Endeavour Mining — The second five-year plan

On 30 September, Endeavour announced a new five-year exploration discovery target of 15.0–20.0Moz of gold in the indicated category of resources at an average cost of less than $25/oz. Full details of Endeavour’s announcement are included in its news release. A summary of the target, on a mine by mine basis, is as follows:

In general, Endeavour’s aims remain to continue to extend the lives of its core assets beyond its 10-year target. In addition, it is targeting the discovery of at least one more new standalone project via greenfields exploration. It also confirmed that it expects to discover at least another 2.5Moz of indicated resources in the remainder of FY21 (which forms part of its 2016–21 target of discovering an additional 10.0–15.0Moz gold) to add to the 8.5Moz already discovered.

By their nature, the targets outlined in Endeavour’s announcement are conceptual and there is no guarantee that exploration will delineate resources of this size. Nevertheless, a number of features of the table are noteworthy:

Three methods present themselves to determine the value (or potential value) of Endeavour’s five-year exploration programme:

At its most simple, the valuation of the resources discovered could be deemed to be the same as the investment required to discover them. In this case, Endeavour is looking to discover 15.0–20.0Moz in the indicated category at a cost of discovery of less than US$25/oz, implying a valuation for the programme of US$375–400m before costs depending on the ultimate level of investment and the final level of resources discovered.

Endeavour’s current enterprise value is US$6.5bn, which implies a market-based valuation per attributable resource ounce of US$199.49/oz. To achieve that valuation however, the company was required to make an investment of US$3.9bn (Edison estimate, end-FY21) or US$106.79 into each of its ounces – implying, among other things, a pre-investment valuation of Endeavour’s resources of US$92.70/oz. On this basis (which may be appropriate, given that the vast majority of Endeavour’s targeted resources are near-mine and therefore comparable to existing resources), we would calculate a value for the company’s exploration programme of US$1,391–1,854m, or US$5.59–7.45/share (cf a cost of US$375–400m, or US$1.51–1.61/share, to achieve).

To date, in Endeavour’s 2016–2021 exploration plan, it has delineated 8.5Moz of new resources with a further 2.5Moz anticipated to be discovered by the company before the year end. Of these 8.5Moz, 7.4Moz (or 87%) have been at three assets, where it has been possible to rapidly integrate a portion of the resources into mine plans, from which it is possible to make an estimate of the tangible value added to Endeavour, as follows:

Pro rata to this performance, in its second five-year exploration plan, we may expect Endeavour to have delineated 12.75Moz by October 2026, with the expectation that it would discover a further 3.75Moz by the end of the year to take the total to 16.5Moz (ie 10% above the lower exploration target boundary limit). Of these 12.75Moz, we might expect 38.3%, or 4.88Moz to be rapidly incorporated into existing mine plans and to add US$1,070m (or US$4.30/share) in attributable value to the company cf a cost to achieve this value of US$375–400m (ie a value uplift of US$670–695m, or US$2.69–2.79/share).

Note that, in this particular scenario, valuation upside continues to exist in the form of additional ounces being discovered and/or additional ounces being rapidly incorporated into Endeavour’s mines’ mine plans.

On 1 October, Endeavour announced the launch of a US$500m offering of fixed rate senior notes as well as a new US$500m revolving credit facility (RCF). Interest on the notes is to be paid semi-annually at a rate equal to 5.00% per annum and the notes will mature on 14 October 2026. The proceeds will be used to (i) repay all amounts outstanding under the group’s US$370m bridge term loan facility (currently attracting interest at a rate of 2.25%), which was used to retire higher cost debt facilities acquired with Teranga; (ii) repay the US$130m drawn under the group’s existing revolving credit facility (Libor + 2.95–3.95%); and (iii) pay fees and expenses etc.

As part of the bond process, Endeavour sought issuer ratings from S&P and Fitch, who filed their issuer ratings as follows:

In the meantime, the new RCF was reported to have received strong support from the syndicate of banks involved. The aggregate coupon rate of the new RCF will be between 2.40–3.40% depending on Endeavour’s leverage. However, the company expects the facility to remain undrawn as of the issue date (albeit with a commitment fee payable on the undrawn portion of 0.84%).

In addition to repaying the existing bridge facility and drawn portion of the RCF, the new financing arrangements will:

Historically, Endeavour has a good record of meeting its production and cost guidance targets and FY20 was the eighth year in succession in which the company achieved its production cost and AISC targets. Currently, Endeavour’s production and cost guidance for each of its mines for FY21 is as follows:

Readers should note that Endeavour’s guidance includes production from Sabodala-Massawa and Wahgnion from 10 February onwards only. They should also note that, for the purposes of our forecasts (below) we have left Agbaou (which was sold by Endeavour in Q121) fully consolidated into Endeavour’s ‘pro forma’ accounts. For those who wish to deconsolidate it, Agbaou’s profit and loss for the period in which it was under Endeavour ownership in Q121 is reproduced below. All told, however, we would note that its contribution to Endeavour’s bottom line was, to all intents and purposes, immaterial during this period.

In the meantime, we understand it is not Endeavour’s intention, at least for the time being, to reflect Karma as an asset held for sale (despite its now being classified as ‘non-core’). With these provisos, our updated forecasts for Endeavour for the remainder of FY21 and in the wake of the end of the Q321 quarter, on both an ‘as reported’ and ‘pro forma’ basis are 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, 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).

Notwithstanding the detailed appearance of our forecasts, readers are cautioned that forecasting on a quarterly basis for mining companies in general is prone to large variations between actual and forecast numbers. As such, the exhibits both above and below should be regarded as indicative, rather than prescriptive, particularly with respect to individual quarters. With this caveat (especially in relation to deferred tax and the minority interest), a comparison between our FY21 adjusted net EPS from continuing operations estimates and consensus estimates, by quarter, is as follows:

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. To date, the effect of COVID-19 on Endeavour’s operations in West Africa has proved to be negligible and is expected to remain so. Nevertheless, Endeavour has mitigated future risks as far as possible by both 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 also by preparing multiple different levels in its pits from which to produce, thereby affording it operational flexibility in the event of 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 and Agbaou in FY20 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 FY21, in the case of Endeavour, we have instead opted to discount six years of forecast cash flows in FY21–26 back to the start of FY21 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 be excluded from such a calculation on the basis that it is an investment. In the case of Endeavour, however, it has been included on the grounds that it is a critical component of ongoing business performance in its ability to continually expand and extend resources and, ultimately, reserves and, thereby, the lives of its mines.

In this case, our estimate of cash flows in FY26 has fallen by 2.5% to US$3.97/share (cf US$4.07/share previously), albeit almost exclusively as a consequence of an assumed increase in Endeavour’s exploration budget from c US$35–40m originally in its first five-year exploration programme (to discover 10.0–15.0Moz at a cost of c US$15/oz) to US$80m pa in its second (see above). This estimated cash flow of US$3.97/share gives rise to a terminal valuation of the company at end-FY26 of US$39.70/share (cf US$40.67/share previously), which (in conjunction with forecast intervening cash flows) then discounts back to a valuation of US$34.62/share (cf US$35.46/share previously) at the start of FY21, as shown in the graph below (albeit with the proviso that the additional exploration expenditure could/should, for a cost of US$400m, or US$1.61/share, add c US$4.30–7.45/share in value to Endeavour’s shares).

Given its elevation into the ranks of the world’s foremost producers of gold, however, we believe that 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 currently expecting 2.3727% inflation (cf 2.2069% previously). These two measures imply an expected real equity return of 6.47% (1.09/1.023727) and applying this to our forecast cash flows would imply a terminal valuation for Endeavour of US$61.33/share (cf US$61.19/share previously) and a current valuation of US$55.84/share (cf US$55.59/share previously). Readers should note that, given its beta of 0.54 (source: Refinitiv, 18 October 2021), even this (real) discount rate of 6.47% is likely to be conservative.

In the meantime, Endeavour’s valuation remains at a material discount to those of its newly acquired peer group, as shown in Exhibit 8, 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), is as follows:

Of note is the fact that Endeavour’s valuation is materially cheaper than the averages of the majors on all but one of the measures shown in Exhibit 8 regardless of whether Edison or consensus forecasts are used (the exception being year 1 yield). On an individual basis, it is cheaper than its senior gold mining peers on at least 38 out of 54 (70% of) valuation measures if Edison forecasts are used and, similarly, 37 out of 54 (68%) if consensus forecasts are used. Reverse engineered, the average valuation measures of its peers imply an average share price for Endeavour of US$32.50, or C$40.13 per share.

According to its Q221 balance sheet, Endeavour had net debt of US$147.6m. This compares with net debt of US$220.2m as at end-Q121 after the completion of the Teranga acquisition and the injection of US$200m by La Mancha and with net debt of US$43.3m as at end-FY20 (pre the Teranga acquisition). This figure of US$147.6m includes lease liabilities of US$50.7m and an option premium of US$44.6m. Excluding these two results in a net debt position of just US$52.3m, or just 1.3% of the company’s balance sheet equity of US$4,441.7m at end-Q221. Note that this figure of US$52.3m also excludes US$29.7m held in the form of ‘restricted cash’ in ‘other financial assets’. It also differs slightly from the figure of US$77.1m quoted elsewhere in Endeavour’s announcements owing to the discounting, variously, of certain committed future payments to present value.

Note that, for the purposes of our financial modelling (see Exhibit 9, below) and for simplicity’s sake, we have assumed the consolidation of Endeavour’s and Teranga’s balance sheets took place retrospectively on 31 December 2020. In this case, we estimate that 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 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 (see Exhibit 9, below).