, and are currently at US$0.90 for FY12, surging 30% to US$1.17 in FY13. On that basis, the stock trades at compelling single-digit forward valuations of 8.8x FY12 EPS and 6.8x FY13 EPS, which is about half its valuations in December 2011. 

Kinross also pays a semi-annual dividend of US$0.08 per share, for an indicated annual yield of 2%. Like Rodney Dangerfield, the stock is getting no respect among investors, which presents an opportunity for patient investors. Potential catalysts in the near term could include positive news from Tasiast or some of its other exploration initiatives, or renewed appetite for gold stocks in general. We reiterate our Buy rating on Kinross, with a $13 price target. Investors who currently hold Kinross (especially those with a double-digit average cost for prior purchases) should consider averaging down at these levels.