Newmont Mining: Dividend Reduction Was Expected, Indonesia Remains the Major Headwind
Like many other gold companies, Newmont Mining Corp (NYSE:NEM) is feeling the heat of lower gold prices. The company has been hit by weaker gold and copper prices and has recorded steep impairment charges in the recent quarters. NEM reported adjusted 4Q13 EPS of $0.33 per share, lower than the consensus estimates of $0.44, with the miss largely due to higher-than-expected operating costs offset by lower corporate expenses. The company pre-reported Q4 attributable production of 1.45 million ounces. Gold and copper costs applicable to sales (CAS) for the quarter were $755 per ounce and $4.02 per pound but included stockpile write-downs of $237 million.
Ability to Generate Positive FCF
Looking forward, 2014 production is expected to fall by ~7 percent from 2013 levels and then is expected to be flat to slightly up over the following two years. With all in sustaining cash costs (AISCs) declining on lower capital expenditures, NEM’s operating costs are expected to be flat over the next few years. Overall, with declining capital expenditure, NEM has the ability to generate positive FCF over the next few years which, combined with cash in hand, could allow the company to fund of the development projects in its pipeline. However, NEM’s ability to internally fund will be dependent on the Contract of Work at Batu Hijau being upheld, which will continue to be an overhand until a resolution is reached.
Indonesia Export Duty Resolution Remains the Most Important Catalyst
NEM reiterated that it believes the new 2014 regulations conflict with the Contract of Work and the management is continuing to engage with government officials in Indonesia in an effort to resolve this issue and gain clarity regarding the new regulations, while also considering other remedies, including possible legal action. Management is continuing discussion with the Indonesian government to a mutual resolution, following the proposed export ban on copper concentrates and the new regulations on export permit conditions and a progressive export tax. The resolution of the proposed Indonesian export duty remains the major headwind for the company. Until a resolution is reached, NEM’s shares are expected to remain range-bound.
Investment Grade Rating a Priority
One of the main priorities of NEM is to maintain its investment grade rating. However, the company has reiterated that it would not consider new equity as a means to improve the balance sheet or protect its investment grade rating. Based on a $1,250 per ounce gold price, which is below spot of $1,336 per ounce, the company should be able to generate positive free cash in 2014. The company recently secured commitments from a group of lenders for a five-year term loan of $575 million. According to management, the proceeds are expected to be used to repay the $575 million of convertible debt maturing in July 2014. The term loan is structured to facilitate early repayment without penalty from free cash flow, as the company expects to de-lever over the five-year period.
To preserve balance sheet flexibility, NEM reduced its gold-linked dividend. The company will continue to retain the gold-linked dividend policy but will be adjusting the annual payout levels. The formula for determining the dividend payout is still based on the average London P.M. The $0.15 per share quarterly dividend announced last week will be the last dividend paid using the old formula. Based on the 1Q14 quarter-to-date gold price of $1,260 per ounce, NEM would now pay a quarterly dividend of $0.025 per share ($0.10 per share annualized) versus $0.15 per share ($0.60 per share annualized) under the previous policy. The figure below details the estimated savings that the company will make under the new policy.
Given the constrained balance sheet of the company, we believe the dividend cut was required to provide more financial flexibility. Investors were also expecting NEM to reduce its dividend or change its gold-linked dividend policy given the company’s reduced production profile in 2014, uncertainty regarding taxation at Batu Hijau and a relatively high debt level. Therefore, the announcement of dividend cut did not come as a surprise.
The lower reserves, impairment charges, and dividend reduction are not a surprise as the company’s peers have also taken similar actions in recent quarter. Newmont, like other gold miners, is hit by lower gold prices. The yellow metal’s price dropped 28 percent last year, the largest annual decline since 1981. The decline was further accelerated by a record bull run in U.S. equities. However, due to concerns regarding health of emerging markets and developing economies, gold prices have received a boost in 2014.
Despite of our cautious view of the gold prices, there are some positive factors in our investment thesis on Newmont. The company has a strong base of production and reserves. It also has low valuation relative to spot gold prices. NEM has a strong operating track record and has the potential to generate relatively strong FCF in 2015 with a resolution of the Indonesia export ban. Clarity on the company’s longer term production profile would improve the company’s outlook even further. However, the company is constrained on balance sheet flexibility to fund growth capex, although the dividend reduction provides additional flexibility.