Endeavour Mining — Irrepressible

Endeavour’s performance in Q321 was the third consecutive quarter in FY21 in which it produced and sold c 20% more gold than Edison’s prior expectations. In its wake, we have revised some of our operating assumptions for Q421 and FY22, which are summarised below:

Historically, Endeavour has a good record of meeting its production and cost guidance targets and FY21 appears almost certain to be the ninth year in succession in which the company achieves (or exceeds) its production and AISC targets.

In the wake of the changes made to our Q421 operating assumptions, our estimates of Endeavour’s mines’ likely production and cost results for the full year relative to official guidance are shown in the table below:

Readers should note that Endeavour’s guidance includes production from Sabodala-Massawa and Wahgnion from 10 February onwards only. They should also note that, for the purposes of our forecasts (below), we have left Agbaou fully consolidated into Endeavour’s ‘pro forma’ accounts. For those who wish to deconsolidate it, Agbaou’s profit and loss for the period in which it was under Endeavour ownership in Q121 is reproduced below. All told, however, we would note that its contribution to Endeavour’s bottom line was, to all intents and purposes, immaterial during this period.

In the meantime, we understand it is not Endeavour’s intention, at least for the time being, to reflect Karma as an asset held for sale (despite its now being classified as ‘non-core’). With these provisos, our updated forecasts for Endeavour for the remainder of FY21 and in the wake of the Q321 results, by quarter, on both an ‘as reported’ and ‘pro forma’ basis, are as follows:

The net result of these changes (including a marginal increase in our forecast gold price for Q4, from US$1,768/oz to US$1,771/oz) is a 13.9% increase in adjusted net EPS from continuing operations, from US$2.006/share to US$2.285/share (on a pro forma basis – see our note, The second five-year plan, published on 20 October 2021 for direct comparison) and a similar 14.8% increase in adjusted net EPS from continuing operations, from US$1.970/share to US$2.262/share (on an ‘as reported’ basis).

For FY22, our adjusted net EPS from continuing operations estimate has declined by an immaterial 2.7% to US$2.378/share. This is in the top half of the consensus range (see Exhibit 5); however, readers should note that this forecast is contingent on the gold price averaging US$1,819/oz for the year. In the event that it remains at current levels (US$1,777/oz at the time of writing) for the full 12-month period, our forecast declines to US$2.217/share (ie marginally below the average).

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).

Notwithstanding 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 both 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, FY21 and FY22 adjusted net EPS from continuing operations estimates and consensus estimates is as follows:

Self-evidently, one of the main assumptions behind our forecasts is that there are no major deleterious effects to ongoing operations as a result of the COVID-19 pandemic. To date, the effect of COVID-19 on Endeavour’s operations in West Africa has proved to be 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 both 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 also by preparing multiple different levels in its pits from which to produce, thereby affording it greater operational flexibility in the event of disruptions.

A full analysis of Endeavour’s Q321 results relative to our prior forecasts is provided below:

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), Edison (at least for the moment) is continuing to show total cash costs excluding royalties unless specifically indicated otherwise (eg the ‘Actual Q121a’ column in Exhibit 6, above).

Notwithstanding the fact that the third quarter is almost invariably Endeavour’s weakest quarter in any particular year, owing to the onset of seasonal rains in west Africa, this year Q321 results were materially ahead of our expectations on virtually every measure from production to adjusted net EPS, putting the company on track to achieve record output and to beat its own production guidance (in this case, for the ninth year in succession) while, at the same time, meeting cost guidance. While revenue was 17.7% ahead of our expectations, costs were ahead by only 6.4%, with the result that adjusted net EPS outperformed our prior forecast by 65.4%. Moreover, more than half of the variance in costs (US$8.6m out of a total of US$15.5m) could be attributed to a non-cash inventory expense associated with a fair value adjustment on the purchase of Teranga. Otherwise, almost all of its seven underlying mines exceeded our expectations on all measures of performance, with the exception of the grade of material processed at Boungou (which nevertheless still outperformed our expectations in terms of profitability – see Exhibit 7) and costs at Wahgnion (albeit these were inflated by a US$1.5m non-cash operating expense relating to the reversal in the period of the fair value adjustment of inventory on hand at the acquisition date).

Full details of each mine’s operational performance and outlook are available in Endeavour’s press release. However, a summary of the financial performance of each mine, relative to our prior expectations, is as follows.

In broad terms, financial results in Q321 fell between those of Q221 and our (with hindsight) conservative prior expectations. As well as exceeding our forecast, however, at US$0.612/share, actual adjusted net EPS for the quarter were also comfortably in excess of the consensus analysts’ forecast of US$0.44/share as well as the top end of the range of expectations, of US$0.50/share:

While corporate costs appeared to exceed our expectations, these were, in fact, inflated by US$3.0m in residual charges relating to the expense of Endeavour’s LSE listing (note: these are excluded in the calculation of adjusted net earnings), without which they would have been broadly in line. Also excluded from adjusted net earnings are losses on financial instruments. Endeavour booked a loss on financial instruments of US$20.0m in Q321, albeit this item could be attributed solely to losses on forex of US$23.3m (which we anyway decline to attempt to forecast). The company also benefited from the absence of tax instalment payments, which typically inflate Endeavour’s tax charge in the second quarter of any particular financial year.

Debt at Endeavour has now reduced to an insignificant US$70m (despite US$70m in dividend payments and US$35m in share repurchases during the quarter – company calculation) and the company has therefore indicated that it will increase its full year dividend payout beyond the US$125m originally indicated.

As disclosed on 7 June 2021, Endeavour has implemented a shareholder returns programme that is composed of a minimum progressive dividend that may be supplemented with additional dividends and buybacks, providing the prevailing gold price remains above US$1,500/oz and Endeavour’s net debt/adjusted EBITDA ratio remains below 0.5x. Subject to the gold price condition being met, the minimum progressive dividend policy has a target of distributing at least US$500m to shareholders over the next three years. To date, minimum dividends have been indicated at US$125m, US$150m and US$175m for FY21, FY22, and FY23, respectively, payable semi-annually (cf a maiden FY20 dividend of US$60m). At the half-year stage, however, Endeavour declared an interim dividend of US$70m (or US$0.28/share) – 12% above the level that might be expected pro rata with its minimum guided level of US$125m for the full year. At the time, this caused us to increase our forecast dividend for the full year, from US$0.50/share to US$0.56/share which we are, at least for the moment, maintaining, albeit with the recognition that this may have to increase once again in the event of another strong quarter in Q4 (which is traditionally the strongest quarter of Endeavour’s year in terms of financial and operating results).

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$27.09 (US$21.31), the NCIB is worth an estimated US$155.9m in additional purchases (on top of the estimated US$111.3m already made) and compares extremely favourably with its FY20 dividend payout of US$60.3m and our forecast of its payout to shareholders of US$138.4m in FY21. Combined, the NCIB and FY21e dividend distribution together represent a potential c US$327.5m in aggregate returns to shareholders – currently equivalent to a total shareholder yield of 6.2% – in FY21 (albeit dependent on whether the maximum allowable under the NCIB is repurchased within the requisite timeframe).

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 11, below, but only historical ones. To date in FY21 (until 9 December), we calculate that Endeavour has repurchased a total of 4.9m shares at an estimated average price of US$22.8 (C$28.99 at the prevailing forex rate), resulting in total cash outflows of c C$141.5m, or US$111.3m.

In the light of its strong operational performance, coupled with its near-zero net debt position, in its Q321 results press release, Endeavour stated: ‘Having already returned $224 million in dividends and share buybacks this year, and considering our near zero Net Debt to adjusted EBITDA leverage ratio, we expect to continue to supplement our shareholder return programme with further share buybacks and deliver more than the guided minimum dividend of $125 million for the full year.’

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 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 remains ostensibly unchanged at US$3.86/share (cf US$3.97/share previously), giving rise to a terminal valuation of the company at end-FY26 of US$38.65/share (cf US$39.73/share previously), which (in conjunction with forecast intervening cash flows) then discounts back to a valuation of US$33.41/share (cf US$34.67/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 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 currently expecting a 2.2964 inflation rate (source: Bloomberg, 9 December) cf 2.3727% previously. These two measures imply an expected real equity return of 6.55% (1.09/1.022964) and applying this to our forecast cash flows would imply a terminal valuation for Endeavour of US$58.97/share (cf US$62.22/share previously) and a current valuation of US$53.32/share (cf US$56.73/share previously). Readers should note that, given its Canadian dollar-derived share price beta of 0.58 (source: Refinitiv, 9 December 2021), even this (real) discount rate of 6.55% could prove conservative.

In the meantime, Endeavour’s valuation remains at a material discount to those of its peer group, as shown in Exhibit 10, 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 the fact that Endeavour’s valuation is materially cheaper than the averages of the majors on all of the measures shown in Exhibit 10 regardless of whether Edison or consensus forecasts are used. On an individual basis, it is cheaper than its senior gold mining peers on at least 41 out of 54 (75%) of valuation measures if Edison forecasts are used and, similarly, 39 out of 54 (72%) if consensus forecasts are used. Reverse engineered, the average valuation measures of its peers imply an average share price for Endeavour of US$31.36, or C$39.87 per share.

According to its Q321 balance sheet, Endeavour had net debt of US$143.6m. This compares with net debt of US$147.6m as at end-Q221, US$220.2m as at end-Q121 (after the completion of the Teranga acquisition and the injection of US$200m by La Mancha) and US$43.3m as at end-FY20 (pre 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.

Note that, for the purposes of our financial modelling (see Exhibit 11, below) and for simplicity’s sake, we have assumed that 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 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 (see Exhibit 11, below).