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Evolution Mining Limited ( EVN.AU ; AUD1.21; Sector Perform)

Independence Group ( IGO.AU ; AUD4.00; Sector Perform)

Newcrest Mining Limited ( NCM.AU ; AUD12.59; Underperform)

Northern Star Resources Limited ( NST.AU ; AUD2.20; Outperform)

OceanaGold Corporation ( OGC.AU ; AUD3.22; Sector Perform)

OZ Minerals Limited ( OZL.AU ; AUD3.68; Sector Perform)

Sandfire Resources NL ( SFR.AU ; AUD5.70; Outperform)

Hiding in Australian gold stocks as the turmoil unravels...

We recognize Australian gold stocks as a preferred position amongst the volatility in the global markets. The continuing fall in the AUD adds further appeal for investment as we expect gold stocks to become the “safe-haven” with strong free cash flow continuing in AUD gold producers.

M&A round should continue as previous lack of exploration has provided little organic growth within the industry...

The recent M&A activity has proven a positive for those willing (or able) to pay up for assets. The most recent example of this is the EVN acquisition of Barrick’s Cowal mine, which we believe the company paid a premium for the asset; however the market’s reaction, similarly with OGC’s acquisition of Waihi, has been positive, with EVN shares trading up significantly against its raising price at A$0.90/sh announced for partial financing of Cowal.

The small to mid-caps have emerged as the winners so far, increasing their production growth via acquisition and gaining further exposure to the AUD gold price which has significantly outperformed USD gold price in recent months. As the market continues to reward those who are pursuing M&A as a strategy, we expect further activity to transpire in this space. Although as little organic growth is realized, we expect those who are left at the table and do not participate, may find themselves in a tougher position, especially as many producers are facing ever-reducing mine lives...production growth via acquisition may be the only option for many.

More M&A expected to come, but who are the major players?

OZ Minerals (ASX: OZL; Sector Perform; Price Target A$4.40)

We identify OZ Minerals (OZL) as the most likely player in the ongoing round of M&A. The company has already strongly alluded to its desire for growth via acquisition, with not only copper as a target, but also gold and other base metals.

As the M&A round heats up we believe higher premiums would likely be required for successful acquisition. The recent sale of the Cowal mine is a good example, where we believe EVN paid a premium to acquire; regardless, the market’s support for the acquisition has so far been strong, with the company trading a significant premium to the acquisition raise price of A$0.90/share. OZL’s desire for any potential asset, which it believes to fit its longer-term objectives, should benefit the seller further who would no doubt only accept a premium, due to 1) knowledge of OZL’s strong desire for acquisition; and 2) recent strong corporate demand for growth via acquisition.

For the reasons mentioned above, in conjunction with minimum mine life from the Prominent Hill open pit, we prefer exposure to Sandfire Resources (SFR) over OZ Minerals.

Sandfire Resources (ASX: SFR; Outperform; Price Target A$5.90)

Sandfire’s more consistent production profile, longer mine life (c.6 years) and exploration upside provide the company with additional corporate appeal, positive catalysts and consistent cash flows over its copper producing peers in the Australian market.

The recent exciting drill results from the company’s Springfield Project (a JV with Talisman Mining, ASX: TLM) which produced 16.5m at 18.9% Cu and 2.1g/t Au (from 410m down-hole) now provides SFR with what will likely produce further strong results and the potential to increase mine life at DeGrussa (if further drilling proves successful). This exploration upside at Springfield (and down plunge extensions to DeGrussa itself) could add the corporate appeal for a potential buyer of SFR.

A declining AUD is somewhat shielding SFR (and OZL for that matter) from the recent falls in the copper price; this too may add appeal for any potential acquirer based offshore.

Independence Group (ASX: IGO; Sector Perform; Price Target A$5.20)

Our recently revised base metals forecast has dropped our valuation for IGO, from which we now derive a price target of A$5.20 (previously A$5.60).

We value IGO using a blend of 75:25 net asset value (NAV) and profit/debt-adjusted cash flow (P/DACF). We believe this provides an appropriate balance between the near-term cash flow potential of the business and the longer-term optionality of the full asset suite. In the case of IGO, the company is in a net cash position. We use a 10.0x DACF multiple and 1.0x NAV in determining our price target. Our multiples reflect that the Tropicana gold mine in Australia provides domestic investors with an opportunity for exposure to a new, high-quality asset, which is being operated by a global major with a relatively good track record. This, as well as the mix of base metal projects (copper, nickel, and zinc), suggests to us that IGO should trade at a premium compared to other domestic stocks under our coverage. However, compared to some of our global stocks in the Tier III coverage group, the lack of mine life at Long and Bentley lowers our DACF multiple to 10x (compared to 13x average).

The recently proposed acquisition of Sirius Resources (SIR) will form a nickel dominant producer, whereas previously IGO was a semi-diversified gold producer, with Tropicana the focus for the market. Alongside a falling nickel price, the market’s reaction has been rather negative, with the stock falling significantly (c.A$6.00 to c.A$4.00) since the announcement of the deal approximately 7 weeks ago. Reasons for the decline are likely due to 1) investors with a stronger gold focus no longer have the desired exposure to the metal; 2) falling nickel prices; and 3) the risk and uncertainties around the upcoming build of Nova/Bollinger, with the potential free cash flow now absorbed by the c.A$500m capex required to build the project.

Although IGO has already made a strong move in the M&A round, we expect further is yet to come, as the company has recently purchased a stake in the gold developer Gold Road Resources (GOR), which holds 100% of its Gruyere deposit in Western Australia, north of Tropicana. If IGO were to make a play for the asset, or GOR itself, it would potentially enjoy a rebalance into a more gold-focused business, but like Nova/Bollinger, the upfront capex required for such a project may deter investors against an existing producing asset.

Evolution Mining (ASX: EVN; Sector Perform; Price Target A$1.00)

The recent acquisition of Cowal from Barrick has so far been a positive for the company in terms of share price. Although we believe EVN paid up for the asset, this catalyst has moved EVN into a new peer group, with the company now expected to produce c.760-860koz pa, which also includes the La Mancha assets (Frog’s leg and White Foil).

Key focus now turns to Cowal, as the company’s major asset, with Mt Rawdon and Edna May now pushed into the background. Therefore, we expect any news in relation to Cowal to be the main share price mover over the company’s remaining assets. The likelihood of EVN moving again into further M&A decreases, in our view, after its recent acquisitions.

OceanaGold Corp (ASX: OGC; Sector Perform; Price Target A$3.00)

OGC recently acquired the Waihi gold mine in New Zealand from Newmont. With OGC already operating within NZ and its strong operating performance from what is considered a difficult ore body, it is fair assumption that the company can too operate Waihi efficiently, and with an existing corporate office in New Zealand, it should be a relative simple transition, with potential cost-out from a leaner corporate charge and potential operating savings.

Post-acquisition and financing of Waihi, we estimate gearing of c.20% (ND/ND+E) for OGC, and with current NZ operations continuing to outperform, largely due to benefits relating to falling NZD, we believe further M&A is a potential for the company if the right asset becomes available. Like EVN’s acquisitions, the market has also reacted strongly to OGC’s deal for Waihi.

Northern Star Resources (ASX: NST; Outperform; Price Target A$2.50)

NST was the first to aggressively take advantage of M&A as the majors began spinning off their lesser-producing assets. The acquisition of Jundee (100%), East Kundana (51%), Kanowna Belle (100%) was not strongly supported by the market upon the transaction; however, NST has shown the significant upside and strong cash flows generated from these assets, with a payback of less than 1 year for all three.

A strong balance sheet, now debt free, puts NST in a strong position for further potential M&A, in our view. The company has a strong underground operating base and we believe NST will likely continue to play to its strengths in this regard. Benefitting strongly from a higher AUD gold price, we estimate strong free cash flow to continue, led by both Jundee and Kundana.

Newcrest Mining (ASX: NCM; Underperform; Price Target A$10.00)

Unlike many of its smaller domestic peers, NCM does not have the flexibility with its balance sheet. The company has outlined its targeted gearing is c.15%, yet with current gearing at c.37% we continue to see a large portion of any free cash flow to be allocated here.

Similar to some of the majors, we believe divestment of some of its assets (Telfer the most probable) may be more likely for NCM in the short term over any potential acquisitions. In addition, with its longer-term growth project, Wafi-Golpu, the company has a growth profile already in place.

As outlined in our recent research note “A primer on currency: exploring the impact on miners”, the currency benefit for NCM is not as clear cut as what investors may think and unlike its smaller peers, NCM does not enjoy the strong benefits from the falling AUD at all its operations; however, of its six producing assets Cadia East and Telfer realize revenues in AUD. However, we recognize offshore investors with a desire to invest in gold stocks with

AUD exposure can only choose NCM since it is the only stock with the liquidity and size for many investors with such requirements, therefore, potentially attracting a premium over many of its smaller Australian peers.

We continue to see Lihir, a USD revenue-generating business, as a capex-heavy operation, absorbing free cash to continue to operate into the future. The uncertainties around this continue to leave us somewhat cautious, especially with longer-term projections.

-- Paul Hissey, Cameron Klutke (Analysts)
 Australian Gold Stocks: A Haven Amid the Chaos?

Evolution Mining Limited (EVN.


