Cadia Suspension Clouds Newcrest Outlook

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

Newcrest Mining has been forced to suspend production at its bellwether Cadia mine, making earnings guidance uncertain.

-Length of suspension may vary, depending on whether Cadia Hill pit or southern tailings dam can be used
-FY18 guidance considered unlikely to be achieved at this stage
-Valuation likely to be discounted until some certainty on the outlook is established
 

By Eva Brocklehurst

A tailings dam breach has sent shudders through broker ranks as Newcrest Mining ((NCM)) suspends production at its bellwether Cadia mine in NSW, pending further investigation. A seismic event, the third in a year, is suspected to have caused a breach in the main tailings dam wall, while tailings have been contained within the lower dam.

Cadia is the company's most profitable asset, accounting for around 60% of operating earnings (EBITDA) for the next three years. The mine accounts for just over 30% of the company's gold production and around 85% of total copper production.

Macquarie is concerned, taking a six week production stoppage as a starting point, while conceding the length of the suspension could vary substantially, depending on whether the company can use the Cadia Hill pit or southern tailings dam as alternatives.

The loss of production is expected to have a material impact on earnings and several brokers temper forecasts accordingly. Macquarie reduces FY18 estimates by -25% to incorporate the lower production ,while changes in the grade profile for Cadia drive 10% and 3% upgrades to its FY21 and FY22 estimates, respectively. UBS suggests, with Cadia out of the picture, FY18 guidance is unlikely to be achieved.

Ord Minnett's view is that there should be no longer-term impact from this event and, in assessing the impact on FY18 earnings, estimates a -10% reduction in FY18 output from Cadia, reducing FY18 operating earnings estimates by -6%.

The Cadia operation utilises the northern tailings dam and the southern tailings dam on a daily basis and Newcrest was already assessing the viability of using the expired Cadia Hill open pit as a tailings storage option as part of its expansion feasibility work. Ord Minnett expects there will be very little infrastructure required to commence these activities although a permit process would need to be undertaken.

Given the recent large failures of tailings dams, notably in Brazil, Shaw and Partners, while applauding the company's proactive response and caution, retains heightened concerns about a potential cut to production at the company's major earner.

Valuation

Macquarie expects the value to be discounted by the market until some certainty on the outlook is established. Macquarie previously held a valuation premium for Newcrest versus its North American peers because of the longer mine life at Cadia and Lihir, but given the increased uncertainty at Cadia, expects the premium to be eroded.

The broker reduces its target to $19 from $23, putting this now in line with the stock's North American gold producer peers, and downgrades to Underperform from Neutral.

If the previous seismic event in 2017 is any guide, UBS believes the response in the share price could be limited. Around two thirds of the company's shareholder base is offshore and they focus on the large reserve and resource position which underpins the mine life.

This drives the market to price in a -5% discount rate which UBS suspects is too low, underscored by the latest announcement. The broker still envisages growth projects will dominate 2018, as Cadia recovered during 2017 from the first seismic event.

UBS does not expect a delay to the Golpu update, during the June quarter, and the long-term mine plan for Cadia. However, should a return to nameplate at Cadia take longer than expected, and growth is pushed back again, this could cause the stock to de-rate.

The main risk, Citi suggests, is recovery and ramp up to full production at Cadia and the performance of this process could materially affect the stock's valuation.

Shaw and Partners, not one of the eight stockbrokers monitored daily on the FNArena database, notes the stock still screens the cheapest of the major Australian gold producers, having lagged a recent offshore buying spree that boosted several local peers. The broker trims the target to $23 and downgrades to Hold while seeking more clarity on the potential impact.

Incident

A failure of the embankment allowed some tailings to flow from the northern dam into the southern dam where the material was fully contained. No tailings have escaped into the local environment but company has ceased operations until stability is certain. The failure of the dam wall on March 9 appears related to two earth tremors, magnitude 2.7, on the prior evening.

Cadia does not use cyanide in processing so there is no danger of the particularly toxic effects that occur with some gold tailings spills. Yet the incident raises questions about the Cadia East operation, which Citi suggests can only be answered by investigations by the company and the NSW regulators. It is unknown how long the operation will be on hold and how much it will cost to repair.

Citi also wonders whether higher engineering standards may be required and whether this may affect the company's bid to expand processing capacity at Cadia. The cost of repairs is likely to be minor, but timing will depend on how long it takes and if the company can find an alternative location to deposit tailings in the interim.

Moreover, are other recent seismic events near Cadia – there was one in November 2017 – related to mining? Geoscience Australia has stated that the first, the damaging 4.3 magnitude earthquake in April 2017, was unrelated to mining.

FNArena's database shows two Buy ratings, three Hold and three Sell. The consensus target is $20.89, signalling 3.7% upside to the last share price. Targets range from $13.90 (UBS) to $27.10 (Citi).

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