A Golden Quarter for Newmont

 Newmont Mining (NEM) reported a great start to 2015, generating adjusted EBITDA of $815 million on 1.2 million attributable gold ounces in the first quarter, compared with $493 million on 1.2 million attributable gold ounces in the prior-year quarter. We think the results reflect Newmont's impressive improvement over the past year. The company has done a good job reducing its cost profile, with first-quarter all-in sustaining costs of $849 per ounce compared with $1,034 per ounce a year ago. The 18% reduction in AISC has helped improve Newmont's cash flow generation, allowing it to rely on internally generated cash to fund developments at Merian and Long Canyon. The company largely maintained its full-year outlook of 4.6 million-4.9 million attributable gold ounces at AISC of $960-$1,020 per ounce. We wouldn't be surprised if Newmont lowers that cost outlook later in the year, as we expect full-year AISC to fall at the lower end of its guidance. We've added the Long Canyon mine to our model, but given its relative size (about 100,000-150,000 gold ounces at full production) compared with the company's total production (4.8 million gold ounces in 2014), our fair value estimate is unchanged at $30 per share. We maintain our no-moat rating.

We're optimistic for the Long Canyon mine development. In a time where other gold miners continue to struggle with geopolitical issues around the world, the potential for Newmont to expand its flagship Nevada portfolio is extremely attractive. Long Canyon is the first mine in a new gold mining district located less than 100 miles from Newmont's other Nevada mines. This proximity should allow mines in this new district to leverage existing infrastructure and equipment to lower capital and operating costs. By itself, Long Canyon isn't large enough to significantly move the needle for the sizable gold miner. But the potential to develop additional nearby mines could serve as a meaningful production growth driver in the future.

New Projects Replace Aging Ones for Growth
Newmont faces stagnant to declining gold production levels and rising operating costs at some mines, primarily driven by the decline of its Yanacocha mine in Peru. Yanacocha had been a major gold producer but is now nearing the end of its life, with production declining, reserves depleting, and expansion unlikely. In addition, lower grades at Ahafo will lead to lower production at the African mine over the next few years. However, the construction of Merian and Long Canyon, mine sequencing at Batu Hijau, and the nearly completed Turf Vent Shaft in Nevada should boost low-cost production and more than offset the decline at Yanacocha and Ahafo.

Nevada is an important piece of Newmont's portfolio, with nearly 20 mines operating in close proximity. This allows the mines to share facilities that employ a variety of processing methods to maximize economic recovery. In addition, brownfield investments can leverage nearby operations, lowering potential capital costs. Newmont's other mines are located in Mexico, Ghana, Australia, and Indonesia. Australia is Newmont's second-largest producing region behind Nevada. However, these mines tend to be higher cost, with all-in sustaining costs above the company average. In Indonesia, Newmont faces more geopolitical risk than it does in most of its other operations. For example, in early 2014, the government introduced a new mining export tax in an attempt to force miners to build domestic smelters.

Our long-term gold price forecast of $1,283 per ounce in 2018 is based on the marginal cost of production for gold miners on an all-in sustaining cost basis. This includes both the cash costs and capital expenditures necessary to sustain current production levels. Our long-term gold demand forecast assumes solidly increasing demand, driven by China and other emerging markets. China and India already constitute an overwhelming share of gold retail demand. Given gold's cultural importance in both countries, we expect rising household incomes will propel continued demand growth.

No Moat for Newmont
We do not believe Newmont has an economic moat. Because of gold's commodified nature, miners establish a moat through low-cost production. However, Newmont's unexceptional production costs weigh on the company's ability to generate returns in excess of its cost of capital. Although a couple of its mines operate at production costs below the industry average, the majority of its mines are not low cost. Newmont's overall cash costs of $700-$800 per ounce and all-in sustaining costs of $1,000-$1,100 per ounce sit in the middle of the industry cost curve. Barring a dramatic return to higher gold prices, we do not expect Newmont to earn excess economic returns.

Newmont has nearly two decades' worth of reserves at current production levels. If the company were able to move into the lower part of the cost curve, we would consider revisiting our moat rating.

In light of the lower gold price environment, gold miners have shifted their focus from maximizing production to maximizing cash flow. This has included a variety of cost-saving programs that target production costs, general and administrative expenses, exploration expense, and others. However, we do not think this will materially affect Newmont's cost position. First, the company has taken its own steps to rationalize costs and manage cost inflation. Second, even when a miner pursues cost-reduction efforts, it cannot change the nature of a mine itself. This limits the potential cost reduction. Therefore, Newmont's production costs should remain stable relative to the industry.

As the Yanacocha mine approaches the end of its life, production costs have risen while production has declined. Newmont believes that mine sequencing and development projects at its existing operations in Nevada and Indonesia will offset the lost ounces at Yanacocha. Furthermore, production costs are expected to decline at these mines. While the shift from higher-cost ounces to lower-cost ounces could lower the company's average production costs, we do not think the shift will be enough to move the company into the lower end of the cost curve.

Gold Prices and Project Development Are Risks
Like most gold producers, Newmont is highly leveraged to gold prices. We believe the company faces average risk to fluctuations in gold price compared with other gold miners. All-in sustaining costs are roughly $1,000 per gold ounce, near the industry average. At today's gold prices, the company faces less difficulty generating free cash flow than some of its higher-cost competitors.

Newmont does not boast as prolific of a growth profile as some other gold miners. However, it faces some execution risk as it brings a handful of expansion projects at existing mines on line over the next few years. We think this risk is intensified by the declining production at Yanacocha as it nears the end of its mine life. Should the company be unable to bring its projects on line on time, it would be unlikely to maintain its historical production levels.

With much of its exposure in stable, mining-friendly jurisdictions, we think Newmont's overall portfolio carries only a moderate amount of geopolitical risk. More than half of Newmont's gold production is based in the United States and Australia, with remaining production in Mexico, Peru, Indonesia, and Ghana. While the company has faced some uncertainty regarding copper exports from its Indonesian operations, we think the relative stability in most of its jurisdictions limits companywide uncertainty.

Newmont initiated the gold industry's first gold-price-linked dividend in 2011. Philosophically, we like the idea of a gold-price-linked dividend because it provides more direct exposure to gold price increases for investors and leaves less cash in management's hands during industry peaks, which could prevent the type of value-destructive merger and acquisition activity that many miners seem prone to. During industry troughs, more cash becomes available while times are tight. We note that the dividend is linked solely to gold prices with no adjustments for either production levels or costs. While this may strain the company if it's unable to keep control of its operations, we think it provides additional motivation for management to prioritize effective management of existing operations.