It’s been a tough year thus far for the Gold Miners Index (GDX), and after a disappointing first-half performance, Newmont (NYSE:NEM) is one of the worst performers. This is evidenced by its 31% year-to-date decline, an 800 basis point underperformance vs. the GDX due to weaker margin performance than expected. However, I believe there are reasons to be optimistic, with gold being hated and the stock trading at its smallest premium to net asset value in years. So, if weakness persists, I would view pullbacks below $40.45 as low-risk buying opportunities.
Q2 Results & Recent Developments
Newmont released its Q2 results in late July, reporting quarterly production of ~1.45 million ounces of gold, a marginal increase from the year-ago period. Meanwhile, quarterly gold-equivalent ounce [GEO] production was up 10% year-over-year to ~333,000, pushing H1 production to 683,000 GEOs. Unfortunately, this slight increase in total sales (~1.79 million ounces vs. ~1.69 million ounces) was overshadowed by weaker metals prices, negatively impacted by unfavorable mark-to-market adjustments on provisionally priced sales.
While the weaker-than-expected revenue was a minor negative, the areas being watched closely due to the inflationary environment delivered the main disappointments. These were the fact that all-in-sustaining cost margins took a significant hit, declining from $905/oz to $575/oz in the period. This was partially related to a $65/oz increase in Q2 alone in its North American business from profit-sharing at Penasquito, the negative impact of mark-to-market adjustments, but mostly due to higher energy, materials, and consumables costs (diesel, steel, cyanide, natural gas), and labor inflation for contracted services. On a full-year basis, Newmont now expects up to 5% higher costs than previously expected, exacerbated by labor tightness in Australia.
Finally, the unexpected additional hit that set the company’s shares sliding post-earnings was that it had also seen inflation and delays in its development projects. At Ahafo North, capex estimates have been revised 15% higher with an updated 2025 commercial production outlook, a slightly negative development for this high-margin project (~300,000 ounces at sub $750/oz all-in sustaining costs). At Tanami, where the company is sinking a ~1,500-meter shaft that will boost production, deliver meaningful cost improvements, and extend the mine life into the 2040s, capex was revised to 25% higher, with commercial production planned for early 2025.
Given these surprise negative developments, it’s not surprising that Newmont has been an underperformer vs. its peers, especially after it came into the year as a significant outperformer, sitting at new 52-week highs above $80.00 per share. These negative developments also raised some uncertainty about the dividend. Still, Newmont was clear in its Q2 Conference Call that it had $4.3 billion in cash, a very low net debt to adjusted EBITDA ratio (0.30x), and $7.3 billion liquidity, giving it the flexibility to support the dividend in this window of higher investment. Specifically, Newmont’s CEO Tom Palmer stated:
- “We recognize that as a long-term business that we’ll reinvest from time to time, you’ll have periods of great reinvestment and lower reinvestment year-over-year or over a period of time. So we take that long-term view into consideration as we look at the spend profile of development capital.”
- “Our dividend is set up to be stable and robust over time”.
In a recent Denver Presentation, CEO Tom Palmer noted that the company would be releasing a new dividend framework that would look similar to its current one but have some changes. For those unfamiliar, the current one has a 6-month lookback on the gold price with dividends calibrated at $1,200/oz, $1,500/oz, $1,800/oz, and $2,100/oz with annualized dividends of $1.00, $1.60 to $1.90, $2.20 – $2.80, and $2.80 – $3.70, respectively. While the gold price is below the $1,800/oz level currently, I am cautiously optimistic that we won’t see a dividend cut, which I’ll expand on below:
Dividend Safety
The below chart shows the current annualized dividend payouts discussed above. With free cash flow expected to come in at ~$1.70 billion next year, supporting the dividend ($1.74 billion based on 790 million shares) wouldn’t be an issue, especially with the strong balance sheet that could provide a buffer. However, assuming gold prices remain below $1,700/oz, free cash flow could sink to less than $1.40 billion in 2024 during a period of slightly higher investment. This would make it more difficult to support the dividend with free cash flow, but there are some points worth considering:
- Newmont conservatively used the 40% payout ratio at $1,800/oz ($2.20 vs. $2.80), saving the company from what would have been a required dividend cut if it had aimed high previously.
- Newmont recently sold its minority stake in MARA for $125 million upfront and $50 million in deferred payments, further strengthening the balance sheet.
- Newmont has pushed out Yanacocha Sulfides, a positive development given that it shifts this capex-heavy project to 2025 or later with capex limited to two water treatment plants ($350 million over the next two years) vs. a previous outlook of $2.5+ billion over the next four years.
So, while the gold price is set to head below the $1,800/oz level on a 6-month look-back basis if it doesn’t recover (currently $1,815/oz), it’s still much closer to the $1,800/oz level than the $1,500/oz level. Additionally, Newmont has a strong balance sheet to support a buffer, its growth capex spend has been cooled off with plans to push out Yanacocha to avoid execution risk (building three major projects at once in an inflationary environment), and it has a slightly stronger balance sheet with the sale of its stake in MARA.
Based on these points, the annualized $2.20 dividend should be safe as long as the $1,625/oz level holds, which I partially attribute to the company adamantly pointing out that it has flexibility in this framework. That said, the dividend framework is set to change due to the new normal of higher operating costs, higher capital costs, and higher costs from a tailings standpoint due to industry-wide changes. Overall, I don’t expect these changes to be that unfavorable, and even with these changes, I expect the dividend to remain very competitive.
A possibility is that the dividend could change to $1.30, $2.20, and $2.80 at gold prices of $1,500/oz, $1,800/oz, and $2,100/oz, respectively, vs. $1.60 – $1.90, $2.20 – $2.80, and $2.80 – $3.70 currently. We could also see a tightening of the current range, with the top side of the range, relaxed considerably. Investors should get more information related to this by year-end, but given the 50% decline in the share price, I believe this is mostly priced into the stock. Additionally, I think the more negative development would be a dividend cut, especially one of more than 10% (annualized dividend of $1.95 or less). I believe we can rule this out for the time being, as long as gold doesn’t weaken further.
Updated Margin Outlook & Earnings Trend
Based on the fact that the high-margin Ahafo North production has been pushed out and the higher operating cost environment, I have revised my previous estimates for Newmont’s all-in-sustaining costs and all-in-sustaining cost margins. My updated expectation is that AISC margins will likely be flat year-over-year from FY2022 to FY2023 after declining sharply in FY2022 ($738/oz to ~$575/oz), which assumes a $1,770/oz gold price in FY2022, FY2023, FY2024 and FY2025. The good news is that we do appear to be seeing some green shoots from an inflationary standpoint, with oil prices pulling back sharply and prices declining for some other materials.
That said, the major input cost for miners is labor, and I don’t expect labor prices to decline for employees. The area where we could see some improvement is within contracted services if the labor market becomes less tight, which is possible if some mines are throttled back at lower gold prices. Based on Q2 2022 potentially marking peak costs and an outlook of a flat gold price ($1,770/oz in 2022, 2023, 2024, and 2025), I would expect 2022 to mark the low for Newmont’s margins. Of course, this is contingent on a $1,770/oz gold price next year. I don’t see this as a stretch given the favorable environment for gold (sentiment extremely low where gold typically shines on a forward 1-year basis, negative real rates).
Meanwhile, from an earnings standpoint, Newmont’s earnings trend is certainly much less pretty but remains in a strong uptrend. Based on updated estimates, Newmont’s annual EPS is expected to decline to $2.28 in FY2022 and further in FY2023, down from $2.66 and $2.96 in FY2020 and FY2021, respectively. However, these figures are still well above pre-COVID-19 levels, which isn’t the case for some producers that continued to post net losses per share. That said, these earnings estimates could change dramatically to the upside if we see an improvement in metals prices.
Looking solely at the recent results and margin compression, it’s understandable if some might prefer to pass on Newmont as an investment. However, I don’t see any value in rear-view mirror analysis. While the landscape is undoubtedly harder due to inflationary pressures, the market often looks forward six to twelve months. In my view, we may have seen peak operating costs in Q2 2022 due to lower…
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