Ann: Quarterly Report March 2016-MML.AX, page-23

@Wieman01 I agree with how you are approaching your analysis, but I have a different view on two points in regards to the numbers you're using.

Firstly, I think when trying to do a "fair value" assessment, the FCF rate you choose should be based on the FCF yields of alternative investment options - cash, stocks, government bonds, corporate bonds.

Aussie gold miners are a very narrow segment of the Australian economy, and they are also very unloved at the moment, best demonstrated by the fact that most have FCF yields of between 6% - 20% when the investing alternatives mentioned above have FCF yields of between 2% - 6%.

To assume that gold miners will be as unloved in 2018 is to assume that the bear market in old will continue as I believe those currently high FCF yields are a result of the negative sentiment and fear of further PoG falls.

Yet if that gold price bear market comes to an end (which it appears to be in the process of) then FCF yields will likely mean revert back to the longer term average of the "cash rate + equity risk premium" (eg 2% + (usually 2% to 5%) = 4% to 7%).

So the reduction in the current equity risk premia being attached to gold mining companies will play as important a role on MML's share price as improving operations. This currently extreme negative sentiment is potentially best demonstrated by the gold miners to gold ratio:

http://stockcharts.com/h-sc/ui?s=$HUI:$GOLD&p=D&st=1997-01-01&en=(today)&id=p92300814867&a=65702648

So even if you wanted to be conservative with your FCF yield multiple I think 10% is a much fairer figure than 18%.

Secondly, I think when doing a valuation it is better to use "Enterprise Value" rather than "Market Cap", ie MML currently has US$16.8m in cash. When you are buying a mining operation, cash is a bonus and debt is a liability that need to be added or stripped from the price you pay.

So let's say they end this year with US$20m in the bank, that's A$0.13 to add on top of the per share valuation derived for the mining operation.

So @Wieman01 even if you use your FCF multiple of 5.5 to get your current valuation of A$0.72, I'd still add A$0.13 to that figure to reflect the Enterprise value to get a current value of $0.85...

So to take a more positive view of the future prospects of MML in 2017/18 using a PoG of $1300, AISC of $880, production of 140,000oz. FCF yield multiple of 10 (ie 10%), cash pile of US$50m and AUD of 0.75 (all of which I think are on the conservative side) the equation changes to this:

(140,000 x ($1300 - $880) x 10 + $50m) / 0.75 = A$850m / 207.8m shares = A$4.09

So assuming MML hit their operational guidance and present market pricing for the AUD and PoG hold, and the FCF multiple continues trend back towards the long run mean I find it hard to envision that MML won't be a $4+ share by 2018.

Looking past operations, I also think the market pricing risks are actually to the upside in regards to the PoG , AUD and the FCF multiple.

For example, the market is already pricing in 58% chance of a rate cut at the next RBA meeting, and a lower cash rate lowers the FCF multiple.

In addition to that a lower cash yield typically leads to a lower AUD which is an important determinant in MML's earnings in AUD terms .

I expect the recent trends in regards to both the cash rate and the AUD to continue for the next couple of years (ie down).

I'm also of the belief that gold has now entered a new bull market and further gains in the gold price from here will rapidly reduce the "equity risk premium" currently attached to gold mining stocks pushing them back towards historical norms of 2% to 5% further compressing the FCF multiple.

So if you want to be more optimistic about the prospects for gold and gold miners by 2018 then assuming a PoG of $1400, cash rate of 1%, equity risk premium of 4%, cash pile of US$65m and a AUD of 0.66 would change the equation for 2018 fair value to this:

(140,000 x ($1400 - $880) x 20 + $65m) / 0.66 = A$2304m / 207.8m shares = A$11.09

Of course we can make these models say anything if we are willing to change the variables.

My personal belief is that MML will trade above $5 a share sometime before 2020.

So irrespective of the operational hiccup reported last week, the upward pressure of an increasing PoG and reducing equity risk premium on gold miners will push the share price higher as long as the long term operational prospects remain the likely outcome.