Gold sector:Reporting season rally,but still some value to be found

ASX gold sector appearing fully valued, however still some standout picks

    With the ASX gold index rising 15% since the start of reporting season, thesector now generally appears fully valued (1.10xNPV at DBe base case, 1.14xat spot). The AUD gold price was up 4% over the period, aiding the rally.Financial results were generally in-line with our expectations, with fewsurprises looking out to FY18. We have incorporated the proposed 3.75% W.A.State royalty, and see this as a marginal drag on sector valuations. Across ourcoverage, we still see value in SBM (0.85xNPV) and OGC (0.9xNPV), with AQGand DCN also screening cheap as their projects develop. We downgrade EVNto HOLD (1.0xNPV), and NCM & NST to SELL on valuation (1.2xNPV).

    Gold price and strong financial reporting season has led to sector rally

    ASX gold companies generally had strong financial results during the FY17reporting season. A mostly stable gold price throughout the financial year andsteady operational performance has resulted in profits being in-line withexpectations, strong cash flow and strengthening of balance sheets. A keytheme over the reporting season was companies reviewing their dividendpolicies and returning cash to shareholders. NCM, EVN, NST and SBM have allupdated their dividend policies, with RRL, EVN and SBM trading at 3-4% Div.yield at spot. With the backdrop of strong financial results and a rising goldprice, the ASX gold sector has risen by 15% since the start of August. The risingcopper price has also contributed to the outperformance of EVN (+12%) andOGC (+8%), which both have exposure to the metal (Figure 3).

    Gold price lifts on geo-political risks and US rate expectations

    Gold has regained its ‘safe haven’ status this year, rising c. 15% YTD. Twoopposing forces (geo-political risk and a hawkish U.S. Federal Reserve) hadkept pricing largely flat throughout the first half of the year. The mood,however, shifted in early July when market expectations of a fourth U.S. ratehike began to fade and the U.S. Federal Reserve took a more dovish stanceafter missing inflation targets. This has been exacerbated through August byrising political tensions on the Korean Peninsula. Sentiment on a U.S. rate risehas softened, with the futures market currently pricing in only a 30% chance ofa rise by the end of the year. We believe the USD gold price has priced in thedovish outlook, with ASX gold stocks rising on the gold price momentum.

    Value in selected stocks OGC, SBM - top picks, AQG and DCN - deep value

    Our top ASX gold picks are OGC (0.9x NPV, ramp up of Haile, balancedportfolio, & low cost), SBM (0.85xNPV, 9% FCF yield at spot even throughfunding expansion and mine life extension projects at Gwalia), AQG (0.55xNPV, increasing confidence in project execution and compelling CY19compsto ASX peers) and DCN (0.7x NPV, Australian development with first gold inMarch 2018). We have maintained a SELL on RRL, and have downgraded EVNto a HOLD, and NST and NCM to SELL on valuation.

    Valuation and sector risks

    Our price targets are set in line with our DCF-derived valuations. Key risks tothe sector include gold price and currency movements.