The point of no return: we`re there, now what?

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The point of no return: we`re there, now what?
The point of no return:
we’re there, now what?
Victor Flores, CFA
416 868-3068
Senior Precious Metals Analyst
PDAC March 2001
[email protected]
Global gold equities: the point of no return
The challenge for the global
gold sector is to begin
looking beyond the
consolidation of the sector
Consolidation
Co-operation
• A good means of reducing overheads and
exploration budgets, creating operational
synergies and combining capital with
resources - but the sector’s track record is
mixed
• Although eminently sensible, the industry
has been slow to to co-operate at the camp
level by rationalising property boundaries
and studying way to operate fragmented
camps as a unit
• The acquisition of juniors with outstanding
deposits is a traditional avenue for growth,
but senior producers must avoid the
‘winner’s curse’
• The industry agrees that additional
marketing is necessary, but that is where
the concord ends
Production
• The industry has become virtually polarised
between those that hedge and those that do
not
• Production is expected to begin declining
as projects are depleted, while the project
pipeline is limited - as is the capital to
develop them
• The industry resists the pressure to close
unprofitable production, citing reclamation
liabilities, the cost of re-starting, and
market perception
Hedging
• The longer the low gold price prevails, the
greater the temptation to hedge, especially
in light of the favourable contango
2
The incredible shrinking multiples
In the past 2 years, the
weighted-average P/NPV at
a constant gold price of
US$300/oz has fallen by
38%
Australia has fared very
poorly, with a P/NPV
decline of 44
North American gold
equities have lost 29% of
their premium
P/NPV ratio for the global gold equities
P/NPV
P/NPV
P/NPV
P/NPV
P/NPV
2yr
Dec-98
Jun-99
Jan-00
Jul-00
Jan-01
chg
Region
Africa
1.51
0.92
0.40
0.38
0.45
-70%
Australia
1.95
1.06
1.30
1.07
1.10
-44%
North America
1.84
1.54
1.40
1.31
1.31
-29%
South Africa
0.92
0.58
0.70
0.72
0.61
-34%
Weighted average
1.62
1.07
1.10
1.08
1.01
-38%
Having gained ground, the
South African producers
have lost recent valuation
gains
Source: HSBC
3
Where has all the value gone?
The global gold sector
destroyed US4.5$b of value
during the year 2000
We believe this is partially
due to poor cost controls
and an inability to achieve
production forecasts…
…but is is also a result of
growth-oriented strategies
at the expense of financial
returns
NPV comparisons
Company
Echo Bay
Jan
2000
Jan Change
2001
Comments
69
87
+26%
Successful re-opening of Lupin buys the company some time
Gold Fields
3090
3562
+15%
Cost cutting and focus on operations making a positive impact on value
New mont
2753
2912
+6%
Battle Mountain acquisition, ramp-up in production at Yanacocha
Normandy
935
913
-2%
Restructuring doesn’t necessarily create value, but neither does it destroy it
Homestake
1312
1253
-4%
Cost cutting, improved balance sheet, and Veladero progress
Placer Dome
2699
2496
-8%
Getchell development slower than expected
Barrick
Pascua delayed by one year in our model, and fully priced acquisition of Pangea
4269
3766
-12%
New crest
649
484
-25%
Closure of Telf er, low er hedge book valuation, higher debt
Harmony
952
679
-29%
Randfontein acquis ition has not unlocked value as quickly as expected
Delta Gold
351
242
-31%
Acquisition of Ross Mining, closure of Gold Ridge and Eureka
Anglogold
6043
4077
-33%
Operational performance has suffered, acquisitions have yet to pay off
Franco-Nevada
2296
1521
-34%
Expectations for Midas, other royalties proved too lofty
Ashanti
722
466
-35%
The cost of surviving 1999’s hedge book crisis
Durban Deep
443
268
-40%
Value-destructive acquis itions in Australia, higher costs in SA operations
Kinross
565
244
-57%
Fort Knox expansion delayed, other assets not performing as expected
Lihir
626
252
-60%
Unit costs per ounce have not fallen, expansion has not proceeded
27,774
23,222
-16%
Value destruction during 2000
Total
Source: HSBC
4
Time for new tools
Return on invested capital - ROIC
Appraised value - AV
Rating to economic profit - REP
Return on invested capital - ROIC
Return on invested capital
= NOPLAT/IC
• Return on invested capital (ROIC) is the principal measure of corporate
performance
– Net operating profit less adjusted tax (NOPLAT) form the basis of the ROIC
calculation - essentially EBIT less depreciation, less a notional tax charge
– Many gold producers continue to generate healthy EBITDA as a result of cost-cutting
and hedge books, but the low ROIC is a result of a large invested capital base
– ROIC is a better measurement of performance because it eliminates accounting
distortions, provides a measure comparable to the cost of capital, and is comparable
across sectors and across borders.
6
Appraised value - AV
Appraised value
= IC + PVeri,
where IC is invested capital
and PVeri is the present
value of the firm’s
economic residual income
• Appraised value is a valuation technique proprietary to HSBC that focuses
on the company’s invested capital base and the future returns that the
company’s assets are expected to generate
– Invested capital is adjusted to incorporate writeoffs and ‘pooling’ purchases
– The present value of economic residual income is calculated at the cost of ungeared
equity (Keu)
– For commodity-based industries we acknowledge an additional embedded option
value
7
Global gold equities - Appraised value and ROIC
A number of global gold
equities are trading at a
discount to Appraised
value...
…even though the average
ROIC for the sector remains
below the cost of capital
HSBC global gold universe
Share Appraised
price US$
value
US$/sh
Anglogold
Im plied
option
ROIC IC
Keu % Growth %
Development cycle
US$/sh
29.42
7.65
21.77
-9.3
2.7
Value destruction
Ashanti
1.88
6.35
-4.47
-4.4
-6.9
Value conservation
Barrick
16.38
9.06
7.32
-3.9
-4.0
Value conservation
Buenaventura
14.50
9.66
4.84
22.5
6.7
Classic growth
Delta Gold
0.64
1.56
-0.92
0.2
25.7
Classic growth
Durban Deeps
0.80
1.63
-0.83
8.1
-25.1
Missed opportunity
Echo Bay
0.43
1.06
-0.63
-8.0
-5.0
Value conservation
11.41
11.55
-0.14
-3.4
-0.5
Value conservation
Value conservation
FrancoNevada
Gold Fields
3.42
2.26
1.16
-10.4
-6.7
Harmony
4.69
2.92
1.77
-3.0
20.4
Value destruction
Homestake
4.19
6.44
-2.25
-5.3
-3.1
Value conservation
Kinross
0.54
0.69
-0.15
-8.4
1.2
Value destruction
Lihir
0.35
0.32
0.03
-11.6
-0.1
Value conservation
Newcrest
2.43
2.84
-0.41
-0.6
20.3
Value destruction
Newmont
17.06
18.59
-1.53
-4.5
-0.8
Value conservation
Normandy
0.55
0.63
-0.08
0.4
7.3
Classic growth
Placer Dome
9.63
7.45
2.18
-0.9
-2.0
Value conservation
Source: HSBC
8
Mapping out the use of capital
Classic growth companies
are those that generate
healthy returns on the
capital they invest
Global gold equities - mostly conserving capital (2001e)
Value destruction
HAR
Value destruction occurs
when invested capital does
not generate returns
DGD
Classic growth
NDY
BVN
6.0%
IC Growth
Most of the global gold
sector is in a capital
conservation phase returns are low but capital
is not being invested
12.0%
NCM
ANG
LHG
K
NEM FN
0.0%
-12.0%
-6.0%
ECO
GFI
Value conservation
HM
0.0%
6.0%
12.0%
ABX PDG
-6.0%
ASL
-12.0%
ROIC - Keu
Missed opportunities
DRD
Source: HSBC
9
Other sectors maintain a classic growth profile
Global PGM equities - firing on all cylinders (2001e)
80
Value destruction
Classic growth
PDL
60
40
IC Growth
The PGM industry is
expected to continue
generating profitable
growth
SWC
20
AMP
IMP
LMI
0
-40
0
40
80
Value conservation
NHM
120
160
Missed opportunities
-20
ROIC-Keu
Source: HSBC
10
Rating to economic profit (REP)
Rating to economic profit
(REP), a spot multiple that
measures the share price
relative to financial
performance
• The Rating to economic profit is another valuation technique proprietary to
HSBC that focuses on the market’s expectations of future returns
– The numerator EV/IC is the Enterprise value divided by Invested capital, and is an
indication of the market’s expectations of the returns that will be generated with the
firm’s capital
– The denominator ROIC/Keu is a scalar representation of a company’s ability to
deliver returns compared to its required rate of return
REP
= EV/IC divided by
ROIC/Keu
• REP can be used to judge whether a company or sector is overvalued or
undervalued relative to its expected ROIC
– A REP > 1.0 does not necessarily indicate an equity is overpriced, but does mean that
the market expects high (or improving) returns on capital
– A REP < 1.0 can represent a company that consistently delivers low returns - or a
company that is being mispriced by the market
– REP is a spot multiple, but a time series of prospective REP can be used to determine
whether a company will begin to generate acceptable returns from its existing
development projects.
11
Global gold equities - Rating to economic profit
The average ROIC for the
sector remains below the
required return
HSBC global gold universe
ROIC %
Keu %
EV
IC
US$m
US$m
EV/IC ROIC/Keu
REP
Seniors
The required return Keu is
derived from the CAPM
Keu = Rf + β x ERP
Anglogold
9.0
18.9
3799.4
3258.8
1.17
0.48
2.44
Ashanti
5.9
9.8
469.4
1202.8
0.39
0.61
0.64
Barrick
Buenaventura
EV/IC - a measure of the
market’s expectations
ROIC/Keu - a measure of
actual financial
performance
An average REP of 1.60 for
the sector indicates the
gold sector is overpriced
relative to the returns that
is generates
Delta
Durban Deep
5.1
9.0
6150.9
4923.4
1.25
0.57
2.19
32.0
9.5
1827.7
402.4
4.54
3.36
1.35
9.4
9.2
243.2
403.7
0.60
1.02
0.59
25.7
18.9
120.5
135.7
0.89
1.36
0.65
Echo Bay
1.0
9.0
242.0
703.1
0.34
0.11
3.18
Franco-N.
5.7
9.1
1355.0
1334.1
1.02
0.63
1.62
Gold Fields
9.2
18.9
1404.7
1610.9
0.87
0.49
1.78
16.2
18.9
443.0
577.4
0.77
0.86
0.90
Homestake
2.8
8.1
1091.6
2269.7
0.48
0.35
1.39
Kinross
0.6
9.0
291.4
1003.5
0.29
0.07
4.39
-3.84
Harmony
Lihir
-1.3
10.3
407.5
844.9
0.48
-0.13
Newcrest
8.6
9.2
1010.7
686.5
1.47
0.93
1.58
Newmont
3.6
8.1
4275.9
5146.0
0.83
0.44
1.87
Normandy
9.6
9.2
1855.3
2018.9
0.92
1.04
0.88
Placer Dome
8.1
9.0
3491.8
3365.1
1.04
0.90
1.15
6.4
10.7
–
–
0.95
0.60
1.60
Average
Source: HSBC
12
Returns match expectations?
Global gold equities - ROIC/Keu plotted against EV/IC
2.00
REP > 1.0
BVN
1.50
NCM
ABX
ANG
EV/IC
We would argue that the
market is fairly efficient,
given that those companies
with high returns are also
those that enjoy the largest
premium to their invested
capital base
PDG
1.00
GFI
DRD
HAR
HM
0.50
NDY
FN
NEM
DGD
ECO
ASL
K
REP < 1.0
0.00
0.00
0.50
1.00
1.50
2.00
ROIC/Keu
Source: HSBC
13
Discounting lower PGM prices
Global PGM equities - ROIC/Keu plotted against EV/IC
8.00
AMP
6.00
EV/IC
The market seems unwilling
to afford the PGM
producers a premium
4.00
IMP
LMI
PDL
SWC
2.00
0.00
0.00
2.00
NHM
4.00
6.00
8.00
ROIC/Keu
Source: HSBC
14
Fun with ROICs and REPs
The concepts of ROIC and
REP can be insightful when
analysing potential
transactions
In this hypothetical
example, senior company A
is proposing to buy senior
company C
Senior A is a mature
producer with good cash
flow
A hypothetical transaction - Senior A buys Senior C
Senior A
Senior C
ROIC
6.8%
12.4%
Keu
8.1%
9.2%
EV
2900.8
767.2
IC
4652.9
804.8
ROIC/Keu
0.84
1.35
EV/IC
0.62
0.95
REP
0.74
0.71
Senior C is fast-growing,
but has taken on debt
Source: HSBC
15
Fun with ROICs and REPs (con’t)
As a result of the
transaction, Senior A has
improved both its ROIC and
its REP
Note that the Keu is not a
weighted average, but is
the lower Keu of the
acquiring company
A hypothetical transaction - value added to REP and ROIC
A+C
A+C
A+C
Year 0
Year 1
Year 2
ROIC
7.6%
8.2%
8.6%
Keu
8.1%
8.1%
8.1%
EV
3744.7
3316.7
2815.9
IC
5496.8
5204.5
4923.6
ROIC/Keu
0.94
1.01
1.06
EV/IC
0.68
0.64
0.57
REP
0.72
0.63
0.54
Source: HSBC
16
Fun with ROICs and REPs (con’t)
In this example, the ROIC is
relative insensitive to the
premium paid
However, a premium of
20%results in a flat REP
A premium greater than
20% results in the
destruction of value
A hypothetical transaction - what is a fair premium?
10%
20%
30%
40%
premium
premium
premium
premium
ROIC
7.6%
7.5%
7.4%
7.3%
Keu
8.1%
8.1%
8.1%
8.1%
EV
3744.7
3822.0
3898.2
3974.9
IC
5496.8
5573.5
5650.3
5727.0
ROIC/Keu
0.94
0.93
0.91
0.90
EV/IC
0.68
0.69
0.69
0.69
REP
0.72
0.74
0.76
0.77
Source: HSBC
17
Conclusions
The challenge for the global
gold sector is to begin to
focus on return-driven
strategies
Out with the old...
…in with the new
• Growth-oriented strategies at the expense
of financial returns will only serve to erode
shareholder value
• Companies must focus on delivering
measurable financial returns
• Performance measures such as production
growth and cash costs have to be discarded
• NPVs as a valuation technique continue to
be discredited - especially when low
discount rates are applied
• The traditional approach makes it difficult
to analyse transactions objectively
• Earnings and ROIC should be the principal
measures of financial performance
• Cash costs are misleading - focus on total
cash costs
• The absence of suitable investments should
be met with improved dividend payouts
• The use of ROIC and REP can be useful
when analysing potential transactions
18
Questions?

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