Why Agnico Eagle Mines’ Business Strategy Could Lead to Outsized Returns for Investors

Agnico Eagle Mines Ltd. (TSX:AEM)(NYSE:AEM) announces another acquisition, but it comes with the potential for either big losses or big rewards.

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Agnico Eagle Mines Ltd. (TSX: AEM)(NYSE: AEM) missed analysts’ expectations on revenue and earnings per share in the second quarter, but swung to a profit as higher production helped to combat declining metal prices.

The miner is not immune to the slump in the price of gold, which is causing all gold miners to struggle, but what makes Agnico Eagle Mines unique is its strategy to combat the slump in prices. Rather than hunker down and wait for metal prices to improve, the company is boosting production and acquiring new properties. This is a risky strategy with the potential to offer huge rewards, but a significant downside threat also exists if the company is unable to contain costs.

Betting on increasing production

In terms of production increases, the company is focusing on increasing output at lower-cost operations — for example, at its Kittila underground mine in northern Finland. Kittila was Agnico Eagle Mines’ largest capital expenditure in the recent quarter. Overall, if things go as planned, the expenditure at Kittila is justified and should also be a positive for shareholders. The 1,000 tonne-per-day expansion at Kittila is expected to boost throughput capacity there to 4,000 tonnes per day starting at the end of 2014. The expansion is expected to cut total cash costs per ounce and offset the impact of a gradual reduction in ore grades over the next several years.

Acquisitions galore

The next thing to look at when considering Agnico Eagle Mines’ production gamble is its recent acquisition activity. Earlier this year, the company announced the joint acquisition of Osisko Mining with Yamana Gold Inc. (TSX: YRI)(NYSE: AUY), a purchase that investors cheered because it gave the company part ownership of the Malartic Mine, a gold mine that was expected to boost its production profile, improve its cost structure, and be accretive. So far, these expectations are proving true.

Just this past week, Agnico Eagle Mines announced yet another acquisition. This time, the company put in an offer on Mexico-focused exploration company Cayden Resources Inc.

Agnico Eagle’s mostly stock offer for the company valued it at $205 million. The offer represented a premium of 42.5% to the volume weighted average price of Cayden shares on the Venture Exchange for the 30-day period ended September 5. Agnico Eagle’s shares dipped the day the offer was announced. Contingent on shareholder and regulatory approval, the deal should close at the end of the year.

Cayden Resources has consistently churned out positive drilling results on its properties in Mexico, making it highly valued as a standalone company on the TSX Venture exchange. Now Agnico Eagle is set to take ownership, for a premium. Cayden’s properties are only in the exploration stage. Therefore, the economics of bringing these properties to production is not yet known and neither is the potential downside risk for Agnico Eagle.

Now what?

In the near term, Agnico Eagle’s purchases should not provide too much downside pressure on the company’s stock, as long as it continues to keep cash costs under control.  With average all-in sustaining cash costs forecast to be $990 this year, the company can still profit, but with gold now trading in around $1,250 per ounce, Agnico Eagle Mines cannot afford to add high-cost operations to its business. Although it is making good progress with its cost containment measures, it is still seeing high costs across a number of mines.

If Agnico Eagle wants to benefit from its production-boosting strategy, it will have to put just as much effort into improving the cost structure of current operations while expanding its reach.  While purchasing the Malartic Mine was a no-brainer, the acquisition of more exploration-stage properties adds more risk. If Agnico Eagle can continue to keep its costs under control while adding to its pipeline, the company will be in a great position to profit when metal prices rebound and will do OK in the short run.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Leia Klingel has no position in any stocks mentioned.

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