Endeavour Mining — Forecasts ahead of St Patrick’s day results

On 24 January, Endeavour provided a production and cost update for its mines in Q4/FY21. The highlights of the update were:

As such, FY21 marks ninth consecutive year in which Endeavour has either met or exceeded its annual guidance.

All seven of Endeavour’s mines exceeded our prior production expectations for the quarter (see Exhibit 1). In addition, the average gold price during the quarter was 1.4% higher at US$1,796/oz (cf US$1,771/oz previously – see our note, Irrepressible, published on 14 December 2021).

In terms of our detailed forecasts, we have revised our earnings estimates for both Q421 and FY21 to reflect the higher gold price and increased production. In addition, we have adjusted our depreciation expectations (to reflect both the higher production, given that Endeavour depreciates on a units of production basis, and recent reserve and resource re-evaluations, which affect the assumed life of an asset) and our corporate cost assumption (which is typically higher in the final quarter of the year, reflecting annually benchmarked share-based compensation schemes).

The result of these adjustments has been a 6.9% increase in our estimate of adjusted net earnings attributable to shareholders for the quarter and a 1.2% increase for the year.

Our detailed updated forecasts for both Q421 and FY21 (on both a ‘pro forma’ and an ‘as reported’ basis) are now as shown in the table below/overleaf:

Items included in the reconciliation between adjusted net earnings attributable and total net and comprehensive earnings are losses from discontinued operations, deferred income tax effects, gains/losses on financial instruments, other expenses, share-based compensation and acquisition costs (all shown independently in the table above), plus the tax impact of adjusting items, non-cash and other adjustments and the minority interest attributable to the adjusting items (not shown independently).

Despite the detailed appearance of our forecasts, readers are cautioned that forecasting on a quarterly basis is prone to large variations between actual and forecast numbers. As such, the exhibits above and below should be regarded as indicative rather than prescriptive, particularly with respect to individual quarters. With this caveat, a comparison between our Q421 and FY21 adjusted net EPS from continuing operations estimates and consensus estimates is as follows:

In addition to its Q4/FY21 production update on 24 January, Endeavour also provided FY22 production guidance of 1,400–1,500koz at an AISC of US$890–940/oz. This was very close to our prior forecasts with the exception of Boungou where mining activities will focus on waste stripping and ore extraction from the East pit in addition to waste stripping in the West pit in H122. In H222, stripping activities will continue in both pits, while ore will be sourced mainly from the West pit. Mill throughput is anticipated to remain broadly consistent with FY21, although grades are expected to decline by slightly more than we had originally forecast, to 3.09g/t (cf 3.95g/t previously). However, we have also increased our gold price forecast for the year, from US$1,819/oz previously to US$1,890/oz currently (the prevailing price at the time of writing). Note that, apart from this, our longer-term gold price forecasts remain unchanged.

As a result, for the full year we have increased our forecast for adjusted net earnings attributable to shareholders by 8.7% (albeit with the usual caveat around quarterly forecasts), as shown below:

As before, items included in the reconciliation between adjusted net earnings attributable and total net and comprehensive earnings are losses from discontinued operations, deferred income tax effects, gains/losses on financial instruments, other expenses, share-based compensation and acquisition costs (all shown independently in the table above), plus the tax impact of adjusting items, non-cash and other adjustments and the minority interest attributable to the adjusting items (not shown independently). Readers are reminded that Endeavour changed its definition of cash costs in Q420 to include royalties. The decision was made so that Endeavour may be more consistent in reporting within the context of its peer group. For reasons of comparability with past results, however, as well as ease of forecasting (given that royalties are reported as a discreet item distinct from operating expenses), we (at least for the moment) are continuing to show total cash costs excluding royalties unless specifically indicated otherwise.

A comparison between our quarterly and full-year forecast and consensus forecasts for FY22 is as follows:

Of particular note, within the context of our financial and operating forecasts for the individual quarters, is the absence of any material decline in either production or profitability (Q3 being the quarter usually most susceptible to disruption from the seasonal rains in west Africa). In this case however, we are expecting a material increase in production at Sabodala-Massawa in Q322 and H222. Ore at Sabodala-Massawa will be primarily sourced from the Sofia North pit, supplemented by lower-grade feed from the Sabodala pit, in H122, whereas it is intended to be sourced from the higher grade Massawa Central and Massawa North in H222. Note that, in the case of FY22, we have not (yet) attempted to forecast any tax instalment payments, which typically inflate Endeavour’s tax charge in the second quarter of any particular financial year.

Self-evidently, one of the main assumptions behind our forecasts is there are no major deleterious effects to ongoing operations as a result of the COVID-19 pandemic. It also assumes no collateral escalation of geopolitical tensions in Ukraine and Russia into West Africa. To date, the effect of COVID-19 on Endeavour’s operations in West Africa has been negligible and is expected to remain so, as the company has now been able to vaccinate more than 50% of its workforce in an ongoing programme of pandemic mitigation. In addition, Endeavour has further mitigated future risks as far as possible by setting itself up to operate under level 2 COVID-19 restrictions (see our note, New senior gold major looking to join FTSE 100, published on 17 December 2020) and by preparing multiple different levels in its pits from which to produce, thereby affording it greater operational flexibility if there are disruptions.

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 FY22, in the case of Endeavour, we have instead opted to discount five years (previously six) of forecast cash flows in FY22–26 back to the start of FY22 then 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 have been excluded from such a calculation on the basis that it is an investment. In the case of Endeavour, however, it was included on the grounds that it was a critical component of ongoing business performance in its ability to continually expand and extend the lives of its mines.

In this case, our estimate of cash flows in FY26 has increased by 3.6% to US$4.00/share (cf US$3.86/share previously), giving rise to a terminal valuation of the company at end-FY26 of US$40.00/share (cf US$38.65/share previously), which (in conjunction with forecast intervening cash flows) then discounts back to a valuation of US$37.16/share as at the start of FY22 (cf US$33.41/share at the start of FY21 previously):

Given its elevation into the ranks of the world’s foremost producers of gold, however, we believe Endeavour can increasingly attract lower-cost finance and, as such, a 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 an inflation rate of 2.3365% (source: Bloomberg, 4 March) cf 2.2964% previously. These two measures imply an expected real equity return of 6.51% (1.09/1.023365) and applying this to our forecast cash flows would imply a terminal valuation for Endeavour of US$61.43/share (cf US$58.97/share previously) and a current valuation of US$58.30/share (cf US$53.32/share previously). Readers should note that, given its share price beta of 0.56 (source: Refinitiv, 4 March 2022), even this (real) discount rate of 6.51% could prove conservative.

In the meantime, Endeavour’s valuation remains at a material discount to those of its peer group, as shown in Exhibit 6, 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 since its takeovers of SEMAFO and Teranga have been completed), is as follows:

Of note is that Endeavour’s valuation is materially cheaper than the averages of the majors on all of the measures shown in Exhibit 6 if Edison or consensus forecasts are used and all but one if consensus forecasts are used. On an individual basis, it is cheaper than its senior gold mining peers on at least 40 out of 54 (74%) of valuation measures if Edison forecasts are used and 32 out of 54 (59%) valuation measures if consensus forecasts are used. Reverse engineered, the average valuation measures of its peers imply an average share price for Endeavour of US$37.72, or C$47.86 (or £28.15) per share.

According to its Q321 balance sheet, Endeavour had net debt of US$143.6m at end-September, despite making US$70m in dividend payments and US$35m in share repurchases during the quarter. This compares with net debt of US$147.6m at end-Q221, US$220.2m at end-Q121 (after the completion of the Teranga acquisition and the injection of US$200m by La Mancha) and US$43.3m at end-FY20 (before the Teranga acquisition). This figure of US$143.6m also includes lease liabilities of US$53.5m and an option premium of US$43.4m. Excluding these two items results in a net debt position of just US$46.7m or just 1.1% of the company’s balance sheet equity of US$4,064.4m at end-Q321 (cf US$52.3m and 1.3% as at end-Q221). Note that this figure of US$46.7m also excludes US$30.5m held in the form of ‘restricted cash’ in ‘other financial assets’ and US$2.7m in marketable securities. It also differs slightly from the US$69.6m net debt figure calculated by Endeavour and quoted in its announcements owing to the discounting, variously, of certain committed future payments to present value.

Endeavour’s estimate of its net debt at end-Q4/FY21 is that it has now reversed into a net cash position of US$76m. This compares with our estimate of US$81.2m (see Exhibit 7, below), albeit the difference is deemed negligible and easily attributable to the effect of the discounting of certain committed future payments to present value.

Note that, for the purposes of our financial modelling in Exhibit 7 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 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 at end-December). As such, on a pro forma basis, we estimate that 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.