Endeavour Mining — A strong opening

A summary of Endeavour’s Q122 results relative to both Q421 and our prior expectations is provided in the table below:

Endeavour’s results for the quarter were distorted by an exceptional loss on financial instruments of US$178.8m and the fact that Karma was reclassified as a discontinued operation after its sale in February. For the purposes of like-for-like comparison, therefore, the former has been excluded from the column entitled ‘Q122a (underlying)’ in Exhibit 1, above, while the latter has been reconsolidated back into Endeavour’s income statement and the associated US$14.8m profit from discontinued operations (including a US$17.8m profit on the mine’s sale) removed. Note therefore that the US$3.3m difference between ‘profit attributable to shareholders’ and ‘adjusted net earnings attributable’ in this column is accounted for by the US$3.3m underlying attributable loss that we calculate was reported by Karma during the quarter after deduction of the appropriate US$0.3m minority interest.

Within that context, gold produced and sold was 7% ahead of our forecasts, with the outperformance accounted for almost exclusively by Endeavour’s flagship assets, Hounde, Ity and Sabodala-Massawa. This outperformance in production was complemented by a realised gold price that was 1.4% better than the actual gold price recorded during the quarter to result in revenue that was 9% ahead of our prior forecasts. In combination with costs that were 6.5% lower in aggregate (13.0% lower at the level of unit cash costs), this in turn resulted in gross profit that was 20.3% better than our expectations and profit before tax that was similarly 20.9%, or US$39.8m, better. However, this outperformance was itself largely offset by a current tax charge that was US$31.8m higher than our prior expectations (owing to an increase in taxable income relative to a reduction in tax provisions in Q421 at Mana and a tax expense relating to the start of mining at the Massawa pits) and which was also augmented by a deferred tax charge of a further US$11.2m (which Edison has historically typically declined to attempt to forecast) to result in adjusted net EPS from continuing operations that were within 4% of our prior forecast, at US$0.49/share.

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 forecasts (below) 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 discrete item distinct from operating expenses), we are continuing to calculate total cash costs excluding royalties. A comparison between Endeavour’s actual results and both our and the market’s prior forecasts for the quarter is as follows:

Endeavour updated its production and cost guidance for FY22 in the aftermath of its sale of the Karma mine in February to 1,315–1,400koz at an all-in sustaining cost (AISC) of US$890–930/oz. This remains unchanged. However, in addition to incorporating its Q122 actual results into our full-year forecasts, in recognition of recent metals price moves, we have also reduced our gold price forecast for the remainder of the year, from US$1,890/oz previously to US$1,823/oz currently (the prevailing price at the time of writing). Note that, apart from this, our longer-term gold price forecasts remain unchanged. Other changes to our forecast treatments are as follows:

As a result (and with the usual caveat around quarterly estimates), our updated forecast for adjusted net earnings attributable to shareholders for FY22 for Endeavour in the wake of its Q122 results is now as follows:

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 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 in 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.

Within this context, 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. Mining activities are expected to continue at the Massawa Central Zone for the remainder of the year along with additional mining at the Sofia North and Sofia Main pits, while mining at the Massawa North Zone is expected to commence mid-year, with non-refractory ore available for immediate treatment in the carbon-in-leach (CIL) plant, while refractory and transitional material is stockpiled. Mined and processed grades are therefore expected to decline in Q222, given the greater focus on waste extraction at the Massawa Central and North Zones ahead of the rainy season, but are then expected to increase in the second half of the year.

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. 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 in the event of disruptions.

On 4 April, Endeavour announced its decision to proceed with the development of its Sabodala-Massawa expansion project, based on the results of a recently completed definitive feasibility study (DFS). A summary of the salient features of the DFS’s results is as follows:

Whereas, in our previous note (see Refining forecasts ahead of results, published on 28 April 2022) we had yet to incorporate the detailed Sabodala-Massawa expansion project into our longer-term forecasts (our previous valuation having been based on the outputs of the 2020 pre-feasibility study), our longer-term financial model has now been updated to rectify this omission. Thus its US$3.47/share standalone valuation (based on its NPV5% of US$861m – management valuation, see above) is now fully included in our company valuation (below). Note that this US$861m valuation is equivalent to US$560 per project ounce mined.

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 of forecast cash flows in FY22–26 back to the start of FY22 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.

All other things being equal, excluding the Sabodala-Massawa expansion project from our calculations, our estimate of cash flows in FY26 would have remained unchanged in the wake of Q122 results at US$3.97/share. However, with it included, our estimate of cash flows in FY26 has instead increased to US$4.28/share. This estimate implies a terminal valuation of the company at end-FY26 of US$42.78/share – which represents an increase of US$3.11/share relative to our prior terminal valuation of US$39.67/share and may be compared with Endeavour’s standalone valuation of the project of US$3.47/share (albeit with the caveat that we habitually use a 10% discount rate where Endeavour used a 5% discount rate in its calculation, above). In conjunction with forecast intervening cash flows, this terminal valuation of US$42.78/share then discounts back to a present valuation of US$35.96/share as at the start of FY22, as follows:

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 2.5289% (source: Bloomberg, 17 May) compared to 2.5432% previously. These two measures imply an expected real equity return of 6.31% (1.09/1.025289) and applying this to our forecast cash flows would imply a terminal valuation for Endeavour of US$67.78/share (cf US$63.01/share previously) and a current valuation of US$60.40/share (cf US$59.48/share previously).

In the meantime, Endeavour’s valuation remains at a material discount to those of its peer group, as shown in Exhibit 7, 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 7 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 36 out of 54 (66%) of valuation measures if Edison forecasts are used and 39 out of 54 (72%) 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$31.52, or C$40.50 (or £25.58), per share.

According to its Q122 balance sheet, Endeavour had net cash of US$82.7m as at end-March, despite making US$69.3m in dividend distributions and US$31.1m in share repurchases during the quarter. This net cash figure compares with net cash/(debt) figures at the end of recent, comparable quarters, as follows:

This figure of US$82.7m includes lease liabilities of US$47.1m and an option premium of US$52.6m which, if excluded, would result in an alternative net cash position of US$182.4m. This is equivalent to, but differs slightly from, the US$166.6m net cash figure calculated by Endeavour and quoted in its announcements owing to the discounting, variously, of certain committed future payments to present value. It also excludes US$31.2m 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 ‘non-current other financial assets’.

Note that, for the purposes of our financial modelling in Exhibit 9 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.