Mid-March this year, I wrote a very bullish article on Newmont Corporation (NYSE:NEM) arguing that the investment case is attractive since it provides a defensive exposure that is correlated with gold dynamics in combination with a decent entry yield of 3%, where the underlying cash flows were subject to strong growth.
Since the publication of my article, the stock price has gone nowhere but up, outperforming the S&P 500 by a huge margin (on a total return basis).
Now, after the recent run-up in the share price, the dividend yield has decreased to 2.5%, which makes the case theoretically less attractive, especially knowing that the current gold price is close to all time highs.
In other words, the question is whether the investment profile is attractive enough to still keep going long NEM or perhaps it is the right moment to take at least part of the profits here.
Thesis review
To determine that, let's take a look at the Q1 2024 earnings profile.
In a nutshell, the overall results came in strong, showing no signs of weakening momentum or deteriorating financials. For example, the adjusted EBITDA increased by 26% compared to the prior quarter, registering a fourth quarter in a row where the adjusted EBITDA generation has consistently moved higher. If we express the adjusted EBITDA in TTM terms, we will arrive at $4.9 billion, which is without the effects from the previous acquisition of Newcrest. If we factor in the financials on a pro forma basis from Newcrest, the TTM adjusted EBITDA lands at $5.8 billion. Assuming the current interest bearing debt position of NEM, the net debt to TTM adjusted EBITDA is only 1.2x, which is a very conservative level, imposing no material financial risk.
There have been really two key drivers behind these strong results of NEM.
First is the higher gold price, which allows NEM to achieve elevated margins. The chart below captures this perfectly, showing how the gold price has been steadily increasing over the past 3 years with a more pronounced run-up in the last 6 - 8 month period.
Given that the current all-in sustaining cost of gold extraction for NEM is $1400 per ounce, while the gold price has increased to ~ $2300 it is quite obvious that the business is currently extremely profitable.
The second driver is related to NEM's internal dynamics, where the focus, especially after the bolt-on acquisition of Newcrest, has been put on extracting the synergies and optimizing the cost base. During Q1, 2024 NEM managed to realize already $104 million in cost savings, while identifying an additional $230 million that will likely be achieved in 2024 as well. Given the remaining synergy potential, NEM has remained committed to its 2024 target of ending the year with an all-in sustaining cost of gold production of $1250 per ounce. Here, if the prevailing price remains the same or even keeps going up, the effects on the next year's adjusted EBITDA generation would again be massive.
Over the next few quarters, it will also be critical to see whether NEM really succeeds in the divestitures of its non-core assets, which at this point in time are estimated to bring an additional $2 billion in cash. Currently, NEM is trying to sell the non-core and relatively expensive Telfer, Eleonore, Musselwhite, Colorado, and Ghana mines together with a greenfield development project in Canada and a 70% stake in the Haverion copper-gold project. The gold all-in sustaining cost for these mines is $1750 per ounce, which is way above what NEM's core assets can achieve and where the objective (target level) is. Plus, after selling these non-core assets, there will also be implied savings on the maintenance CapEx front, where historically the relevant CapEx spend has been at roughly $100 million per year.
Finally, during the recent earnings call Karyn Ovelmen - EVP & CFO - provided a nice color on the near-term capital allocation policy:
As we go through the divestitures and as I've indicated as our free cash flow picks up in the second half of the year. First priority is to ensure that we've got that our cash replenished on our balance sheet. And then there will be flexibility in terms of as long as we have line of sight in terms of that debt reduction over the next 24 months, we would -- at that point in time, if we were in a position start to think about executing on share buybacks.
From this, we can conclude that NEM's key priority is to further optimize the balance sheet (including reducing the credit revolver from temporary increases in net working capital) and then only consider the share buybacks, which given the current price of NEM seems reasonable.
The bottom line
After the recent share price run-up of ~18% and the fact that the gold is trading at all time highs, investing in NEM is not that straightforward anymore. Also, for 2024 NEM has outlined a very ambitious strategy to divest a large chunk of its non-core and expensive mines, which is a prerequisite to achieve the all-in sustaining cost target of $1250 per ounce. Given the relatively inactive M&A market as the interest rates still remain rather restrictive, finding buyers at the right price seems challenging.
So, even though the current business is sound and generating strong cash flows, where the leverage is also set to go down, in my humble opinion, there is a higher downside risk than a potential to experience a continued uptick in NEM's share price.
As a result of this, my recommendation is to de-emphasize allocations in NEM.