Australia | Sep 12 2007
By Greg Peel
The global gold sector is littered with bitten bullets. Newcrest Mining (NCM) has become the latest among gold producers large and small to take a big chomp out of their own bullet. As the gold price sails over US$700/oz, Newcrest is buying back its hedge book.
For an explanation as to what gold hedging is all about, readers are directed to “Gold Hedging – How and Why” (Sell&Buyology, 07/04/06).
There have been three significant factors hanging over the Newcrest share price for some time now – the disaster that is Telfer, high levels of debt, and a substantial hedge book. With a hedge book in place, Newcrest has been unable to fully participate in the gold price rally over the past years and has been subsequently rated accordingly.
It has recently appeared that maybe, just maybe, the troubles at one of Australia’s largest gold resources – Telfer – have been weeded out and a nadir in valuation reached. Inventors in Newcrest have done nothing but bang their heads against the wall over the past couple of years as this highly promising project has suffered production downgrade after production downgrade. Consensus now, however, is that we’ve turned a corner.
Which brings attention back to high debt levels and the hedge book. In one fell swoop, Newcrest has moved to alleviate those constraints as well. Yesterday the company announced a fully underwritten, $2 billion 7:20 rights issue at a 30% discount to the market. The money will be used to close out hedge contracts, close out forward sales, repay a gold loan, and close out debt.
Part of the proceeds will be used to buy gold put options with a strike of A$800/oz. While this is itself a form of hedge, it represents a known one-off payment for downside protection which, unlike forward sales, does not encumber upside exposure to a rising gold price.
That’s a pretty substantial discount, which just goes to show what importance management is placing in its desire to shake off the constraints of the past. But analysts are in solid consensus – despite the initial share price dilution, this is a very positive move for Newcrest.
Ultimately the move is EPS accretive, and materially so from FY09 (anything between 16% and 24% according to broker calculations). It is also a positive for Newcrest’s price/earnings ratio, and thus analysts suggest everything points to a higher share price once the initial effects of the discount issue are absorbed. Citi makes note that a similar move by Lihir (LGL) affected an almost instantaneous re-rating. Consensus is that existing shareholders should take up their rights.
Despite general exuberance amongst the analyst fraternity, there was no change to the B/H/S ratio in the FNArena database. At 3/7/0, it’s not manifestly inspiring. The main reason is that many an analyst believes Newcrest is already well priced, having anticipated this hedge book buyback some time ago. There is also a fairly positive view on the gold price built in, and one cannot forget this remains a risk, along with Newcrest’s exposure to the copper price as well.
And there’s always Telfer.
A little bit of shuffling for both EPS changes and net present value adjustments sees the average target price rise from $27.23 to $27.25. Woohoo. The range, however, extends from ABN Amro (Hold) at $22.64 to Citi (Buy) at $31.00.
Investment in Newcrest really comes down to your view on the direction of gold. Without a hedge book, Newcrest is now positioned to be better leveraged to that move. Analysts point out, however, that a freed-up Newcrest now becomes a potential takeover target in the current global consolidation story.
And when the last miner buys back its hedge book, is it all over for gold?