Tuesday 17 February 2015 by Legacy

Why we liked the Newcrest 1H15 results but the sharemarket didn’t

Newcrest’s 1H15 result focused on strengthening its balance sheet and reducing debt, while holding back on an interim dividend. This highlights that the company is focused on maintaining its investment grade credit rating

We were pleased overall with Newcrest’s 1H15 performance. Statutory profit of $200m was up 400% on 1H14 and free cash flow was at a healthy $268m versus negative $229m in 1H14. The improvement in performance was against the backdrop of a 4% fall in the company’s realised US dollar gold price.  

Other key highlights from the 1H15 result were:

  • Revenues and EBITDA were broadly in line with 1H14 at $2.0bn and $730m respectively
  • The all in sustaining cost margin improved by 20% to $481/ounce
  • $2.3bn available in liquidity, comprising $128m in cash and $2.2bn in undrawn bank facilities
  • Gearing levels were broadly unchanged from 30 June 2014 at 33.9%          

But there was something even more impressive in the 1H15 results. Instead of using the free cash flow to pay a dividend to shareholders, Newcrest paid down debt by US$220m. This is a good signal that maintaining an investment grade rating and strengthening the balance sheet is more important to Newcrest than pleasing shareholders with a dividend. While all the usual media outlets have highlighted the disappointment of no interim dividend, it is actually a very prudent measure and should be applauded by bondholders.

Looking ahead, Newcrest’s credit will benefit from a weaker Australian dollar despite holding US dollar unhedged debt. This is because a stronger US dollar generates higher gold revenues. In addition, the high proportion of costs in Australian dollars will allow for higher debt repayment capacity, resulting in stronger credit ratios. If Newcrest can generate consistent strong free cash flows like 1H15, and improve the performance at its struggling Lihir mine, we expect to see positive rating action on the company in the future.

Newcrest is Australia’s largest publicly listed gold producer and one of the largest publicly listed companies in Australia overall, with a market capitalisation of $13.7bn. Newcrest has the longest reserve life of its peers at 32 years, which means it has enough gold reserves to support current production levels until 2047, beyond the maturity of its longest dated 2041 bond. Newcrest also has additional exploration opportunities in the pipeline which will most likely add to current reserves in future. FIIG has supply available in each of the 2021, 2022 and 2041 Newcrest US dollar bonds, with indicative yields to maturity of 4.45%, 4.85% and 6.23% respectively. While the 2022 bonds are yielding about 60 basis points below the Kinross 2024’s, we think that Newcrest is still showing good relative value with its leading cost position and reserve life against its peers. 

While the 2041 bonds offer the highest yield to maturity, please note that they also have a much longer duration than the shorter dated Newcrest bonds, meaning they are more sensitive to movements in underlying US interest rates. They are exposed to US rather than Australian rates because they are a US dollar bond. In addition, the 2041 bonds have a higher credit risk than the shorter dated bonds, because bondholders are relying on a longer period of sustained performance from the company and resultant coupon payments to realise the yield to maturity.  

If you believe that interest rates in the US will stay lower for longer and are comfortable with the longer term outlook for the company then the 2041’s seem like a logical choice. However, if you are concerned about the risk of an increase in rates, then it’s worth considering an exposure to the shorter dated Newcrest lines. With a $10,000 minimum investment we think exposure to Newcrest makes sense in a diversified bond portfolio.

Note: Prices current as at 17 February 2015, but subject to change. Newcrest bonds are only available to wholesale investors.