Newcrest Mining: Results 2014

Rather than the sickly gold price, it was asset write downs and poor free cash flow that blighted full year results from Newcrest Mining. The country’s biggest gold miner raised production 14% to 2.6m ounces but reported a loss of $2.2bn following yet another write down from the Lihir mine worth $2.6bn.

On an underlying basis, profits fell 3% to $432m as gold prices eased 9% in Australian dollar terms. For once, the currency worked in the miners favour. Without a lower Australian dollar, realised gold prices would have been far lower. The miner cancelled its dividend for the first time in years.

Operating cash flow fell slightly to $1bn but about $900m was spent on capital expenditure so free cash flow was a miserly $130m. Newcrest must spend about $700m annually on maintenance capital expenditure, much of that on mines that don’t generate profit. It will always be hard to generate free cash flow for the business in its current state.  

Counting costs

All in sustaining costs for the business fell 24% to $976 per ounce, a respectable figure. On paper margins have expanded and Newcrest was quick to claim credit for this. A closer look suggests some of the cost savings were one off at best and, at worst, manufactured.

The company mined 24% less material than last year but increased output 14%. How did it accomplish this seemingly miraculous feat? A clue comes from the enormous change in ‘ore inventory’ which fell by almost $250m. This suggests that Newcrest used stockpiles rather than freshly mined ore to produce gold. When you don’t mine you don’t incur costs. This is unsustainable and misrepresents true costs.

Even though stockpiles were mined at Lihir, all in costs soared to $1,261 per ounce. The mine is making no money. Lihir is a complex orebody that demands complex logistics. It requires massive output to reduce unit costs. Without a huge investment binge, it’s hard to see how costs can be bought down. Newcrest has launched a review of the asset, a hint that it might be sold.

The cost reduction at Telfer was miraculous, with sustaining costs falling 40% to $1,000 an ounce. This too is a difficult mine and we are a little sceptical about these costs being sustained. Recoveries were far higher which contributed to higher output but depreciation costs fell 70% because of previous asset write downs.

Newcrest appears to be running Telfer for cash; it has depleted ore from heaping pads and cut capital expenditure suggesting costs may rise in future.  We’ll keep an eye on this asset over the next few quarters. If Newcrest really has solved the riddle of this giant mine, it could bode well for aggregate profits.

Break up

Newcrest’s star asset is Cadia Valley, where soaring grades and volumes saw output rise 33%. Cadia alone generates an operating profit of almost $500m at an astonishing cost of just $326. This is the kind of asset we would love to own. Operating profit at Lihir fell 68% to just $132m. Keep in mind that Newcrest paid over $10bn for this mine, a disastrous acquisition. Hidden Valley and Bonriko continued to make losses.

The numbers suggest Newcrest would be worth more if it were to sell or close poorly performing mines. We made this argument in Newcrest: the good and the bad (Hold - $10.64) and we repeat it again: shareholders would do better by breaking up the company.

There is an excellent gold mining business buried within Newcrest but it is currently diluted by poorly performing mines that detract from aggregate performance. Although management have used every trick to reduce costs and enhance cash flow, returns are simply too low and unlikely to increase. For those seeking gold exposure, we recommend our mini gold portfolio. We’re closer to selling but willing to hold out a little longer. With the share price down marginally since Newcrest: Interim result 2014 (Hold - $11.24), HOLD.