MAC/20: Mines and Communities

Landslide In Lihir: Setback Or Symptomatic?

Published by MAC on 2005-10-11

Landslide In Lihir: Setback Or Symptomatic?

October 11 2005

Australasian Investment Review – (AIR) Lihir Gold (LHG) has recently polarised broker opinion about whether the stock’s heavy leverage to the gold price should justify its significant premium. There is little consensus.

Lihir disasterNow a devastating landslide on the island of Lihir in PNG has cut power, water, and the only road, resulting in a delay to production of a yet undetermined period. Two PNG nationals are also believed to have lost their lives. Broker response has again been mixed.

Credit Suisse (Underperform) suggests recovery from the failure may be rapid and earnings limited to a single year, but the fact remains it is well established that Lihir is an unstable island, and this disaster points to either error or compromise in the location of a long term stockpile.

The analysts suggest that in this context, one must question the safety of other areas until now assessed as geotechnically stable. This includes the mine and intended sea wall to enable recovery of deeper gold.

They see the incident as confirming the risk associated with Lihir and questions why the equity is able to attract such an enormous premium to valuation. Risk normally is priced with a discount.

JP Morgan (Underweight) has also questioned Lihir’s premium, which is presently 117% above the analysts’ NPV calculation. While details are scant at the moment, the analysts calculate that a 25koz production loss could result in a US$12m 2005 operating cash flow loss and a US$8m loss of profit. They remind investors that while Lihir has benefited to leverage to rising gold prices, just as influential is its leverage to production volumes.

Lihir disasterUBS has chosen to downgrade Lihir from Buy to Neutral. Lihir has been the analysts’ preferred gold play due its greater leverage to the gold price, and expected step-change in production. Despite the downgrade, the landslide and temporary production interruption has not changed their view. UBS remains positive on the stock and continues to be positive on the outlook for the gold price in 2006 and beyond. As proof, the analysts have lifted their target price from $1.70 to $1.85.

GSJB Were (Outperform) is largely unperturbed. While admitting the landslide is a negative, and that it highlights the risks associated with single-mine companies, the broker has not readdressed its rating and is waiting until further clarification is available.

In the mean time, GSJB Were has reiterated its long term Buy recommendation, based on the fact this is a temporary setback, it will not impact on 3Q production, and that an incident at Zinifex’s (ZFX) Century operation saw the market overreact on the downside before the stock re-rated and rose 50%. Lihir Gold last traded at $1.83.

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