Overpriced, despite strong results

Mariyam Zhumadil, CFAMay 11, 2011

Based on Centerra’s 1Q2011 results and updated gold price and production forecasts, we maintain our Sell recommendation, but revise our target price to CAD13.45 per share.

1Q2011 financial results are largely in line with market expectations. The company's quarterly revenue equals $250mn, reflecting a higher average gold price of $1386/oz. Physical production fell 14% QoQ to 180koz of gold due to processing of lower grade stockpile material with lower recoveries at Boroo mine and a reduction in the average mill head grade at Kumtor mine.

Centerra Gold has been quickly accumulating cash on the back of the rally in the gold price. However, absent value-enhancing M&A opportunities, a large cash pile has been creating a downward pressure on CG’s return on equity.  Based on its continued solid financial performance, Centerra declared a special dividend of CDN$0.30 per share and a regular dividend of CDN$0.10 per share, which implies a dividend payout ratio of almost 70%. In our view, the company’s decision to pay out a substantial portion of current period earnings is good news for its shareholders.

Currently, Centerra is trading at 2011 EV/Sales multiple of 5.0x, roughly at its EM peer average of 5.6x. On 2011 EV/EBITDA multiple, CG stock may seem undervalued relative to the emerging markets’ peers.  However, until the situation with mining licenses in Mongolia is resolved and in the absence of other organic growth options, there is no fundamental reason for Centerra stock to trade at a higher multiple, in our opinion. Valuation multiples of many gold miners are elevated, signaling that the sector is overvalued, in our opinion. Our long-term view on gold equities remains bearish, although we believe that some short-term opportunities within the sector may still exist.

  Revenue Revenue growth EBITDA EBITDA margin Net income Net debt ROE After-tax ROIC EPS
  ($ mn) (yoy, %) ($ mn) (%) ($ mn) ($ mn) (%) (%) ($)
                   
2010 846 23.5  471 55.6  323 (413) 25.4 33.6  1.37
2011E 938 10.8  651 69.4  436 (714) 25.9 44.8  1.85
2012E 927 (1.1) 616 66.4  382 (1069) 18.6 38.7  1.62
2013E 1,225 32.1  761 62.1  490 (1452) 19.5 45.6  2.08
Sources: company data, Halyk Finance estimates      

Financial performance driven by gold price

1Q2011 financial results reported by Centerra Gold are largely in line with market expectations. The company's quarterly revenue equaled $250mn, reflecting a higher average gold price of $1386/oz. The company produced 180koz of gold (-14% QoQ) at an average total cash cost of $370/oz (+9% QoQ).  Gold production fell due to processing of lower grade stockpile material with lower recoveries at Boroo mine and a reduction in the average mill head grade at Kumtor mine. The quarterly increase in the total cash cost is largely attributed to lower production volumes at Kumtor and Boroo mines. 

In 1Q2011, capital expenditures amounted to $72.1mn (+147% QoQ). Of this amount, Centerra spent $65.3mn on growth capital and the rest on sustaining capital projects. Exploration expenditures increased by 45% QoQ to $7.4mn because of increased drilling activity at Kumtor mine. Net earnings grew by 10% QoQ to $137mn, backed by a 25% QoQ increase in gold price.

Table 1. Summary of key financials      
  1Q2011 1Q2010 QoQ growth 
Revenue, $mn 250.2 255.5 (2.1%)
Cost of sales, $mn 61.8 78.4 (21.2%)
Net earnings, $mn 136.6 123.9 10.3%
Earnings per share (EPS), $/share 0.58 0.53 9.4%
Capex, $mn 72.1 29.2 146.9%
Average gold spot price, $/oz 1386 1109 24.9%
Average realized gold price, $/oz 1385 1112 24.6%
Gold produced, oz 180716 211039 (14.4%)
Total cash cost, $/oz 370 340 8.8%
Total production cost, $/oz 468 442 5.9%
Source: Company data      

Higher dividend is good news

Centerra's balance sheet position remains strong, with $494mn in cash and cash equivalents and zero debt.  The company has been quickly accumulating cash on the back of the rally in the gold price. However, absent value-enhancing M&A opportunities, a large cash pile has been creating a downward pressure on Centerra’s return on equity.

Based on its continued solid financial performance, the company declared a special dividend of CDN$0.30 per share and raised the regular dividend from CDN$0.06 to CDN$0.10 per share, which implies a dividend payout ratio of almost 70%.  In our view, the company’s decision to pay out most of the current period earnings is good news for Centerra’s shareholders.

The higher dividends are particularly timely for one of the largest shareholders of Centerra Gold, KyrgyzAltyn. The company, owned by the Government of Kyrgyzstan, will receive about $31mn in dividends, we estimate. Recently, there have been a discussion within the Kyrgyz Government of a possible sale of some of its stake in Centerra Gold to replenish the state budget. We believe that Kyrgyzstani Government may now reconsider plans to sell some of its Centerra shares.

Uncertainties in Mongolia remain

Our main concern regarding Centerra’s future is yet to be addressed.  Specifically, the status of the company’s license for Gatsuurt mine in Mongolia, which can be revoked if the 2009 Water and Forest law is fully implemented, is still unclear.  The receipt of the final operating permit for the Boroo heap leach facility is also moving slower than we expected.

Revision of model assumptions

To reflect the high level of gold prices and our short- and medium term forecasts of the precious metal price, we revised gold price assumptions included in our valuation model.  Until there is more certainty regarding the speed and sustainability of the global economic recovery, the demand for gold, as a key safe haven, will remain high. However, we believe that the expected tightening of the fiscal and monetary policy in Europe, the U.S. and China may weaken the medium-term inflationary pressures and limit further growth of gold.

Table 2. Revision of gold price forecasts        
  2011 2012 2013 2014 2015 2016
Old forecast 1300 1200 1100 1000 926 906
% growth   (7.7%) (8.3%) (9.1%) (7.4%) (2.2%)
New forecast 1500 1350 1250 1200 1150 1150
% growth   (10.0%) (7.4%) (4.0%) (4.2%) 0.0%
Source: Halyk Finance estimates          

We also revised our 2011 capex estimates to $213mn ($175mn growth and $38mn sustaining capital), reflecting the company’s guidance. Almost no capex at Gatsuurt and Boroo mines is modeled for 2011, until the situation with Mongolian licensing is resolved. Additionally we excluded Gatsuurt from our 2011 production estimates, and moved the start of production at the mine from 2011 to 2013.

Currently, Centerra is trading at 2011EV/Sales multiple of 5.0x, with a small discount to the EM peers average of 5.6x. On 2011 EV/EBITDA multiple, CG stock may seem undervalued relative to EM peers. However, until the situation with its mines in Mongolia is resolved, and in the absence of organic growth options, there is no fundamental reason for Centerra stock to trade at a higher multiple, in our opinion. We also note that valuation multiples of many gold mining companies appear to be elevated, signaling that the sector is overvalued, in our opinion. Our long-term view on gold mining equities remains bearish, but we believe that short-term opportunities within the sector may still exist (See Appendix 1).

The positive effect of the revised gold price assumptions on CG’s estimated share value was almost completely offset by the delay of production at Gatsuurt. We maintain our Sell recommendation on the stock and establish our target price at CAD13.50 per share.

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