Emanuel Datt: Why this ASX miner (and its sector) is a sell

Since the beginning of 2022, market sentiment has been - to put it politely - negative. Long-duration stocks have been mostly brushed aside in favour of quality and value-oriented equities across the globe. But whether you're a perma-bull, a perma-bear, or somewhere in between, you've probably heard the Mathan Somasundaram axiom at least once in your investing travels:

Always keep a little gold in your portfolio.

If you listened to his advice, chances are that you keep one of the top two ASX miners in your portfolio. One of them, Northern Star Resources (ASX: NST), reported a billion-dollar-plus earnings year today. The figure smashed last year's result of $648 million. 

But, at least in the brokers' eyes, that's where the good news ends. All its other metrics - revenues, EBIT, and underlying net profits all came in line with consensus. And if we've learned anything about August reporting season this year, it's that inline may no longer be good enough for some investors.

The one saving grace will probably be the surprise buyback it launched - a $300 million program to start in mid-September.

To run us through the result and more importantly, whether the reiterated outlook for the gold price will stand up in this environment will stack up, we spoke to Emanuel Datt of Datt Capital earlier today. Datt has analysed NST for eight years, and has held the company in the flagship absolute return fund in the past.

Note: This interview took place on Monday 29th August 2022. While this stock was a featured holding in the past, it is no longer in the portfolio. To learn more about the Datt Capital Absolute Return Fund click the link below: 

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Northern Star Resources (ASX: NST) FY22 KEY RESULTS

• Revenues up 35.3% to $3.75 billion
• Net profit down 27% to $273 million
• Underlying EBITDA +31% to $1.52 billion
• AISC +10% to $1,633/oz
• Final dividend of 11.5c/share
  

What were the key takeaways from this result? 

The company broadly met guidance from a holistic point of view but it did miss in terms of financial metrics.

I think the key takeaways for any gold miner are ultimately down to the production assets themselves. The key takeaway is that the flagship Australian operation remains far superior to its Canadian mine. Out of its Australian assets, the Yandal production hub is clearly the jewel in the crown. It has been for a number of years and it was the only one to perform within the guidance on cost per ounce and capital expenditure. 

I think Kalgoorlie (the largest Australian mine) marginally underperformed on all-in-sustaining costs (AISC) and capital expenditure. And to round that out, Pogo (their Canadian mine) is the perennial black sheep of the portfolio and it was the highest-cost asset in the group by a significant margin. 

The biggest surprise out of these results was the announcement of the $300 million share buyback. 

Was this buyback the right decision for the company right now?

No. And that's why it was a big surprise. I guess the best way to think of it is that the company wants to send a counter-signal to the headwinds being faced by gold miners at this point across the board. The market cap, today, is about $8.8 billion. The company trades at quite a high multiple and the question from this will be - "is this the best way to add value for long-term shareholders or is it just a way to tick boxes for board incentives". 

What was the market’s reaction to this result? Was this an overreaction, an under reaction or appropriate? 

Rating: Underreaction

I'd probably say it is a little bit of an under-reaction and I think the buyback announcement is supporting prices somewhat. Having said that, the company guided well in their latest quarterly and towards final expectations quite well. That's ultimately the right thing to do, and guiding them well ahead of the result. As a result, whoever wanted to get out and felt the company underperformed had already sold out. That's left the true believers of those who wish to keep exposure to the company.

Would you buy, hold or sell Northern Star on the back of these results?

Rating: Sell

I would say sell unless you believe the price of gold will increase materially for whatever reason. I say that because I think it's quite unlikely that given current industry conditions, that Northern Star can reduce its cost per ounce without significant capital investment. 

The largest opportunity ahead along those lines is the flagship Kalgoorlie super pit. They disclosed that the long-term plan is to move to a larger processing plant which I think is sound. But they expect the CAPEX for that to be somewhere around $1.2 billion. 

But CAPEX has blown up across the sector. So in practical terms, it may be far higher. That exercise was basically to upgrade the capacity to 24 million tonnes per annum. But I think there are still studies and options being done on that front.

There are growth options in this company but ultimately it all depends on the ability to fund. They also did disclose today that they have $1.5 billion in liquidity available but post-buyback, and assuming some cost escalation, that figure could be eaten away. I guess, ultimately, I'm of the strong opinion that it should optimise operations rather than try to prop up share prices. I think NST here might be trying to balance a lot of different incentives rather than having a clear focus and a single goal of optimising the portfolio. That's why, in a nutshell, I'd say sell.

What’s your outlook on Northern Star and the gold sector over FY23? 

I think FY23 is likely to be a year of consolidation [for NST] and an opportunity for them to rationalise their portfolio. I'm a really big believer in increasing the quality of exposure across the portfolio when it comes to mineral producers. Accordingly, I think NST should try to exit from its Pogo operation - which I think it's been an expensive distraction. It should focus on higher-quality WA assets. The mine's been effectively deadwood since its acquisition in 2018. 

I think that one impediment that is stopping that is the possibility of a write-down (and it might be quite high). We always considered that Northern Star probably overpaid and overinvested for this asset. It might be demerged into a separate asset for shareholders.

More broadly, all gold miners are challenged in this cost environment. But they [NST] have been far from the only gold miner that's been seduced by the allure of cheap Canadian assets. Evolution and Newcrest also experienced issues with their Canadian projects. Ultimately, across the sector, there's a case that all three could divest or demerge. That would result in a big uplift to its portfolio quality but it's yet to be seen. 

From 1-5, where 1 is cheap and 5 is expensive, how much value are you seeing in the market right now? Are you excited or are you cautious on the market in general?

Rating: 3

The market, at present, is quite fragmented. There's a lot of variance between sectors (energy is doing very well while tech is down significantly). Overall, it is a difficult market but it is beginning to throw up interesting opportunities. We're excited by the outlook because we are active managers. I think we need to understand the broader context - we're going to experience headwinds of strongly rising interest rates which may persist until the end of this year at least. Ultimately, I think I believe there is a lot of opportunity out there but it has to be balanced with caution and discretion as well. 

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