Endeavour Mining — Picking up the crown

Endeavour is a multi-asset company that has shown a willingness and desire to trade assets to maintain production, reduce costs and maximise returns to shareholders (eg the sale of Youga in FY16, Nzema in FY17, Tabakoto in FY18 and Agbaou in FY20 and the acquisition of SEMAFO in FY20 and Teranga in FY21). Historically, rather than our customary method of discounting maximum potential dividends over the life of operations back to FY21, in the case of Endeavour, we have instead opted to discount six years of forecast cash flows in FY21–26 back to the start of FY21 and then to apply an ex-growth terminal multiple of 10x (consistent with using a standardised discount rate of 10%) to forecast cash flows in that year (ie FY26). In the normal course of events, exploration expenditure would be excluded from such a calculation on the basis that it is an investment. In the case of Endeavour, however, it has been included on the grounds that it is a critical component of its ongoing business performance to enable it to continually expand and extend the lives of its mines.

In this case, our estimate of cash flows in FY26 is US$4.03 (cf US$4.00/share previously), giving rise to a terminal valuation of the company at end-FY26 of US$40.30/share (cf US$39.96/share previously), which (in conjunction with forecast intervening cash flows) then discounts back to a valuation of US$35.88/share (cf US$35.66/share previously) at the start of FY21, as shown in the graph below.

Given its elevation into the ranks of the world’s foremost producers of gold however, we believe that Endeavour can increasingly attract lower cost finance and, as such, a capital asset pricing model (CAPM)-derived WACC can also be considered (as discussed in our February 2021 initiation on Newmont Corporation). Long-term nominal equity returns have been 9% and 30-year break-evens are expecting 2.32% inflation. These two measures imply an expected real equity return of 6.5% (1.09/1.0232) and applying this to our forecast cash flows would imply a terminal valuation for Endeavour of US$61.76/share (cf US$60.05/share previously) and a current valuation of US$56.96/share (cf US$55.39/share previously). Readers should note that, given its realised beta of 0.56 (source: Refinitiv, 10 June 2021), even this (real) discount rate of 6.5% is likely to prove conservative.

In the meantime, Endeavour’s valuation remains at a material discount to those of its newly acquired peer group of gold majors, as shown in Exhibit 2, below.

Endeavour’s valuation on a series of commonly used measures, relative to a selection of gold mining majors (the ranks of which it has now joined following its takeovers of SEMAFO and Teranga), is as follows:

Of note is the fact that Endeavour’s valuation is materially cheaper than the averages of the majors in all the measures shown in Exhibit 2, regardless of whether consensus or Edison forecasts are used. On an individual basis, it is cheaper than the majors on at least 45 out of 54 (83%) of individual valuation measures if Edison forecasts are used or 45 out of 54 (83%) if consensus forecasts are used. Reverse engineered, the average valuation measures of its peers imply an average share price for Endeavour of US$37.02, or C$44.82 or £26.23, per share.

Relative to its new-found peers listed in London, Endeavour’s valuation is as follows:

Of note is the fact that Endeavour’s valuation is materially cheaper than the averages of its LSE-listed peers in six out of nine of the measures shown in Exhibit 2 if Edison forecasts are used and seven out of nine if consensus forecasts are used. On an individual basis, it is cheaper than its LSE listed peers on 49 out of 101 (48%) of individual valuation measures if Edison forecasts are used or 53 out of 101 (52%) if consensus forecasts are used. Reverse engineered, the average valuation measures of its LSE-listed peers imply an average share price for Endeavour of US$25.79, C$31.23 or £18.27 per share.

Edison has adjusted its dividend distribution assumptions since Endeavour’s capital markets day (CMD) on 7 June.

Previously (when it declared its maiden dividend of US$0.37/share for FY20 in November), Endeavour announced a policy of declaring future dividends on a semi-annual basis with the aim of maintaining an approximate dividend yield of 1.6% until it reached a targeted net cash position of c US$250m (note, in H122 according to our estimates). Thereupon, it said that it would re-assess its capital allocation priorities, which could involve augmenting its shareholder return programme. As a result, our previous dividend forecast for FY22 and FY23 was based on the maximum distribution that Endeavour could make and still retain a net cash position of US$250m on its balance sheet. Although we believed that such payouts would be unlikely in practice, this methodology nevertheless served to demonstrate the latitude that Endeavour had at its disposal to increase its dividend distributions in the short to medium term.

At its CMD however, Endeavour announced an update to its dividend policy to the effect that it would pay minimum progressive dividends of 50 US cents, 60c and 70c per share in FY21, FY22 and FY23, respectively (assuming that the gold price remains above US$1,500/oz, otherwise payment becomes discretionary based on balance sheet strength), with the potential for additional supplementary shareholder returns as long as net debt remains below 0.5x EBITDA.

In tandem with its FY20 results, on 18 March 2021, Endeavour announced a normal course issuer bid (NCIB) or share buyback programme to supplement its policy of augmenting shareholder returns. The NCIB commenced on 22 March and will end on 21 March 2022 and will allow Endeavour to buy up to 12.2m ordinary shares, or approximately 5% of its total issued and outstanding ordinary shares at the time of the announcement, whereupon the purchased shares will be cancelled. At Endeavour’s current share price of C$28.95 (US$23.91), the NCIB is worth c US$291.7m and compares extremely favourably with its FY20 dividend payout of US$60.3m and its forecast US$125.2m pay-out in FY21. Combined, the NCIB and FY21e dividend distribution together represent c US$416.9m in aggregate returns to shareholders – equivalent to a dividend yield of 7.0% – in FY21.

Note that, owing to the inherent uncertainty surrounding whether purchases are made and at what price under the NCIB, we have not attempted to include potential future share buybacks in our financial forecasts in Exhibit 3, below, but only historical ones. To date in FY21, we estimate that Endeavour has repurchased and cancelled a total of 2.2m shares for consideration of C$60.4m, or US$49.0m.

According to its Q121 balance sheet, Endeavour had net debt of US$220.2m post the acquisition of Teranga and the injection of US$200m by La Mancha. This compares with net debt of US$43.3m as at end-FY20 (pre the Teranga acquisition). This figure of US$220.2m includes lease liabilities of US$43.6m and an option premium of US$46.3m. Excluding the latter results in a net debt position of US$173.9m or just 4.3% of the company’s balance sheet equity of US$4,007.7m at end-Q121. Note that it differs slightly from the figure of US$161.8m quoted elsewhere in Endeavour’s announcements in that the latter excludes US$43.6m in lease liabilities and owing to the discounting, variously, of certain committed future payments to present value.

Note that, for the purposes of its financial modelling (see Exhibit 3, below) and for simplicity’s sake, we have assumed the consolidation of Endeavour’s and Teranga’s balance sheets took place retrospectively on 31 December 2020. In this case, we estimate that Endeavour would have consolidated c US$242.6m in net debt on its balance sheet and c US$349.2m in gross debt as a consequence of its Teranga acquisition. As such, on a pro forma basis, we estimate Endeavour would have had US$323.1m in net debt on its balance sheet at end-FY20, which we calculate would have equated to a gearing (net debt/equity) ratio of just 8.8% and a leverage (net debt/[net debt+equity]) ratio of 8.1% on the group’s enlarged equity base.