Is Newcrest’s New Strategy Sustainable?

This story features NEWCREST MINING LIMITED, and other companies. For more info SHARE ANALYSIS: NCM

-Telfer sale abandoned, EVN stake for sale
-Lihir still not realising potential
-Hopes for return to dividend in FY16
 

By Eva Brocklehurst

Newcrest Mining ((NCM)), Australia's largest gold miner, is now in a more robust state. Brokers are impressed with the recent turnaround, as the company reduces debt and improves production at most of its mines. Newcrest has abandoned the prospective sale of Telfer and will now concentrate on extending mine life.

JP Morgan makes sizeable downgrades to FY16 and FY17 profit estimates, given increased operating and capital cost forecasts. Newcrest is expected to produce 2.4-2.6m ounces at all-in sustaining costs of $2.65-95bn versus 2.5m ozs at $2.27bn in FY15. The broker observes the plan to undertake small, progressive cut-backs at Telfer should reduce risk and maintain positive free cash flow.

Most pleasing to Credit Suisse was the reduction in debt over FY15. This remains a focus for the company, although the gearing target is revised to "under 25%" from 15% previously. Cost estimates for FY16 reflect production growth from the lower-cost Cadia East and the benefit of lower energy costs relative to FY15. The rest of the Evolution Mining ((EVN)) stake is for sale and Credit Suisse considers this stake, alone, could pay for the $100m in scheduled debt reduction over the next three years.

The Lihir mine in PNG remains challenged but at least there is at last a recognition of the problems amid plans to address the issues, Credit Suisse asserts. The mine is yet to deliver on potential, although it is becoming more reliable, which augurs well for generating cash. The strong performance at Telfer surprised the broker. The plant is good but the ore body is low grade. The broker is accustomed to considering Telfer to be a challenging asset that never achieves its investment case because of this lower grade.

UBS maintains a Sell rating on the stock, with its biggest concern being the valuation of Lihir. The broker does not like the limited information on the life-of-mine plan, but acknowledges investors appear willing to overlook this fact, instead being drawn to the size and liquidity of the stock. Copper prices remain low and gold is uncertain so UBS is cautious.

Goldman Sachs believes the problem with Lihir has been the failure to grow volume above 800,000 ozs to justify the large capital expenditure. The broker, not one of the eight brokers monitored daily on the FNArena database, suspects management is intent on stabilising operations rather than worrying about growth.

If the grinding circuit can be maintained, Goldman believes production of 750,000 ozs is sustainable from Lihir at US$80-100m of annual capex. This should result in free cash flow of US$300m, whereby the asset contributes significant value to the company.

Newcrest is the only large scale gold stock in Goldman's coverage which does not pay a dividend. With improving profitability the broker is hopeful Newcrest could reactivate the dividend at the FY16 results.

The company plans to move to a US dollar reporting basis in FY16. Brokers welcomes this move as it will align the company better with its peers. Citi flags the free cash flow and believes the company is well placed to meet debt and project capex, while the move to US dollar reporting will make the stock more accessible to global investors.

The value of retaining Telfer will need to be tested, Morgan Stanley maintains. The decision to extend the mine life through a series of staged cut backs at the open pit is quite a change of strategy. Morgan Stanley previously believed the prospect of a cut-back was uneconomic, based on prior activities where such work was done as a large scale capital project.

Outside of life extensions at the assets, the greatest positive for the company is the rise in the Australian dollar gold price and the fall in the oil price. How these two prices are exploited suggests greater leverage, in Credit Suisse's view, specifically with regard to the large, defined material movements required at Lihir and Telfer, albeit these material movements are, as yet, deferred.

The strong results are unsustainable, in Deutsche Bank's opinion. The increase in operating and capital expenditure outlined for FY16 is likely to be more representative of future years. The broker suspects the company is being quite strategic in its disclosure on new project commitments, outlining small preliminary budgets without disclosing the overall amount required to deliver the project. With the uncertainty surrounding the re-committed projects, and no valuation support, the broker retains a Sell rating.

FNArena's database contains two Buy ratings, two Hold and four Sell. The consensus target is $11.98, signalling 6.3% upside to the last share price. This compares with $12.22 ahead of the results. Targets range from $9.40 (UBS) to $15.10 (Citi).
 

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