The company has a further USD$488million worth of committed funds to forward contracts and put options in FY02. The USD$80million loss attributable to the forward contracts has been novated between counterparties for a non-cash expense of USD$4.1million.
The company is highly geared at 50% with the amount of debt equivalent to the amount of equity in the company. The high gearing makes the company very sensitive to interest rate movements.
Key Financials of Newcrest
Standard Accounting ratios have been used to compare Newcrest with its main local competitor Aurion. Specific ratios relevant to the Gold Industry are also used to compare Newcrest with Aurion and other international gold plays such as Barrick and AngloGold.
Newcrest has also been heavily involved in hedging strategies that have been unfavourable due to the several circumstances, one of which was the fall in the local currency against the US dollar. Details of Newcrest’s hedging strategies will be evaluated in the proceeding sections.
Accounting Ratios
A comprehensive evaluation of the key financial ratios analysis is provided in Appendix 1. The main ratios are evaluated in the table below for both Newcrest and Aurion Gold for the last 2 financial years. The commentary provided in the table below considers the biennial trend as well as the competitor’s trends.
The major points worth noting from the table above are the high gearing of Newcrest, leaving itself exposed to potential monetary tightening by the Federal Reserve when the global economy shows signs of recovery. The next area of concern is NCM’s ability to only cover 69% of its current liabilities with its current assets. Furthermore, NCM reported a substantial loss of earnings with potentially good cash flows from its operating activities. Based on the ratio analysis we can conclude that NCM is flawed in its capital structure. NCM is quite sensitive to interest rate changes and has an inflated share price compared to AOR.
The top twenty shareholders represent about 85% of total shareholder value and comprise of predominantly banks and fund managers.
Financials Specific to the Gold Industry
In order to achieve a subjective financial assessment of Newcrest, comparisons were made with both local (AurionGold) and larger multinational Gold companies, AngloGold and Barrick. These companies were selected as they represent core activities in different continents.
AngloGold has achieved the recognition as the sustainability leader in the Precious metals sector of the Dow Jones Sustainability World Index. The stability of earnings and history of operation in the precious metals industry ensure we are benchmarking a truly best practice organisation. AngloGold operates mines in 10 countries and is listed on the following securities exchanges: Johannesburg (ANG), New York (AU) and Australia (AGG) as well as the London Stock Exchange (79LK) and the Paris (VA FP) and Brussels (ANG BB) bourses.
The other global player being benchmarked against is Barrick, considered a relatively young player compared to AngloGold with operations beginning in 1983 in North America.
The commentary provided in the table below considers the current snapshot for the companies being evaluated.
Recent Economic Indicators
Gold has proven to be a strong performer up 16.99% from September 11 2001 to September 11 2002. While gold continues to make gains, the US Dollar is down more than 7%, the Dow has fallen over 14%, S&P 500 down over 19% and the Nasdaq has the worst stock market performance of all, down over 24%.
Buying into gold stocks is a preferred way to balance and diversify share portfolio. Gold can reduce the volatility of the portfolio, lower exposure to risky stocks. Weak economy and volatile stock market is not expected to recover in near future. On top of this a terrorist attack of any kind would adversely affect the share market. NASDAQ and DOW are already trading at very low levels since post-September 11th and a drop from here would be a disaster.
Some analysts feel that the DOW can drop well below 6,000 maybe as low as 5,000. A drop to these levels could be an economic disaster for U.S. stocks for decades to come. Likewise, no one can forecast how high gold prices could rise in the event of another terrorist attack.
Gold prices are up dramatically this year (2002). Weaker US dollar and the threat of war will continue to keep strong interest in gold. Gold stocks will benefit from stronger demand and high gold prices.
Gold imports were up 105.5% for the year in Japan. Many Japanese have looked to gold in recent months as a safer investment than the country's shaky banking system. The Nikkei is not performing well while Japan was in a recession over the last few years. These days, the Japanese are also very worried that their banks may be next to fail. That's exactly why they've doubled their demand for gold in recent months. The Asian demand especially from India and China is expected to remain strong in the future.
Worldwide, many indicators point to a deep and widening U.S. recession, not a quick recovery. Indeed, we feel the 16.99% rise in gold in the past 12 months is the most significant reason to invest into gold stocks. While past performance is no guarantee of future earnings, moving 5% to 10% of your portfolio into a safe haven like gold makes sense to even the most conservative investors.
Since gold is traded worldwide in U.S. Dollars, the recent record high dollar forced down gold prices to record lows. With the dollar appearing to be on the decline long-term, the price of gold is expected to rise automatically.
During a strong economy, with low inflation rates, and peaceful times, gold traded down to a 20-year low of $255/oz. It has been historically proven that gold performs best when the economy is weak and the war threats are looming. During the late 1970's when the Iranians seized the American Embassy the stocks declined and gold hit an all-time high of $850 per ounce. Currently the economy is weakening and we have an expensive War on Terrorism underway. As government spending and the U.S. budget deficit soars, few investments benefit more from financial problems than gold.
Gold is a supply/demand driven market and demand has been at record levels for several years. However, European Central Banks flooded the market with an abundant supply artificially forcing down gold prices. But, the Bank of England made its final gold sale earlier this year. This means that only the Swiss now have significant reserves for sale under the Washington Agreement on gold in 1999. Although the disposals have been well controlled a hefty 820 tonnes of Switzerland’s designated 1300 tonnes still remain for sale. We feel rising prices and soaring demand is about to create a huge shortage of physical gold and further spike gold prices.
Due to low gold prices over the last five years, new gold exploration came to a standstill. Worldwide studies predict a 30% decline in industrial gold production over the next 10 years. Today, with gold prices rising dramatically and Central Bank supplies drying up, anti terrorists and terrorist activity causing markets to flutter and equity to continue to fall it is envisaged that prices will rise quickly as gold demand overwhelms the physical supply. In times of uncertainty and fall in equity prices markets turn to safe havens such as gold for investment. Rising prices and reducing costs bode well for the gold industry with produces and investors alike set to benefit. As gold breaks free from the doldrums of its economic cycle it is looking very attractive.
Future Prospects
Newcrest Mining has to clear its damaging currency hedge book position in coming years. It has two difficult years ahead of it before it extracts the first ore from its new Telfer gold project in Western Australia. Newcrest expects the $1.2 billion Telfer mine to open in late 2004 and become Australia's largest known gold deposit. The mine will boost its annual output to 1.5 to 2 million ounces a year. Trebling its current gold production. Telfer contains 26 million ounces of gold. It is expected to generate strong cash flows, which would allow the company to quickly reduce the $600 million in loans related to the Telfer project.
Newcrest was already on track towards posting a profit this financial year but it is not expected to improve significantly on last year's final dividend of 5c until 2004-05. Newcrest posted a net loss of $53 million from 2001-02, including a surprise $25 million loss on currency hedging. The foreign currency hedging position meant the company lost on average $108 for every ounce of gold it sold.
Despite the hedging problem, Newcrest had reduced its mining costs to an average $220 an ounce, which put it in the top quartile of gold producers. With the Indonesian Gosowong mine heading for exhaustion, Mr. Palmer said the current insecurity in Indonesia should work in Newcrest's favour. Citing the exit of foreign investment out of Indonesia - heightened by the Bali blasts - he said the Indonesian Government may allow Newcrest to go through with the development of its controversial Toguraci mine.
The company also has a complex gold hedge book and has flagged further hedging contracts, which could affect revenue in the second half. Its entire hedging position has become a major issue for the company and one it will have to address as best it can. The situation in which Newcrest finds itself presents a very good case for having no hedging at all.
Although the company has good assets and growth potential, the business is presently highly geared.
Financial Valuation Methodologies
The financial valuation method used to determine the value of the company is the constant dividend growth model. Calculate of expected return on a stock depends on correct estimation of the cost of debt and equity to the company. Debt cost can be estimated fairly accurately from interest and various loan figures from the financial reports. But, estimating accurate cost of equity capital can be a more complex task. The Capital Asset Pricing Model (CAPM) can be used to estimate the expected return on equity on a stock. CAPM requires estimating beta for the stock based on historical data, current risk free rate and market risk premium. Beta calculated for last 12 months is 3.7 for Newcrest (refer to Appendix 1). It is quite high and reflects the increase in the stock price in last 12 months in comparison with the ASX index. Beta for Newcrest over 3 years historical data is 2.135.
The cost of equity (rE) is derived as follows (for summary of calculations and comparisons with competitor AuironGold, refer to Appendix 1):
rE = RFR + B ( Rm- RFR) …………………………………………..(1)
Where,
RFR - Risk free rate is assumed as 5.5% which is current bond rate
B - Beta is calculated to be 3.7 (for the past 12 months)
Rm – Market return in assumed as 10%
Substituting these figures into equation (1) returns a cost of equity, rE, of 22%.
Once we have cost of equity then the weighted average cost of capital (WACC) can be calculated from the debt and equity of company. The cost of debt for Newcrest is calculated as follows:
rD = net interest / average net debt …………………………………………..(2)
WACC = (rD * D)/(E+D) + (rE * E)/(E+D) ……………………………………...(3)
Where,
rD – debt cost of capital
rE – equity cost of capital
D – the value of debt
E – the value of equity
Interest paid for 2002 is $20m for the $535.6m borrowings and substituting into equation (2) yields cost of debt, rD, of 3.73%
Newcrest capital structure has a debt and equity distribution of 51% and 49% respectively. Consequently, substituting the calculated values into equation (3) yields a WACC of 12.83% for a Beta of 3.7.
Using the constant dividend growth model value of the company and equity can be estimated. Value of the company can be derived as
V = F / (WACC – g) ………………………………………………………..(4)
Where,
F is free cash flows
G is the constant growth rate = 4%
Newcrest is showing negative free cash flow because of high capital expense for new mining exploration specially the Telfer mines. Telfer mines are expected to produce high volume of Gold in fact trebling its current output.
The value for the stock price, SP, would then be derived from the following:
SP = V / Outstanding shares on issue……………………………………..(5)
Where the Outstanding shares on issue is 276,723,487 as at August 2002.
Further assumptions used to evaluate the free cash flows are listed below:
- The total production cost is weighted towards Telfer and Ridgeway mines, therefore an average cost of $290 per ounce is used;
- The price of Gold is assumed at $500 per ounce (since in 2002 the average price received was $559), hence the profit margin used is $210;
- The development cost of both Ridgeway and Telfer ($1.4 billion) mines is distributed over 10 and 20 years;
- The growth rate of earnings will remain constant over the evaluation period;
- Telfer is expected to produce 800,000 ounces year over the next 20 years; and
- Assume impact of copper on earnings as negligible.
Sensitivity Analysis for capital distributed over 10 Years
Sensitivity Analysis for capital distributed over 20 Years
Notes:
- Yr 0 to Yr 3 assumed growth in production of 10%
- Yr 4 production includes Telfer
- Yr 5 to Yr 10 assumed growth in production of 10% including Telfer
- Value of firm (Newcrest) does not include depreciation write downs of the Telfer mine
Summary of Findings
Although reporting a loss of $53 million for the year to June 2002, caused primarily by two significant items, provisions for surplus foreign currency and hedging restructure. Fortunately, the Gold price received was $559 while the spot price was $548 reducing what could have been a more significant loss.
The outlook for the company is promising with a major capital project, Telfer, well under way with Newcrest management currently in the process of finalising funding. Feasibility studies for the Telfer project have been completed and indicate 26 million ounces of gold which will treble the current gold production of Newcrest.
However, Newcrest management is placed in a dilemma with how to fund the project, that is, debt, equity or both. The company is currently highly geared with debt representing about 50% of the available capital and consequently very sensitive to interest rate movements. Furthermore, it is struggling to cover its current liabilities and the signs are that it has not improved over time. Furthermore the Telfer project is expected to cost $1.2 billion for a 20 year mine life. The Telfer reserves of 26 million ounces will potentially treble its current gold production within the next 5 years. Having a focussed strategy on low cost and long life mines (e.g. Telfer and Ridgeway) places the company in the mid range in profit margin when compared against other gold mines. If the gold price remains at the current levels (about $AUD550/ounce), the profit margin would be approximately $AUD210 per ounce.
The constant dividend growth model yields the following share prices based on the successful implementation of $1.2 billion Telfer project, and a beta of 3.7 (based on the past 12 months share price movements). If a lower beta is used (e.g. 2.1 based on share movements over a three-year period) then the share value is likely to be greater than those projected below.
Therefore, based on the data above, the current share price of $6.19 appears to be overpriced. The low dividend yield of 0.8% coupled with the short-term currency hedging issues makes the investment less attractive at the current share price. Consequently, the short-term outlook is a sell recommendation. The longer-term prospects appear to be good if Newcrest generates the expected production levels from the Telfer and Ridgeway mines.
APPENDIX 1 – Financial Details
The table below is a summary of the Financial and Production details for the past 5 years for Newcrest Mining Limited.
Source: Newcrest Mining Limited Annual Report for 2002.
The following graph indicates the returns of the Newcrest share price relative to their competitor AurionGold, the All Ordinaries Index and the Gold Index. Newcrest has outperformed all 3 in capital growth over the past 12 months.
The Market Risk Premium is determined for both Newcrest and AurionGold by using the Market Index (All Ordinaries) as well as the Industry Index (Gold Index) for the past 12 months. Newcrest has a higher risk premium than Aurion, however, both stocks are more than 3 suggesting that more than 200% in their expected returns than for a given change in the market.
The following charts are the market risk premiums determined via the industry returns, yielding a much higher correlation with industry returns. The R2 of 0.79 for Newcrest suggests that 79% of the variation in Newcrest’s rate of return is related to industry fluctuations (and 92% for Aurion Gold).
Source: Comsec Ltd supplied reports.
* The stock and market returns were discounted by 5%pa bond returns (i.e. 0.0042/mth).
Key Financial Ratios
The following analysis compares the key ratios for Newcrest against those for AurionGold. The ratios which follow these compares Newcrest with foreign successful gold companies.
The Global Comparison
APPENDIX 2 – General Economic Conditions
The general economics conditions outlined below indicates the difficult times ahead for the economy and as a whole and more importantly for the consequences for the Gold industry. The AGC/Macquarie Gold Index is charted below and shows high volatility in the first half of the year with sharp gains in the 2nd quarter of this year wiped out in the 3rd quarter.
The following chart depicts the average gold price since 1900. It has only been since the early 1970’s that the gold price began its rapid rise.
Source: www.australiangold.org.au
The chart below depicts the borrowing behaviours of consumers in Australia. There appears to be an inverse correlation with personal/credit loans and housing loans. It seems that personal loans are a reasonable leading indicator for the housing loan market.
Another area worth considering is the bank lending by sector as depicted in the chart below. An understanding of the distribution of funds will allow the Newcrest to identify the avenues for sourcing funds for growth. The commercial lending has been low over the past 4 years and much of the growth has been in housing. However, the recent surge in commercial lending is attributable to the slow down in the Government debt portion of the sector. Newcrest management who are currently in the process of finalising funding for the Telfer project will welcome the focus in commercial lending.
The business confidence should be a good indicator of commercial capital expenditure as indicated in the chart below. Although the NAB business confidence survey is a mere subjective view of a select group of business professionals, it does leading signs of capital expenditure. The past 12 mths has seen relatively high confidence levels suggesting a possible surge in capital expenditure over the short to medium term. This translates into easier access to capital especially for planning post Telfer which is scheduled to expand production by end of 2004.
The low inflation, growing GDP and low interest rates has enabled the Australian Gold producers to take advantage of the readily available credit to expand their operations. The inflation was temporarily distorted in July 2000 after the introduction of the goods and services tax. The inflation is slightly overstepped the Reserve Bank’s target for inflation and may temp the Governor to lift rates soon after the global economy shows any signs of recovery.
Evaluation of Newcrest Mining Page of
Australian Commodity Statistics
2002 Newcrest Annual report
www.investor.ninemsn.com.au
Introduction to Corporate Finance, Frino, Cusack, and Wilson, pp53-54. Prentice Hall 2001.
The beta for the 3year period was obtained from the University of New South Wales /www.maths.unsw.edu.au/ForStudents/courses/math5995/. Furthermore, a beta of 0.8 was found for Newcrest from Bloombergs () - possibly a longer-term trend.
The bond rates are obtained from the RBA statistics, refer to www.rba.gov.au
If beta is determine from the 3 yr trends is used, i.e. B=2.1, then the cost of equity, rE, would result in 15.1%.
Introduction to Corporate Finance, Frino, Cusack, and Wilson, p160. Prentice Hall 2001.
Using beta of 2.1 would yield a WACC of 9.4%.
Newcrest’s share price on 17 November 2002 is $6.19.
The data is sourced from the Australian Gold organisation, refer to www.australiangold.org.au
Source: RBA monthly economic indicator data available from www.rba.gov.au
The Expenditure and business confidence data is obtained from the RBA monthly reales, visit www.rba.gov.au
