Is Newmont Back On The Right Track?

Sep. 1.14 | About: Newmont Mining (NEM)

Summary

Newmont drastically improved its operating and net margin despite the non-favorable market conditions and negative top-line growth by reducing costs applicable to sales and other operating expenses.

The divestiture of high-cost non-core assets would enable the company to lower its average gold mining costs to free-up its capital for better allocation and repay its debt.

The company’s future does not appear favorable with regards to the gold market and this could hurt Newmont’s revenues.

The reduction in operating costs and divestment of non-core assets could help the company to continue adding growth to the bottom line even if the gold market remains under pressure.

The sluggish demand and adverse pricing environment of gold has affected the fortunes of many gold producers as reflected by their financial performances in their latest quarters. According to the World Gold Council, gold demand in the second quarter fell 16% YoY compared to a decline of 21% in the first quarter of 2014. Gold jewelry demand dropped 30% YoY in the quarter led by wide declines in the largest yellow metal consuming countries, China and India.

The chart below reflects the falling prices as a result of declining demand over the last two years. The trend has hurt the third-largest gold producer, Newmont Mining Corporation (NYSE:NEM), as the company's net revenues in this quarter declined 12.5% despite increased gold production.

Source: GOLDPRICE

Gold segment sales plummeted 12% due to lower sales volume as well as lower realized prices. The average realized price in this quarter was $1,283 per ounce compared to $1,386 per ounce in the second quarter of 2013. The demand for copper in the quarter was steady and its average realized prices increased but Newmont's inability to export copper concentrate at Batu Hijau decreased the segment's YoY revenues by 22%. The average realized price in the second quarter was $3.01 per pound compared to $2.69 per pound in the second quarter of 2013.

However, Newmont successfully improved its operating margin despite non-favorable market conditions and negative top-line growth by reducing the costs applicable to sales. The operating margin per ounce for gold jumped to 42% compared to 35.5% in the same quarter of the previous year whereas the operating margin per pound for copper improved to 16% from the negative margin reported in the second quarter of 2013.

Source: SEC Filings

Moreover, Newmont also cut its other operating costs including exploration, research and development, general and administrative, and other costs. The company's GAAP operating margin increased from -129% last year to 10.4% despite lower revenues. The improved margin helped the company to recover from last year's losses as per share earnings jumped from a loss of $4.14 per share in the second quarter of 2013 to 36 cents.

Divestitures

To tighten its operating expenses Newmont is focusing on low-cost, long-life operations and optimizing its portfolio by divesting several non-core assets. Recently it completed the sale of the Jundee underground gold mine in Australia to Northern Star Resources Limited for proceeds of approximately $91 million. In March 2014, the company divested a 5.4% equity interest in ASX-listed Paladin Energy Ltd. through a block sale agreement with UBS Australia. The third transaction made in 2014 was the sale of Midas Operation in Nevada in February to Klondex Mines Ltd. for a total consideration of more than$83 million.

With the completion of the recent Jundee divestiture, Newmont has raised approximately $800 million in proceeds from July 2013 to July 2014 from the sales of non-core assets. The divestment of these high-cost non-core assets will enable the company to lower its average costs of mining gold to free-up its capital for better allocation and repay its debt. These portfolio optimization strategies along with the reduction in operating expenses will enhance Newmont's productivity and lower its all-in sustaining costs in the future.

Future Outlook

Newmont's revenues are highly dependent on the demand and prices of gold and copper. The current situation for gold seems bleak as year-over-year demand in the second quarter has dropped considerably. Gold imports in the largest consumer country, China, dropped for the fifth month due to weaker demand. The nation's consumption plunged 52% in the second quarter and is anticipated to decline further in the next half of 2014 as President Xi Jinping's anti-graft drive is hurting demand for luxury goods. The market for gold in the U.S. is very choppy and more money is going into the equity markets.

However, in Asia the prices have started increasing as the metal is regaining its lost sparkle in India during the festive season. Unfortunately, the overall global demand for gold is not expected to improve in the next couple of quarters due so the prices will remain under pressure. The trend will continue to hurt Newmont's revenues throughout 2014.

However, as Newmont since started to implement really effective cost reduction strategies this will lead to an expansion in the company's operating and net margins despite the negative revenue growth. This will eventually translate into better net margins and higher return on equity.

since the company has a gold-priced linked dividend policy the dividends will not increase in the next two quarters. The company's first payout level begins between $1,200 and $1,299 per ounce with an annual dividend of $0.10 per share or $0.025 per quarter. The second payout is between $1,300 and $1,399 per ounce with an annual dividend of $0.20 per share or $0.05 per quarter. Currently, it is projected that metal price would remain below $1,300 per ounce so Newmont will continue paying $0.025 per ounce.

Final Thoughts

Newmont has shown a drastic YoY improvement in its financial performance despite facing a relatively unfavorable gold market situation. However, the reduction in costs applicable to sales and the divestment of non-core assets will help the company to continue adding growth to the bottom line even if the gold market remains under pressure.

Although the lower anticipated gold prices will disallow any improvement in the dividends payments, the stock price appreciation should compensate investors. Year-to-date the stock price has been appreciated by more than 15% and due to the company's stellar performance I expect that the stock price will continue appreciating. Keeping these factors in mind, I would suggest investing in the stock.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by APEX Financial Consultants. This article was written by one of our research analysts. APEX Financial Consultants is not receiving compensation for this article (other than from Seeking Alpha). APEX Financial Consultants has no business relationship with any company whose stock is mentioned in this article.