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Morningstar | Newcrest’s Guidance Disappoints, but Long-Term Positives See Our AUD 23 FVE Maintained

Newcrest’s fiscal 2018 result was in line with our expectations. Adjusted net profit after tax of USD 369 million (AUD 476 million) was in line with our USD 369 million (AUD 483 million) forecast and 6% below fiscal 2017. The unadjusted net profit of USD 202 million reflected net aftertax abnormal expenses of USD 167 million. This included USD 280 million of asset impairments and write-downs, primarily from Telfer and Namosi. We also exclude the insurance payout of USD 121 million from the adjusted result. The insurance claim was from the April 2017 seismic event, which shut down underground mining at Cadia East. The interruption primarily affected earnings in fiscal 2017. The lower adjusted net profit versus fiscal 2017 was due to a 1.5% decline in gold output and a 6% increase in all-in sustaining costs to USD 836 per ounce, with more gold coming from Newcrest’s relatively higher-cost mines.

With the result meeting our expectations, we maintain our AUD 23 per share fair value estimate. We view shares as slightly undervalued. In our view, this reflects a modest degree of market scepticism around the potential for further incremental expansions at Lihir and Cadia and the expectation of lower gold prices following recent price declines.

Guidance for fiscal 2019 is to produce 2.35 million-2.6 million ounces of gold and 100,000-110,000 tonnes of copper. Unit cost guidance was also higher than we expected. As a result, we’ve slightly lowered our production forecasts and reduced our near-term earnings forecasts. However, over the long term, we think the potential to extract further cost efficiencies and incremental volume growth through expansions at Lihir and Cadia will increase future earnings. We've also updated our forecast to assume a 100% chance of the Wafi-Golpu project proceeding. We value Newcrest’s interest at AUD 0.85 per share, assuming the Papua New Guinean government exercises its right to 30% and dilutes the firm’s ownership from 50% to 35%.

Newcrest is in strong financial shape. Operating cash flow of USD 1.4 billion was in line with fiscal 2017, while free cash flow was USD 0.6 billion. Net debt fell 30% in the year ended June 2018 to USD 1.0 billion. Net debt has fallen by half in the past two years, and the company is on sound financial footing. At its peak in fiscal 2013, net debt was nearly USD 4.0 billion, so improvement in the past five years is substantial. As of June 2018, net debt/EBITDA was 0.7 and EBIT/net interest was 6.1, both comfortable. Liquidity was ample with cash approaching USD 1.0 billion. The firm also has meaningful undrawn debt.

Newcrest intends to continue building cash in advance of the key debt repayments of USD 750 million due in November 2021 and a further USD 750 million due in October 2022. The remaining USD 500 million of senior unsecured notes are long-term and don’t fall due until 2041. With a coupon of 5.75%, this debt represents a reasonably priced source of long-term funding for Newcrest.

With an improved balance sheet, Newcrest is well placed to turn its attention towards growth. The company should be able to comfortably finance the likely development of Wafi-Golpu in Papua New Guinea through operating cash flow. Under our base-case gold and copper price assumptions, Newcrest should be able to repay the USD 1.5 billion of bonds due in fiscal 2022 and 2023 and finance development expenditures without taking on new debt facilities. That said, it’s likely Newcrest will secure some debt to ensure headroom in the event of a delay to first production, a capital cost overrun, or an unexpected downturn in commodity prices. The ability to increase debt would also allow Newcrest the financial flexibility to take advantage of additional investment opportunities.

In addition to Wafi-Golpu, Newcrest intends to continue its program of incremental expenditure and improvements at Lihir and Cadia. Newcrest has increased its plant throughput goal at Lihir from 15 million to 17 million tonnes a year, which we think will bring additional production and unit cost efficiencies. At Cadia, the company is examining the opportunity to expand mill throughput from current levels of about 30 million tonnes a year to 35 million tonnes a year.