Why I Bought Northern Orion Resources

Jul. 7.05 | About: Northern Orion (NTO)

Northern Orion Resources (NTO) is usually considered to be a "Canadian junior," which is how you'll hear folks refer to small mining companies north of the border. They are a $500 million (US) market cap mining company focused on copper, and they rely heavily on two projects: a 12.5% ownership interest in a very successful but aging copper mine called Alumbrera in Argentina, and a 100% interest in Agua Rica, a similar mine, also in Argentina, that is not yet in production.

I thought this was a good one to address today, since the London bombings are making people think about the safety of their investments and one of the things that people tend to flock to is gold and other commodities. While I just sold AAUK yesterday, which is a broad-based commodity concern that I didn't fully understand, NTO is a much smaller, more focused concern that I think I do understand and that I think has potential for dramatic growth in the long term. And the Northern Orion story is an interesting one that is tied both to growth of the global economy AND the defensive interest in gold.

Why gold for a company that is unabashedly focused on copper? Because the two metals are often found in quantity in the same places, and in the case of both Alumbrera and the future Agua Rica, gold is and will be a valuable by-product of copper production which helps to offset the cost of mining and make these two mines some of the lowest cost producers of copper out there.

Increasing demand for copper is the global growth story. Copper demand is very tightly tied to construction and development, since it is the material of choice for both wiring and plumbing. China is what everyone thinks about, and they currently use about a tenth of the amount of copper per person that the industrialized nations use. Since the world copper supply is currently barely adequate to meet demand, any increase in demand from China or elsewhere as the world continue to industrialize will dramatically increase the demand for copper. With the lowest cost mines in their portfolio, NTO is leveraged nicely to that increased demand and can survive quite nicely even if demand slacks off for a long time.

Some pertinent details: NTO's share of Alumbrera production is expected to be about 50 million pounds of copper and 75,000 ounces of gold next year, and that amount is likely to tail off over the next several years. Agua Rica is planned to be a self-financed mine, using primarily bank debt, and production is expected to begin in 2009. With an assumed slight discount to current gold and molybdenum (another byproduct expected from the mine) prices at production, the cost of the copper is projected to be .23/pound, making Agua Rica one of the lowest cost copper mines in the world at a time when copper prices are well over a dollar a pound and, in my opinion, likely to increase over the long term.

Why did I buy?

In the world of small mining companies, Northern Orion seems to be a pretty safe bet. They have excellent cash flow from Alumbrera, more than a quarter of their market cap in cash, and they are in a good position to develop the Agua Rica mine smartly and independently to build a cash cow that should last for at least 30 years at current estimates. While they will become leveraged with bank debt, they are not yet there. They are profitable and, I think, undervalued, and they have not been forced to sell out the potential of Agua Rica in order to develop it -- they are starting the development phase of Agua Rica on very good footing.

When or why would I sell?

This is a fairly small position for me, and I don't foresee selling for the next ten years. I'm interested in seeing how Agua Rica develops, and I see much more potential to the upside than the down. With the recent assessments of the site just released a week ago, all looks very good and, even in the worst possible scenario Northern Orion could sell out their Agua Rica interest today and, even with conservative discounting of net present value, probably get enough cash that they'd be trading at close to cash value at this price. I'm waiting it out, even if copper drops under a dollar for a few years.

There are certainly some risks, the primary ones being that not everyone agrees that the copper supply-demand picture will remain favorable for producers, and that it is possible that the current copper demand will spur enough additional exploration and production activity (such as the recent mines being assayed in Mongolia) that the supply will spike in the next decade. I'm not worried about that, primarily because I think the demand for infrastructure in the developing world will continue to grow unabated in the long term.

Some good resources for information on Northern Orion:

Investor news page with their new estimates for the Agua Rica s.

Link to a good pdf presentation done at the end of June is available here, with lots of detail on the movement from Alumbrera to Agua Rica.

Northern Orion's filings with the SEC are available at Edgar (the filings are a little different, since it's a Canadian company).

Interesting postings on copper from a blog on metal markets.