While the likes of Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP) have performed well in 2016, their gains of 11% and 10% respectively pale into insignificance when compared to Newcrest Mining Limited's (ASX: NCM) 96% rise.
Internal changes
The gold miner has risen so sharply in such a short period of time due in part to the improvements it has made as a business in recent years. For example, Newcrest has reduced gearing by 13% from 33.8% in financial year 2014 to 29.3% in FY 2015. Further, it has increased its return on capital employed (ROCE) from 6.4% in 2014 to 8% in 2015. This has been aided by Newcrest's Edge transformation plan.
Edge has allowed Newcrest to record $390 million in cash benefits in the first year of its implementation, with further cost savings, efficiencies and productivity gains set to come. While they will aid cash flow, Newcrest's free cash flow has already risen $194 million in 2014 to $1.025 billion in 2015 as capital expenditure was cut by a third.
Together, these changes have allowed Newcrest to not only become more profitable, but also more attractive among investors as the company now has a more stable financial footing.
Diversity
Newcrest's share price has also almost doubled in 2016 because of its long-term growth potential. It has an excellent asset base which is well-diversified and this provides it with a very favourable risk/reward ratio in my view.
For example, Newcrest operates in four countries and therefore has greater geographic diversification than many of its mining peers (which reduces overall risk). It also has growth potential via the world-class Golpu orebody in Papua New Guinea, while the turnaround of Lihir and ramp-up of Cadia East (which in my view is among the most lucrative gold mines in Australia, where Newcrest has a 100% stake) should aid cash flow over the coming years.
Although Newcrest has cut capital expenditure, its exploration and evaluation expenditure remains at a sufficiently high level of $46 million to continue to develop its asset base in my view. And with operating cash flow rising by 53% in 2015, the affordability of further investment in its mines remains high.
Gold price
Clearly, Newcrest's shares haven't risen by 96% in 2016 solely due to the above two reasons. A key factor is the price of gold, which is now 27% higher than it was at the start of the year. Newcrest is also a beneficiary of the weaker Australian dollar as gold is sold in US dollars. Further, with the Federal Reserve expected to increase interest rates by just 25 basis points in the next year, it would be unsurprising for the gold price to remain at least stable in the near term.
However, with an interest rate of 2.25% expected within the next three and a half years in the US, the appeal of gold versus interest producing assets could decline. Therefore, while Newcrest may continue to make the right decisions on its investment, costs and production figures, it may be hurt by a less rosy outlook for gold over the medium to long term. As ever, it remains a price taker, so it almost certainly will not repeat year-to-date gains of 96% in future.
