NCM 1.44% $32.26 newcrest mining limited

macquarie says buy - high risk

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    Wednesday, 22 December 2004

    Newcrest vs. Lihir
    Recommendation upgrade for Newcrest


    Newcrest (NCM) $17.38

    Recommendation change
    Short term Outperform, long term Outperform, volatility index very high

    Lihir Gold (LHG) $1.18

    Short term Underperform, long term Underperform, volatility index very high

    We have compared Australia's two largest gold companies, Newcrest and Lihir Gold, with a peer group of 16 global gold companies.

    Production: as Newcrest's production base grows towards 2 million oz per annum, the company clearly moves into the realms of global major gold producer. Lihir Gold, on the other hand, has struggled to capitalise on its extensive gold endowment, with production yet to peak above 700,000 oz. Size of production is a key driver of share price reratings for gold companies.

    Earnings: Lihir Gold is trading at roughly a 25% discount to Newcrest on 2005 and 2006 Price to earnings ratio. However, the discount applied to Lihir Gold appears justifiable, given the company's history of earnings changes and downgrades. Over the past two years, Macquarie has downgraded Lihir Gold's earnings nearly 1.5 times more frequently than Newcrest, and has upgraded Newcrest's earnings 1.5 times more often than Lihir Gold.

    Country risk: based on the most recent "Euromoney" country risk survey (the lower the number the less risky), Newcrest's reserve-weighted country risk is 18 (essentially Australia), while Lihir Gold's country risk score is 110. As a basis of comparison, the major global gold companies have country risk scores of 40-65.

    Reserve efficiency: as a measure of the efficient extraction of gold reserves, we have compared annual production to reserves for the 16 global gold companies. On this analysis, Newcrest's forecast production rate of 1.8-2.0 million oz per annum is 'efficient'. However, given Lihir Gold's reserve base of 20 million oz, the 'efficient' level of production is 1.3 million oz - nearly double the current production rate.

    Gold price leverage: both Newcrest and Lihir Gold are extensively hedged for 2005 and 2006, with Newcrest's committed hedging totalling 75% of forecast production and Lihir Gold 60% of production. Coupled with Lihir Gold's higher cash costs (US$80-100/oz high than Newcrest), Lihir Gold's leverage to gold price is substantially greater than Newcrest. However, it should be noted that over the next two years, Newcrest's average hedged gold price is US$95-125/oz higher than Lihir Gold's hedged price.

    Action and recommendation

    On most of the financial and non-financial measures considered, Newcrest is far and away the premier large Australian gold company. When overlaid with the current strong gold price and bullish sentiment, we believe Newcrest will outperform Lihir Gold, both in the short and long term.

    On the back of the peer group analysis performed, we have increased our 12-month share price target for Newcrest from $16.40 to $20.00 and upgraded our recommendation to short term Outperform/long term Outperform.

    We maintain an Underperform on Lihir Gold with a 12-month price target of $0.95.

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