Monday, April 23, 2007

The CopperCorp Disaster (GoldCorp)

"How come Goldcorp is underperforming," I read over and over.

Tear into the fundamentals and the changing business dynamics and it isn't hard to figure out. My first post on the over valuation of Goldcorp pointed out many of the reasons why Goldcorp would not perform well.

It is time to update.

Prior to the merger with Glamis most of the earnings were from copper.

The cost of production changed from -$73/oz in Q4 2005 to $160/oz in Q4 2006. That's an enormous increase of $233/oz in production costs.

The eps for Q4 2006 compared to Q4 2005 is 11c compared to 30c, a whopping 63% decline. People should be grateful that the price has held at all. In Q2 2006 Goldcorp had 50c eps. Some of that reduced earnings is from a three-fold hit on copper:

  • A 20% royalty kicking in.
  • A 20% reduction in production.
  • A 30% reduction in copper price.
There will be some recovery for the copper hit for Q1 2007 as they work out their copper production problems and copper prices recover. But, there is still a 20% royalty. To appreciate the effect of the negative leverage of copper, coupled with the reduced production and price, for Northern Orion from Q2 to Q4 eps when from 22c to 6c, a 73% decline. Gold corp has gone from 50c in Q2 2006 to 11c in Q4, a 78% decline. Part of this decline is from copper, but a big part is also from the Glamis merger.

The Glamis Effect on Earnings

The gross effect of the Glamis merger on earnings was not discussed in my previous post, only that it had been expensive.

Prior to the merger, and the restated eps, Goldcorp's eps was 89c for the first 9 months, but Glamis was only 44c. This was made much worse in that Goldcorp issues 1.69 shares for each of these dog Glamis shares. 44/1.69 gives a weighted average of only 26c eps. 284 million of these dog shares were added.

To just appreciate the affect of adding these shares consider the scenario that Goldcorp been able to continue at the same rate of performance, without the Glamis merger, you would have expected about $1.19 eps for 2007 (4/3*$.89). Using the same extrapolation for Glamis, you would have expected 35c eps for the diluted Glamis shares. If you do weighted average of the 418 million Goldcorp shares with the estimated $1.19 eps with the 284 Glamis shares that had the estimated 35c eps, the combined earning potential is 67c eps.

Never mind the copper hit, assuming all things remained the same, the Glamis merger reduced the possibility of earnings by 44% due to the vast difference in earnings at the time of the merger and the gross level of share dilution to acquire Glamis.

Goldcorp debases math

When I looked at their reporting of 2006 results, imho, how they reported the earnings should be against the law. It certainly violates every math concept I know, and I teach math. You have no idea how much I use this kind of debasing of math in the class room. I find that it get kids attention that they should appreciate math like nothing else I've ever used.

As far as I can tell what has been done is legal, but I can make an argument that earnings reports should correct for mergers and dilutions to reflect the effect on earnings of the dilution or merger. It is utterly nonsensical to add numbers together with different parameters as is done is earnings reports.

To show the point, here are is what Goldcorp has reported.

eps# of shares diluted
# of shares
Q1 2006$0.27340,961,000$0.24383,180,000
Q2 2006$0.50381,274,000 $0.49386,951,000
Q3 2006$0.14418,180,000$0.14422,345,000
Q4 2006$0.11597,706,000$0.11603,429,000
Dec 31,


Net earnings were $408.3 million for the full year. If you divide the net earnings by the actual number of shares December 31, 2006, you get 408.3/703.5= $0.58 eps. Goldcorp reports 62% higher eps than if you take what the company actually earned and divide it by the real number of shares.

Above I did a weighted average between what Glamis' earnings had been and Goldcorp's to get 67c eps. The $408.3 million is only Goldcorp's earnings. Glamis had earnings prior to the merger and a proper way to do weighted averaging is to add those earnings to Goldcorp's earnings and then divide by the true number of shares. That gives 67c.

If you just look at Q4, the net earnings were $65.9 million, which if you divide by the 703.5 million shares give you 9c eps, not 11c. This result is overstated by 18% because there is over a month that the 284 million dog shares from Glamis are not included in the share count.

In this example the difference between what is truth when sound mathematical principles are applied and what is reported because of simply adding numbers with grossly different parameter is beyond comprehension, grossly misleading to investors and ought to be illegal.

And to make matters worse for Goldcorp investors, as of March 8, 2007 Goldcorp has 707.7 million shares, 15.1 million stock options (average exercise price $19.16) and 8.4 million warrants (exercise price $45.75), for a fully diluted count of 731 million.

Mines are depleting assets, and as such, it isn't wise to purchase mining stocks with a P/E of over 12 unless they have a stellar growth profile. If you buy into the fiscally insane idea that a gold stock should trade at a P/E multiple of 25, at the very least, it should be calculated on true earning potential. Goldcorp's earning potential is in the 67c/share range, and using that it is currently trading at an adjusted P/E of 43.

And, using the weighted average eps of 67c, it gives a share price of $16.75.

A future post will go over more problems with the Glamis merger and tear apart an analyst's valuation report. The analyst's report has set a price of 2x the NAV, which is like me saying my home is worth 2x the assessed value. The target price based on 2x the NAV was $36. But hey, I will sell you my home for 2x the assessed value. I'll even throw in my car.


Simon said...

Your analysis is sound in terms of EPS calculation. However, even you make an assumption, if the company has a stellar growth profile, it should deserve a higher P/E. What if the price of gold goes much higher in the future than the price of gold at the time of merger?

Would that justify the merger price?

Deborah said...

Goldcorp's growth is anemic relative to its issuing of new equity. Goldcorp issues new shares at a far great rate then it has production growth.