Newmont Corporation — Material outperformance begets material upgrade

Newmont’s financial results for Q221 exceeded our expectations for the third quarter in succession, in this case by a material degree. All other things being equal, an improvement relative to Q1 was expected. In this case, however, revenues grew by more than costs, resulting in an increase in margins at the pre-tax level that persisted below the line, despite a normalisation of the effective tax rate (see Exhibit 2 for analysis).

A summary of the operational highlights of the quarter relative to our prior expectations is provided in Exhibit 1. In general, operations in South America and Australia recovered relative to Q1, despite ongoing disruptions as a result of the COVID-19 pandemic, while recovery in North America was delayed. Africa continued to perform at elevated levels, while output at Nevada Gold Mines was adversely affected by a mechanical mill failure at Carlin’s Goldstrike roaster (more information on this failure will be forthcoming at Barrick’s Q221 results, scheduled for release on 9 August).

At the level of the individual mines, one (Penasquito) performed definitively better than our expectations, three (Yanacocha, Merian and Boddington) performed slightly better than our expectations and two (Musselwhite and Cerro Negro) performed in line with our expectations, with the balance performing either slightly worse or worse than our expectations. At least two other features of Newmont’s results were noteworthy:

In financial terms, adjusted net income exceeded our prior forecast by US$220m, or a material 48.9%. The main features behind this outperformance were a 3.8% (or US$111m) positive variance in revenues (of which 2.4% could be attributed to the gold price – US$1,823/oz realised vs US$1,814/oz average price during the period and US$1,781/oz previously forecast) and a 2.8% (US$61m) further positive variance in the form of lower costs. The other material variance was a positive swing in ‘other net income’ from a loss of US$82m in Q121 to a profit of US$50m in Q221. The aggregate positive variance of these three items of US$264m was moderated by a US$101m negative variance in taxation to result in adjusted net income of US$670m versus our prior forecast of US$450m.

A full analysis of Newmont’s Q121 financial performance relative to both our prior forecasts and Q121 results is provided in the exhibit below.

As noted at the time of Newmont’s Q420/FY20 results, both (higher) production and (lower) costs are expected to be weighted towards H221 (approximately in the ratio 47:53) and this effect will be most pronounced in the first and last quarters of the year. In part, this profile will reflect rising grade profiles, in particular at Boddington and Ahafo (the H1:H2 production ratio at Boddington will be enhanced by productivity improvements from the autonomous haulage system ramp-up, while that at Ahafo will also be volume driven by productivity improvements throughout the year from the change in mining method at Subika underground to sub-level shrinkage). However, Merian, Musselwhite, Porcupine and CC&V are all expected to exhibit rising production profiles as well, as the year progresses. At the same time, costs will be weighted in the other direction; that is, H221 costs are expected to be lower than H121 costs. In part, this reflects lower production in H121. However, it also reflects higher sustaining capital costs in H121 relating to the installation of the autonomous haulage system at Boddington.

In the light of Q121 results, the prevailing gold price (US$1,793/oz vs US$1,776/oz previously) and slight adjustments to our ongoing treatment of ‘other’ income and expenses, our updated financial forecasts for Newmont for the remainder of FY21, by quarter, are now as follows:

Note that, all other things being equal, the more the gold price rises, the more Newmont’s effective tax rate falls as lower tax operations contribute proportionately more to pre-tax profits. After our revisions for the remainder of the year, our basic adjusted EPS forecast of US$3.209/share (vs US$2.711/share previously) for FY21 compares to the market consensus, as follows:

Newmont’s dividend for Q121 was maintained at US$0.55/share. At the time of its Q320 results in October 2020, Newmont unveiled a new dividend framework whereby it formally rebased its dividend to a ‘base’ pay-out of US$1.00/share (or US$0.25/share per quarter) at a gold price of US$1,200/oz, but also stated explicitly that it would return 40–60% of incremental attributable free cash flow that it generated above a gold price of US$1,200/oz to shareholders. Under the new framework, Newmont will augment the ‘base’ pay-out in increments of US$0.60–0.90/share per year (or US$0.15–0.225/share per quarter), evaluated in gold price increments of US$300/oz for gold prices above US$1,200/oz, with the goal of targeting 40–60% of incremental free cash flow above a gold price of US$1,200/oz returned to shareholders. Thus, a (sustainable) gold price at US$1,800/oz should (on this basis) result in a quarterly dividend of US$0.55/share, whereas a gold price below that level could result in one of US$0.40/share. In this context, however, it is worth noting that Newmont affords itself a degree of latitude in the level of the ultimate pay-out in that, should it decide to pay out nearer 60% of incremental attributable free cash flow to shareholders that it generates above a US$1,200/oz gold price, rather than 40%, then there is scope for the quarterly dividend to remain at the higher level, notwithstanding the gold price dipping below the US$1,800/oz level. In consequence, we have left our dividend forecasts for Q321–Q421 and FY21 unchanged on the basis that we believe the gold price temporarily dipping below US$1,800/oz is unlikely to result in any readjustment in the quarterly distribution.

In addition to its financial results, Newmont also reported some signs of modest cost pressure within the industry at large. These pressures derive from a number of sources (eg labour) and, in some cases they are also mitigated (eg by automation), albeit not entirely extinguished. While these pressures are expected to have little or no effect on Newmont’s performance for the rest of this financial year, they are nevertheless expected to result in underlying cost inflation of c 3–5% in aggregate (nominal) terms by the end of FY22 relative to prior expectations and we have now built this additional assumption into our financial models for the remainder of the lives of Newmont’s mines’ operations.

Our approach to the valuation of Newmont has remained unchanged since our initiation note (see The sustainable leader, published on 9 February 2021; see that note for a fuller explanation of the methodologies involved). The following is an update of our valuation in light of the Q221 results and our updated forecasts for FY21 and our longer-term assumption (cost) changes.

Newmont is a multi-asset company that has shown a willingness and desire to trade assets in the past to maintain production, reduce costs and maximise shareholder returns. As a result, rather than our customary method of discounting maximum potential dividends over the life of operations back to FY21, in the case of Newmont, we have opted to discount forecast dividends back over six years (previously five) from the start of FY21, then apply an ex-growth terminal multiple to forecast cash flows in that year (ie FY26) at the appropriate discount rate. In the normal course of events, we would exclude exploration expenditure from such a calculation on the basis that it is an investment. In the case of Newmont, however, we have included it in our estimate of future cash flows on the grounds that it may be a critical component of ongoing business performance in its ability to continually expand and extend the lives of the company’s assets via exploration.

Despite the changes to our short-term forecasts for FY21, our estimate of Newmont’s pre-financing cash flow in FY26 has declined by 3.8% to US$5.27 per share (vs US$5.48/share previously and US$1.22/share in FY18) to reflect our increased cost assumptions. On this basis, our terminal valuation of the company at end-FY26 would be US$81.10/share (vs US$86.95/share previously). This valuation is based on an assumption of zero growth in (real) cash flows beyond FY26, which is inherently conservative; in this case, however, whereas the discount rate that we used previously was 6.3% (in real terms), this has now increased to 6.5% as expectations of inflation in the wider economy (as measured by US 30yr breakeven bond yields) have fallen to 2.3% in recent months (vs 2.5% previously). Note that, had the analysis been performed by applying the prior real discount rate of 6.3%, our valuation would have declined to only US$83.68/share).

In conjunction with forecast intervening dividends, this terminal value then discounts to a net present value of US$73.15/share (vs US$78.08/share previously) at the start of FY21.

This (absolute) analysis inherently excludes any value to Newmont from its other development assets, such as Coffee, Galore Creek, Conga, Norte Abierto and Nueva Union, which together represent combined reserves and resources of 53.93Moz attributable to Newmont. It is also conservative in its assumption of zero growth in cash flows after FY26.

Newmont’s valuation on a series of commonly used measures, relative to its peer group of the 10 largest publicly quoted senior gold producers, is as follows.

In comparing this table with the equivalent table in our initiation note on Newmont (see Exhibit 23 on page 25 of The sustainable leader, published on 9 February 2021), it can be seen there has been a de-rating of all but two companies over all years since that date and a de-rating of the majority of companies across all three years, with the most pronounced effect being in year 1. Nevertheless, it can also be seen that while Newmont continues to command a premium rating relative to its peer group on most valuation measures, it remains materially cheap with respect to its dividend yield. Based on consensus forecasts, we estimate that Newmont’s share price would have to rise by an average of 45.5% for its dividend yield to match those of its peer group. Based on our forecasts, we estimate its share price would have to rise 53.9%.

As before, one further observation concerning the comparability of the above measures is merited. Given its policy of proportionately consolidating its interest in Nevada Gold Mines and that it owns 100% interests in the majority of its remaining mining operations (with the exceptions of Yanacocha and Merian), estimates of cash flow in particular are also close to estimates of cash flow attributable to shareholders (Newmont estimates that 97% of free cash flow was attributable to the company in Q221). This is not always the case for its peers, where fully consolidated earnings and cash flow from assets not owned 100% may not so easily approximate cash flow attributable to shareholders, making direct comparison using these measures either difficult or, potentially, misleading.

A summary of our updated valuation of Newmont over 29 measures of value across three different methodologies over the next five years shown in Exhibit 7.