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Production Rumbles For Newcrest’s Cadia

Australia | Apr 19 2017

Brokers assess the early impact on Newcrest Mining's flagship gold operation, Cadia, where mining has been suspended because of an earthquake.

-Gold production, earnings forecasts reduced but exact outcome unclear as yet
-Underground mining expected to be suspended for at least four weeks
-Recent gold price strength supportive but is the stock fair value?


By Eva Brocklehurst

Newcrest Mining's ((NCM)) flagship gold operation, Cadia in NSW, has been rocked by a nearby earthquake, with mining operations suspended since April 14. The plant continues to operate, although Cadia East stockpiles will be depleted by today. Both Cadia East PC1 and PC2 mines have sustained damage. As a result Cadia is not expected to meet full year guidance for 730-820,000 ounces of gold and 65-70,000 tonnes of copper.

Macquarie reduces forecasts for gold production by -13% and copper production by -11%. The broker notes Cadia East is currently in a critical phase of its development as the PC2 moves into PC1. This process was expected to be completed before the end of FY17 and assessing the impact of the seismic event on the cave will be the main focus over the next few weeks.

Macquarie makes only modest adjustments to FY18 assumptions while reducing FY17 earnings forecasts for Cadia by -18%. The broker suspects some risk for the ramping back to full production, depending on the damage to the underground infrastructure and the cave itself.

Cadia's Value

Cadia accounted for around 31% of Newcrest's FY17 production guidance, prior to the seismic event, and 67% of UBS growth asset value estimates. In the December half year, the mine accounted for 56% of the company's free cash flow. Every month of lost production risks around 70,000 ounces or -9% to the broker's earnings estimates.

While the company's two main assets, Cadia and Lihir, are world-class, the broker does not believe Newcrest has enough diversity in its operations relative to peers. Offsetting this seismic event, increasing geopolitical tensions could mean interest in gold increases and elevates the value of the stock, UBS suggests. Nevertheless, the broker finds better risk/reward elsewhere in the sector and retains a Sell recommendation.

Deutsche Bank downgrades production forecasts by -10%, suspecting underground mining activities will be suspended for four weeks and there will be a following four week ramp-up back to full operations. FY17 earnings estimates are reduced by -15%, such as the significance of Cadia to the group.

The broker finds the timing of the event unfortunate, given the release of the Cadia expansion pre-feasibility study is imminent. This also raises a question regarding the potential impact of higher mining rates.

Assuming one month is lost, Morgan Stanley's production estimates for Cadia drop to 37,000 ounces, which is 5% of the asset and 1.4% of the group total. Because Cadia is the lowest-cost operation in the group the impact on FY17 earnings per share is expected to be around -4%. The outage has potential to affect sentiment in the short term but should not significantly alter the fundamental valuation, in the broker's opinion, provided normal operations resume soon.

Mining Re-commencement

A prohibition notice is in place ahead of assessment of the damage and the remediation required. The epicentre of the quake was 4km to the west of Cadia at a depth of 4km. The Mines Inspectorate needs to give the all clear before mining can resume.

The company believes PC2 has sustained only minor damage but Deutsche Bank believes it will be difficult to restart mining while assessment and remediation of PC1 is ongoing. Cadia is a high-margin, long-life asset with potential for growth, which makes the issues for operations a greater concern for investors, in Deutsche Bank's view.

Citi agrees PC1 holds the remaining downside risk in terms of delaying a resumption of mining. Surface operations are unaffected and the company will need to feed low-grade Cadia Hill stockpiles to the mill in the interim.

The investigation is expected to include an assessment of whether the mining operation is affecting regional are seismic activity, which could have implications for the potential expansion plans. However, Citi cites Geoscience Australia, which has suggested there is no apparent causal relationship between the mine and the seismic event.

While the event is unfortunate, such engineering challenges are usually overcome by time and expenditure, in the broker's opinion. Pending further news, Citi retains a Buy recommendation.

Morgans also awaits further updates on any changes to the shape of the block caves and, at this point, factors in a two-month impact to Cadia production in the June quarter. As a result, the broker lowers FY17 estimates for earnings per share by -17%. The broker believes the stock is trading close to fair value, as recent gold price strength has helped support a share price recovery.

At this point, Morgans believes the sector is likely to be generating significant amounts of cash flow but, in Newcrest's case, this is largely reflected in its recent performance. As a result, the broker downgrades to Hold from Add.

UBS believes the wide difference between valuation and where the stock has been trading can be mostly explained by the discount rate. The broker values the stock with a 10% discount rate, leading to a $14 per share valuation. At 5% this approaches $24 per share. While the company recently suggested that US investors prefer a lower 5% discount rate, in the broker's view mining is inherently risky and warrants a higher rate.

The consensus target on FNArena's database is $21.33, signalling -8.8% in downside to the last share price. Targets range from $14.02 (UBS) to $27.40 (Citi). There are four Sell recommendations, three Hold and one Buy (Citi).

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