Gold equities, by their very nature, depend on the price of gold as a key driver of value and earnings. But being equities, they also depend on good management and investment. This overlays the gold price in determining our recommendation on Northern Star Resources.
In our view, the best gold producers create value independent of the gold price. They do this by reinvesting in existing resources, generating high-return production growth of mine life extensions, or through smart acquisitions.
Secondly, a strong emphasis on ‘cash-all-in-costs’ and free cashflow generation are better measures of success than simple production and ‘all-in-sustaining-costs’.
Finally, as Central Banks around the world move closer towards easing monetary policy, gold becomes a more attractive asset class and a hedge against economic uncertainty. We think a long term gold price of US$1,900 per ounce equates to a US 10-year real rate of about 1.5%. As the cost of extraction and grade decline happens over time, the natural price of gold will rise. In five of the last seven recessions, gold has delivered positive returns as a safe-haven asset compared to other risk assets.
In the current environment, we see an opportunity to own Australian gold producers that can manage margins and make judicious investment decisions.
Investment View
True to its name, EVN’s portfolio has evolved in the last few years so that it now has three key assets – Ernest Henry (Qld), Cowal (NSW) and Red Lake (Canada). The assembly of this core group of assets has stretched the balance sheet. EVN must now execute on its operational plans, particularly at Red Lake and Cowal before it can consider further strategic moves. As the gold price has risen, the expectation now built into EVN’s share price means it must deliver on its production growth to justify its market valuation.
A recent weather event at Ernest Henry has disturbed the March 2023 quarter production. EVN has updated its FY23 production guidance to 660koz at an AISC (all-in-sustaining-cost) of A$1,390 per ounce. Copper production (also from Ernest Henry) will be approximately 48kt for the year. The guidance for Red Lake at 28.2koz was disappointing and well below consensus. June quarter guidance for Red Lake production is now ‘at least 35koz’ implying FY23 production of >125koz, but this is well down on prior guidance of 160koz.
Risks to Investment View
Operational risks are key for EVN as it expands production at its key assets. If the company can deliver on its plans without significant issues, then further growth options become a possibility which would enhance earnings potential. EVN is carrying higher debt than its peers exposing it to greater interest rate risk. If EVN can generate sufficient cashflow to reduce leverage in a timely manner, this would also enhance the outlook for the business.
Recommendation
We have initiated our coverage with a Sell recommendation.
Evolution Mining
Ernest Henry (Qld). EVN first acquired a stake in Ernest Henry back in 2016 and attained full ownership in 2022. EVN is undertaking a Pre-feasibility Study (PFS) to extend the mine life beyond FY26. Ernest Henry generates a substantial amount of cash due to its copper production supplementing the gold production. The mine life can be extended underground but will require significant capital and could be technically challenging.
Cowal (NSW). EVN will completed its underground mine in FY23 and will be the main avenue to take long term production towards 350koz pa. Cowal is the largest gold producing asset in the group
Red Lake (Ontario, Canada). Undergoing an operational transformation and mill optimisation program, Red Lake has a long term production goal of 350koz pa. EVN has invested ~A$1.2bn in this project since acquisition but has yet to fulfil its potential.
Mungari (WA). A plant expansion plan could increase annual production to 200koz, but this looks to be high risk and not necessarily the best use of EVN’s capital.
Mt Rawdon (Qld). This asset has a short mine life remaining with processing shifting to stockpiles until FY27. A study to convert the mine to a pumped hydro station is underway.
Figure 1: EVN ASSET SUMMARY
As at 31 December 2022, EVN had group ore reserves containing 10Moz of gold and 661kt of copper. Group mineral resources are estimated at 30.3Moz of gold and 1.8mt of copper.
Figure 2: GOLD PRICE
EVN’s portfolio has changed materially in FY22 following the acquisition of the outstanding stake in Ernest Henry. Together with Cowal and Red Lake, these three assets will drive future growth and earnings, subject to delivering the expansion projects within budget. Across the whole portfolio, only Ernest Henry is generating any meaningful cash for the business.
EVN needs to complete its current capital programs and deliver on the growth pipeline in order to reduce unit costs, improve margins and restore the balance sheet to full health.
If it can negotiate the next 3-4 years and deliver on its projects, EVN could have one of the best gold portfolios among its Australian peers.
Figure 3: GOLD PRODUCTION BY PROJECT
EVN trades on similar multiples (PE and EV/EBITDA) as the sector, but we think this is difficult to justify given the higher leverage and riskier growth profile it presents.
Figure 4: PE RATIO
Figure 5: EV/EBITDA
