Australia | Jun 06 2013
– Newcrest shelves expansion plans
– Shifts to focus to cashflow
– Production and earnings forecasts slashed
– Rating downgrades follow
By Greg Peel
Back in March, goldminer Newcrest Mining ((NCM)) had just completed the ramp-up of its much feted Million Ounce Production Upgrade, or MOPU, on Lihir Island. The MOPU ensured Newcrest could process a million ounces of gold per year in PNG, but production expansion was still required to provide sufficient ore. Three months later, MOPU has become the Bridge Too Far.
Back in March, the gold price was failing to impress but had yet to collapse to today’s levels. That came in April. At the time, stock analysts were wary of Newcrest’s risky production expansion plans but appreciated the value upside if all went well. With growth the driving force, four of eight brokers in the FNArena database ascribed Buy or equivalent ratings to Newcrest and four sat at Hold. The consensus twelve month target price on the stock was $27.73. (Could Newcrest Disappoint, Again?)
Last year Australia’s big diversified miners BHP Billiton and Rio Tinto decided to shelve major growth plans across a range of commodities given commodity prices were falling while development and production costs were rising. Both companies instead looked to consolidate existing production expansion projects which were still offering solid returns. A couple of months ago Australia’s biggest oil & gas company Woodside Petroleum decided to stop pursuing further costly expansion plans given rising costs and a less certain outlook and instead consolidate existing operations. With the recently completed Pluto LNG plant producing strong cashflows on top of legacy LNG assets, the company decided to hand back money to shareholders instead of investing unwisely.
Across the resources sector, miners and drillers are cutting costs and shelving ambitious upgrades in the face of a global slowdown and uncertain commodity price outlook. If ever there is a commodity that has seen weak recent prices, it is gold. If ever there was a company that saw its future determined by ambitious growth plans, it was Newcrest. But not anymore.
Newcrest has become the latest miner, and a globally significant miner at that, to face up to reality. The gold price has fallen 18% in 2013 and 26% since the 2011 high. Expanded production ounces are high-cost ounces, particularly in difficult locales such as Lihir Island but also, given the cost of development, most anywhere else. Legacy production ounces are lower cost ounces. Development costs burn cash, and if marginal ounces are being produced at a net cost higher than the gold price, cashflow becomes negative.
As we entered 2013 just about every gold analyst across the globe was predicting gold to exceed its 2011 high of over US$1900/oz due to widespread easy global monetary policy and money printing. But even the entry of Japan into the “print at will” stakes failed to have much of an impact on the gold price. Gold price forecasts were based on monetary inflation, and inflation has failed to materialise. Now the US Federal Reserve is talking about when it might start winding back its policy. Now gold analysts are forecasting lower prices ahead.
Analysts might be right and analysts might be wrong but the risky business of mining is not one in which bold punts are taken. Better to assume the worst and plan accordingly, lest the money run out. So it is that Newcrest has decided to shift from growth to cashflow generation. This means lowering production guidance by shelving expansion projects, and hence lowering net cash costs by concentrating on producing from lower cost legacy operations.
No further capital is expected to be allocated to Telfer since its recent expansion. At current margins over the lower gold price, Lihir and Telfer can’t support their book values or justify additional capital, suggests Credit Suisse. Among Newcrest’s suite of assets, BA-Merrill Lynch estimates Telfer, Hidden Valley and Bonriko to be unprofitable, such that Lihir, Cadia and Gosowong are subsidising the underperformers. Production growth is now less accretive to Newcrest’s value.
The good news is that in return for making the tough decision on growth, Newcrest will be able to increase its cashflow generation. Deutsche Bank, for example, sees total production falling to 2.45mozpa from a previous forecast of 2.7mozpa but $155m per year of additional free cash flow (FCF) being generated. Merrills sees 10% lower production but as much as $600-900m in improved FCF in FY14.
It all depends on what your gold price forecast is. Citi is longer term bearish on the gold price, and suggests Newcrest’s FCF generation will only be “marginally positive” in FY14. Consensus FCF estimates have already declined 70% in seven months, notes Citi, representing a $1.5bn turnaround, and could still trend lower in the broker’s view.
The story gets worse. Woodside has plenty of FCF and no debt problems so has elected to substantially increase its dividend payout ratio rather than pursue low-return growth. BHP and Rio have lots of FCF but also debt obligations, and have chosen to continue with high-return Pilbara expansions while offering creeping payout ratios. Newcrest is targeting 15% gearing and is currently sitting on 17%, and that figure might yet rise before it can fall. The company is trying to rescue its FCF generation so there is no room for an increased payout. Indeed, Citi suggests Newcrest dividends now offer downside risk.
It all sounds like a horror story, but brokers are not questioning Newcrest’s wisdom. Citi, for one, “welcomes” the revised strategy. But analysts have now taken an axe to earnings forecasts and the results are not pretty.
Forecasts, as suggested earlier are highly dependent on gold price assumptions. CIMB, for example, is “slightly positive” on gold and hence retains its Outperform rating on Newcrest despite noting, through research, that gold miner stocks do not historically perform positively during periods of gold price weakness. Merrills has also retained Buy, and has “not at this stage materially altered our forecasts”. JP Morgan and Macquarie are still on Buy-equivalent ratings, but have not updated since April.
This means Newcrest still boasts four Buy ratings out of eight database brokers. If we average the target prices of the Buy-raters, we get $21.23. But Citi has now downgraded to Sell from Neutral, UBS has downgraded to Sell from Neutral, and Credit Suisse has double-downgraded to Underperform from Outperform. Deutsche has retained Hold, leaving four Buy, one Hold, and three Sell or equivalent ratings.
If we average the new target prices of the four non-Buy brokers we get $13.81, or 35% less than the Buys. Total consensus provides for $17.52. That suggests 29% upside from the current trading price, but a 37% reduction on consensus back in March.
It all comes down to one’s view on gold. In the meantime, Newcrest is the latest major miner to bite the bullet, and hence bite the dust on growth.
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