Teething trouble at Boddington irrelevant

Since our last note on the company (see Material outperformance begets material upgrade, published on 2 August 2021), there have been a number of developments at Newmont pertaining to its operational and financial performance for the remainder of FY21. Chief among these was Newmont’s announcement on 5 October that it had delivered the gold industry’s first Autonomous Haulage System (AHS) fleet at Boddington (Western Australia’s largest gold mine). Notwithstanding the coronavirus pandemic, the fully autonomous haulage fleet, comprising 36 Caterpillar trucks, was delivered on time and on budget (US$150m) and will improve mine safety and productivity, while simultaneously extending its productive life. During commissioning, however, the project faced several challenges, including unusually severe weather and heavy rainfall, shovel reliability and operational delays associated with managing bench hygiene as mining moved into the deeper sections of the pit, as a result of which the mine delivered lower ex-pit tons to the plant than anticipated and therefore now expects to produce 140koz (or 16.9%) fewer ounces than originally expected in FY21 (note that, for the purposes of our financial modelling, below, we have assumed that this effect falls approximately in the ratio two-thirds/one-third for Q3:Q4).

Other developments include:

Operations at Nevada Gold Mines continued to be adversely affected by the mechanical mill failure at Carlin’s Goldstrike roaster in Q2 (albeit this was repaired in late Q3). In addition, we believe that a number of Newmont’s mines may have continued to be adversely affected by lingering disruptions related to the coronavirus pandemic, including Tanami in Australia, which was shut for two weeks during the quarter.

As noted at the time of Newmont’s Q420/FY20 results, both (higher) production and (lower) costs were expected to be weighted towards the second half (approximately in the ratio 47:53) in FY21 and this effect was anticipated to be most pronounced in the first and last quarters of the year. In part, this profile was expected to reflect rising grade profiles, in particular at Boddington and Ahafo (the latter also being as a result of volume, driven by productivity improvements throughout the year from the change in mining method at Subika underground to sub-level shrinkage). However, Merian, Musselwhite, Porcupine and CC&V were all expected to exhibit rising production profiles as well. At the same time, costs were expected be weighted in the other direction, that is H221 costs were expected to be lower than H121 costs. In part, this reflected lower production in H121. However, it also reflected higher sustaining capital costs in H121 relating to the installation of Boddington’s AHS. In the light of the developments noted above, however, we believe that Boddington will have been required to mill material from lower-grade stockpiles in Q3 and, to some extent, in Q4, with the result that the overall recovery in production and the decline in costs expected in H2 will now be delayed until Q4. An updated summary of our production and cost assumptions for each of Newmont’s geographic sub-divisions in the light of these developments is provided in Exhibit 1, below.

In addition, we have adjusted our forecasts for actual rather than forecast metals prices – principally, US$1,790/oz gold cf US$1,798/oz forecast previously for Q321 and US$1,791/oz cf US$1,796/oz for Q421. In the light of these changes, our updated financial forecasts for Newmont for the remainder of FY21, by quarter, are now as follows:

After our revisions for the remainder of the year, our basic adjusted EPS forecast of US$2.879/share for FY21 compares to the market consensus, as follows:

While these changes represent an 10.3% reduction relative to previously, at US$2.879/share, they nevertheless leave our basic adjusted EPS 6.2% higher than it was before our August upgrade, when our forecast was US$2.711/share (see Material outperformance begets material upgrade, published on 2 August 2021). An analysis of the individual component parts of the changes to our basic adjusted EPS forecasts for Q3, Q4 and FY21 is as follows:

While Boddington represents the largest single component of our forecast changes for the year, it is continuing to ramp up its truck fleet to full productivity and to fine tune its haulage system to operate in a deep open pit mine. In this respect, the reasons for the changes may be characterised as no more than early-stage teething problems, of the type that beset many mining projects – especially in cases where the deployment of new technology is concerned. In the longer term, however, Newmont is convinced that the Boddington AHS project is a positive development in implementing more sustainable and efficient projects, encompassing the following benefits (among others):

At the time of its Q320 results in October 2020, Newmont unveiled a new dividend framework whereby it formally rebased its dividend to a ‘base’ payout of US$1.00/share (or US$0.25/share per quarter) at a gold price of US$1,200/oz, but also stated explicitly that it would return 40–60% of incremental attributable free cash flow that it generated above a gold price of US$1,200/oz to shareholders. Under the new framework, Newmont will augment the ‘base’ payout in increments of US$0.60–0.90/share per year (or US$0.15–0.225/share per quarter), evaluated in gold price increments of US$300/oz for gold prices above US$1,200/oz, with the goal of targeting 40–60% of incremental free cash flow above a gold price of US$1,200/oz returned to shareholders. Thus, a (sustainable) gold price at US$1,800/oz should (on this basis) result in a quarterly dividend of US$0.55/share, whereas a gold price below that level could result in one of US$0.40/share. In this context, however, it is worth noting that Newmont affords itself a degree of latitude in the level of the ultimate payout in that, should it decide to pay out nearer 60% of incremental attributable free cash flow to shareholders that it generates above a US$1,200/oz gold price, rather than 40%, then there is scope for the quarterly dividend to remain at the higher level, notwithstanding the gold price dipping below the US$1,800/oz level. In consequence, we have left our dividend forecasts for Q321–Q421 and FY21 unchanged on the basis that we believe the gold price temporarily dipping below US$1,800/oz is unlikely to result in any readjustment in the quarterly distribution.

Our approach to the valuation of Newmont has remained unchanged since our initiation note (see The sustainable leader, published on 9 February 2021; see that note for a fuller explanation of the methodologies involved). The following is an update of our valuation in light of the changes to our Q3, Q4 and FY21 forecasts.

Newmont is a multi-asset company that has shown a willingness and desire to trade assets in the past to maintain production, reduce costs and maximise shareholder returns. As a result, rather than our customary method of discounting maximum potential dividends over the life of operations back to FY21, in the case of Newmont, we have opted to discount forecast dividends back over six years from the start of FY21 and then to apply an ex-growth terminal multiple to forecast cash flows in that year (ie FY26) at the appropriate discount rate. In the normal course of events, we would exclude exploration expenditure from such a calculation on the basis that it is a discretionary investment. In the case of Newmont, however, we have included it in our estimate of future cash flows on the grounds that it may be a critical component of ongoing business performance in its ability to continually expand and extend the lives of the company’s assets via exploration.

As a result of the changes made to our short-term financial forecasts for FY21, our estimate of Newmont’s pre-financing cash flow in FY26 has declined by a modest 2.5% to US$5.14 per share (cf US$5.27/share previously and US$1.22/share in FY18 – note that it now reaches US$5.27/share one year later in FY27). On this basis, applying an almost unchanged (real) discount rate of 6.4% (calculated from a nominal expected equity return of 9% and long-term inflation expectations of 2.4192% as defined by US 30-year break-evens – source: Bloomberg, 26 October), our terminal valuation of the company at end-FY26 is US$80.01/share (cf US$81.10/share previously). However, note that this valuation is based on the inherently conservative assumption of zero growth in (real) cash flows beyond FY26.

In conjunction with forecast intervening dividends, this terminal value then discounts back to a net present value of US$71.57/share (cf US$73.15/share previously) at the start of FY21.

This (absolute) analysis inherently excludes any value to Newmont from its other development assets, such as Coffee, Galore Creek, Conga, Norte Abierto and Nueva Union, which together represent combined reserves and resources of 53.93Moz attributable to Newmont. As noted previously, it is also conservative in its assumption of zero growth in (real) cash flows after FY26, whereas historically the gold price has appreciated at a rate of c 2% per year in real terms.

Newmont’s valuation on a series of commonly used measures, relative to its peer group of the 10 largest publicly quoted senior gold producers, is as follows.

From this table, it can be seen that, while Newmont continues to command a premium rating relative to its peer group on most valuation measures, it remains materially cheap with respect to its dividend yield. Based on consensus forecasts, we estimate that Newmont’s share price would have to rise by an average of 91.3% for its dividend yield to match those of its peer group. Based on our forecasts, we estimate that its share price would have to rise 92.8%.

As before, one further observation concerning the comparability of the above measures is merited. Given its policy of proportionately consolidating its interest in Nevada Gold Mines and that it owns 100% interests in the majority of its remaining mining operations (with the exceptions of Yanacocha and Merian), estimates of cash flow in particular are also close to estimates of cash flow attributable to shareholders (Newmont estimates that 97% of free cash flow was attributable to the company in Q221). This is in contrast to a number of its peers, where earnings and cash flow from assets not 100%-owned tend to be fully consolidated and therefore may not so easily approximate cash flow attributable to shareholders, making direct comparison using these measures either difficult or, potentially, misleading.

A summary of our updated valuation of Newmont over 29 measures of value across three different methodologies (namely absolute, historical and peer group) over the next five years is shown in Exhibit 7, below.