Over the past few months, stocks in the gold mining sector have fallen dramatically. Even though there is much debate on the direction of gold and gold stocks over the long-term, if you are bullish on gold and gold stocks, this decline in prices has presented an opportunity to investigate gold companies for investment purposes. One company worth analyzing for future investment purposes is New Gold Incorporated (NYSEMKT:NGD).
Over the past three years New Gold Incorporated has produced some excellent results. They have increased gold production from 382,911 oz in 2010 to 411,892 oz in 2012. They have responded well to a strong gold market as they have an average realized price (US$/oz) that has increased from $1,194 oz in 2011 to $1,551 oz in 2012. The results from these strong performances are that the company's revenues have increased from $530.5 million in 2010 to $791.3 million in 2012. Based on this information above we can see that New Gold will do well in a bull market for gold but over the past five months we have seen gold fall. So, the above figures are great but what about some down side protection.
One of the greatest defenses against a strong down side fall is analyzing the debt side of a company. In the article below, We will look at New Gold's total debt, total liabilities, debt ratios and WACC. From this analysis, we should get an idea if the company is highly leveraged, how much it is paying for its debt, what it's paying in taxes and how much to expect in return for investing in this company over the long term. As well in the case of a gold miner it is important to look at the "all in cost of production" as this will give the shareholder a basement for the stock.
New Gold is an intermediate gold mining company. The company has a portfolio of four producing assets and two significant development projects. The combination of the New Afton Mine in Canada, the Cerro San Pedro Mine in Mexico, the Mesquite Mine in the United States, and the Peak Mines in Australia positions New Gold as one of the lowest cost producers in the industry.
1. Total Debt = Long-Term Debt + Short-Term Debt
Total debt is the sum of long-term debt, which is debt that is due in one year or more, and short-term debt, which is any debt due within one year.
- 2009 - $225 million + $12 million = $225 million
- 2010 - $230 million + $0 million = $230 million
- 2011 - $252 million + $0 million = $252 million
- 2012 - $848 million + $0 million = $848 million
- 2013 TTM - $854 million + $0 million = $854 million
New Gold's total debt has increased over the past five years. In 2009 New Gold posted a total debt of $225 million while in 2013 TTM the company posted a total debt of $854 million. This signifies an increase of 279.56%.
The increase in long-term debt was attributed to the company issuing bonds. On April 5th, 2012 the company issued $300.00 million in unsecured notes. These bonds were issued at a rate of 7% while on November 15th, 2012, New Gold issued $500.00 million in unsecured notes at 6.25%.
As New Gold owns 30% of the El Morro project in Chile shared with Goldcorp (NYSE:GG) who own the other 70%. New Gold received $50 million to help fund the El Morro project.
2. Total Liabilities
Liabilities are a company's legal debts or obligations that arise during the course of business operations, so debts are one type of liability, but not all liabilities. Total liabilities are the combination of long-term liabilities, which are the liabilities that are due in one year or more, and short-term or current liabilities, which are any liabilities due within one year.
- 2009 - $757 million
- 2010 - $846 million
- 2011 - $939 million
- 2012 - $1.607 billion
- 2013 TTM - $1.572 billion
Over the past four years New Gold's liabilities have also increased. In 2009, New Gold reported liabilities of $757 million while in 2013 TTM New Gold reported liabilities of $1.572 billion. This marks an increase of 107.66%.
In 2012, New Gold issued bonds to supplement the company's growth. As the company issued $800.00 million in bonds in 2012, this has a profound effect on the company's total debt and liabilities.
1. Total Debt to Total Assets Ratio = Total Debt / Total Assets
This is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. It is calculated by adding short-term and long-term debt and then dividing by the company's total assets.
A debt ratio of greater than 1 indicates that a company has more total debt than assets. Meanwhile, a debt ratio of less than 1 indicates that a company has more assets than total debt. Used along with other measures of financial health, the total debt to total assets ratio can help investors determine a company's level of risk.
- 2011 - $252 million / $3.221 billion = .08
- 2012 - $848 million / $4.284 billion = .20
- 2013 TTM - $854 million / $4.302 billion = .20
Currently, New Gold has a total debt to total assets ratio of .20. The total debt to total assets ratio has increased over the past three years. As the total debt to total assets ratio has increased, this indicates a slight increase in financial risk to the company.
4. Debt ratio = Total Liabilities / Total Assets
Total liabilities divided by total assets. The debt ratio shows the proportion of a company's assets that is financed through debt. If the ratio is less than 0.5, most of the company's assets are financed through equity. If the ratio is greater than 0.5, most of the company's assets are financed through debt. Companies with high debt/asset ratios are said to be "highly leveraged." A company with a high-debt ratio or that is "highly leveraged" could be in danger if creditors start to demand repayment of debt.
- 2011 - $939 million / $3.221 billion = .29
- 2012 - $1.607 billion / $4.284 billion = .38
- 2013 TTM - $1.572 billion / $4.302 billion = .37
In looking at New Gold's total liabilities to total assets ratio over the past three years, we can see that this ratio has also increased. The ratio has increased from .29 in 2012 to .37 in 2013 TTM. As the ratio is below .5 this states that currently the company is not in danger of being "highly leveraged."
As New Gold has aggressively grown and by making acquisitions such as the Silver Quest Resources, Geo Mineral Limited and Richfield Ventures in 2011, it is a positive to see that New Gold's total liabilities to total assets ratio is still under .50.
5. Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity
The debt-to-equity ratio is another leverage ratio that compares a company's total liabilities with its total shareholders' equity. This is a measurement of how much suppliers, lenders, creditors and obligators have committed to the company versus what the shareholders have committed.
A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in the company reporting volatile earnings. In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations, and therefore is considered a riskier investment.
- 2011 - $939 million / $2.282 billion = .41
- 2012 - $1.607 billion / $2.677 billion = .60
- 2013 TTM - $1.572 billion / $2.730 billion = .58
Compared with 2011, New Gold's debt-to-equity ratio has increased. The ratio has increased from .41 to .58. As the ratio is currently below 1, this indicates that shareholders have more invested than suppliers, lenders, creditors and obligators. .58 indicates a lower amount of risk for the company and the shareholder.
6. Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity
(LT Debt = Long-Term Debt)
The capitalization ratio tells the investors the extent to which the company is using its equity to support operations and growth. This ratio helps in the assessment of risk. Companies with a high capitalization ratio are considered to be risky because they are at a risk of insolvency if they fail to repay their debt on time. Companies with a high capitalization ratio may also find it difficult to get more loans in the future.
- 2011 - $939 million / $3.221 billion = .29
- 2012 - $1.607 billion / $4.284 billion = .38
- 2013 TTM - $1.572 billion / $4.302 billion = .37
Over the past three years, New Gold's capitalization ratio has increased from .29 to .37. As these ratios are lower, financially this implies a lower amount of risk to the company.
7. Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt
This coverage ratio compares a company's operating cash flow with its total debt. This ratio provides an indication of a company's ability to cover total debt with its yearly cash flow from operations. The higher the percentage ratio, the better the company's ability to carry its total debt. The larger the ratio, the better a company can weather rough economic conditions.
- 2011 - $230 million / $252 million = .91
- 2012 - $236 million / $848 million = .29
- 2013 TTM - $258 million / $854 million = .30
In 2012, as New Gold issued debt to support its acquisitions and growth New Gold's cash flow to total debt ratio has decreased. As the ratio has decreased over the past few years this indicates that the company has had less of the ability to pay its total debt from its operating cash flow. As the current cash flow to debt ratio is below 1, this implies that the company does not have the ability to cover its total debt with its yearly cash flow from operations.
Over the past couple of years New Gold has made some aggressive moves regarding its growth. In 2011, New Gold acquired Silver Quest Resources, Geo Mineral Limited and Richfield Ventures. To support these acquisitions New Gold then issued $800.00 million in bonds at 7% and 6.25% respectively. Even though these are bold moves, the ratios indicate that management has not over leveraged the company. But the ratios do indicate that the company did increase its risk from a financial standpoint. The next step will reveal how much the company will pay for the debt incurred.
Cost of Debt
The cost of debt is the effective rate that a company pays on its total debt.
As a company acquires debt through various bonds, loans and other forms of debt, the cost of debt is a useful metric. It gives an idea as to the overall rate being paid by the company to use debt financing. This measure is also useful because it gives investors an idea as to the riskiness of the company compared with others. The higher the cost of debt, the higher the risk.
8. Cost of debt (before tax) = Corporate Bond rate of company's bond rating.
- New Gold Inc. Cda 6.25% = 6.25%
- Current cost of Debt as of May 13th, 2013 = 6.25%
9. Current tax rate
- 2011 - $79 million / $258 million = 30.62%
- 2012 - $80 million / $279 million = 28.67%
- 2013 TTM - $74 million / $276 million = 26.81%
2010 - 2012 3-year average = 28.70%
From 2011 - 2013 TTM New Gold has averaged tax rate of 28.70%.
10. Cost of Debt (After Tax) = (Cost of Debt Before Tax) (1 - Tax Rate)
The effective rate that a company pays on its current debt after tax.
- .0625 x (1 - .2870) = Cost of debt after tax
The cost of debt after tax for New Gold is 4.46%
Cost of Equity or R Equity = Risk Free Rate + Beta Equity (Average Market Return - Risk Free Rate)
The cost of equity is the return a firm theoretically pays to its equity investors (for example, shareholders) to compensate for the risk they undertake by investing in their company.
- Risk Free Rate = U.S. 10-year bond = 1.92% (Bloomberg)
- Average Market Return 1950 - 2012 = 7%
- Beta = (Google Finance) New Gold's Beta = 1.02
Risk Free Rate + Beta Equity (Average Market Return - Risk Free Rate)
- 1.92 + 1.02 (7- 1.92)
- 1.92 + 1.02 x 5.08
- 1.92 + 6.10 = 8.02%
Currently, New Gold has a Cost of Equity or R Equity of 8.02%, so investors should expect to get a return of 8.02% per-year average over the long term on their investment to compensate for the risk they undertake by investing in this company.
(Please note that this is the CAPM approach to finding the cost of equity. Inherently, there are some flaws with this approach and that the numbers are very "general." This approach is based off of the S&P average return from 1950 - 2012 at 7%, the U.S. 10-year bond for the risk-free rate, which is susceptible to daily change and Google Finance beta.)
Weighted Average Cost of Capital or WACC
The WACC calculation is a calculation of a company's cost of capital in which each category of capital is equally weighted. All capital sources such as common stock, preferred stock, bonds and all other long-term debt are included in this calculation.
As the WACC of a firm increases, and the beta and rate of return on equity increases, this is an indicator of a decrease in valuation and a higher risk. By taking the weighted average, we can see how much interest the company has to pay for every dollar it finances. For this calculation, you will need to know the following listed below:
Tax Rate = 28.70%
Cost of Debt (before tax) or R debt = 6.25%
Cost of Equity or R equity = 8.02%
Debt (Total Liabilities) for 2012 or D = $1.572 billion
Stock Price = $7.42 (May 13th, 2013)
Outstanding Shares = 476.92 million
Equity = Stock price x Outstanding Shares or E = $3.539 billion
Debt + Equity or D+E = $5.111 billion
WACC = R = (1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)
(1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)
(1 - .287) x .0625 x ($1.572/$5.111) + .0802 ($3.539/$5.111)
.713 x .0625 x .308 + .0802 x .6924
.0137 + .0555
Based on the calculations above, we can conclude that New Gold pays 6.92% on every dollar that it finances, or 6.92 cents on every dollar. From this calculation, we understand that on every dollar the company spends on an investment, the company must make $.0692 plus the cost of the investment for the investment to be feasible for the company.
Debt Side Summary
All indications above reveal that New Gold has increased its debt and therefore its financial risk over the past couple of years. The ratios state that New Gold currently is financially stable from a debt side but does carry a larger amount of risk when compared to its competitors. The CAPM for Goldcorp is 4.68%, while the WACC is 3.99%. As well the CAPM for Kinross Gold (NYSE:KGC) is 4.27% while the WACC for Kinross is 4.17%. These figures support the greater financial risk of New Gold as the CAPM and WACC state that the investor needs 8.02% year-over-year over the long term to get good value on his or her money and that New Gold pays 6.92% on every dollar that it finances.
Seasonality for Gold
As the price of gold has come off over the past few months this will have a negative effect on the earnings for the company moving forward. From a seasonal point of view, May is usually a stronger month for gold (NYSEARCA:GLD); this is supported over the past 20 years. Gold has produced a positive return 63% of the time. Having stated this, over the past 20 years, gold and gold stocks have continued their decline until mid July. In mid July the seasonality for gold usually turns positive. We will have to wait and see if this happens this year.
In 2013, New Gold is estimating to increase gold production to 440,000 and 480,000 ounces. They are also estimating all in Cash Costs of $875 per ounce. On the spending side of the equation, New Gold is looking to spend $230 million on Capital Expenditures in 2013. As of Q1 2013, New Gold has $672.4 million in cash and short-term investments. As New Gold has $672.4 million in cash and short-term investments and projecting to spend $230 million in Capex they should not have to issue any more debt in the near term to support its assets.
Charts sourced by FINVIZ
The above analysis reveals that New Gold has been aggressive in its growth. The analysis indicates that New Gold has increased its risk from a financial standpoint over the past couple of years. The ratios also indicate that due to the recent acquisitions and added debt, New Gold carries more financial risk than its competitors Goldcorp and Kinross. If gold prices continue to fall this might not be the stock to be in. But, if you believe that gold is going to recover, then New Gold would be an excellent company to look at for the long term. If you like the acquisitions that management has made and if patience is exercised and the stock price begins to form a bottom and ultimately break to the upside, it could prove to be an excellent opportunity.
Disclosure: I am long GG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.