The Most Asymmetric Opportunity In The Market Right Now?
Newmont Corporation $NEM
It’s #SundaySpecial!
Though not much of a macro specialist, or even macro believer, over the last month or two I’ve become increasingly skeptical of the US stock market, and just how much further it can run. Though there are deals in the market still (which I’ll continue to discuss), there’s been a few figures and graphs I’ve seen that have led me to believe I should be looking in slightly different areas to where I’ve been looking the past 24 months.
Look at this graph for example. This shows Microsoft’s market cap and free cash flow compared to the entire energy market:
Does that raise some eyebrows?
Yes, admittedly companies like MSFT 0.00%↑ should no doubt have higher multiples than energy companies due to the arguably unlimited opportunities they boast, but…Microsoft vs the entire energy market…?
And then there’s the US Leading Index:
And then there’s the fact that the Nasdaq Price-to-Book ratio is larger than China’s Price-to-Earnings ratio. This should never happen.
Yes, we are in an AI boom that is ultimately revolutionary which I respect. To be honest, it’s something we have never seen before (very different to the Internet bubble) and therefore shouldn’t be compared to other bubbles. But it’s very unlikely that this revolution will change the fact that markets go through cycles and inflated valuations will eventually deflate.
Admittedly, I could go on and on here but I don’t want to be this big pessimist who also contradicts himself by saying you shouldn’t bother studying many macro trends.
But as a value investor, I’m always on the lookout for the best opportunities that provide high upside with low downside. To me, at current valuations, it’s difficult to make an argument that a lot of tech has low downside risk or any significant margin of safety that makes them investable.
“Value investing strategies have worked for years and everyone knows about them. They continue to work because it’s hard for people to do, for two main reasons. First, the companies that show up on the screens can be scary and not doing so well, so people find then difficult to buy. Second, there can be one, two, or three year periods when a strategy like this doesn’t work. Most people aren’t capable of sticking it out through that.” - Joel Greenblatt
That’s the background story. Because of this I started to look at other markets, specifically gold and gold miners which has historically been a good performer during periods of economic uncertainty. And where better to look than the #1 gold producer globally?
Newmont Corporation NEM 0.00%↑
Description
Newmont Corporation is the leading gold producer globally after a recent acquisition of Newcrest. The Company operates in North America (Nevada and Colorado), South America (mainly Peru and Suriname), Australia (Boddington, Tanami, and Kaloorlie), and Africa (primarily Ghana).
NEM 0.00%↑ generates about 90% of its revenue purely from gold. The other 10% comes from copper, silver, lead, and zinc.
What’s Happened
Since I’ve kept my eye on this stock the past 2 months, it’s dropped 21%, which is great news for me as a value investor. It’s also dropped 27% in 1 year, 43.4% in 3 years, and is currently down 15.7% since IPO in 1990.
Here’s the current price chart. As you can see it’s very cyclical (more on this later):
There’s 2 main reasons for the recent weakness.
1. Acquisition of Newcrest
Over the last year Newmont and Newcrest were going back and forth over an acquisition price. Initially Newmont offered $17 billion which was rejected. Eventually, a $19 billion buyout was accepted in May.
In the mining industry, it’s extremely rare for a stock to rise in value during a pending merger quite simply because ~70% of M&A’s don’t actually add any value.
Of course it didn’t help that Newcrest reported pretty poor Q3 results, but this was mainly due to maintenance of many mines which led to a decline in revenue.
2. Weak Financial Results
Operating cash flow was (on average) higher than in previous year, but gold prices were higher this year.
Free cash flow was lower this year due to high capital expenditure.
Low Q2 and Q3 revenue due to a strike at Penasquito, paused production in Eleonore (wildfires in Canada), paused production in Cerro Negro for safety inspections, and low grade stock in Aykem in Q2.
Steadily decreasing cash pile and increased long term debt.
On the face of it, admittedly not so positive and not a “quality stock” that I’d normally consider. But I’ve been buying the dip heavily over the last 4 weeks because asymmetric bets like this don’t come around too often. Time to tell you why:
Investment Thesis
Gold Outlook📈
Central Banks
In 2023, central banks accumulated more gold than any other year in the last 50 years. Largest purchases came from Singapore, Turkey, China, Russia, and India.
You’ll notice that 3 of these countries are BRICS countries which is actually quite significant. The BRICS countries (Brazil, Russia, India, China, and South Africa) are on the rise as can be evidenced from their increased economic weighting compared to the “big players”/G7.
Central banks in BRICS countries are diversifying away from the US dollar and towards gold as a way of supporting their currencies.
So demand for the US dollar is decreasing, whilst demand for gold is increasing.
Geopolitical Tensions
It’s clear there’s geopolitical tensions out there at the moment at elevated levels:
Eastern Europe
Middle East
Korean Peninsula
Taiwan
Iran and Israel
Historically, gold has always been a safe haven and this time won’t be any different.
Macro Uncertainty
As I explained earlier, I’m getting less and less confident in the US stock market on a weekly basis.
Because I’ve already shown you my pessimistic side, let me add to that and really nail home the point.
Federal debt is on track to grow 50% larger than levels seen in World War II. This projection does not factor in any recession or major geopolitical conflict.
End of Interest Rate Hikes
The Federal Reserve has indicated it’s unlikely to hike rates much further. Historically, this has always been a bullish indicator for gold (and one of the reasons for the recent price movement).
Gold becomes a more attractive investment post-rate hikes as investors shift their focus to stability. Here’s evidence from the 2006-2011 period.
Clearly Newmont’s fundamentals are anchored to the price of gold adding $400 million in FCF for every $100/oz rise in gold prices. However, the rising gold prices have yet to translate into rising stock prices in the mining industry, creating one of the most opportunistic divergences in the wider market.
Finally, let’s check this graph out by Tavi Costa of Crescent Capital.
The implied volatility of call options on gold has reached one of the lowest levels in history. The last time this happened gold prices rallied 75%.
Newcrest Acquisition📈
The acquisition of Newcrest has now positioned NEM 0.00%↑ to be the largest gold producer globally, managing to produce ~8 million ounces annually. The Company now boasts 10 Tier 1 assets (that’s more than half of the world’s tier 1 gold deposits). Tier 1 assets in the mining industry refer to those of highest quality, large scale, long lives, strong profitability, and low production costs.
With the increased portfolio that the Newcrest acquisition now presents for Newmont, NEM 0.00%↑ are anticipating 6 divestitures allowing management to focus primarily on these Tier 1 assets. This will unlock approximately $2 billion in capital.
Perhaps even more relevant is the $500 million in annual synergies that this acquisition has created.
Of course these aren’t realized yet, but I sense that when investors begin to see a reversal in the margin and profitability trends, there will be a quick change in focus towards merger integration success that has most definitely not been priced in currently.
Anyhow, perhaps the most bullish factor in this acquisition for me is the diversifying portfolio that Newcrest gives to Newmont in the form of copper production. 👇
Copper Outlook📈
Newmont’s acquisition of Newcrest is expected to quadruple Newmont’s copper exposure, due to the Cadia mine in Australia. Therefore, it’s important to understand the copper outlook.
McKinsey estimates copper demand will increase by 46% by 2031 with supply running short by 6.5 million metric tons. Here's the article from McKinsey.
S&P states that currently 60% of copper is sourced from countries with unstable geopolitical situations. This makes Newmont’s Australia production even more attractive.
Why the copper bullishness though?
Decarbonization is one of the biggest challenges we face as humanity. Achieving this goal is heavily dependent on electrification and the shift to renewable power sources.
This is where common becomes invaluable. To quote Rick Mills, a copper specialist:
“Simply put, the road to reaching net zero begins and ends with copper. All infrastructure built to support renewable energy uses large amounts of copper, as the metal is highly efficient conductor of electricity and heat.”
S&P are even more bullish than McKinsey on coppers demand stating ~50 million tons will be required by 2035.
For reference, last years production was 22 million tons (short of even today’s current demand).
With mining output of copper currently increasing at 2.7% annually, global output will reach 31 million tones by 2035…far away from the 50 million tons of demand.
Therefore, with demand soaring and supply struggling to catch up, especially in areas such as Peru where there’s geopolitical unrest, this means areas like Newmont’s Australian mine will be heavily sought after.
Newmont’s increasing focus on copper production with its acquisition of Newcrest has them positioned extremely well for the next decade’s surge in copper demand.
Project Pipeline 📈
As we’ve discussed above, Newmont are well positioned to take advantage of the copper outlook but let’s take a look at the production expansion over the next decade:
2 major gold expansions in Tanami, Australia and Ahafo, Ghana.
2 longer-term gold expansions in Cerro Negro and Peru (Sulfide).
Trimetallic expansion in Peru (45% gold, 45% copper, 10% silver) with a mine life past 2040.
Financial Strength📈
Q4 earnings were released on February 22nd so we have relatively fresh numbers.
Newmont performed well, beating many estimates.
Q4 revenue was $4B (24% YoY growth)
$88M free cash flow
EPS of $0.67 which beats by $0.07
Current ratio of 2.12, and 0.72x net debt to EBITDA.
Current assets exceed long-term debt
$3B cash pile
However, despite this the stock closed the day down 8% due to an announcement of a dividend cut and plans to restructure the portfolio as we discussed earlier with the focus on Tier 1 assets.
The focus was on the dividend cut, but if we look at Newmont’s history, there is an inherent pattern of erratic payouts despite strong fundamentals.
In this case, management are reallocating capital to maximize value through their longer-term investments and outlined priorities:
This is no sign of financial weakness.
Super investors are buying📈
Jim Rogers, John Paulson, Elliot Investment Management, and most notable of all, Stanley Drunkenmiller has recently unloaded his tech stocks and bought $NEM.
Valuation 💭
NEM 0.00%↑ is currently trading attractively with the stock price down 27% over the last year. The mining industry generally is trading at a very low valuation currently when current and future development are pretty exciting.
With a forward P/E of 21.4 (with proven reserves of 20+ years) vs peers who have only 10-15 years), this is quite inexpensive.
Further, Newmont has consistently been valued at a 50% premium to the S&P, but today’s valuation suggests around a 5% discount to U.S. blue chip stocks.
And finally, we have NEM 0.00%↑ trading at a P/S of 3.1x compared to a 35 year average of +4x.
Risks 📉
The mining industry is a relatively unpredictable industry with weather, pricing, mine quality, regulations, labor, and costs are varying quite extensively.
My opinion is that NEM 0.00%↑ has not increased significantly with the recent gold surge simply because of the unpredictability of the Newcrest acquisition. To me, this isn’t a bad sign as I believe the integrations will eventually be value adding.
However, there is general skepticism in the mining market that mergers will never actually recover their cost basis. Remember Newmont bought Newcrest for $19 billion…
Although I believe NEM 0.00%↑ is now in an excellent position, the market will need to see a big improvement in the numbers before they’re convinced of the acquisition. This could mean NEM 0.00%↑ could see some more downside, especially if the wider market sees some pullbacks.
Summary ✅
"The three most important words in investing are margin of safety.” - Warren Buffett
With growing copper exposure, a refined portfolio, strong balance sheet, bullish gold and copper outlook, and synergistic improvements over the next couple years, it’s difficult to understand why NEM 0.00%↑ has been so beaten down, especially in 2024.
Newmont Corporation should begin to boast considerable free cash flow over the next year. Once that comes into fruition, and gold continues to deliver, there’s no doubt NEM 0.00%↑ could see a pretty impressive rise.
Although I’m not yet selling out of my other investments, I most definitely wouldn’t be buying the broader index at today’s valuation. NEM 0.00%↑ provides an excellent opportunity to hedge against the macro uncertainty and offer the potential for exceptional returns.
What are your thoughts on Newmont Corporation after reading this?
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That’s it for the day
I hope you loved this article. As I develop on here, I’m sure there will be some changes to my structure and style, so please do leave some feedback for me.
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Interesting read, Oliver. I enjoyed it. A question and a comment from me:
1). In what way is the AI bubble different from the dotcom bubble? Genuine question - would love to hear your take on it.
2). I've been keeping an eye on Newmont and Barrick Gold. I'll trade them short- or intermediate-term if I spot a good opportunity to enter the stocks. But I've been buying Au, Ag, Pt, and Pd bullion so I agree that precious metals can only go up long-term, especially in the context of war.