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Morningstar | Newcrest Delivers Solid 1H by Focusing on Core Operations

No-moat-rated Newcrest’s first-half fiscal 2019 adjusted net profit after tax doubled to USD 237 million versus a year ago. The result looked slightly stronger than our USD 226 million forecast, but the difference was just unrealised foreign exchange gains. Stripping out these gains, net profit was as expected. A strong improvement in production volumes at Cadia and lower unit costs at Lihir underpinned the higher profit. Gold output was up 6% and copper 33%, while group all-in-sustaining costs declined 13% to USD 747 per ounce. Higher profit came despite a headwind from lower prices. Newcrest’s realised gold and copper prices were down 5% and 7%, respectively.

With the result as expected, our AUD 23 per share fair value estimate is unchanged. Newcrest reaffirms fiscal 2019 guidance for production and operating costs. Guidance is to produce 2.35 to 2.60 million ounces of gold and 100,000 to 110,000 tonnes of copper. The guidance midpoints represent a 5.5% uplift in gold and 35% rise in gold production versus fiscal 2018. As we had already forecast, management now says capital expenditure will be towards the bottom of the guidance range, in part helped by favourable currency moves. Newcrest’s share price has risen with the improved operating performance at Cadia and Lihir and the recent gold price rally. The shares are now close to fairly valued.

Lihir and Cadia remain the long-life engines for Newcrest. Incremental expansions at Lihir remain on track with the company expecting to achieve annualised processing plant throughput of 15 million tonnes per year from mid-2019. We continue to see long-term upside to Lihir’s production volumes and unit costs, underpinned by the large, long-life orebody and technological innovation. The study for the planned expansion of Cadia to process 33 million tonnes of ore per year is expected to complete in late 2019. It’s a valuable, low-capital cost option to partly offset the planned grade decline.

Given the recent industry consolidation, with Newmont agreeing to buy Goldcorp, there was speculation Newcrest desired to do a large merger or acquisition, or M&A. This was not in keeping with our view of the company’s strategy or what the strategic priorities should be. Our general aversion to large scale M&A is heightened by the company’s value destructive Lihir acquisition in 2010.

Counter to the speculation, management pleasingly reaffirmed a strategy and focus in alignment with our view. The company is focused on generating shareholder value, not growing in size or production. Key priorities are first organic growth, then greenfield exploration, then early entry into joint ventures with junior explorers and lastly M&A. Pleasingly, Newcrest heavily caveated its desire to grow via M&A. In broad terms, management said shareholder returns were likely to be diluted by M&A unless there were unique project synergies or specific skills Newcrest could bring to improve overall economics. Management’s reluctance to engage in large-scaled M&A is in accord with our view that, in general, value is destroyed.

We agree with management that the other strategic priorities should come before large scaled M&A. The primary focus on organic growth, as exemplified by the expansions of Lihir and Cadia, has been key to the improved financial results. We see a longer-runway there through the application of technology to the company’s large resource base. Successful greenfield exploration is a major reason why Newcrest has the long-life orebodies and development options it enjoys today. We also think partnering with junior explorers at an early stage makes sense. The strategy importantly minimises the entry cost while allowing Newcrest to leverage its exploration expertise. Key will be to quickly and efficiently distinguish the valuable joint ventures from the chaff.

Over time, Newcrest intends to focus on further technical innovation to unlock value. The market is generally downbeat on the prospects for Telfer for example, and the historical results show an underperforming mine. However, the 6.4-million-ounce resource is sizable and represents significant optionality. If management improves Telfer through a combination of ore sorting, low cost mining such as block caving or enhanced processing technology, it could represent an important contributor alongside Lihir and Cadia and incremental upside to our fair value estimate. The other major growth option is at Wafi-Golpu in Papua New Guinea. Newcrest still hopes to finalise the special mining lease with the government by mid-2019. This would allow the five-year development phase to start.