Australian Golds: Revising our AUD/USD; leaning on cash flow for value
EQUITY RESEARCH
Royal Bank of Canada - Sydney Branch
Cameron Klutke (AVP)
+61 3 8688 6551
[email protected]
Paul Hissey (Analyst)
+61 3 8688 6512
[email protected]
May 16, 2016
Australian Golds: Revising our AUD/USD; leaning on cash flow for value
Updating our domestic gold coverage with greater emphasis on cash flow
As previously flagged in our recent research note ('Australian Golds: Trading focus on free cash flow as bull market gains momentum'), we now place greater emphasis on the gold producers' ability to generate near term cash flow. We believe this current bull market in gold equities is delivering a shortened investment horizon, with those providing a strong turnaround in cash flow (and more importantly, free cash flow) being most rewarded by the general market. The dramatic uplift in Resolute Mining's (RSG) share price (due to FCF turnaround, in our view) is a strong example of this trading philosophy, where long term valuations have remained relatively flat, and the only significant change being the free cash flow.
Due to what we believe to be an ongoing trading emphasis on near term cash flow, we lift all our gold coverage to reflect a 25% increase towards our debt-adjusted cash flow. Since we derive our price targets using a blend of debt-adjusted cash flow and NAV, our average blend now sits at 75% weighted debt- adjusted cash flow and 25% weighted towards NAV (previously 50:50).
Incorporating our revised AUD/USD and base metal prices into our gold coverage provides near term benefits, but longer term greater headwinds...
We have recently revised our long term AUD/USD upwards to 75c (previously 70c), however, we expect near term weakness in the AUD/USD which provides the short term cash flow upgrades in our AUD exposed names.
Since several of the domestic gold names (NCM, OGC, EVN) are exposed to copper prices (as by-product credits), our revised copper price forecasts, which indicate a small increase in long term prices to US
$2.85/lb Cu (previously US$2.75/lb Cu) show a marginal benefit.
Our long term gold price forecast has remained unchanged at US$1,300/oz.
Investment Recommendations
Preferred names:
Our revised numbers continue to indicate upside in Saracen Mineral Holdings (SAR) and Silver Lake Resources (SLR). We continue to like these names not only for the expected lift to near term cash flow, but also for the organic growth opportunities available.
Caution (on free cash flow):
With greater weight towards companies' near term cash flow, we flag Perseus Mining (PRU, Sector Perform) as a weaker name using this metric, however, a more positive longer term strategy (Yaoure) remains in place.
Our Underperforms:
We highlight both Newcrest Mining (NCM) and Evolution Mining (EVN) as our 'Underperform' names with valuations for both remaining stretched at current trading levels.
Connor O'Brien (Associate)
+61 3 8688 6519
[email protected]
Priced as of prior trading day's market close, EST (unless otherwise noted).
All values in AUD unless otherwise noted.
For Required Non-U.S. Analyst and Conflicts Disclosures, see page 5.
Gold equities building momentum; we now weigh more heavily on FCF
As we previously reported (Australian Golds: Trading focus on free cash flow as bull market gains momentum, May 12, 2016), we believe the broader domestic market is shifting towards a cash flow based trading strategy. This reflects the switch away from more raw fundamental valuations (NAV) which we think the market is now looking well beyond in the current bull market.
As part of what we believe to be current market valuation criteria, we re-rate our Australia gold coverage universe accordingly. From the table below, the companies we expect to be rewarded in this environment are those with strong near-term (12 months) cash flow prospects.
The largest beneficiaries in our coverage of a more heavily weighted cash flow based valuation are: Resolute Mining (RSG), Evolution Mining (EVN) and Silver Lake Resources (SLR).
Exhibit 1: Changes to our AUD/USD and copper price forecasts
|
FY15
|
FY16E
|
FY17E
|
FY18E
|
FY19E
|
FY20E
|
FY16 US$
Long Term
|
|
AUDUSD
|
Prev.
|
0.75
|
0.72
|
0.71
|
0.70
|
0.70
|
0.71
|
0.71
|
|
New
|
0.75
|
0.72
|
0.67
|
0.69
|
0.71
|
0.73
|
0.75
|
|
%
|
0.5%
|
(5.6%)
|
(2.0%)
|
1.9%
|
3.5%
|
6.4%
|
|
Copper
|
Prev.
|
2.50
|
2.03
|
2.25
|
2.50
|
2.75
|
3.04
|
2.75
|
|
New
|
2.50
|
2.10
|
2.25
|
2.50
|
2.75
|
3.00
|
2.85
|
|
%
|
3.5%
|
0.0%
|
0.0%
|
0.0%
|
(1.3%)
|
3.6%
|
Source: RBC Capital Markets estimates
Exhibit 2: Changes to earnings, cash flow, valuation, and target prices
|
FY16
Old New
|
EPS ($/Share)
FY17
Old New
|
FY16
Old New
|
CF/ sh. ($)
FY17
Old New
|
NAV A$/Share
Old New
|
TP (A$/Share)
Old New
|
TP Blend (DACF-NAV)
Old New
|
Rating Spec
|
|
BDR
|
0.06
|
0.05
|
0%
|
0.06
|
0.06
|
8%
|
0.09
|
0.09
|
0%
|
0.08
|
0.09
|
6%
|
0.33
|
0.33
|
-1%
|
0.30
|
0.35
|
17%
|
50-50
|
75-25
|
SP
|
-
|
|
EVN
|
0.18
|
0.17
|
-4%
|
0.26
|
0.28
|
9%
|
0.35
|
0.34
|
-2%
|
0.43
|
0.45
|
6%
|
0.84
|
0.83
|
-2%
|
1.50
|
1.90
|
27%
|
50-50
|
75-25
|
UP
|
-
|
|
GOR
|
-0.01
|
-0.01
|
0%
|
-0.01
|
-0.01
|
0%
|
0.00
|
0.00
|
0%
|
-0.01
|
-0.01
|
0%
|
0.68
|
0.56
|
-18%
|
0.50
|
0.60
|
20%
|
50-50
|
75-25
|
OP
|
Spec
|
|
NCM*
|
0.38
|
0.38
|
-2%
|
0.67
|
0.72
|
6%
|
1.25
|
1.24
|
-1%
|
1.55
|
1.59
|
3%
|
11.47
|
10.99
|
-4%
|
14.50
|
15.50
|
7%
|
50-50
|
75-25
|
UP
|
-
|
|
NST
|
0.32
|
0.31
|
-2%
|
0.46
|
0.51
|
9%
|
0.68
|
0.67
|
-2%
|
0.75
|
0.81
|
7%
|
2.81
|
2.86
|
1%
|
3.70
|
4.10
|
11%
|
50-50
|
75-25
|
SP
|
-
|
|
OGC*
|
0.19
|
0.20
|
4%
|
0.28
|
0.29
|
3%
|
0.44
|
0.44
|
1%
|
0.64
|
0.66
|
4%
|
3.48
|
3.40
|
-2%
|
3.90
|
4.20
|
8%
|
50-50
|
75-25
|
SP
|
-
|
|
PRU
|
-0.01
|
-0.01
|
-7%
|
0.00
|
0.00
|
-5%
|
0.03
|
0.03
|
-2%
|
0.07
|
0.07
|
4%
|
0.63
|
0.58
|
-8%
|
0.40
|
0.30
|
-25%
|
50-50
|
75-25
|
SP
|
-
|
|
RRL
|
0.21
|
0.20
|
-4%
|
0.27
|
0.30
|
10%
|
0.37
|
0.36
|
-3%
|
0.40
|
0.43
|
9%
|
1.93
|
1.91
|
-1%
|
2.40
|
2.70
|
13%
|
50-50
|
75-25
|
SP
|
-
|
|
RSG
|
0.25
|
0.24
|
-4%
|
0.29
|
0.31
|
6%
|
0.29
|
0.28
|
-3%
|
0.35
|
0.37
|
6%
|
0.43
|
0.43
|
-2%
|
0.70
|
1.00
|
43%
|
25-75
|
50-50
|
SP
|
-
|
|
S2R
|
-0.05
|
-0.05
|
0%
|
-0.03
|
-0.03
|
0%
|
-0.01
|
-0.01
|
0%
|
-0.01
|
-0.01
|
0%
|
0.27
|
0.27
|
0%
|
0.30
|
0.30
|
0%
|
n.a
|
n.a
|
OP
|
Spec
|
|
SAR
|
0.07
|
0.07
|
-5%
|
0.18
|
0.20
|
8%
|
0.17
|
0.16
|
-3%
|
0.29
|
0.31
|
6%
|
1.03
|
1.02
|
-1%
|
1.40
|
1.50
|
7%
|
50-50
|
75-25
|
OP
|
-
|
|
SLR
|
0.02
|
0.02
|
-8%
|
0.07
|
0.07
|
13%
|
0.10
|
0.10
|
-2%
|
0.16
|
0.17
|
7%
|
0.63
|
0.62
|
-2%
|
0.60
|
0.70
|
17%
|
50-50
|
75-25
|
OP
|
Spec
|
*Reported in USD
Source: RBC Capital Markets estimates
Where does the value swing to from here?
As outlined in the chart below, gold equities continue to deviate away (higher) from movements in both the AUD and USD gold prices. This poses the question if gold prices do not maintain this upward trend, who can hold onto the current fundamental valuation premiums in place?
We believe the companies with strong organic growth opportunities, and their ability to exploit these opportunities, should hold values against those with a shorter term cash flow horizon. Essentially, we look towards the producers who can maintain, or grow, current free cash flow beyond just a 12-month window.
Our preferred names to maintain/grow FCF/share are: Saracen Mineral Holdings (SAR), Silver Lake Resources (SLR) and OceanaGold (OGC).
Exhibit 3: Australian gold equities significantly outperforming both A$ and US$ gold prices.
XGD.ASX US$ Gold Price A$ Gold Price
60%
50%
Percentage movement (%)
40%
30%
20%
10%
0%
-10%
-20%
-30%
-40%
May-14 Aug-14 Nov-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16
Source: RBC Capital Markets estimates, IRESS
Exhibit 4: Snapshot of our coverage universe
|
Company name Gold Producers
|
Ticker
|
RBC rating
|
Share price (A$ps)
|
Price target (A$ps)
|
Implied TSR (%)
|
NAV (A$ps)
|
P/NAV (x)
|
EV/EBITDA (X)
|
|
Newcrest Mining
|
NCM
|
Underperform
|
21.10
|
15.50
|
-26.2%
|
10.99
|
1.9x
|
11.4x
|
|
Evolution Mining
|
EVN
|
Underperform
|
2.24
|
1.90
|
-14.3%
|
0.83
|
2.7x
|
6.3x
|
|
Oceanagold
|
OGC
|
Sector Perform
|
4.82
|
4.20
|
-12.0%
|
3.40
|
1.4x
|
11.2x
|
|
Northern Star Resources Ltd
|
NST
|
Sector Perform
|
4.70
|
4.10
|
-11.5%
|
2.86
|
1.6x
|
6.0x
|
|
Regis Resources
|
RRL
|
Sector Perform
|
3.21
|
2.70
|
-13.4%
|
1.91
|
1.7x
|
7.7x
|
|
Saracen Mineral Holdings
|
SAR
|
Outperform
|
1.28
|
1.50
|
17.2%
|
1.02
|
1.3x
|
9.0x
|
|
Resolute Mining
|
RSG
|
Sector Perform
|
0.90
|
1.00
|
11.1%
|
0.43
|
2.1x
|
2.9x
|
|
Perseus Mining
|
PRU
|
Sector Perform
|
0.60
|
0.30
|
-49.6%
|
0.58
|
1.0x
|
11.6x
|
|
Beadell Resources
|
BDR
|
Sector Perform
|
0.31
|
0.35
|
14.8%
|
0.33
|
0.9x
|
7.0x
|
|
Mean
|
-9.3%
|
2.48
|
1.6x
|
8.1x
|
|
Gold Exploration and Development
|
|
Gold Road Resources GOR
|
Outperform
|
* 0.57
|
0.60
|
5.3%
|
0.56
|
1.0x
|
-56.0x
|
|
S2 Resources Ltd S2R
|
Outperform
|
* 0.28
|
0.30
|
7.1%
|
0.27
|
1.1x
|
-3.8x
|
|
Silver Lake Resources Ltd SLR
|
Outperform
|
* 0.55
|
0.70
|
28.4%
|
0.62
|
0.9x
|
4.7x
|
|
Mean
|
13.6%
|
0.48
|
1.0x
|
-18.4x
|
|
* = Speculative risk
|
|
Date 2016/05/16
|
Source: Company reports, RBC Capital Markets estimates, IRESS
Valuation
BDR
In setting our A$0.35 price target, we assume prioritised production from the high-grade Duckhead Stage 3 pit, which will likely conclude in SepQ'16, with a further c.6.5 years of production from the existing open-pit resource base at Tucano, Tap AB, etc. We also assume a nominal A$10m valuation for further resources not included outside of the current base case and additional exploration prospects. Our 12-month price target is based on our (25:75) NAV and P/DACF methodology, with a 5.0x DACF and 0.8x NAV. Our price target supports our Sector Perform rating.
EVN
We value EVN in line with RBC Capital Markets' global approach to the valuation of gold equities. Our 12-month target price of A$1.90 is based on our consistent methodology weighting NAV (1.0x) and DACF (7.0x) on a 25:75 basis. Our target supports an Underperform rating.
GOR
Our 12-month price target of A$0.60/share is based on 0.9x our sum of the parts (SOTP) NAV. Our SOTP valuation is based on the explicit forecasting of potential production and cash cost outcomes at Gruyere, overlain by our own views on commodity and currency. At an asset level, we consider Gruyere to be valued at c.A$365m (10% WACC), with additional exploration potential (resource ounces outside our base case, and all other exploration blue-sky) valued conservatively at A$40m (or 7cps). Our price target and implied return support our Outperform (Speculative Risk) rating.
NCM
Based on our 25:75 weighting of NAV (1.0x) and DACF (14.0x) methodology, we rate Newcrest Mining Limited (NCM) Underperform with a price target of A$15.50. Our target multiples reflect a discount to comparable global peers (sector averages 1.2x and 17x, respectively) owing to the skew towards two key assets - one of which we believe is genuinely world class, while Lihir will require continued improvement to unlock value. We believe NCM's major peer group has a better spread contribution from a broader asset base.
NST
Our price target for NST of AUD 4.10 is based on a 75:25 blended DACF and NAV valuation. Our unchanged target multiples of 6.0x DACF and 1.0x NAV are slightly above average for our Australian domestic gold coverage universe and generally in line with its closest peers, IGO and RRL. We believe the company's strong returns, potential for resource additions, and good track record underpin this slight premium against its broader peer group. Our price target supports a Sector Perform rating.
OGC
We set our price target at A$4.20/share based on our 12-month NAV (1.0x) and DACF (8.0x). Our 1.0x NAV multiple is generally in line with other producers with multiple assets which we believe have a good track record (such as RRL, IGO, and NST). Our cash flow multiple of 8.0x is also in line with OGC's peer group and, although the mine life at Didipio and Haile is comfortably longer than this, it takes into account a decline in overall output longer-term when the wind-down at NZ commences. Our price target supports a Sector Perform rating on the stock
PRU
Our price target of A$0.30 is based on unchanged multiples of 0.8x NAV and 6x Adj CF. This is a discount to other Tier III miners due to the operating issues that the company has faced. Our price target supports our Sector Perform rating.
RRL
We value RRL using a blend of 25% NAV and 75% DACF. We believe this provides an appropriate balance between the near-term pre-financing cash flow potential of the business and the longer-term optionality of the full asset suite. Our debt-adjusted cash flow (DACF) is based on an 8.0x multiple and a 1.0x multiple for the NAV. The return implied by our price target supports a Sector Perform rating. Our price target is A$2.70/share for RRL.
RSG
Our 12-month price target of A$1.00 is generated from a blend of debt-adjusted cash flow (50%) and sum-of-the-parts NAV (50%). We apply multiples of 0.8x for the NAV and 5.0x for the debt-adjusted cash flow. These multiples are marginally below the average for our remaining Australia-listed gold coverage
due to what we believe to be higher country risk (Mali) and unproven production from Syama Underground, which is in the development phase. Our price target supports a Sector Perform rating.
S2R
Our 12-month price target of A$0.30/share is based on a fully diluted sum-of-the-parts valuation, including cash, corporate expenses, and estimated value of exploration assets. Due to the strong track record and success of the management team, with all projects located in both mining friendly jurisdiction and well known mineral belts, we apply a 1.0x to our NAV to our valuation. Our price target supports our Outperform (Spec Risk) rating.
SLR
Our 12-month price target for SLR is A$0.70, based on a 25:75 blend of our NAV and P/ DACF valuations. Our target multiples of 0.8x and 5.0x, respectively, are below the averages of Tier III gold producers under RBC coverage and Australian peers owing to: (1) the numerous resource locations, which leads to some erosion of confidence in the latter years of our estimates (beyond 2017-18); (2) the potential for incremental capital costs as each of these sources is tested and prepared for mining; and (3) the rolling 2-3 year reserve base and the operational exposure of a single processing facility, which may increase production volatility. Our price target and the implied return support our Outperform, Speculative Risk rating
SAR
Our 12-month price target is derived from a 75:25 blend of debt-adjusted cash flow (7x) and our sum-of-the-parts NAV (1.1x). Due to the significant growth phase that the company is in, strong track record of management, and significant exploration upside, we incorporate a slight premium in NAV against the remaining peer group in our Australian gold coverage. We view this exploration upside, and, therefore, potential for mine life extension, to be the main driver in delivering additional valuation upside into the price, which we believe is not fully recognised by the general market. This supports our Outperform rating and A$1.50/share price target.