Cost inflation hit miners’ Q2 results but might signal an attractive buyback chance, says BMO

Many miners have raised their unit cost guidance during their June-quarter financial reporting, signalling an intensification of a trend BMO Capital Markets Metals & Mining analyst Jackie Przybylowski first picked up on during the first quarter this year.

On a by-product basis, the analyst attributes the cost inflation mainly to higher primary product commodity prices (which would raise royalty costs) and/or lower by-product commodity costs.

According to the analyst, the latter point significantly impacted base metals companies, which tend to have more contribution from the by-product. “On average, C1 cost guidance of base metals companies under our coverage has increased by 13% since 2022 guidance was first released, while precious metals producers under our coverage have seen cost guidance increased by 2%,” wrote Przybylowski in an Aug. 16 research note.

“Across our coverage universe (royalty/streamers excluded), 2022 unit cost guidance has increased by 7% since it was initially released.”

The analyst points out the low point represents an opportunity for some companies to double down on share buyback programs. “What we hope is a low point in market sentiment, and a high watermark for operating costs can present an attractive reinvestment opportunity for companies with outstanding share buyback programs — this includes Teck Resources (TSX: TECK.A/TECK.B; NYSE: TECK), Newmont (TSX: SKE; NYSE: SKE), Barrick Gold (TSX: ABX; NYSE: GOLD), and Agnico Eagle Mines (TSX: AEM; NYSE: AEM),” said BMO.

According to Przybylowski, the market is not paying for growth. “We have clearly seen a strong market preference for capital returns and capital discipline for the past several years. Companies have responded to these investor preferences by demonstrating their discipline and by increasing the regular dividend, special dividend, and/or share buyback.”

Further, the analyst highlights royalty and streaming companies, including Franco-Nevada (TSX: FNV; NYSE: FNV), as companies with gold exposure but limited operating and capital cost inflation risk. “The market continues to be cautious on near-term growth or other factors, which could negatively impact near-term free cash flows. Our order of preference now reflects this, with a bias towards capital returns (including buybacks) and away from growth,” wrote Przybylowski.

Agnico Eagle continues to be BMO’s top pick precious metals company. The reasons entail its strong cost management (aided by a successful hedge program), its lower geopolitical risk profile, and a balance of growth and capital returns, “which both appeals to the current appetite for capital returns and the necessity for miners to reinvest in replacing mining depletion,” according to the analyst.

Teck continues to be BMO’s top pick base metals company. “We continue to expect strong (although declining) cash flows from the coal business; lower spending on the QB2 project after its commercial production should also buoy cash flows in 2023 and beyond,” said Przybylowski.