Warning: These Stocks Could Be Punished The Most if Gold Prices Continue to Be Weak

It was one of the darlings of the gold sector…

After bottoming in 2008, Nevada-based gold producer Allied Nevada soared 2,600% over the next three years.

But since 2013, Allied Nevada has been one of the worst-performing gold miners. The stock fell 98% from its 2011 peak to its 2014 low. And on Tuesday, the company filed for bankruptcy. Shares are now worth virtually nothing.

[ad#Google Adsense 336×280-IA]The company didn’t fall because of a giant fraud or major disaster.

The main problem that took Allied Nevada down was debt.

And it’s a problem many gold producers are facing today…

As regular Growth Stock Wire readers know, since peaking in 2011, the price of gold has fallen 38%.

The decline has caused many gold miners to struggle.

The benchmark Market Vectors Gold Miners Fund (GDX) is down around 69% since gold’s peak in 2011.

You see, low gold prices are crushing the profit margins of gold miners and are causing many to be strapped for cash. And when a company has a lot of debt it has to make payments on, this can become a huge problem.

Take Allied Nevada, for example.

Allied Nevada operates the Hycroft mine in Nevada – one of the largest gold and silver deposits in the state. Allied produced more than 200,000 ounces of gold and 1.8 ounces of silver there last year. The mine generated more than $300 million in revenue during the 12 months that ended in September 2014.

But to bring Hycroft to production, Allied Nevada had to borrow a lot of money. The company’s debt increased every year from 2009 to 2013. It went from $6 million at the end of 2008 to nearly $600 million in 2013.

By the end of last year, Allied Nevada’s debt was equal to 95% of its enterprise value (EV). EV is simply a company’s market cap plus debt minus cash. In short, it’s a measure of a company’s total value.

A debt-to-EV ratio of 95% is extremely high. For comparison, the debt-to-EV ratio for the small-cap Russell 2000 Index (which Allied Nevada was part of as of Russell’s list in June 2014) is just 35%.

Meanwhile, in 2013, Allied Nevada’s debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio was nearly 12.6.

EBITDA is basically a company’s cash flow. So the debt-to-EBITDA ratio shows a company’s debt compared to the cash coming in. The lower the ratio, the better. For example, the Russell 2000 Index has a debt-to-EBITDA ratio of about 4.

A debt-to-EBITDA ratio of 12.6 is extremely high. It’s like having a take-home income of $47,000, yet having a $600,000 mortgage.

In May 2012, Allied raised debt in Canadian dollars through a “currency swap.” In short, the swap protected it if the Canadian currency appreciated against the U.S. dollar.

But as you know, that didn’t happen. The Canadian dollar weakened against the U.S. dollar. The swap lost money, and Allied Nevada was left on the hook for the difference. (Think of it like a margin call from your broker when trading options.)

The payments for the swap and other debt obligations coupled with low gold prices were too much for Allied Nevada to handle. The cash crunch forced the company into bankruptcy.

And Allied Nevada isn’t alone. The table below shows five gold producers with high levels of debt today.

CaptureBarrick is the largest company in the table… and it has the most debt. The company acquired several high-priced assets when the gold price was peaking. So while its debt is large, the majority of it isn’t due until after 2020. And Barrick has been working to improve its ratios by selling non-core assets over the past few years.

Meanwhile, Coeur Mining is the only name on this list that has seen its EBITDA fall for the past three years. And its debt-to-EBITDA ratio for the past two years has been negative. You can see the company’s high relative debt and low earnings reflected in the decline of its stock price.

In February, the company purchased the Wharf gold mine in South Dakota from Goldcorp. Couer is counting on the mine to do well to bring up its cash flow and bring investors back.

I’m not saying Couer and the other names above are in danger of going bankrupt. Each company has enough cash to service its short-term debt, based on their most recent quarterly filings.

But weak gold prices are affecting all gold producers’ bottom lines. And companies with high levels of debt are more vulnerable. They’ll likely be the stocks investors punish the most if gold prices continue to be weak in the months ahead.

Good investing,

Brian Weepie

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Source: Growth Stock Wire