Kingsgate Consolidated (KCN) is a gold miner, operating in South East Asia, South America and Australia. The company's major operation is the Chatree Mine in Thailand, and it also has the smaller Challenger Mine in South Australia.

Rising cash costs squeezing margins

In late January, KCN revealed a 13.4% slide in 2Q13 gold output relative to the same period a year earlier. Compared to 1Q13, gold output rose slightly by 4%.

Production was affected by the temporary closure of the Chatree North Expansion Plant (Plant 2) and interruptions at Challenger following the establishment of two new mining fronts.

The biggest disappointment with the result was another rise in the group's cash costs. Cash costs rose 37% from 1Q13 to US$975/oz. However, compared to 2Q12 costs surged 60%.

KCN attributed the cost squeeze to lower ore grades at Chatree and ore sourced from an area of Chatree's Pit A that was known to have lower recoveries.

The poor 2Q13 production result contributed to a 76% slide in 1H13 net profit to $8.1 million. Revenue was up 10% on-year, however the growth was driven primarily from stronger gold sales. Weaker output from Challenger and a lower realised average gold selling price detracted from the growth in revenue.

Gold prices trending down

The price of gold has weakened noticeably in recent months. Spot gold is trading around 7% below KCN's 1H13 average realised selling price of US$1676.

The outlook for the precious metal has declined amid signs of weakening physical demand and diminished prospects for further monetary easing. In an example of waning demand, the US Mint sold 62,000 ounces of American Eagle gold coins last month.

This was much lower than the sale of 80,500 ounces in February and 150,000 ounces in January. Holdings in gold-backed exchange-traded funds are also 6.9% weaker in the year-to-date.

Furthermore, with the world economy stabilising, central banks like the US Federal Reserve are less inclined to implement additional monetary easing measures.

In our view these are among the key factors that will handicap gold prices, and by extension, KCN's revenue growth.

Outlook

KCN stuck to its FY13 gold production guidance of between 200,000 and 220,000 ounces. 1H13 production totalled 90,413 ounces, meaning KCN is relying on stronger 2H13 output numbers in order to meet its guidance. Although Chatree's Plant 2 is now back online, development at Challenger is expected to continue.

Also, the limited availability of stoping areas at Challenger the company highlighted in its 2Q13 production report indicates difficulties accessing the ore body being mined. Therefore we don't share KCN's optimism that full year production guidance will be met.

Moreover, the upward trend in its cash costs is coming at a time when gold prices have been retreating. This is creating pressure on cash margins and will ultimately translate into poor earnings in our view.

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