Endeavour Mining — A strong year ahead

Endeavour remains on track to achieve its FY23 production guidance of 1,325–1,425koz at an all-in sustaining cost (AISC) of US$940–995/oz. After Q1 production of 301koz, output, as previously guided, is set to be weighted towards H223. This is due to Endeavour focusing on development over production in H123 (primarily Q123) as lower grades are processed at Sabodala in preparation for in-pit tailings deposition and development of the new Massawa North Zone satellite pit. Similarly, both Houndé and Boungou focused on higher stripping activity in Q123, allowing access to higher-grade mining areas in H223. However, strong production at both Ity and Mana (91.2koz cf 83.6koz and 44.1koz cf 39.5koz expected, respectively) compensated for the reduced production at Boungou, in particular, during the quarter. Unit costs were somewhat affected by lower production figures and increased sustaining capital during Q123 (AISC US$978/oz cf US$911/oz in Q422). However, this was partly offset by lower aggregate costs and the aforementioned pre-stripping and waste stripping activities at Boungou, Sabodala-Massawa and Houndé to result in a 21.9%, or US$34m, increase in earnings from mine operations quarter-on-quarter to US$189m in Q123. We expect the trend of improving earnings from mining operations to continue throughout the year, as a result of increased gold production in H223 and the prevailing gold price.

As discussed in our prior note, Endeavour completed a strong FY22 dividend programme totalling US$200m (c US$0.81/share). This represents a US$50m or 33% uplift relative to the base dividend commitment for the year. Endeavour paid its H222 dividend of US$100.0m or US$0.40 per share on 28 March 2023. The company has reaffirmed its shareholder returns programme comprising a minimum progressive dividend subject to additional dividends and share buybacks, provided the prevailing gold price remains above US$1,500/oz, and that Endeavour’s leverage remains below 0.5x net debt/adjusted EBITDA. Endeavour has set the minimum dividend commitment for FY23 at US$175m, up US$25m from FY22’s base level.

Shareholder returns were supplemented through the company’s share buyback programme in FY22 to the sum of US$98.7m, or 4.6m shares. We note the continuation of this returns programme, with US$10.9m or 0.4m shares repurchased in Q123.

Endeavour’s 2022 sustainability report was released on 16 May 2023. The company calculates that its total economic contribution to host countries was more than US$1.9bn in 2022 and reports that 81% of total procurement was in country, supporting more than 1,600 national and local businesses. Endeavour’s 2022 CO2/oz emissions intensity of 640kg CO2/oz was ahead of its targeted <670kg CO2/oz for the year. 2022 also saw a 57% success rate for water reused and recycled and management has set an ambitious target of 70% for 2023. 2023 ESG targets (including safety, diversity and climate change) represent 30% of executive short-term and 15% of long-term incentive compensation. Additionally, Endeavour has reaffirmed its target of achieving a 30% reduction in its carbon emissions intensity by 2030 and net zero by 2050.

Endeavour continues to enjoy organic growth, with management aiming to expand current projects and delineate resources further. This is shown across three key ventures: first, the BIOX expansion, which remains on budget and is set for completion in Q224 with US$203m (or 70%) of the total growth capital committed to date; second, the Lafigué greenfield project construction, with US$205m or 46% of the total budget committed following the results of a robust definitive feasibility study (DFS); and third, Endeavour will continue its company-wide exploration programme with a US$70m budget for FY23 (US$22m spent in Q123), with a key focus on the new Tanda-Iguela discovery, where an updated resource estimate is expected in H223.

Endeavour’s Q123 financial results were materially ahead of our expectations, both on a headline and underlying basis. They were also ahead of the market, with adjusted net earnings from continuing operations attributable to shareholders of US$0.283/share compared to a prior consensus expectation of US$0.23/share, within a range of US$0.13–0.33/share. Exhibit 1, below, analyses the company’s results with respect to both our prior forecasts (see our note Rising gold prices begin to feed through, published on 18 April) and the results of the prior quarter (Q422). Considering Endeavour’s underlying results (stripping out adjusting items), in general terms its outperformance could be attributed to it producing 8.0koz (2.7%) more gold than we had forecast during the quarter and selling 16.0koz more (ie 8.0koz more than it produced), which gave rise to a positive variance of US$39.4m in revenue relative to our prior expectations. This was augmented by depreciation, which was US$23.5m lower to result in a positive pre-tax variance of US$63.2m, partially offset by tax that was US$19.0m higher (albeit the effective tax rate was 4.3 percentage points lower) to result in earnings that were US$37.3m (or US$0.145/share) ahead of our forecasts.

Note that Endeavour changed its definition of cash costs in Q420 to include royalties. The decision was made so that Endeavour could 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 royalties are reported as a standalone item distinct from operating expenses), we are continuing to present total cash costs in Exhibits 1 and 2 excluding royalties.

Following Q123 results, we have updated our FY23 financial forecasts, which continue to be consistent with Endeavour’s operational guidance of production estimated at 1,325–1,425koz and an AISC of US$940–995/oz. We have also, in recognition of recent metals price moves, increased our gold price forecast for the remainder of the year, from US$1,962/oz previously to US$2,003/oz. Note that, apart from this, our longer-term gold price forecasts remain unchanged (although we are working on updating our long-term forecast). Of note, increased gold prices, coupled with the higher production moving into H223 and the decrease in depreciation (attributable to the combination of lower production volumes in Q123 and the lower depreciable base following the Q422 impairment charge, discussed in our prior note) lead us to increase our estimated adjusted net earnings from continuing operations by 14.6% for the full year to US$395.5m. Our updated forecasts are as follows:

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 FY23, for Endeavour we have opted to discount four years of forecast cash flows in FY23–26 back to FY23, 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). We would normally exclude exploration expenditure from such a calculation on the basis that it is an investment. In the case of Endeavour, however, we include it because it is a critical component of the company’s ability to continually expand and extend the lives of its mines.

Our estimate of cash flows remains consistent in FY26 at US$4.25/share (cf US$4.25/share previously), which implies a terminal valuation of Endeavour at end-FY26 of US$42.48/share, calculated using a discount rate of 10%. With our forecast intervening cash flows, this terminal valuation then discounts back to a present valuation of US$36.73/share (cf US$35.59/share, previously) at the start of FY23, as shown in Exhibit 3 below.

Now that Endeavour is one of the world’s most important producers of gold, we believe it can increasingly attract lower-cost finance, which leads us to also consider a capital asset pricing model (CAPM) derived valuation. Long-term nominal equity returns have been 9% and 30-year break-evens indicate an inflation rate of 2.2345% (source Bloomberg, 5 May 2023) versus 2.2399% previously. These two measures imply an expected real equity return of 6.62% (1.09/1.022345) and applying this to our forecast cash flows would imply a terminal valuation for Endeavour of US$64.20/share (US$64.25/share previously) and a current valuation of US$58.15/share (US$57.02/share previously).

Endeavour’s valuation on a series of commonly used measures relative to a selection of gold mining majors (the ranks of which it has joined since its takeover of SEMAFO and Teranga) is as follows:

Of note is the fact that, without exception, Endeavour’s valuation is materially cheaper than the averages of all nine of the measures shown in Exhibit 4, regardless of whether Edison or consensus forecasts are used. On an individual basis, it is lower than its senior gold mining peers on at least 47 out of 54 (87%) valuation measures if Edison forecasts are used and 48 out of 54 (89%) 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$39.04 (C$53.15 or £31.07) per share. The current LSE share price is £21.09, equivalent to US$26.60 at an exchange rate of $1.2564//£.

According to its Q123 balance sheet, Endeavour had net debt of US$85.8m (including leases) as at end-March. This compares with net cash/debt figures at the end of previous comparable quarters as follows:

The net debt figure of US$85.8m includes lease liabilities of US$41.5m, which, if excluded, would result in an adjusted net debt position of US$44.3m. This is equivalent to, but differs slightly from, the US$50.3m net debt figure calculated by Endeavour and quoted in its announcements owing to discounting certain committed future payments to present value on Endeavour’s balance sheet. It also excludes US$38.3m held in the form of ‘restricted cash’ and US$40.0m in shares of Allied Gold received as consideration for the sale of Agbaou (agreed on 22 January 2021), both held in ‘non-current other financial assets’ on the company’s balance sheet. The end March net debt of US$85.8m was a swing from end December net cash of US$79.3m. Key cash movements in Q123 included:

Historical note: for the purposes of our financial modelling in Exhibit 6 and for simplicity, 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 2020). 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.