Harmony Gold: Unconvincing Margins & Overestimated Price Support (HMY)

There has been much talk surrounding gold miners amid an anticipated gold price pivot. However, much of the published research I’ve seen is one-dimensional, which assumes certain indicators as settled law. Thus, I decided to juxtapose preliminary research with coverage of one of the most renowned gold securities.

Today’s article discusses Harmony Gold (NYSE:HMY), a precious metals miner whose stock has risen by more than 20% in the past six months. Gold prices are assessed within the article, and the assessment of the company’s profit margins is of particular focus.

Dow To Gold Ratio & Other Price Arguments

Dow To Gold

The Dow to Gold ratio is a well-known market anomaly that measures the units of Gold required to buy the Dow Jones Index. The theory claims investors will buy Gold and sell stocks whenever the ratio exceeds 15. The ratio is currently above 15, and Gold has surged during the past six months; however, the Dow has performed in line.

The issue I have with this ratio pertains to confirmation bias. According BullionVault, market participants would’ve traded this strategy six times in the past 100 years. How on earth can we conclude that something is statistically significant with merely six observations?

U.S. Dollar Correlation

Based on my anecdote and according to academic research, the price of Gold has an inverse relationship with the U.S. dollar due to demand elasticity and inflation, among other reasons.

The current U.S. yield curve is downward sloping. This means the market anticipated future interest rates to settle lower, which also conveys lower inflation estimates (until the curve steepens again). In theory, lower rates and lower implied inflation will likely translate into dollar index compression and gold price support.

Recession Risk

An overlooked argument is recession risk. Although gold can sustain value during economic downturns, the commodity remains susceptible to deep recessions. The word on the street is that the U.S. and most other nations will enter a recession in this year’s third quarter. Whether the predicted recession comes to fruition is a debate on its own. However, the market could price a prospective economic slowdown, leading to a potential gold price slump.

Operational Overview & Outlook

Operational Analysis

Harmony Gold’s operations are primarily situated in South Africa. However, its endeavor extends to Morobe in Papua New Guinea and corporate joint ventures in Australia, which will be discussed later on.

South African Underground

Harmony’s South African operations are primarily deep mining focused via its eight underground mines, predominantly in the Wits basin. In addition, the company has an open-cast mine on the Kraaipan Greenbelt and hosts various surface retreatment operations.

I’ve repeated this time and time. I simply don’t like the South African deep gold mining landscape, as the cost versus benefit isn’t what it used to be in past decades. For instance, Harmony’s Mponeng mine (the world’s deepest mine) delivers approximately 14.15% of the firm’s milled ore, yet, its operating free cash flow margin is at a mere 5% to 13%. Keep in mind that this was a recent acquisition as part of the company’s growth plan, which is why I highlight it.

Collectively, the company’s South African underground assets aren’t providing illustrious performance ratios. The portfolio’s sales to CapEx ratio of 7.8x and its operating free cash flow margin of 9% are simply underwhelming from my point of view.

In U.S. dollar terms, the company’s all-in-sustaining costs dropped by around 12% during its latest quarter, while revenue and production only tapered by roughly 3.5% and 2.1% apiece. I anticipate that both fixed and variable costs will compress slightly as broad-based inflation, including wage growth, service costs, and fuel prices, could flatline. Nevertheless, keep in mind that South Africa’s Eskom crisis could keep base electricity costs elevated for the foreseeable future.

South African Surface

The firm’s surface operations are slightly less elastic than its underground interests. Nonetheless, margins are unconvincing, with the segment’s sales to CapEx at 6.39 and operating free cash flow margin of 8% looking slightly unconvincing.

Although Harmony’s surface operations aren’t convincing, it is mining waste-rock dumps with relative success, as indicated by its Central Park Reclamation and Mavuka Tailings sites’ operating cash flow margins of 35% and 31%.

Papua New Guinea & Australia

Harmony’s Hidden Valley mine has tremendous open-pit prospects. However, recent results show that production has receded by 11% year-over-year. The mine delivers gold and silver ore and is a strategic diversification play. Yet, tangible portfolio effects remain thin as the asset only accounts for an infinitesimal amount of the company’s total production.

Compressed Profit Margins

Harmony Gold has a mountain to climb to replenish its profitability margins. Even if gold prices surge and base input costs stabilize, the company needs to recover a 3.44% return on common equity deficit for shareholders to receive residual value.

Although I believe input costs will find calm. I don’t know whether gold prices will break out. In addition, even if Harmony returns to its cyclical peak, you’ll still be invested in a company with a net income margin marginally above breakeven.

Valuation Metrics & Dividend Profile

At an underwhelming forward dividend yield of 0.62%, Harmony Gold’s return prospects hinge on price returns. To be fair, the stock’s price-to-book ratio of 1.33x isn’t terrible, and its price-to-sales ratio (0.96) suggests the stock’s trading at a discount to its fair topline value. Anyhow, I don’t see enough embedded value in the stock’s price multiples to compensate for its low dividend yield, which leads me to conclude that Harmony Gold’s stock presents poor value for money.

Final Word

A holistic analysis suggests Harmony Gold might receive systemic support due to proliferating gold prices and flatlining input costs. However, the company’s profitability margins are underwhelming, which stems from its unappealing deep gold mining profile. Moreover, apart from a few dump sites, Harmony’s surface operations also lack economic feasibility.

The stock’s dividend yield is compressed, and there isn’t enough in its valuation multiples to present telling expected returns.

I/we assign a Hold rating with an indefinite time horizon.