More than a year ago, I warned Motley Fool readers that shareholders in Russian gold miner Petropavlovsk (LSE: POG) “could be left with nothing”.
The firm’s shares fell by 85% following my warning, but Petropavlovsk founder Peter Hambro did manage to pull off a rescue refinancing.
Although this was heavily dilutive for shareholders who chose not to take part, it has repaired the company’s finances and enabled the firm to start paying down its mountain of debt.
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Indeed, Petropavlovsk’s trading update this morning was impressive enough for me to question whether the shares are now a buy.
An impressive performance
At the end of last year, Petropavlovsk’s net debt was $930m. Earnings had collapsed and the dividend was a distant memory. That’s now changing.
During the first nine months of 2015, the miner has repaid $255m of debt, reducing its net debt from $930m to $675m. The firm confirmed today that it expects net debt to fall to around $600m by the end of the year.
A change in strategy to focus on the most profitable production has seen gold production fall by 25% to 343,500oz so far this year, but has provided a serious boost to cash generation.
Cash costs per ounce have fallen from $865/oz. in 2014 to an expected level of $600/oz. for 2015. Although the firm’s cost-cutting has been helped by the devaluation of the Russian rouble, that’s still an impressive performance.
A potential double bagger?
I believe Petropavlovsk’s success so far has created an investment opportunity. If the group can continue to repay debt at the current rate, Petropavlovsk could be free of debt in 2-3 years.
This doesn’t depend on a recovery in the gold market, it just needs the price of gold to remain at current levels.
The firm’s shares currently trade at just 0.5 times their book value, but as net debt falls, I’d expect this discount to narrow. The shares book value may also rise, due to the reduction in liabilities.
On this basis, I think Petropavlovsk shares could double in value over the next few years, assuming the price of gold remains stable.
A better buy than Randgold
I’ve previously tipped African miner Randgold Resources (LSE: RRS) as a gold recovery buy. In my view it remains the top London-listed gold miner in terms of quality.
The problem is that Randgold shares have already risen by 26% from a 52-week low of 3,546p to around 4,500p. I believe Randgold’s quality is already reflected in its share price.
Randgold shares currently trade on a P/E of 33 times 2015 forecast earnings and offer a dividend yield of just 0.9%. Despite the firm’s 28% operating margin, that’s a demanding valuation.
I can’t see too much upside for Randgold stock unless the price of gold starts to rise.
For that reason, I believe the potential profits from a new investment in Petropavlovsk could be bigger than those from a purchase of Randgold stock.
However, it’s worth noting that Petropavlovsk’s recovery could still be derailed. A recovery in the strength of the rouble would hit costs. Too much production without adding new reserves would be likely to hit the company’s asset value.
I believe any investment in Petropavlovsk should be cautiously sized as part of a diversified portfolio.
