I have expressed several times that Freeport-McMoRan (FCX) has significant upside from its current multiples expansion (see here and here). One miner that I believe has poor risk/reward at the present moment is Newmont Mining (NEM), which is a bit unusual given gold is an attractive hedge against domestic stagnation. Despite strong third quarter earnings, I find that the dividend yield has attracted more investor entry than reasonable.
From a multiples perspective, Freeport is a good degree cheaper. It trades at only a respective 6.5x and 7.6x past and forward earnings. Newmont, on the other hand, trades at a respective 13.1x and 11.1x past and forward earnings. In addition, Freeport has greater flexibility in cutting expenses as gross margins are 1,300 basis points below that of its competitor.
At the third quarter earnings call, Newmont's CEO, Richard O'Brien, noted promising trends:
"Across our wider project pipeline, we have advanced approximately 20 earlier-stage development assets through our project pipeline in each of our 4 operating regions thus far in 2011. Our investment-grade balance sheet continues to strengthen as we delivered our 11th straight quarter of increase in gross margin, while generating quarterly records of revenue at $2.7 billion, operating cash flow of $1.3 billion and net income of $635 million adjusted. We also ended the quarter with over $3 billion in cash and marketable securities. We also continued to explore one of the most extensive land positions in the gold industry. Across our exploration portfolio, we are currently operating 100 drill rigs around the globe in over 40 locations, spanning greenfields and brownfields projects, as well as surface and underground opportunities.
And as we announced on Wednesday, we increased our dividend again for the sixth straight quarter to $0.35 per share based on our average realized gold sales price for the third quarter of $1,695. This is a 133% increase over the year-ago quarter. On an annualized basis, Newmont's dividend stands at a yield of over 2%, which is higher than the current S&P 500 average yield and certainly the highest in the gold industry".
While I am attracted to how miners are passing off increasing more of their earnings through dividend distributions, I wish greater emphasis was placed on share repurchases. This alternative to capital allocation has a tax advantage and is accretive to EPS and ROE. In any event, Newmont currently has a dividend yield of 2.3%, which is actually below 2.7% for Freeport.
Newmont's third quarter earnings were strong with particularly strong results in Batu Hijau. Operational catalyst have also been discovered at Boddington to yield higher grade materials than what was expected. With that said, management suggested that 2011 results could be at the low end of guidance. Most concerning is that Newmont is delaying construction at the multi-billion dollar Conga Project in Peru. The reason? Anti-mining protests. This will make it more difficult for the firm to reach its goal of 7M oz/year from gold production by 2017. Consequentially, fourth quarter earnings will likely be an inflection point for Newmont as investors get a chance to see a year in review for operational execution.
Consensus estimates for the miner's EPS are that it will grow by 18.4% to $4.56 in 2011 and then by 33.6% and 2% more in the following two years. Assuming a multiple of 10.5x and a conservative 2012 EPS of $5.87, the stock is fairly valued. If the multiple were to drop to 9x and 2012 EPS turns out to be 6.4% below the consensus at $5.70, the stock would fall for 16.9%. Accordingly, I believe risk, ironically, outweighs reward right now, despite the "buy" rating on the Street.
Admittedly, Freeport has problems of its own. The strike has turned out be much more detrimental to operational performance than I expected (see here). The union actually vandalized the pipeline that transports resources and is causing disruptions for other workers. On the other hand, the firm has had positive cash growth and $1B worth of planned capital expenditures signals managerial confidence about operations. Also, as I have pointed out, the Anglo American sale of 22.5% of its copper business to Mitsubishi implied a valuation of $22B, which suggests that Freeport should significantly appreciate. Freeport has a greater geographical exposure and top growth rates.
Consensus estimates for the miner's EPS are that it will grow by 7.1% to $4.98 in 2011, decline by 5% in 2012, and then grow by 20.3% in 2013. Assuming a multiple of 11x and a conservative 2012 EPS of $4.68, the stock has 39.6% upside.