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Cash Is Trumps At Evolution Mining

Australia | Jan 30 2017


Gold miner Evolution Mining is cashing up and brokers laud the company for its production and debt-free potential.

-FY17 guidance appears relatively easy
-Exploration program has potential upside surprise
-Decision regarding Cowal stage H cut-back due


By Eva Brocklehurst

Evolution Mining ((EVN)) is cashing up. The gold miner is appealing to many brokers, given perceived upside potential in the near-term gold price. The company sustained record production in the December quarter. Operating cash flow was flat, as reduced cash costs offset a declining realised gold price.

The company has been able to re-pay $70m in debt and net debt now stands at $588m. Debt amortisation is ahead of schedule and there are no further repayments until October. The Cowal (NSW) mine had a record quarter under the company's ownership, producing 71,900 ounces at costs (AISC) of $815/oz. The company has revised the mine plan and is now intent on mining more low-cost tonnage from the open pit.

The offtake from Ernest Henry (Queensland) started to contribute to Evolution Mining from November 1 and the company forecasts FY17 production of 55-60,000 ounces of gold at cost of $100-150/oz. Deutsche Bank and Credit Suisse rate the stock a Buy and Outperform respectively, noting achieving FY17 guidance appears relatively easy.

Macroeconomic Risks Provide Appeal

While the market has been testing 10-year lows since the election of Donald Trump, Morgans believes this indicates excessive complacency had materialised, given risks that were inherent in the execution of the US President's intended economic reforms.

With this situation, and the abundance of separate macro economic risks in 2017, the broker recognises upside in the short term gold price and therefore the appeal of large, liquid gold producers such as Evolution Mining.

Morgans slightly reduces its valuation but maintains an Add rating, recognising risks to market volatility offer upside. Upside also exists in exploration, the release of positive mining studies at Cowal and Edna May (Western Australia) and commodity price appreciation.

Production beat Macquarie's forecasts, as output from Ernest Henry was over estimated. The broker make some changes to account for the treatment of the Ernest Henry gold revenue. The adjustments result in a -22% decrease to the broker's FY17 estimates but a 4-5% increase in long-term forecasts. There are number of key decisions on the horizon which the broker believes should provide a catalyst or two for the stock. The exploration program also has a potential for an upside surprise. Exploration results were particularly promising at the Cowal stage H cut-back. A board decision regarding the cut-back is expected in the current quarter. The company expects long-term gold recovery can be lifted by 5-88%.

Softer Second Half At Cowal Likely

Despite expectations FY17 guidance will be comfortably achieved, Canaccord Genuity notes a softer second half is expected at Cowal. While continuing to rate the stock amongst the premier gold miners on the ASX, the rally in the last six weeks means it is trading in line with the target. Hence the broker, not one of the eight stockbrokers monitored daily on the FNArena database, downgrades to Hold from Buy.

Canaccord Genuity highlights the company's growing reputation for cost control and also notes accounting treatment has made for a messy reconciliation in the short term for Ernest Henry, although this should normalise by FY18.

Evolution Mining expects to account for production/sales of gold/copper/silver from Ernest Henry thus: under the offtake from Glencore, copper and silver revenue will be recognised in the month of production, while gold revenue will be treated with an effective three-month delay. In contrast, costs will be reported as they are incurred.

Consensus Overweight

Consensus is overweight the stock for a reason, Morgan Stanley asserts. The broker sticks to its Overweight rating. Rapid debt reduction can be accelerated by the company reaching the high end of its FY17 guidance. While several mines contributed to the outcome in the December quarter, the flagship Cowal mine stood out, yet the broker acknowledges it will encounter lower grades in the third and fourth quarters.

Overall, FY17 guidance is for 800-860,000 ounces at cost of $900-960/oz. Some mines will produce lower grades in the second half such as Cowal and Mungari (Western Australia) but there are others with positive drivers, the broker notes, such as Mt Carlton and Crakow in Queensland.

Morgan Stanley expects the company to be net cash by the middle of 2018. The broker also adjusts for a lower gold price forecast, which brings FY17 estimates for earnings per share down -21% while FY18 and FY19 estimates are adjusted up 3% and down -3% respectively. While the gold price might have been volatile of late, Australian dollar prices and cash flow are considered robust.

The stock remains a top relative exposure in the broker's opinion, given the free cash flow expected over the next three years. While Evolution Mining has significant leverage to ongoing cost reductions and conversion of resources to reserves, the downside risks include a slumping in commodity prices/strengthening of the Australian dollar, as well as mine life reductions and potential problems with the integration of new projects.

Citi continues to rate the stock as a Buy on the basis of valuation, after the value-adding acquisition at Ernest Henry, which provides leverage to copper. The broker divides the company's projects into three high-quality mines – Cowal, Mungari, Mt Carlton – and three of intermediate value – Crakow, Mt Rawdon (Qld), Edna May.

The stock shows seven Buy ratings on the FNArena database including UBS, which is yet to update on the production report. The consensus target is $2.49, signalling 17.4% upside to the last share price. Targets range from $2.30 (Credit Suisse) to $2.70 (Morgan Stanley).

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