DOA Dr. Copper part 2: Northgate Minerals (NXG)

See part 1 (Freeport McMoran FCX) here.

Northgate Minerals also had a rough Q3:

  • Gold production of 64.6k oz au fell 28% below projections.  Copper production @ 9.2M lbs was 41.3% lower than forecasted a quarter earlier.  While their flagship Kemess mine was the main culprit due to some operational issues (now resolved), all three mines performed poorly.
  • Cash costs, @ $702/oz au net of credits, was 62% higher than expected.  Main culprits included lower grade ore and lower volume.  Resolved issues at Kemess, operational improvements in Australia and lower operating costs due to currencies are expected to lead to much lower Q4 cash costs.
  • NXG still managed positive OCF of $638k despite operational issues and massive drop in copper prices ($2.04 realized).  Both Kemess and Stawell were cash flow positive.
  • The company recognized a permanent impairment of $16M related to the auction rate securities. Additionally, with Lehman’s demise, there is some ambiguity related to the $44M ARS loan and the arbitration case.
  • Young Davidson is still on track for 3M oz resource.  In a bit of good news, management is strongly implying that the initial $300M capital cost could be reduced by as much as half.
  • An additional 160k oz of gold resource was added at the Stawell mine, extending mine life to mid 2011.
  • Management lowered baseline expectations going forward, now projecting that NXG can produce 350k oz gold annually.  Previously, this number had been 400k oz.
  • The company has 16.2k metric tonnes of copper  (roughly 1 quarter’s worth) hedged @ $2.52/lb.  This hedge is currently worth $22M and apparently can be cashed out at the company’s discretion.

Northgate has historically been viewed as more of a copper company than a gold one.  But with recent acquisitions, Northgate’s metals exposure is now 73% gold and 27% copper.  As such, NXG is not as levered to copper prices as FCX but they have different problems altogether:

  • The company has two Australian mines in the turnaround stage, with Fosterville losing money currently.
  • The Kemess mine provides the vast majority of cash flow but is estimated to end production in early 2011.
  • NXG also has a promising prospect in Young Davidson but as of now, that’s going to require $300M to start up. Where’s the money going to come from?
    • NXG has $70M on the balance sheet after acquiring Perseverance and the Lehman ARS fiasco (which cost them $72M in liquidity).
    • The share price has been obliterated (currently less than 1x projected 2009 OCF + cash) so raising money in the equity would be massively dilutive (current market cap ~$160M).
    • The credit crisis makes debt issuance a murky prospect.
    • Last quarter’s $68k OCF is not an acceptable run rate to cover much of YD’s costs.
  • 2 of the 3 mines (Kemess & Stawell) are projected to close down in 2011. No timing on Young-Davidson has been provided as it’s still early days on that project, leaving only Fosterville after 2011 until YD comes online.

The gold price has held up much better than other commodities.  As long as that continues, NXG’s main keys to weathering the current crisis is hitting production targets and holding down costs.  That combined with moving resources into reserves could help the share price recover while providing solid cash flow and a good base to borrow money, if needed.  If gold begins to swoon and operation issues persist, NXG will quickly find itself in the same boat as FCX — no safety net and looking at closing down mines.

Shareholders bear extra risk in addition to operational challenges.  Management has shown little inclination to reward shareholders.  NXG pays no dividend and does very little IR work to boost the stock, even at these depressed levels.  In June 2008, NXG filed a shelf prospectus for up to C$250M in new securities, which is more than double the current market cap.  CEO Ken Stowe also mentioned the possibility of acquiring companies during the current crisis.  Considering Young Davidson’s considerable capital requirements, it is difficult to see where the money is going to come from to fund all this expansion, much less reward shareholders.  One may even get the impression that management runs the company more for their own benefit than for the benefit of shareholders.  As far as I can tell, none of the executives have significant stakes.  For full disclosure, this holding is a tiny portion of my portfolio, even after being assigned the puts.

Performance measurements:

  • Hit production targets and cash costs (or at least come close!):
    • Q4 2008: 130k oz au, 18.5M lbs cu @ $268/oz
    • 2009: 390k oz au, 54M lbs cu @ $395/oz
    • unknown price assumptions on company’s target
  • Continue resource extension @ Fosterville and Stawell.
  • Young-Davidson
    • Hit 3M oz resource.
    • Reduce initial capital cost of $300M.
    • Complete feasibility study in 1H 2009.
    • Formalize IBA with First Nation tribe.
  • Resolve the ARS Lehman/Barclays situation.
More on this topic (What's this?) Read more on Northgate Minerals, Copper Prices at Wikinvest

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