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By: Mike Niehuser of Beacon Rock Research
There appears to be an enhanced investment opportunity for long-term value investors in emerging producers selling near cost of investment or book value. We see the mining sector gaining in interest for value investors as they screen for companies selling at 52-week lows, below book value, and with potential to expand margins and earnings. Wholesale redemptions by investors, along with tax loss selling in both the U.S. and Canada, are creating opportunities for value investors looking to acquire companies with both real assets and the potential for increasing production.
Reduced global lending and investment, which caused a shortage of liquidity, has resulted in a deflationary environment unfavorable to commodities, including precious and base metal prices. Recent actions by governments and central banks are largely inflationary, which should lead to higher gold and silver prices as banks begin to lend and invest. A reduction in credit risk should spur a resumption of global growth, increasing demand for commodities and leading to higher base metal prices. While this cycle appears inevitable to long-term investors, this scenario may be delayed by credit markets or anti-growth policies including protectionism, higher taxes, and increased regulation.
It follows that deflation in the near term should be favorable for companies that have cash or the ability to operate profitably at current metal prices. Clearly, the inflationary environment in the mining industry in 2007 has reversed and costs of labor, materials and supplies are moderating or declining. Recent declines in the price of fuel lifts a burden on both operating profits and the barrier to resumption of economic growth. As this situation persists, should metal prices rebound, margins will also expand, leading to potentially significant appreciation for emerging producers above current levels.
China continues to be important for sustained economic growth through wealth accumulation and investment in infrastructure. Despite concerns over declining rates of growth, China still maintains near double-digit annual growth rates. The ongoing demand for precious metals as a store of value, and base metals for the production of goods and infrastructure, remains immense. China’s 1.3 billion people consumed $1.2 trillion last year, while America’s 300 million consumed $9.7 trillion. While China is criticized for a lack of domestic markets, this situation may be revered as financed by its central bank’s reserves, largely composed of U.S. treasuries.
NovaGold’s market cap is significantly less than the sum of the book value of its three major projects:
NovaGold Resources Inc.’s (NG) market cap is currently about $317 million, which is only slightly higher than the book value of its Rock Creek gold mine including property, plant, and equipment, plus development costs. This would imply that the market is currently attributing no value for NovaGold’s share of its 50% ownership in its two world-class projects, the partnership with Barrick Gold Corporation (ABX) on the Donlin Creek gold project and with Teck Cominco Ltd. (TCK) on the Galore Creek copper-gold project. NovaGold’s share of the total investment in property, plant, and equipment plus development costs at Donlin Creek is $238 million, with $360 million on the Galore Creek project, for a total of $868 million on these three main assets. NovaGold’s market capitalization is about one third of its share of the capitalized investment in these projects.
NovaGold Gold Pour, Rock Creek Mine, Nome, Alaska
We understand that Barrick is working toward completion of a Feasibility Study on Donlin Creek by 1Q09. This would mean that a majority of NovaGold’s 50% ownership of this gold resource of 31.7 million Measured and Indicated ounces should move into the reserve category and allow for the start of the permit process. In addition, Teck Cominco is anticipated to provide an update on a new design plan for the Galore Creek project, which would be the basis for an updated Feasibility Study and initiation of permitting. Continued development by Barrick and Teck Cominco should assure markets, leading to NovaGold’s market cap appreciating toward total book value.
NovaGold is in the process of commissioning its Rock Creek gold mine in Nome, Alaska, and has recently completed its first gold pour. NovaGold is scheduled to produce 100,000 ounces annually, generating an estimated $25-$35 million in 2009, at an average cash cost of $500 per ounce. NovaGold is working to increase the resource to extend the mine life to ten years. Management estimates that production from the Rock Creek mine, plus cash on hand and proceeds of other non-core assets, should provide funds for planned activities for the next twelve months. NovaGold remains a viable company with significantly undervalued and unrecognized assets.
Etruscan’s market cap is less than the book value of its Youga gold mine which does not include the development potential of projects in West Africa:
Etruscan Resources Inc.’s (ETRUF.PK) market cap is currently about $73 million, which is less than its investment in property, plant, and equipment, plus development costs for the Youga Gold project of about $109 million. The Youga Gold Mine produced 7,450 ounces of gold in October; this was about 14% above September production of 6,572 ounces of gold, and 11% above estimated average monthly production. We suspect that with further optimization, production may continue to exceed published scheduled production, important to build its treasury to fund further development. Cash costs should improve through project stabilization to an estimated $450 per ounce for the life of the mine. The project includes a program to limit price exposure of the gold price on the downside to $629 per ounce.
The current market cap does not appear to reflect Etruscan’s other assets. Etruscan may have the largest land position of any mining company in West Africa. We are looking for additional reports on their Bitou project about 35 kilometers from the Youga Gold Mine and new discoveries in southwest Ghana. We are also quite keen on further developments on its recently announced rare earth deposit in Namibia. As the market cap of the company is now less than the construction cost or book value of the Youga Gold Mine, value investors have the upside to increasing gold prices, as well as exploration in West Africa, Namibia, and its diamond assets in South Africa.
Minefinders’ market cap is close to book value and half base case economic study of Dolores mine:
Minefinders Corporation Ltd. (MFN) has a market cap of about $250 million, slightly above the book value of its Dolores gold-silver mine in Chihuahua, Mexico. Current book value of the Dolores mine, including property, plant, and equipment plus development costs, totaled $203 million as of the end of June 2008. The total budget for the project is $191 million, which includes about $10 million for contingency, with available cash and credit to complete construction. Incidentally, Minefinders recently negotiated an additional $10 million in credit for additional working capital.
Minefinders recently began leaching ore, a major milestone, and anticipates its first gold and silver production in the next few weeks. Previously they had targeted producing 10,000 ounces of gold and 350,000 ounces of silver in the remainder of 2008. They report crushing at a rate of 15,000 tpd, close to the design capacity of 18,000 tpd. Estimated operating cost for gold equivalent during ramp up may range from $400 to $450 per gold equivalent ounce, declining to $297 per gold equivalent ounce over the average life of the mine, scheduled for 15 years.
The Dolores open pit mine currently has 99.3 million tonnes of Proven and Probable reserves, containing 2.44 million ounces gold and 126.6 million ounces of silver. The most recent economic study estimated an NPV at a discount rate of 3% to be $563 million (metal assumptions of $675 gold and $13 silver). The study did not include the potential benefit of adding a 3,000 tpd flotation circuit to increase recoveries of gold and silver in the pit, or located in a high-grade gold-silver resource below and parallel to the identified reserve. As Minefinder’s market capitalization is close to the book value of its investment, and less than one half of its base case economic study, we also consider the company to be significantly undervalued and of interest to value investors.
Mercator’s market cap is less than almost half book value and profitable at significantly lower metal prices:
Mercator Minerals Ltd.’s (MLKKF.PK) market cap is currently about $72 million. As of June 30, 2008 the book value of its Mineral Park mine near Kingman, Arizona, including property, plant, and equipment and development costs was over $141 million. The original budget for both phases of the 50,000 tpd facility ($128 million for stage one and $62 million for stage two) is about $200 million. Mercator is completing commissioning and anticipates production in the near term and has completed and paid for about 40% of stage two.
The first stage of the Mineral Park mine was financed by debt. The balance of the second phase will be paid out of cash flow from the first phase, remaining cathode copper production, and cash from the sale of its silver stream to Silver Wheaton Corp. (SLW). The mine has an estimated life of 25 years, and with a strip ratio of only 0.18, the project has good economics. Cost of production, assuming a 50-50 split for production of copper and molybdenum (net silver credits from Silver Wheaton), is estimated at $1.28 per pound and $6.49 per pound, respectively.
Their pre-feasibility study, assuming metal prices of $1.53 copper, $10.16 molybdenum, and $7.50 silver (prior to the sale to Silver Wheaton), estimated an after-tax IRR of 51% and NPV of $426 million with a 1.8 year payback of capital. As Mercator’s market capitalization is about one-quarter the estimated value of the pre-feasibility study and one-half the book value of the Mineral Park mine, the company should be of interest to risk averse value investors.
Acadian’s market cap is less than Scotia mine book value and replacement value not including significant gold assets:
Acadian Mining Corporation’s (ADGLF.PK) market cap is about $14 million. This is less than one-half book value of their Scotia Mine operation in Nova Scotia, including property, plant, and equipment plus development costs of approximately C$30 million. This includes the cost to acquire the mothballed Scotia Mine and bring it into production. Management estimates the replacement cost of the Scotia Mine to be about C$100 million.
Acadian brought the operation into production in 2007 on time but faced challenges in early 2008 due to difficult weather conditions. This was followed by declining zinc and lead prices. Management estimates an operating breakeven rate of $0.55 per pound zinc-lead, and overall company breakeven of $0.59 per pound zinc-lead. This was prior to the decline in the Canadian Dollar to the U.S. Dollar, which benefited Acadian, as their costs are in Canadian Dollars. Prior to declining metal prices, management implemented an aggressive cost reduction program, with plans to resume development of its gold assets in 2009.
Acadian has a gold resource in Nova Scotia of about 1.6 million ounces. When Acadian acquired the Scotia Mine it was expected to centrally process gold resources. Record zinc and lead prices accommodated restart of the mine as previously designed. Should base metals stabilize at lower levels, we expect management to revisit the original concept of processing gold ore. We estimate this could be accomplished in six to eight months at a cost of C$5 to C$10 million.
Disclosure: The author is long NG, ETRUF.PK, MFN, and ADAIF.PK. An affiliate of the author’s employer provides corporate advisory services to NG, ETRUF.PK, MFN, MLKKF.PK and ADAIF.PK.
My Note: I am also long NG and am looking at the others-jschulmansr