Evaluation of Newcrest Mining Limited

Ever since the great California gold rush of 1848 Australian interest and enthusiasm for gold has been strong. Australia is the third largest producer of gold in the world accounting for 13% of the world total gold production. The importance of gold to the Australian economy is unquestionable. The economy benefits from the gold mining industry through contributions to government revenue in the form of mineral royalties, direct taxes such as company taxes, PAYE and indirect taxes such as stamp duty.

Minerals Council of Australia estimates that Australian mining contributes $4.5 billion to State and Federal governments. It is also estimated that for every one person employed in the gold industry another 3. 5 jobs are created elsewhere in the economy1. Newcrest is one of the leading gold produces in Australia and with the contribution of Telfer in 2004-2005 will become the biggest gold producer in Australia. The NCM strategy is simple and prominent in the 2002 annual report, "create low cost long life mines". This is reinforced by their strategy to divest the New Celebration mine. NCM reported a loss of $53m for year 2002.

Caused in part by two significant items that we will discuss in detail in this report. It does highlight the dangers of management hedging both gold and currency fluctuation. Analysis of the important ratios demonstrates a highly geared company with capital funded 50-50 between equity and debt. This leaves NCM exposed to interest rate fluctuations. The current ratio is also very concerning at 69%. Compared to global competitors analysed in this report, NCM are in the medium range of margins at $77. 75 USD and have a high share price compared to that of better performing companies.

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Recent economic indicators are favourable for all gold stocks. Economic decline, equity falls and the threat of terrorism all bode well for gold prices. Only the Swiss hold significant reserves for sale under the Washington Agreement on Gold in 1999. This could result in a physical shortage of gold contributing to the further spike in gold prices. Favourable economic conditions combined with the increase in production from the Telfer mine from 2004 and the decrease in mining costs will improve the NCM financial results.

Our financial evaluation concludes that the current Newcrest share price is over priced. According to our analysis the share price will be affected by the distribution of the capital either in 10 or 20 years. Distributing the capital costs of Telfer over the life of the mine (20 years) will improve the share price in a shorter period of time. Low dividend yield coupled with hedging issues make investing in NCM less attractive at the current share price. The short-term outlook is a sell recommendation.

Longer-term prospects appear to be more positive due to economic conditions, decrease in costs and increase in production from the Telfer mine. Newcrest Mining is a leading Australian gold producer with mining and exploration projects in Australia, Indonesia, and the USA. The strategy is to focus on low cost, long life mines improving the international cost competitiveness and durability of the gold and copper business. The overall decrease in cost of production and managing financial exposures via hedging was the means of achieving the strategy.

This prompted Newcrest to divest the high cost New Celebration mine enabling Newcrest to lower its total cash cost of production and focus on more profitable mines and developments. By closing the Telfer mine, selling New Celebration and ceasing remnant mining in Boddington Newcrest operations is now in the lowest quartile on the world cost curve2. Newcrest reported a loss of $53 million for the year to June 2002. Caused primarily by two significant items. $80. 6 million provision for surplus foreign currency and $25 million provision for hedging restructure.

Gold price received was $559 while the spot price was $548. Softening the impact. Contrary to strategy Newcrest advised the market that its proposed Telfer project cost in WA had risen by 22% due to a staged underground development. Newcrest will now spend an extra $215m on the project boosting the total capital cost to 1. 19 billion3. Resource studies for the Telfer project have been completed and indicate 26 m ounces of gold. This could treble the current gold production of Newcrest by 2005. Although the Telfer cost has blown out the potential production benefits to Newcrest are substantial.

This increase will place Newcrest as the number one producer of gold in Australia. Newcrest has taken significant risks with its hedging strategies making uncustomary management decisions placing the company in serious financial risk. The main purpose of hedging is to reduce the risk of the company or exposure to any downturn in the Gold price. Guarding against such downturns is done via forward contracts and call options.

However, the Management team at Newcrest has risked shareholders funds in speculating on currency movements by undertaking Put options at more than 0.70USD (to the AUD). Consequently losing several millions dollars and contributing to the reported loss in FY02. The company has a further USD$488million worth of committed funds to forward contracts and put options in FY02. The USD$80million loss attributable to the forward contracts has been novated between counterparties for a non-cash expense of USD$4. 1million. The company is highly geared at 50% with the amount of debt equivalent to the amount of equity in the company. The high gearing makes the company very sensitive to interest rate movements.

Standard Accounting ratios have been used to compare Newcrest with its main local competitor Aurion. Specific ratios relevant to the Gold Industry are also used to compare Newcrest with Aurion and other international gold plays such as Barrick and AngloGold. Newcrest has also been heavily involved in hedging strategies that have been unfavourable due to the several circumstances, one of which was the fall in the local currency against the US dollar. Details of Newcrest's hedging strategies will be evaluated in the proceeding sections.

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