When in Oz, spin the gold

For years there has been a perception, muttered as such from some grizzly jaws, that Australian gold stocks are relatively undervalued, given the princely ratings accorded to peers perched like big hairy Cheshire cats in North America. This Thursday’s action involving the continent’s two biggest gold names suggests that the perception may need a reality check of sorts.Newcrest’s proposed takeover of Lihir has been rejected, with a reaction akin to a kookaburra in full decibel madness mode, to at least foster the idea that further value can be squirreled out. Investors thought otherwise, taking Lihir’s stock price up by 33% on Thursday, pushing its market value to USD 8.8bn. A pro forma combined Newcrest-Lihir would today have a market value of USD 23.8bn, ranking it fifth globally, after Barrick, Freeport-McMoRan, Goldcorp, and just after Newmont.From a production viewpoint, the combined entity would rank sixth, after Barrick, Newmont, AngloGold Ashanti, Gold Fields, and Freeport-McMoRan, which operates the world’s biggest gold mine, but is not valued as a gold producer by the global investor community.The pro forma Newcrest-Lihir ratings are not too poor, considering a pro forma merged reported gold production for 2009 (Newcrest has a 30 June year end) of 2.8m ounces of gold (with 1.6m from Newcrest). The marketable metric is that pro forma production is set to rise substantially, mainly thanks to Newcrest, to a projected pro forma 3.75m ounces in 2014. This excludes potential further increments from, at Newcrest, Wafi/Golpu, O’Callaghans, Namosi, Camp Dome, Gosowong 2 Vertical Stockwork Corridor, West Dome Deeps, Marsden, and, for Lihir, in West Africa.Like a number of gold majors, Newcrest downplays, if not heavily treads on, the crucial role of base, and other, metals in its portfolio. For the 2009 financial year, gold contributed 76% of Newcrest’s revenue line, with much of the balance coming from copper sales, produced at its Cadia, Telfer and Ridgeway mines, and some from silver sales. The contribution from copper would have been higher, but for the total collapse in copper prices across the second half of 2008, followed by the gradual recovery across 2009, to recent levels which have made levels last seen about 18 months ago.On the reserves line, the pro forma merged entity offers the great benefit of two monsters: Cadia (copper-gold), which holds 65% of Newcrest’s 69m ounce reserves, expressed as gold-equivalent (that is, just be a sport and pretend that the copper is gold as well), and Lihir, which holds 94% of Lihir’s 31m ounces of reserves. The mine is found on Lihir, or Niolam, Island, the largest in the Lihir group of islands in Papua New Guinea’s New Ireland Province. Trends in recent years have shown convincingly that, given a choice, large scale, preferably monster, assets are more capital efficient.

This importance of the "capital" factor is increasing at an exponential rate, given the significant increases in capital costs as the commodity complex has generally experienced price increases, from 2001. The principle at work here applies both to new capital expenditure, and to stay-in-business capital expenditure.The free cash flow (operating cash flow less capital expenditure) numbers for a historic pro forma Newcrest-Lihir show up pretty well, over the past three calendar years, relative to other gold majors. This suggests that both Newcrest and Lihir have been relatively efficient in capital utilization, and capital allocation.