Newcrest Has Cash Flow But Is This Enough?

This story features NEWCREST MINING LIMITED. For more info SHARE ANALYSIS: NCM

-Debt rising with falling Aussie
-Is an equity raising the answer?
-Will selling a stake in Telfer help?
 

By Eva Brocklehurst

Australia’s largest gold miner, Newcrest Mining ((NCM)), failed to impress after its first half results. Cash flow improved nevertheless, reflecting stronger production at lower costs as well as constrained capital expenditure.

UBS described the numbers as “OK”. The broker has questions regarding the validity of some of the company’s estimates, particularly at Lihir in PNG, where increased knowledge of the ore body appears to have simply raised the level of complexity. The broker’s below-market valuation is principally based on this uncertainty over Lihir. Subsequently, UBS believes the board should consider raising equity, given the prospect that gold prices may soften in a US interest rate tightening cycle. The broker’s golden rule is – gold stocks should have minimal financial leverage.

UBS is also concerned about what is contained in the current reserve statement, suspecting there is a risk to those investors holding the stock on the basis of the reserve base of 75m ozs, which could be significantly overstated.

The efficiency drive is continuing but near-term operational catalysts are not apparent to Morgan Stanley, and there is nothing to shift a cautious stance. New thinking on sulphur and the autoclaves at Lihir could improve throughput and output, but ore type, rather than sulphur content, then becomes the controlling factor in the broker’s view. The Australian dollar might also be a sting in the tail. Translation of US dollar debt will become an issue at the full year result if the Australian currency remains at current levels.

This is Deutsche Bank’s bone of contention too. The balance sheet still looks stretched to the broker, with $4.4bn of debt. Free cash flow benefits may have come in the first half from the lower Australian dollar and cost reductions but the US dollar-denominated debt position grows as a result. Selling a stake in Telfer, which the company suggested it was mulling, may cover capex but Deutsche Bank doubts a full sale would be achievable. The stock remains expensive and the broker retains a Sell rating.

A “holiday” on project capex means debt repayments can be met and free cash flow remain positive. On this basis, Citi’s Buy thesis is unchanged. The broker, the most upbeat on FNArena’s database, concedes there is considerable work to do in increasing efficiency and boosting productive at the Lihir mine. Management may have signalled it would entertain offers to buy Telfer but Citi finds it hard to ascertain just where a new owner could come from.

Macquarie downgrades forecasts after incorporating updated reserves and higher depreciation guidance. The broker acknowledges that improved production and cash generation at Lihir are the key catalysts for 2015, while a potential sale of Telfer could be positive. That said, Macquarie also flags the debt conversion, noting that, despite generating free cash flow in the half, debt rose by 9.0% because of a weaker Australian dollar.

Credit Suisse observes the market is divided between those that want the balance sheet to be de-risked by an opportunistic capital raising, or through hedging to lock in current Australian dollar gold prices and oil prices, on the one hand, and those wanting free cash generation and declining capex to fund debt reductions without an equity dilution.

The broker believes Lihir is deeply challenged and yet to deliver on its potential, expecting the asset could disappoint yet again. Cadia East in NSW is the company’s best asset, de-risked by the breakthrough to the surface at Panel Cave 1 with Panel Cave 2 now ramping up. Grade is also meeting expectations. Telfer, Western Australia, has turned out to have lower grades than its investment case originally assumed while lower margins have continually challenged the operation. The main question for Credit Suisse is whether the company just harvests cash from the limited remaining life of Telfer or reinvests this into an extension in order to leverage the remaining resource.

The greatest positive for Newcrest, outside Cadia East, is the rise in the gold price in Australian dollar terms and the fall in oil, in Credit Suisse’s view. How the company exploits this situation will be important in the near-term. Moreover, the broker believes the management team would risk a significant credibility question if equity was issued now, given the team expressed confidence in the balance sheet previously and the stock price suggests the market is no longer pricing in the risk of a discounted rights issue.

JP Morgan expects Newcrest is more likely to proceed with the proposal to cut back the open pit at Telfer, given costs have been reduced. A decision on a cut-back is to be made before October 2015 and, as part of the discussions, the company will consider the potential for a part or full sale. The company had previously indicated a lower cost base was needed to support investment in a future cut-back. Newcrest would not be drawn into providing capital cost estimates, or what the implications of a cut-back would have on mine life. JP Morgan maintains a Neutral rating and finds better/ risk/reward elsewhere in the sector.

FNArena’s database shows one Buy rating, three Hold and four Sell for Newcrest. Consensus target price is $11.99, suggesting 11.7% downside to the last share price. This compares with $11.87 ahead of the results. Targets range from $8.40 (UBS) to $16.00 (Citi). 
 

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