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Morningstar | Long Life Orebodies Provide a Platform for Newcrest Innovation

Newcrest updated its strategy and outlined plans for operational improvements at its latest annual investor day. The upshot is we remain confident the company will be able to drive incremental enhancements and we retain our AUD 23 per share fair value estimate for this no-moat firm. Shares remain slightly undervalued. The market is likely undervaluing the potential for management to add longer-term value through the application of new technologies, as well as some residual concerns around the reliability of Cadia post the tailings dam and seismic production interruptions. We don’t think a discount for Cadia is warranted longer term and sustaining reliable production is all that’s needed for market assumptions to change.

We continue to be impressed by Newcrest’s management. The methodical approach to continuous improvement has been a hallmark of the team since the current CEO started in 2014. We see further upside from it, principally through expansions of Lihir and Cadia. Over time, this should lower real unit costs to mine and process ore and make lower-grade ores more profitable. Cadia faces a declining grade profile but Lihir’s grades should remain around current levels for more than a decade. Likely low capital-cost, incremental throughput expansions and recovery improvements at Lihir and Cadia, along with the development of Wafi-Golpu, should see Newcrest maintain its current production level and cost position longer term despite the grade decline at Cadia. We expect the company to remain inside the lowest quartile of the cost curve longer term.

The long list of potential longer-term improvements, which if successful, should be able to be rolled out across several sites. The application of technology in metallurgy, processing, mining and energy should drive long-term value. Ore sorting to upgrade marginal grade ore and low capital processing solutions to drive plant throughput and recoveries are two of the more promising innovation areas.

The large, long-life orebodies Newcrest owns remain a key point of differentiation relative to the firm’s major global gold mining peers. The large mineral endowments at Lihir, Cadia, Wafi-Golpu and Telfer mean management has the mine life and potential value upside to develop and apply new technologies. A relatively low-grade reserve is the key challenge at Telfer, but the resource is large. We see ore sorting as a promising innovation which could allow Newcrest to upgrade marginal ore. This could improve margins and make more of the resource economic. Innovation to reduce unit costs, or upgrades of the ore grade feeding the processing plant, could add meaningful value. Newcrest has significant infrastructure at Telfer, including a more than 20 million tonne per year processing plant. It’s a substantial base from which to improve if some of the longer-term options can be brought to fruition.

At Cadia, there is also the potential to apply ore sorting. The processing plant expansion from the current 30 million tonnes to potentially 35 million tonnes per year is the major lever to add value and partly offset the planned decline in copper and gold grades. Innovation in the processing plant should be able to at least maintain metal recoveries around current levels, despite the drop off in grade as the mine matures. A longer-term, blue sky option is the potential to use leaching to strip gold and copper from the remnant low-grade ore at Cadia East and Ridgeway, negating the need to mine and process it.

We still see further upside at Lihir too. Processing plant throughput is key to productivity at Lihir. Since fiscal 2014, it has grown 42% to 14.3 million tonnes in fiscal 2018. Guidance is for a further increase to 15 million tonnes by June 2019. The history of steady throughput increases at site, and the avenues for further improvement in plant throughput and availability, means we think it’s likely Lihir will reach managements aspirational goal of 17 million tonnes a year in the medium- to longer-term. Concurrent efforts optimise separation sees Newcrest seeking to lift gold recoveries by 4% to 6%. Gold recoveries were 78% in fiscal 2018.

Newcrest is in strong financial shape and we expect it to remain so. Based on our forecasts, and assuming no acquisitions, the balance sheet should further strengthen. By the end of fiscal 2021, we expect Newcrest’s net debt to be close to zero, from USD 1.0 billion at the end of June 2018. The forecast decline in debt is despite the upcoming capital expenditure to develop Wafi-Golpu in PNG. There we assume the government will exercise its right to 30% of the project, diluting Newcrest to 35%. If Newcrest ends up retaining 50% of the project, which we would estimate to be modestly value accretive at around AUD 0.30 per share, net debt would still be less than end fiscal 2018 levels of USD 1.0 billion for the entire five-year forecast period. Newcrest hopes to have the mining lease for Wafi-Golpu in place by June 2019, with construction then set to complete around first half 2024. It will be another low-cost, long life asset which Newcrest should further be able to incrementally improve.