Osisko (TSE:OSK) – Yet another promotional gold miner

Originally, I was interested in Osisko since it has dropped by three quarters since 2011 and it seemed cheap.  However, the company consistently uses aggressive accounting so it’s not as cheap as it seems.  Overall, Osisko is hard for me to evaluate since (1) I don’t trust the promotional management and (2) there isn’t enough information being disclosed.  I also prefer to invest in management teams that are really good at generating value.

Questionable asset allocation

The MD&A states that Osisko’s assets may see an impairment in the future (if gold prices were to continue their decline).  This suggests that the Malartic project has been borderline profitable despite gold prices going up over the past several years.  While this is hard to prove, it’s possible that Osisko’s management plowed money into a project that was unlikely to see a return of capital.  They committed money to construction when gold prices were lower.

On the exploration front, Osisko has been crazy about expanding.  It has made investments in a number of junior explorers.  This is a dubious move in my opinion as junior explorers tend to destroy value (e.g. excessive G&A costs).  As well, Osisko was engaged in exploration in Argentina- one of the worst countries to do business in.  Argentina steals foreign assets and prints too much money.  Argentina has a thriving black market for US dollars as its citizens wish to circumvent Argentina’s currency controls.

On the other hand, Osisko used their shares (and a small amount of cash to pay off AEM) to purchase Queenston Mining.  It was probably a good idea to acquire assets with overpriced shares.  So they did do some things that made sense for Osisko shareholders.

Aggressive accounting

Capitalization of expenses

Osisko capitalizes most of its exploration costs.  This is reasonable but on the aggressive side.

Malartic capex for 2013 and beyond

I don’t understand why a producing mine would need so much capex (far higher than the sustaining capex anticipated in the flawed 2008 feasibility studies).  To be fair, there are some very legitimate reasons for the Malartic mine to have unforeseen capex.  There are noise issues with the mine that Osisko needs to fix.  There are problems with the mill that are preventing it from reaching its originally intended production rate (though I’m of the view that they overstated the mill’s production rate).  There are cost overruns that Osisko has not acknowledged.

Furthermore, what I worry about is that Osisko may be trying to inappropriately capitalize expenses to boost its reported earnings.  There has not been enough information disclosed for me to verify if this is or isn’t the case.

IFRIC 20 — Stripping Costs in the Production Phase of a Surface Mine

Producing mines may have to capitalize some of their stripping costs if it helps them to access other ore in the deposit.  In my opinion, I think that this is a stupid accounting rule for Canadian miners.

  1. It will obviously be abused.  Unscrupulous management teams will make aggressive assumptions (e.g. regarding mine life) so that they can capitalize more expenses.
  2. It makes mining assets more difficult to understand for investors.  Expensing all stripping costs would make mining assets easier to analyze.  You won’t have wonky non-cash charges to deal with and you won’t have earnings manipulation to deal with.
  3. It creates unnecessary work for accountants.

In any case, this is a mechanism that Osisko is using to inflate its IFRS earnings.

Cash costs per ounce is not helpful

Most miners manipulate their cash cost figures.  Osisko is no exception.  The purpose of the cash cost figure should be to help investors understand a miner’s leverage to commodity prices.  Unfortunately, this metric has been so heavily manipulated that it is mostly useless nowadays.

  1. Osisko deducts by-product credits from expenses.  I strongly disagree with this practice.
  2. Osisko capitalizes stripping costs to lower reported cash costs.  Labour, fuel for the equipment, and explosives used to remove waste ore are all paid for in cash.  Removal of waste ore is a very real cash cost.  Again, I strongly disagree with this practice.
  3. Corporate G&A is excluded.  However, it’s unclear what portion of corporate G&A should be allocated to Malartic and what portion to exploration activities.  But certainly the Malartic portion should be included and is a very real cash cost.
  4. Stock-based compensation is excluded.  This should definitely be included because it’s an expense.

The Bottom Line

Osisko’s management is definitely not the worst in the mining sector.  However, there are things about management that I dislike.  Like most gold miners, there is a big difference between what they said they would do and what has actually happened.  It’s not worth the time to figure out this nonsense.  This is not the smartest management team in the business and their integrity could be better.

Valuation-wise, I don’t think that the company is either cheap or expensive.

A good investment in this sector would be a company that is undervalued and buying back shares (suggesting that management is smart and allocates capital well).  Unfortunately, there just aren’t a lot of mining companies that are buying back shares right now even though their share prices have fallen so much.

*Disclosure: I owned this stock briefly when Osisko took over Queenston Mining.  Thankfully, I dumped my Osisko shares shortly after the takeover.  I currently have no position.

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