An analysis that I posted on the ABX site for my peer review. Let me know what you guys think of this.
This is part two:
Lets recap my hypothesis:
<<..NEM is not anymore leveraged to gold price than ABX (did I get everyones attention?). I would even argue that "realizable leverage" is with ABX and not with NEM. How can this be? You'll get the answer in part two..>
I ran the numbers, and yes, ABX is equally leverage to gold with NEM. How is this possible?
- Can earning for ABX and NEM be equally sensitive to POG?
This is really not the best question to ask. Here is what I believe to be a better question?
- Can Free Cash Flow (FCF) for ABX and NEM be equally sensitive to change in POG?
To get at the answer we need to strip away the accounting BS and look at FCF. FCF is a better indicator of sensitivities to POG for the following reason:
- FCF is before capex, M&A, writedowns etc.; therefore, coporate policies does not mask FCF, as with earnings, and hence can be used as a better measure for sensitivities to POG (more apples to apples comparison).
This was time consuming process and would be too cumbersome to layout here and almost impossible to explain in detail; therefore, let me use the 80/20 rule and explain it simply:
The following is a quoted from NEM's SEC 10-Q quarterly report dated May 14, 1999 downloaded from www.edgar-online.com, Item#2 Management's Discussion and Analysis of Results of Operations and Financial Condition in the Market Conditions and Risks section. It is further labled Gold price and can be found in paragraph two of this section.
<<..Newmont generally sells its production at market prices; therefore, revenue, earnings and cash flow are highly leveraged to the gold price. Based on estimates of 1999 production and expenses, a $10 per ounce change in the average annual gold price would result in an increase or decrease of approximately $38 million in cash flow from operations and approximately $28 million (about $0.16 per share) in net income..>>
Lets equalize just the capex of both ABX and NEM (this is the 80/20 of the 80/20 rule):
- ABX in 1999 plans to spend $510 million (see ABX homepage, financial data, five year record).
- NEM in 1999 is on pace to spend $148 million (see SEC 10Q 1Q '99)
Follow the arithmatic with me:
- 510-148=362 subtract ABX capex from NEM capex. This number ($362 million) is the amount of additional ABX FCF if capex was the same as NEM for 1999
- 362/28=12.93 Take ABX additional FCF and divide by the 28 ($28 million is additional NEM earnings for every $10 increase in POG. See above NEM quote).
- 12.93*10=129.3 Take 12.93 and multiply with $10. Therefore, POG must rise $129.3 from the average unhedged price of NEM ounce sold for NEM to have the same $362 million in additional FCF
- 129.3+257.60=386.6 Add $129.3 to todays spot price and we get the POG would have to rise to $386.6 (under NEM's assumptions) per ounce for NEM to have the same ($362 million) FCF available to it.
- $386.6 is pretty close to ABX's average ounce sold of $385. I would say its the same.
Otherwise, structurally ABX and NEM has almost the same cost base. There is very little difference operationally. Why? If we assume the same capex for each company NEM would have to sell gold at $386.6 to have the same FCF as ABX. $386.6 is almost exactly $385 which is the locked in average price ABX will sell for the next three years.
The so what is, from a sensitivity point, ABX and NEM has no difference!!!!! Yes, ABX had other FCF but it is negligible. The numbers speak for themselves. If gold rises ABX will make as much FCF as NEM.
But who is the better positioned company? Clearly it is ABX because they are not deferring capex or other vital operatinal investments becuase of their hedge. All this while having the same FCF opportunity as NEM. ABX is realizing their leverage today while NEM waits for the POG to rise before having a chance (with the additional drain of investing in deferred project tomorrow).
Your replys are welcomed.
Cheers,
Exsrch
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