Thursday, September 15, 2011

Newmont Mining Won't Dig Portfolio Gold

Gold producer, Newmont Mining (NYSE: NEM), is near the top of Fortune's list of big fastest-growing companies. Is that a good enough reason to buy its stock?

A look at Newmont's latest earnings suggests that fast growth does not necessarily mean high profitability. While Newmont is digging for gold around the world -- Ghana, North America, South America and the Asia Pacific region -- it looks like its costs are rising faster than gold prices.

With an 11% rise in revenues and an 18% profit boost, you'd think all's well at Newmont. But due to a spike in Newmont's cost to product gold -- from $507 an ounce in 2010 to $588 this year -- Newmont missed analysts' expectations by 10 cents a share (10% below expectations).

Is this a temporary problem that could make the stock more attractively priced? Or should you avoid Newmont altogether?

Here are two reasons to consider buying its shares:
  • Low valuation. It trades at a Price-Earnings-to-Growth ratio of 0.80 (1.0 is fair value) — a P/E of 13.3 on earnings forecast to grow 16.6% to $5.63 in 2012.
  • Higher sales and profits and decent balance sheet. Newmont sales have grown at an 18% annual rate over the last five years from $4.9 billion (2006) to $9.5 billion (2010) and its net income has surged at a 42.2% annual rate from $563 million (2006) to $2.3 billion (2010) -- yielding a wide 24% net margin. Its debt has risen -- but its cash is up faster. Specifically, its long term debt rose at a 23.6% annual rate from $1.8 billion (2006) to $4.2 billion (2010) while its cash climbed at a 34.1% annual rate from $1.3 billion (2006) to $4.2 billion (2010).
Two negatives:
  • Unpredictable earnings reports. Newmont has been able beat analyst’s expectations in three of its past five earnings reports but when it misses, it misses big.
  • Out-earning its cost of capital but getting worse. Newmont is earning more than its cost of capital – but it’s getting worse. How so? It’s producing negative EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In 2011, Newmont's EVA momentum was -3%, based on six month annualized 2010 revenue of $8.8 billion, and EVA that deteriorated from six months annualized 2010's $1.2 billion to six months annualized 2011's $964 million, using a 7% weighted average cost of capital.
What bothers me about Newmont is that it does not achieve economies of scale. It's getting much bigger, but its cost of producing gold is rising instead of falling. This means that it is not taking full advantage of the cost reduction opportunities that should go along with being bigger. The result is volatile results and an inability to generate positive EVA momentum.

Despite the low valuation, I would be wary of investing in this mining stock.


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