Newmont Mining Corp., North America's third-largest gold company by market capitalization, is approaching valuation territory that is terra incognita for precious metal producers: the single-digit price-earnings multiple.
According to some analysts, Newmont is trading at a mere 11 times its estimated earnings this year and, at its recent share prices of $57 (U.S.), it has dipped below 10 times projected earnings for next year.
For a senior producer cranking out the yellow metal at near record high prices for bullion , these are extremely low numbers. P/Es, as they are known, are calculated by dividing a company's share price by its earnings, and low figures often indicate a bargain.
In previous bull runs, big gold miners frequently traded at double or even triple Newmont's valuations. Investors paid up for the seniors and gave them high P/Es based on the thinking that the companies offered a liquid, leveraged play on bullion and held a treasure trove of wealth in the ground.
There are no damaged goods in Newmont's profit aisle that would explain the cheap price; earnings were up a stunning 76 per cent to a new record last year.
So do the lowly valuation and profit growth make Newmont, which trades in both New York and Toronto, a screaming buy? Or is the multiple deserved, a sign that the company is a dreaded value trap, a stock that is inexpensive for a reason but tantalizes investors into buying, only to frustrate them indefinitely?
There are significant worries around big gold producers in general. Royal Bank recently issued a note to clients asserting that senior producers, when they reach an output around five million ounces a year, lose some lustre because of their sheer size and the inexorable depletion of existing deposits. Newmont, for instance, produced 5.4 million ounces last year, but the output is expected to fall to 5.1 million ounces this year. To keep from wasting away, big miners are forced into the costly acquisition game for the few juniors that have managed to find mega deposits.
In RBC Dominion Securities' view, all the big producers carry some value-trap risk. "A value trap means that the shares may look inexpensive; however, the share price continues to fall and multiples continue to contract," the brokerage said of the phenomenon.
Although RBC was diplomatic and didn't explicitly call Newmont a trap for the unwary, it says the "best investment ideas" were among mid-sized and smaller producers. RBC has a one-year target of only $62 a share for Newmont, not much above the current market price. That view is partly based on gold prices falling next year to $1,300 an ounce.
CIBC, however, has a more upbeat $80 target, thanks to a gold price it thinks will rise to $1,700 an ounce in 2012.
Newmont has supporters who say the shrinking multiple is getting so out of hand that the shares are bound to eventually rally. "Newmont is selling at a level as cheap as I've seen it," says Fred Hickey, publisher of the High-Tech Strategist newsletter and a fan of gold investments. He says bullion prices are going higher, which will improve Newmont's profits and share price.
"If the cash flows and earnings continue to explode higher, the P/Es will get to such a low level that the stock will be forced up," he contends.
Newmont isn't standing by while its stock languishes. It plans several mine expansions that it says could take output up to seven million ounces by 2017, and it's trying to create some razzmatazz over its promised dividend increases - 5 cents a share for every $100 an ounce increase in the gold price.
In fact, Newmont is the first producer to explicitly link its payouts to the surging gold price. Mr. Hickey says it's "a brilliant idea" that will be imitated by others.
Another good omen for senior producers such as Newmont is that many investors hate them. Most buyers prefer mid-tier and junior names, suggesting that the larger producers are becoming attractive as a contrarian bet.
Barry Allan, head of the mining group at Mackie Research Capital Corp., says that on a recent trip to Europe to meet investors he was repeatedly told, "Don't even waste my time talking about senior gold stocks." He thinks the Newmont share price could rally to $84.50.