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Morningstar | Buenaventura’s Production Falls in 3Q; Looks to De-Bottlenecking Program to Cut Costs

Buenaventura saw production fall during the third quarter, with gold ounces from direct operations declining 25% year on year to 72,518 ounces. Lower production at Orcopampa and La Zanja were the major drivers of the fall. Combined with an 8% lower average realized gold price, revenue fell 27% to $266 million. As a result, EBITDA from direct operations fell 55% to $53 million. Better performance from investments helped protect profitability for the company, as Yanacocha and Cerro Verde saw EBITDA improvement over the prior-year quarter.

The company looks to help protect profitability through its de-bottlenecking program, which management forecasts will save roughly $28 million-$35 million for the full year. The program looks to pursue various optimizations across its mine portfolio.

We’ve made minor changes to our full-year forecast. However, we’re slightly raising our fair value estimate to $12.50 per ADR from $12, partially because of the impact of the time value of money on our valuation. Buenaventura's no-moat rating is unchanged. We see shares as roughly fairly valued at this time.

In September 2018, the U.S. Federal Reserve once again raised the federal-funds rate by 25 basis points to 2.25% from 2%. This was the third rate hike of the year. Most central bank officials expect one additional rate hike in 2018 and three in 2019. The market appears to be largely in line with this view, as current interest rate option prices imply a more-than 70% chance that there will be at least one more hike by the end of 2018.

All else equal, the prospect of higher inflation adds to gold's investment appeal, which is one reason ETF gold holdings rose through most of 2018 and spot prices remained above $1,300. However, as we had anticipated, higher inflation has emboldened the Fed to pursue rate hikes at a quicker pace, which lifts the real interest rate and, in doing so, increases the opportunity cost of holding gold.

Historically, we've observed a strong inverse relationship between the real interest rate and the price of gold. When the former rises, the latter tends to fall. We thought it was only a matter of time before gold investment adjusts to the higher opportunity cost, not only leading to slowing investment demand, but also outflow of gold from ETFs back into the gold market. Our prediction has proven true, as ETFs have seen net outflows since June through September.

On the back of weak investment demand, gold prices have fallen to nearly $1,200 per ounce. Nevertheless, we still believe gold has a promising future and we forecast a nominal gold price of $1,300 per ounce by 2020. We expect that, in the long term, Chinese and Indian jewelry demand will fill the gap left by waning investor demand.