S&P: Newcrest Mining Ltd. Outlook Revised To Positive On Debt Reduction And Strong Results; 'BBB-' Ratings Affirmed
"The outlook revision reflects our expectations that Newcrest could maintain its strong credit metrics in the year ended June 30, 2016, over the next two years. We consider the company could sustain its low cost production, reduced leverage, and stable operations at the Lihir gold mine," said S&P Global Ratings credit analyst May Zhong.
Newcrest continues to be a major global gold mining company, supported by its long reserve life at current production levels of about 28 years and low cost production. Offsetting these strengths are: the company's limited product diversity, significant dependence on a few large operations, and exposure to country risks in Papua New Guinea (PNG).
We expect Newcrest to maintain its low cost of production. We believe the company will continue to generate above-average profitability, driven by about US$600 per ounce (oz) cash costs (net of byproducts, such as copper and silver) against a gold price of US$1,300 per oz. In addition, we estimate the company could generate free operating cash flow (after capital expenditure) even if gold prices declined to US$900 per oz. The company's all-in sustaining costs (AISC) are about US$750-US$800 per oz, assuming stable operations at its Lihir mine.
Further underpinning Newcrest's low cost position is its Cadia mine's very low AISC of US$274 per oz in fiscal 2016. Cadia contributed more than 50% earnings to the group. The use of low-cost block-caving mining and the benefits of byproduct (copper) credits are key drivers of Cadia's low AISC. The rest of the mines within Newcrest's portfolio are in the third or fourth quartile of the global cost curve.
This low cost production is key to Newcrest generating positive cash flows during periods of weak prices. Gold prices have significantly fluctuated over recent years, and we expect the volatility to continue over the next 12 months. Newcrest's profitability is sensitive to gold price volatility given its limited commodity diversification. In addition, the company remains exposed to elevated country risks in PNG.
Compared with its peers globally like Barrick Gold Corp. or Newmont Mining Corp., Newcrest has less asset diversity. Its financial performance is heavily dependent on the performance of its two largest mines, namely Cadia in Australia and Lihir in PNG, which together accounted for 80% of the group's EBITDA in fiscal 2016.
Newcrest's Lihir mining operations have recently turned around, generating a record production volume in fiscal 2016. The mine's production cost could reduce further if volumes increase with further improvements in its operational performance.
We expect Newcrest to generate stronger credit metrics for the rating level in fiscal 2017, due to its low cost production, reduced leverage, and stable operations at the Lihir gold mine. Under our base-case assumption for gold prices, we expect Newcrest's funds from operations (FFO) to debt to be higher than 50% and debt to EBITDA lower than 2x in fiscal 2017, which are stronger than our expectation for an intermediate financial risk profile.
However, the company remains sensitive to volatility in gold prices. A moderate fall in gold prices from our base-case assumption could materially worsen its credit metrics. In addition, if Lihir underperformed materially, it could also drag down the group's earnings and credit metrics. We expect the company will continue to use its free cash flows to reduce debt--in fiscal 2016, it paid down about US$900 million of gross debt. This, together with stronger earnings, has provided a large rating buffer for the company.
We have revised our assessment of the company's management and governance to satisfactory from fair, to reflect the settlement of a class action. On Feb. 22, 2016, Newcrest reached an agreement to settle the class action proceedings commenced by Earglow Pty Ltd. on July 21, 2014, in the Federal Court of Australia on its own behalf and on behalf of a group of shareholders who acquired an interest in Newcrest securities between Aug. 13, 2012, and June 6, 2013. On May 3, 2016, the court approved the settlement.
The change of the assessment also reflects our view of the management's expertise and experience. The new CEO has established a track record in turning around the previously underperforming Lihir operation.
Ms. Zhong added: "The positive outlook reflects our view that Newcrest's continued debt reduction and improved operations at its Lihir gold mine have increased the rating buffer for the company, strengthening its resilience if industry conditions were to weaken."
An upgrade could occur over the next two years if Newcrest can maintain a conservative financial risk profile--for example, its adjusted debt to EBITDA sustaining below 2.0x and free cash flows remaining positive even when gold prices fall moderately or when the company expands. In addition, we expect Lihir to develop a track record of stable performance. However, a significant increase in exposure to higher risk geographies could limit potential rating upside for the company.
We could revise the outlook back to stable if significant operational issues at its Cadia or Lihir mine were to occur, reducing the group's earnings and cash flows; or if gold prices were to fall materially without any favorable movement in exchange rates. This scenario would reduce prospects of an improvement in the company's credit metrics; for example, worsening its debt to EBITDA to above 2.0x.