Switch Out Of Lihir To Avoid Disappointment

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This story features LYNCH GROUP HOLDING LIMITED.
For more info SHARE ANALYSIS: LGL

By Chris Shaw

With policy makers around the world doing all they can to create liquidity to limit the extent of the global economic downturn, the scope remains for inflation to become a future problem. This would suggest upside for the gold price, and as a result, for gold stocks.

This is reflected in largely positive views with respect to Lihir Gold ((LGL)) given the company’s earnings are highly leveraged to the gold price. The FNArena database shows the stock is rated as Buy six times against three Holds and one Sell recommendation.

It is the Sell recommendation of Bank of America Merrill Lynch that is of most interest, as in the broker’s view the stock’s current premium to net asset value of around 13% is simply not justified. It sees the stock as a reasonable chance to continue what has been a long history of disappointing with respect to earnings expectations.

At present the market is waiting for news as to whether the group’s production ramp-up at its Bonikro project is proceeding according to expectations. The broker sees this as an important milestone for the credibility of management given the company’s ongoing issues with lifting output at its flagship Lihir operations.

The company is also presently attempting to finalise funding for an expansion of the Lihir mine to output of one million ounces annually. While this is only one issue in the current tough financial environment, the fact there have been operational problems at the mine is another. Combined these factors leave the company open to falling short of market estimates, in the broker’s view.

This is reflected in the stockbroker’s earnings per share forecasts, which at present stand 11% below market consensus for 2008 and 20% below for 2009. As a result, the broker’s price target of $2.20 is well below the average target of $2.76 according to the FNArena database.

Given its negative view on the stock, the broker sees better relative value elsewhere in the sector. On its numbers, Newcrest ((NCM)) is trading at a relative P/E (Price to Earnings ratio) discount of 49% at present and without the same level of risk. The broker sees production disappointments as much less likely given more than half of expected annual output should be in the bag by the end of the first half of the financial year.

The broker also expects Newcrest to add as much as 15 million ounces equivalent in reserves over the course of the year. It also sees upside potential from the company being a potential corporate target for further consolidation in the global gold sector given the company’s relatively low costs of production and expansion of reserves.

To reflect this, the broker recommends switching into Newcrest now rather than waiting for February profit results, as that only gives Lihir another chance to disappoint investors. The broker’s bullish view on Newcrest is reflected in the fact its Buy rating is accompanied by the highest price target on the stock in the FNArena database at $47.00. This compares to an average target of $31.34. Overall the database shows Newcrest is rated as Buy six times and Hold four times.

Today, shares in Lihir are significantly stronger and as at 12.05pm the stock was up more than 9% or 23c at $2.69, while Newcrest was up almost 6% or $1.68 at $30.03.

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