Australia | Nov 20 2006
By Greg Peel
It’s hard to believe that Newcrest (NCM) is selling gold at US$350-380/oz when current spot is around US$620/oz. However, that is the nature of hedging. Gold producers forward sell gold into the distance to provide funding for their mining operations. This also provides a hedge against falling gold prices.
Unfortunately for Newcrest, gold prices have taken off since the forward sales were locked in, making the company look pretty silly in hindsight. Who was to know gold would stage its greatest rally since 1980?
Newcrest has been hampered for a long time now by production problems at its Telfer mine. Telfer appears to be turning around now, but there has been some concern that production delays would mean Newcrest failing to deliver on its forward sale obligations. Those concerns have now been relieved, as Newcrest has restructured its hedge book.
What this means is that 1.6 million ounces of gold obligations have been shifted forward in time, allowing Newcrest to benefit from current spot prices. Previously, 88% of 2007 gold production and 65% of 2008 was locked in at low prices. Now only 56% and 38% is locked in, allowing the balance to be sold at spot.
Suddenly Newcrest has received an enormous boost in cashflow, and a mighty boost in short term earnings. Macquarie has increased its earnings forecasts by 52% in 2007 and 33% in 2008, GSJB Were by 45% and 27%, and ABN Amro by 95% and 23%.
BUT…
Before you go and mortgage your house again, there are two factors to consider.
The first, and most important, of these is that Newcrest has only deferred its hedge book, not sold it. Had it sold it the company would have effectively locked in gold prices around that US$350/oz mark. Delivery obligations have now been pushed out beyond 2010, and extended from 2011 to 2013. If the spot gold price is materially higher in years to come, then we’re back where we started, although contract prices will shift up the forward curve to be more like US$400-460/oz.
Secondly, given rather strange accounting standards, out of the control of Newcrest, profit has to be booked as if the hedge restructure hasn’t taken place. So be warned that those earnings increases won’t actually show up in profits until analysts make the realistic adjustment for comparison purposes.
Nevertheless, brokers agree that the restructure represents a shift in Newcrest’s fortunes, and as such target prices have received a boost. Never mind that five or so years away the situation might be a lot different. The average target price in the FNArena database has jumped from $25.34 to $25.97.
The B/H/S ratio still stands at 3/7/0, although GSJB Were has moved its long term recommendation to Buy from Hold. The analysts admit this is “an early call”, but aside from the shorter term leverage provided by the hedge book restructure, they believe Telfer has reached a turning point.
Don’t forget Newcrest is also a player in the copper market too.