New Gold's Blackwater Project Won't Be Built Anytime Soon

Dec.16.13 | About: New Gold (NGD)

Introduction

In this article I'll discuss New Gold's (NYSEMKT:NGD) feasibility study on the Blackwater project in British Columbia, Canada, which was published earlier this month. Even though this feasibility study didn't contain any surprises, it's highly unlikely this project will be built as long as the gold price is trading under $1450-1500 per ounce. I will explain the results of the feasibility study and the implications on the viability of the project.

The Feasibility Study

The feasibility study was based on the reserve estimate of Blackwater which contained in excess of 8 million ounces of gold and almost 61 million ounces of silver in 344 million tonnes of ore. The base case envisaged a throughput of 60,000 tonnes per day which would make this project quite large with an average annual production of 413,000 ounces of gold during the life of mine and a higher throughput in the first 9 years of operation with an average production rate of 485,000 ounces of gold and 1.84 million ounces of silver per year. The project economics are obviously positively influenced by selling silver as a by-product, which results in a credit of approximately $90 per produced ounce of gold. This helped to bring the cash costs down to $578/oz and the All-In sustaining costs (AISC) which includes the sustaining capex to $670/oz, which is extremely low compared to the AISC of other producers.

However, as the operation is quite large, the capital expenditures were an important factor to look at. As the capex came in at almost $1.9B, one immediately sees the returns on this investment are relatively low, despite the excellent all-in sustaining production costs.

(click to enlarge)Click to enlarge

According to the company, the pre-tax NPV5% of the Blackwater project is $991M using a gold price of $1300/oz and just $402M at a gold price of $1150/oz. I have to admit it bothers me a bit to see a pre-tax NPV but no mention at all of how a post-tax NPV would look like (which is a more realistic valuation as New Gold won't get an eternal tax holiday from the Canadian and BC government).

So I took the liberty to calculate the after-tax NPV5% using the same input parameters, and using a 26% corporate tax rate in British Columbia.

Cash Flow per year

Corporate tax at 26%

after tax

Discount rate (5% per annum)

NPV5%

-1985000000

0%

-1985000000

-1985000000

298000000

0%

298000000

1,00

298000000

298000000

0%

298000000

1,05

283809524

298000000

0%

298000000

1,10

270294785

298000000

0%

298000000

1,16

257423604

298000000

0%

298000000

1,22

245165337

298000000

0%

298000000

1,28

233490798

298000000

0%

298000000

1,34

222372188

298000000

26%

220520000

1,41

156719447

298000000

26%

220520000

1,48

149256616

285000000

26%

210900000

1,55

135948020

285000000

26%

210900000

1,63

129474305

285000000

26%

210900000

1,71

123308862

285000000

26%

210900000

1,80

117437011

285000000

26%

210900000

1,89

111844773

34000000

26%

25160000

1,98

12707510

34000000

26%

25160000

2,08

12102390

34000000

26%

25160000

2,18

11526086

785,881,257

Click to enlarge

As you can see, the after-tax NPV5% comes in at 'just' $786M, which is relatively low given the risk of putting up almost $2B in initial capital expenditures.

If I recalculate everything using the bear case scenario with a gold price of $1150/oz, the NPV changes dramatically.

Cash Flow per year

Corporate tax at 26%

after tax

Discount rate (5% per annum)

NPV5%

-1985000000

0%

-1985000000

-1985000000

225000000

0%

225000000

1,00

225000000

225000000

0%

225000000

1,05

214285714

225000000

0%

225000000

1,10

204081633

225000000

0%

225000000

1,16

194363460

225000000

0%

225000000

1,22

185108057

225000000

0%

225000000

1,28

176293387

225000000

0%

225000000

1,34

167898464

225000000

0%

225000000

1,41

159903299

225000000

0%

225000000

1,48

152288856

215000000

26%

159100000

1,55

102557279

215000000

26%

159100000

1,63

97673599

215000000

26%

159100000

1,71

93022475

215000000

26%

159100000

1,80

88592833

215000000

26%

159100000

1,89

84374127

5000000

26%

3700000

1,98

1868751

5000000

26%

3700000

2,08

1779763

5000000

26%

3700000

2,18

1695013

165,786,710

Click to enlarge

Using a gold price of $1150/oz, the after-tax NPV5% of the project decreases to just $165.8M, which is absolutely peanuts compared to the upfront risk.

And just for fun, I also recalculated the bear case scenario using a discount rate of 8% compared to the company's 5%. This results in a negative NPV, as you can see in the next table.

Cash Flow per year

Corporate tax at 26%

after tax

Discount rate (8% per annum)

NPV8%

-1985000000

0%

-1985000000

-1985000000

225000000

0%

225000000

1,00

225000000

225000000

0%

225000000

1,08

208333333

225000000

0%

225000000

1,17

192901235

225000000

0%

225000000

1,26

178612254

225000000

0%

225000000

1,36

165381717

225000000

0%

225000000

1,47

153131219

225000000

0%

225000000

1,59

141788166

225000000

0%

225000000

1,71

131285339

225000000

0%

225000000

1,85

121560499

215000000

26%

159100000

2,00

79589611

215000000

26%

159100000

2,16

73694084

215000000

26%

159100000

2,33

68235263

215000000

26%

159100000

2,52

63180799

215000000

26%

159100000

2,72

58500740

5000000

26%

3700000

2,94

1259706

5000000

26%

3700000

3,17

1166394

5000000

26%

3700000

3,43

1079995

-120,299,646

Click to enlarge

Where to go from here?

It's obvious the Blackwater project isn't very promising at the current gold price, and the NPV is even negative using a discount rate of 8% and a gold price of $1150/oz. I think it's safe to conclude that the project won't get built as long as the gold price doesn't increase considerably.

I'm glad the management seems to realize this as well, as the press release now states that the development of the company's Rainy River project now is the primary objective of the company, and I can only agree with this strategy. It just doesn't make sense to spend almost $2B on a project which is barely viable at the current gold price.

Conclusion

When New Gold acquired the Blackwater project about two years ago, it was meant to be the company's next crown jewel. Unfortunately a deteriorating gold market has decided otherwise, and the project will be put back on the shelf for the foreseeable future. Whilst the all-in sustaining costs are extremely good at $685/oz, the real killer of the project is the price tag. As the initial capex came in at almost $2B, it doesn't make a lot of sense to take on the risk to build the project.

This doesn't mean Blackwater hasn't got any value, and I'm sure New Gold will revisit its development plans when the gold price goes up again.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.