DCN has materially downgraded its production guidance and 5-year outlook for Mt Morgans.
- We see reason to have more confidence in the revised outlook and believe there is value to be had.
- However, having been through a persistent downgrade cycle, the operation and management have a long road ahead to regaining credibility.
Event
- DCN has materially downgraded near-term guidance and the five-year outlook for its Mt Morgans gold project.
Impact
- Downgrading everything. Mt Morgans is now expected to produce between 160kozpa to 180kozpa. Operational issues have compounded the near-term but poor reserve reconciliation is the key driver of the downgrade to the longterm outlook.
- Value to be had but credibility needs to be restored. The much higher level of reconciliation between grade control drilling and the mill suggests that there is some basis for improved confidence in the revised outlook. However, credibility needs to be restored before value can be realised.
Earnings and target price revision
- Incorporating the downgrade has a significant impact on our earnings forecasts. We now expect a $23m loss to be reported in FY19 versus our previous $7m profit. Earnings estimates for FY20 to FY23 are cut by 71%, 60% 66% and 70%, respectively. In light of the heightened uncertainty created by DCN’s recent performance, we cut our 1.2x NAV 5x CFPS target price multiples to 0.8x NAV and 2x CFPS. Consequently, we cut our target price 77% to $0.70.
Price catalyst
- 12-month price target: A$0.70 based on a 50:50 08.x NAV 2x CFPS methodology.
- Catalyst: Delivering to its guidance is the key catalyst for DCN. The first opportunity for this will be the current June quarter, reported at the end of July. We expect a more detailed five-year outlook to be provided at the same time. Exploration is ongoing and has the potential to provide upside surprises.
Action and recommendation
- Maintain Outperform. Whilst some of the issues at Mt Morgans had been foreshadowed by recent production misses and downgrades, the scale of this downgrade is surprising. That said, we do not believe Mt Morgans to be fatally flawed and see value at the current share price. Company commentary suggests a high level of confidence in the revised outlook. However, in our view much needs to be done to restore investor confidence.
- DCN has downgraded its June quarter production guidance to 36koz to 38koz at an AISC of $1,500/oz to $1,600/oz from 50koz to 55koz at $1,050/oz to $1,150/oz. Lower underground productivity and a ball mill motor failure have impacted performance to date. Lower than expected grades at both the Beresford underground and Jupiter open pit have also contributed to the poor performance. Grade underperformance appears to be a combination of ‘high-nugget’ effect and dilution with reserve to mill reconciliation at just 85%.
Significant downgrade to the 5-year outlook
-DCN now expects Mt Morgans to produce 160koz to 180koz per annum over the next 5 years. DCN’s FY16 Definitive Feasibility Study for the project envisaged production of well over 200kozpa over the same period. Production guidance for FY20 is 150koz to 170koz at AISC of $1,350/oz to $1,450/oz. DCN now expects to produce between 750koz to 850koz over the next five years versus the ~1Moz presented by DCN in its 2016 Definitive Feasibility Study over the same period.
Confidence and credibility severely hit
- Clearly investor confidence in both geology and management’s ability to deliver its stated outcomes has been hit severely. Commentary from the company indicates a high level of confidence in the revised outlook. The much higher level of reconciliation between grade control drilling and mill of 98% suggests that there is some basis for this. Our understanding is that 60% of current Westralia reserves have been drilled to grade control level, including 80% of FY20 production. This should at least provide some certainty over the near-term outlook. For us, the question now comes down to delivery with quarterly performance the only way of earning back lost confidence.
- We have revised our forecasts to the bottom of DCN’s respective June quarter, FY20 and five-year outlook ranges. The only change we have made to our assumptions has been grade, with mined volumes, recovery and unit costs unchanged.
- However, whilst our DCF and multiples support a higher valuation, we do not believe that this can be realised without a demonstration of operational and management credibility.
Changes to our earnings forecasts and target price
- Unsurprisingly, incorporating the downgrade has a significant impact on our earnings forecasts for DCN. We now expect a $23m loss to be reported in FY19. Earnings estimates for FY20 to FY23 are cut by 71%, 60% 66% and 70%, respectively. In light of the heightened uncertainty on whether DCN’s revised outlook can be delivered, we cut our 1.2x NAV 5x CFPS target price multiples to 0.8x NAV and 2x CFPS.
Consequently our target price is cut 77% to $0.70.
Edit. I just reformatted to make easier to read. Management have to go. Rohan on your bike.
