When it comes to the mining industry, I am particularly bullish about gold. This stems both from my outlook on the market's sensitivity to federal spending levels and my concerns about inflation. With that said, alumina also faces strong secular trends. In this article, I will run you through my DCF model on Alcoa (AA) and then triangulate the result with a review of the fundamentals against Newmont Mining (NEM) and Yamana Gold (AUY).
First, let's begin with an assumption about the top-line. Alcoa finished FY2011 with $21B in revenue, which represented a 14% gain off of the preceding year. I model growth trending from 13.1% to 11% over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold as 82% of revenue versus 4.8% for SG&A, 0.9% for R&D, and 7.5% for capex. Taxes are estimated at 27% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital to get free cash flow. I model this figure hovering around -1.5% over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $12.30 for 26.5% upside. The market seems to be factoring in a WACC of 11%, which is a little on the high-side. In any event, Alcoa only trades at 6.7x my 2015 free cash flow estimate.
All of this falls within the context of a strong start to the fiscal year:
And we think we started the year with an excellent first quarter, and I say that from both an earnings perspective as well as a cash perspective. On the earnings front, as we go through this, it will become evident, but our business performance was outstanding in that all of the businesses generated significant productivity. And on the cash side where we experienced the usual first quarter use of funds, we set a first quarter record on days working capital, and we funded 1/3 of this year's pension contributions in cash.
From a multiples perspective, Alcoa is also attractive. It trades at 28.6x past earnings but only 10.4x forward earnings. This compares to corresponding figures of 49.1x and 8.6x for Newmont and 19.9x and 9.6x for Yamana.
Consensus estimates for Newmont's EPS forecast that it will grow by 8% to $4.74 in 2012, grow by 16.5% in 2013, and then fall by 6.9% in 2014. Assuming a multiple of 12x and a conservative 2013 EPS of $5.45, the stock would $65.40, the stock would take off by 37.3%. This upside is also well complemented by low volatility and a high dividend yield of 2.9%.
Consensus estimates for Yamana's EPS forecast that it will grow by 21.9% to $1.17 in 2012, grow by 28.2% in 2013, and then fall by 10% in 2014. Assuming a multiple of 12x and a conservative 2013 EPS of $1.48, the stock would rise by 20.8%. This gold producer has slightly more volatility than Newmont but is still around 30% less volatile than the broader market.
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