From low betas to aggressive capital allocation, basic materials are one of the most defensive sectors right now. One producer that contrasts somewhat with this overall thesis is Newmont (NEM), which has had project disruptions and worse than expected tax losses. Barrick Gold (ASX), on the other hand, has been called the "Hedging Miracle" and a record of beating expectations. While Newmont is rated closer to a "hold", Barrick rightfully receives its "strong buy" rating.
Although Freeport (FCX) stands out as being one of the most undervalued producers in the sector, Barrick is also fairly cheap. The latter trades at a respective 10.9x and 8.1x past and forward earning, which compares to corresponding figures of 13.1x and 10.4x for Newmont. In addition to being the cheapest at 6.8x past earnings, Freeport also offers the highest dividend yield at 2.6%. Between Barrick and Newmont, however, the clear choice is the bigger of the two. Given its smaller size, Newmont has less room to grow operating margins despite past success.
At the third quarter earnings call, Newmont's CFO, Russell Ball, noted shortcomings amidst overall success:
"I'm pleased to be able to talk to you this morning about another strong quarter of operating and financial results. Clearly, we benefited from a 39% increase in the gold price, realizing $1,695 an ounce, which was $7 or approximately 0.4% lower than the average of the daily fix. This was due to the timing of doré sales, concentrated shipments and mark-to-market adjustments at quarter end in what was a very volatile quarter …
Net income from continuing operations of $493 million was impacted by a noncash impairment charge of approximately $152 million on an after-tax basis. And this is related to marketable securities of Paladin Energy Limited, a uranium producer, and Pilot Gold, both acquired on April 6, 2011, as part of the acquisition of Fronteer. These charges were offset by a $10 million after-tax gain realized on the sale of a minority position in Lydian Resources. The net noncash impairment of $142 million equates to $0.29 a share on an after-tax basis and results in adjusted net income for the quarter of $1.29 a share.
Net income for the quarter was also adversely impacted by an effective tax rate of 36% due to some timing issues and a valuation allowance on certain capital losses."
While the Batu Hijau project has been an overall winner, the transition to waste stripping reduced overall gold production. As investors begin to disassociate Newmont with gold, we could start to see a continued pullback in value. Moreover, disruptions in operations will further make investors wary about long-term sustainability. A while back, Newmont had to suspend its $4.8B Peruvian Conga project due to environmental protestors. This may cause disruptions in other projects that have previously been the target of protests. The Conga project is expected to make up around one-fifth of the increase in net gold production over the following six years - thus, the disruption is particularly problematic.
With that said, the company's strengths should not be dismissed. Management remains committed to returning free cash flow to shareholders and increased the dividend for the sixth consecutive quarter. Notwithstanding project disruptions, gross margins have also meaningfully increased for the last 11 consecutive quarters. Add in an investment grade rating and you have some limitations to downside - although, as I noted earlier here, the company is most likely to underperform the market and industry.
Consensus estimates for Newmont's EPS are that it will grow by 17.4% to $4.52 and then by 32.5% and 2.5% more in the following two years. Assuming a multiple of 13x and a conservative 2012 EPS of $5.82, the rough intrinsic value of the stock is $75.66, implying 22.1% upside. If the multiple were to return to a more reasonable level of 9.5x and 2012 EPS turns out to be 3.8% below the consensus, the stock would fall by 11.7%.
In light of this backdrop, Barrick is likely to outperform its competitor. The large producer is well diversified and has strong potential in global expansion. Third quarter results were also strong as management met high targets in terms of costs and production. With a record of exceeding expectations 9 out of the last 10 quarters, management consists of a stellar team that merit the company receiving a premium multiple.
Consensus estimates for Barrick's EPS are that it will grow by 47.9% to $4.91 and then by 22.2% and 12.8% more in the following two years. Assuming a multiple of 12x and a conservative 2012 EPS of $5.70, the rough intrinsic value of the stock is $68.40, implying substantial upside.