Endeavour Mining — Ninth successive year of outperformance

Endeavour’s Q421/FY21 results were reported on 17 March, within the context of known production and known all-in sustaining costs (AISC) since, on 24 January, Endeavour had provided a production and cost update for its mines, the highlights of which were:

As such, FY21 was the ninth consecutive year in which Endeavour has either met or exceeded its annual guidance, with all seven of its mines exceeding our prior production expectations. We updated our financial forecasts in the light of Endeavour’s 24 January announcement (see our note, Forecasts ahead of St Patrick’s day results, published on 7 March), which resulted in 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. In the event, Endeavour’s actual underlying adjusted net earnings were approximately US$10.8m (or 10.0% or US$0.041/share) better than our updated expectations for the quarter.

Like-for-like comparison between actual results for Q421/FY21 was rendered difficult by three factors:

Endeavour’s actual results within the context of our prior expectations for both the quarter and the full year (both on an ‘as reported’ and a ‘pro forma’ basis) are provided in the table below. In this case, for the purposes of easier comparison, calculation of Endeavour’s adjusted net earnings attributable has been translated back into its previous format (ie excluding share-based payments and deferred tax effects). In future, however – and for the purposes of our forecasting – we will conform to the new protocol (eg in Exhibit 6). In addition, we have introduced an additional column for each set of results, excluding the impairment, denoted ‘underlying’. On this basis, it may be seen that adjusted net earnings exceeded our prior forecast for Q421 by US$10.8m (US$118.8m cf US$108.0m). In general, depreciation exceeded our prior estimate by US$21.1m (or 11.7%), while interest expenses exceeded our prior estimate by US$13.8m and increased on the prior quarter, which was a surprise given that Endeavour achieved a net cash position during the quarter. Nevertheless, as a consequence, our estimate of adjusted net earnings for the full year on a pro forma basis (ie assuming the acquisition of Teranga on 31 December 2020 rather than 10 February 2021) also exceeded our prior forecast by the same amount – albeit this translated into a much smaller percentage variance of just 1.9% (cf 10.0% for the quarter). Endeavour’s reported full year earnings were affected by an implied adjustment upwards to costs of US$26.2m and an adjustment upwards to depreciation of US$9.4m – that is to say, costs and depreciation were higher by those amounts than the sums of their individual quarters. However, these two restatements were largely offset by an almost identical in magnitude US$37.3m upwards adjustment to ‘non-cash and other’ items plus smaller adjustments to corporate costs and ‘other’ expenses to result in adjusted net earnings attributable for the full year – on an ‘as reported’ basis – that were US$9.1m (or 1.7%) above our prior expectation (US$557.9m cf US$548.8m) on a like-for-like basis.

Note that, with share-based payments and deferred tax not excluded from the calculation, adjusted net earnings attributable to shareholders for the quarter would have been US$145.4m (or US$0.58/share) and US$577.2m (US$2.40/share) for the full year, on an ‘as reported’ basis – as calculated by Endeavour.

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).

On the previous basis (ie including share-based payments and deferred tax effects), Endeavour’s results were well within the range of analysts’ expectations both for the quarter and for the full year:

On 11 March, Endeavour announced that it had concluded the sale of its 90% interest in its non-core Karma mine to Néré Mining (a Burkina Faso-based consortium led by Elie Ouedraogo – a board member of both Karma and Mana and a prominent local businessman – who owns 29% of Néré).

Under the terms of the agreement, the total consideration of the transaction of US$25m will be apportioned as follows:

Consideration of up to US$25m compares with a simplified version of Karma’s balance sheet as at 31 December, as follows:

On this basis (and depending on the gold price and the valuation of Endeavour’s 2.5% net smelter royalty), we infer that Endeavour may record a small loss in the order of US$7.4m on disposal in Q122 (based on the gold price at the time of writing). However, note that this item is not included in our estimates in Exhibit 6, below, on the basis that it is a) insignificant within the context of Endeavour’s broader accounts and b) non-recurring.

Nevertheless, consideration of up to US$25m also compares with Karma’s reserves and resources statement as at end-FY20 and our forecast of its statement as at end-FY21 (net of depletion) as follows:

On this basis, consideration of US$20m (US$22.2m on a 100% basis) values Karma at US$9.08 per resource oz of gold and US$766 per reserve oz of gold.

In the light of its sale of Karma, Endeavour updated its production and cost guidance for FY22 as follows:

In addition, we have also increased our gold price forecast for the remainder of the year, from US$1,890/oz previously to US$1,926/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 (and with the usual caveat around quarterly estimates), our forecast for adjusted net earnings attributable to shareholders for FY22 has decreased by 1.3%, 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, gains/losses on financial instruments, other expenses 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). As noted previously, Endeavour has now changed its definition of adjusted net earnings attributable, such that deferred tax effects and share-based payments are no longer included in the adjustments to total net and comprehensive earnings, and this is now the manner in which our FY22 forecasts (above) are presented. Readers are also 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 are continuing to show total cash costs excluding royalties.

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 in Q3 (being the quarter historically 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 war between Russia and Ukraine 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, Agbaou in FY20 and Karma in FY22, 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 remained, to all intents and purposes, unchanged at US$3.96/share (cf US$4.00/share previously), giving rise to a terminal valuation of the company at end-FY26 of US$39.65/share (cf US$40.00/share previously), which (in conjunction with forecast intervening cash flows) then discounts back to a valuation of US$36.57/share as at the start of FY22 (cf US$37.16/share 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 2.5623% (source: Bloomberg, 22 March) cf 2.3365% previously. These two measures imply an expected real equity return of 6.28% (1.09/1.025623) and applying this to our forecast cash flows would imply a terminal valuation for Endeavour of US$63.17/share (cf US$61.43/share previously) and a current valuation of US$59.78/share (cf US$58.30/share previously).

In the meantime, Endeavour’s valuation remains at a material discount to those of its peer group, as shown in Exhibit 9, 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 9 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 39 out of 54 (72%) of valuation measures if Edison forecasts are used and 38 out of 54 (70%) 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$40.48, or C$50.93 (or £30.54) per share.

According to its Q421/FY21 balance sheet, Endeavour had net cash of US$13.2m at end-December, despite making US$43.9m in share repurchases during the quarter. This compares with net debt of US$143.6m at end-Q321, 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$13.2m also includes lease liabilities of US$51.1m and an option premium of US$34.6m. Excluding these two items results in a net cash position of US$98.9m. This figure also excludes US$30.6m held in the form of ‘restricted cash’ and US$40.0m in shares of Allied Gold received as consideration for the sale of Agbaou, both held in ‘other financial assets’. It also differs slightly from the US$76.2m net cash 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 in Exhibit 10 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 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.