Australia | Jul 16 2012
– BA-ML initiates with Buy rating on Evolution
– Production growth an attraction
– Exploration is key
– Mid-tier gold stocks outperform
By Chris Shaw
Evolution Mining ((EVN)) is the creation of a three-way merger between Catalpa, Conquest and the Queensland assets of Newcrest Mining ((NCM)). The company has four operating mines and is developing an additional project, with a target for gold production of 400,000-800,000 ounces annually. Current production is around 350,000 ounces per year.
BA Merrill Lynch has initiated coverage on Evolution with a Buy rating, supported by signs of an operational turnaround and strong leverage to the gold price. The turnaround has been most evident at the Mt Rawdon and Pajingo projects, where BA-ML notes both production and costs have improved since the creation of the merged entity.
As an example, BA-ML notes June quarter production of 97,000 ounces was better than the 90,000 ounces the broker had forecast, while cash costs were also about $10 per ounce better than had been expected.
Further gains are expected as the turnaround at the Edna May project is not yet complete. Achieving such gains would be a positive as BA-ML points out Evolution doesn't screen well relative to global peers on a cost curve comparison given cash costs of around US$900 per ounce. This also makes Evolution highly leveraged to the gold price.
Along with high costs, Evolution's assets also suffer from relatively short mine lives, meaning the assets are not 'A' grade mines , as BA-ML notes. The mine life issue is a major one for Evolution, as BA-ML suggests maintaining base load production of more than 300,000 ounces per year beyond 2017 will be difficult based on current resources. This reflects the fact both the Cracow and Pajingo mines are expected to finish production over the next five years.
The need for further reserve growth means Evolution's value is strongly correlated with further exploration success. As an example, BA-ML's model shows an additional four years of mine life at all key operations would translate to a 36% increase in the broker's base net prevent value to $2.20 per share. BA-ML remains confident of further exploration success and an extending of mine life at Evolution's operations.
Providing a short-term boost to production will be Evolution's Mt Carlton project, which should be ramped-up in 2013. This will add a further 60,000 ounces to production for the group and also offers some growth optionality and exposure to silver, both of which are viewed positively by BA-ML.
Adding in the expected production at Mt Carlton would solidify Evolution as a mid-tier producer. This would be a positive for the company, as BA-ML notes the mid-tier producers have outperformed the global gold majors since 2001.
The lack of mine life for Evolution is reflected in the share price in the view of BA-ML, as the current earnings multiple for the stock is considered attractive. On its numbers Evolution is trading on an earnings multiple of 3.5 times in FY14, which is well below the peer average of 5.6 times. Price to free cash flow is also below that of peers.
Based on its forecasts, BA-ML has set a price target for Evolution of $1.80 per share. This compares to a consensus price target according to the FNArena database of $1.94. Targets range from Credit Suisse at $1.70 to RBS Australia at $2.15.
BA-ML initiating coverage on Evolution brings to four the number of brokers in the database to cover the stock. All rate Evolution as a Buy. RBS sees scope for further M&A activity involving the company, while Macquarie is positive on the recent move to acquire the Holleton gold project as it would help build a tenement package around the Edna May project. This highlights management's focus on moves to build reserves going forward.
Acquisitions should be part of the process of building reserves, as BA-ML notes a recent capital raising leaves Evolution with net cash of more than $200 million. While some of the funds will be use to develop the Mt Carlton project, there will be money available for further acquisitions in the broker's view.
Shares in Evolution today are higher in a stronger overall market and as at 11.45am the stock was up 3.5c at $1.34. This compares to a range over the past 12 months of $1.24 to $2.02, the current share price implying upside of around 46% relative to the consensus price target in the FNArena database.
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