BENONI – Of late we’ve seen clever moves by some precious metals mining companies to link the dividends they pay to the income they achieve on a quarterly basis. These include Silver Wheaton, Newmont, Hecla -no doubt to be followed by many more. Why have they decided to do this? The answer goes back to why we invest in the first place. We do so to make money to provide income and capital in the future. To do this we must maximize our total returns from those investments. Investments therefore must be money-making machines, not just good miners or growing companies.
FROM SUMMER TO WINTER
It is generally hoped that if a mining company is growing, its share price will grow with it. Like a flower in the garden, it must have adequate rain, good soil, protection, and plenty of sunshine. This happens in spring and summer. Now take away some of these ingredients as the season changes to autumn and winter; the plant may be just as good as before, but the conditions it needs to thrive are just not there and it won’t produce the blooms when the gardener wants. What’s more, the gardener will not sympathize with the plant hoping for conditions to improve. He will dig up that plant and throw it away and replace it if it doesn’t perform, with one that will blossom in such conditions. The same is happening in the investment world today as the glorious days of summer from 1985 changed to winter in 2007.
In the last few years, financial conditions have seen growth disappear and rising costs squeeze the profits of all corporations in the first world. In the precious metals world, the same is happening to mining companies, but the precious metal prices are rising and combatting these cost pressures, giving profits as never before. But during these times, precious metal share prices have not performed nearly as well as expected. Yes, there are many reasons why this is so, but one is that shareholders have seen little return for their investment, particularly from those miners who did not have a credible dividend policy. They hoped their shareholders would tolerate this because of the capital growth that should come with increased profits. But share prices in all sectors have shown a poor performance generally.
Capital gains in mining companies are proving insufficient, set against an uncertain, unstable, economic and financial backdrop. The days of earnings don’t count or dividends are not necessary have gone. The investor wants to see hard cash in his hand as a reward for investing in that company. He wants to be paid for the heightened risks he is suffering and he wants his investments to reward him long term. No longer satisfied with hopes and dreams of huge capital gains, he’s fully aware that management must turn to servicing shareholders on a definite basis. He wants to be sure that that income will grow. He will pay more by way of price to get a fair cash flow reflecting the rising profits of the company. He wants to be able to measure the shares that will do well in winter because in summer they will blossom even better. If a share value and cash flow can grow in winter then summer will bring just profits; however, when winter saps these, summer will barely cover the losses. It’s good policy to see capital preserved or grow in winter, so that in summer they have a far stronger base on which to reach full blossom.
Let’s face it, when a financial winter sets in investors want less risk but a secure income. Capital gain is dispensed with in favor of certain capital preservation. Hence when yields rise (say, due to interest rate rises) the only place to be is cash whose value is not supposed to fall. Once interest rates have peaked, fixed interest securities offer the best place to be, as growth splutters into life. Then a switch from Fixed interest securities to equities as spring arrives. But what if you can find a share that is inherently growing its present and future cash flow and providing a stream of dividends that outperforms cash, then fixed interest securities as the hoped for but unlikely spring arrives? The total returns in winter will have given a portfolio growth that has broadened the base and will give excellent returns when the weather is better. The investment or portfolio manager that can achieve that will be at the front of the pack.
MINING SHARE DIVIDENDS SET TO GROW ON A COMMITTED BASIS
We’ve been writing about this aspect of share requirements for a couple of years now and are delighted to see precious metal mining companies have got the message and are returning to paying fair dividends. A trend is growing among precious metal miners -there is a solid commitment to pay a defined percentage of their cash flow by way of dividends.
With precious metal shares, the risks are greater than with the broad market equities. A share like Wal-Mart is a long-term retailer, which if properly managed will be here for generations. But a mining share relies on the time it takes to produce metals from the proven reserves. It’s a wasting asset. This can be lessened if it’s in a position to replace or increase the used up reserves. This depends on successful exploration or the proving of known and unknown resources. The first is a function of management and expenditure; the second relies on expenditure in proving resources.
If during the life of the mine and its reserves, the company does not reward shareholders directly, shareholders have to rely on future shareholders to pay the market price for those shares to existing shareholders, to make any profit or return. If as we see now, future market expectations are lessened, for a multitude of reasons, outside the control of company management, then such investments simply fail to perform. With the rising commitment to pay a set percentage of cash flow to shareholders on a quarterly basis, risks and values become more defined and measureable. Direct comparisons to fixed interest performance by such companies are more certain. Where growth of dividends is believed to be certain, then rising dividends will allow for capital gains to be justified on the basis of income comparisons. Shareholders will be able to buy into those shares and be able to justify the purchase to even the most jaundiced of investment committees.