Bad Stock, Poor Market Conditions, but otherwise a great company. (NEM:US)

Newmont Mining, “Newmont”, is one of the world’s largest gold mining company by Market Capitalization with operations in the United States, Australia, Peru, Ghana and Suriname. On average, over the past 7 years, the company has contributed to 3.58% of the world’s supply of gold (based on World Gold Council figures). Compared to its strongest competition, Barrick Gold, its operational mines are located in politically stable geographical zones. In an industry where government intervention and scrutinity is part and parcel of normal business, an investor would most certaintly benefit from companies that has less exposure to such erratic regulations. Newmont’s share price is highly correlated to gold price, which should be of no surprise as its bulk of profit is derived from gold mining.

Gold, for a good part of modern history, has served as a hedge against inflation and would probably continue to do so. It has also become an asset investors flock to in times of uncertainty. While it is great that we are getting news almost every day about indices making new highs, investors should not be complacent and assume this would continue forever.

Firstly, the Chinese financial industry is undergoing a deleveraging process. In an article by CNBC, according to the Institute of International Finance in June 2016, China’s debt-to-GDP ratio stands at 327 percent. If we recall, just about a decade ago, overleveraging was the cause of the great recession, causing the economy to plunge into freefall. Gold prices rallied from the low of US$781 per ounce at the start of the crisis in September 2007 to an all-time high of US$1878 in August 2011. To put it simply, no one had a clue about where we would move on from there, and their best bet in times of uncertainty would always trace back to Gold. As you are reading, China is still in the midst of their deleveraging process. Money supply growth has slowed tremendously while aggregate financing was RMB 70 billion lower than estimated, at RMB 1.04 trillion, according to a report by Bloomberg. With lesser money going around the economy, interest rates are set to rise. The Chinese 10-Year Bond Yield stands at 3.96% as of this writing, up from 2.66% about a year ago. As the interest rates rise, companies would find it increasingly difficult to meet their debt obligations as refinancing becomes more expensive while they are still drowned in excess capacity. Due to the significant amount of bureaucratic red tape around Chinese statistics, investors’ sentiment is should be best reflected in the market. The Shanghai Stock Exchange Composite Index (SHCOMP) is at 3,276, down about 5% from this year’s high of 3,447. While we have yet to see any event that could trigger a market-wide correction, it would not be right to assume a black swan event is not brewing somewhere.

Secondly, US unemployment rate is at 4.1%. The lowest unemployment rate the US economy has achieved prior to the Financial Crisis but after the dotcom bubble was 4.4%. If history was a guideline, the stock market tends to top when unemployment rate hits about 4%, when it starts to stagnate before heading higher. It isn’t a definite pre-emptive signal, but it would certainly serve as a warning. As things are relatively rosy for now, it may take a year or two before we see a full correction in the markets. Remember, the market is often a reflection of investors’ sentiment. What we are seeing right now would probably be investors’ exuberance due to Trump’s tax policy, though I personally think that the deficit would ultimately bring down the dollar as the world’s reserve currency, especially when Petro-Yuan formally takes over the market, but that story shall be saved for another time.

Now that we are done with the macroeconomic factors, let’s move into the specific company we are looking at. As mentioned earlier, Newmont’s operations are located in geopolitically safe areas, hence reducing risks investors have to undertake in the sector where operating cash flows can be pretty uncertain. Recently, during an investor’s conference hosted by Newmont, the management has decided to shift away from the old dividend structure of being intertwined with gold prices, towards a policy of sustainability of production pipeline and stability. It should also be noted that while gold has been trading in a tight range of US$1200 to $1350, Newmont has managed to maintain a positive Free Cash Flow for the past 7 quarters, while projection of average FCF for the next 5 years is $1.4b.

It should also be noted in a capital-intensive industry, companies are usually debt-laden in order to fuel operations. This was not the case for Newmont as the company’s debt profile consists of 100% fixed interest rate, with Debt-to-Equity ratio at a healthy 0.39. Newmont’s management has pledged to reduce debt further, hence relieving the company (and its shareholders) of additional debt obligations. With existing projects in place, the company is set to increase production by at least 380,000 oz of gold per annum earliest by 2019.

Based on my personal valuation using Price/Revenue Ratio, the projected price for Newmont is $43. Currently, the industrial average (Newmont, Barrick Gold, Goldcorp, Newcrest, Kinross) Price/Revenue ratio is 3.46. With the model taking into account for growth in production into revenue from $6.7b in 2016 to $8b in 2022, the target price for Newmont in that year would be $51.96. Based on the current capital structure, the WACC is 3.92% as equity takes up a significant part of financing, while the stock’s beta is only 0.22. Discounting back to date, that would give us a price of $43.

Another valuation method employed was based on Discounted Cash Flow (DCF). As mentioned earlier, annual FCF generated by the company would be $1.4b. Discounting that figure back to date would give us a terminal value of $141.70. While that number appears to be unrealistic, I choose to infer that the company is still undervalued purely due to the fact that its stock is highly correlated to gold prices, which in turn, is negatively correlated to the broad market.

Moving on to risks, if the economy trumps higher, we could probably see stagnant or even lower gold prices. That would probably sink the stock further as it currently trades at $34.90, about 12% of this year’s high. The other risk that could affect the company negatively would be a surge in All-In Sustainable Costs (AISC), an industry benchmark to gauge the profitability of its mines. Higher AISC represents higher costs to extract gold due to lower ore grade and reduced output as mining gets harder. In Q3 2017, Newmont’s AISC is $909/oz, about 3.6% higher than industrial average of $877/oz. That figure remains well within the projections of the management of $900-$950/oz.

To conclude, the gold mining sector isn’t the most attractive sector right now, but that is the point. Too much interest, and upside would be very limited. While we may be slightly early to the game, I think it would be a great time to hedge your portfolio (since the stock can be considered as counter-cyclical) before market turmoil starts. Newmont, relative to its peers, fares better in my opinion due to the low debt/equity ratio, management’s commitment to increase production as well as a change to the dividend policy which investors could all benefit from.



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23, Trading and Writing from Singapore.

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