Alumbrera is the name of another mine in Argentina that is currently producing 400 million pounds of copper and 600,000 ounces of gold per year. Proven and probable reserves are 4 billion pounds of copper and 6 million ounces of gold. Alumbrera is one of the world’s lowest cash cost producers of copper.
Would you believe that the same company valued at just $529 million has a 12.5% stake in this Goliath open-pit mine named Alumbrera? How Goliath? The 12.5% stake is currently generating $22 million per quarter in profit, nearly double the amount generated during the same quarter last year. And it will be producing for at least another 8 years, with a mine life beyond 2016.
Add in over $180 million in cash holdings and you have a miner that appears to be significantly undervalued. Northern Orion (NTO) stock is trading at only $3.80, despite two days of solid gains. With a P/E ratio of around 7 and a net profit margin over 100%, we like the fundamentals.
And by the way, that NPV of $2 billion was based on outdated prices. At more recent metal prices ($3.45 copper, $590 gold and $27 molybdenum), the project would have an NPV (8%) of $5.2 billion post taxes and royalties, an IRR of 36%, FOB operating costs of negative $1.01/lb copper net of by-products and a payback of 1.7 years. Not too shabby.
Northern Orion’s strategy is to use part of the cash flows from their Alumbrera mine to move the Aqua Rica project into production. They will also need new financing, which should be helped along by approval of the necessary permits and a green light from the recent feasibility study.
Solid Management Team
So many companies are plagued by short-term thinkers. The structure often encourages it. So it is nice to see a management team that believes in their products and in the bull market we are riding. Northern Orion is kept 100% percent unhedged, as to provide maximum leverage to increases in the prices of copper, gold and moly.
While a bit of hedging might have helped during the recent downturn in copper prices, NTO already has significant cash flows and we believe remaining unhedged sends the right message to investors. Management seems to be making all of the right moves, so let’s take a closer look at the players.
President & CEO - David Cohen has held executive operating, project development and commercial positions in major global resource and construction companies with over 20 years international experience. He has started and financed a number of successfully listed resource companies. In restructuring and developing Northern Orion, it has grown from a market capitalization of US$10 million to generating over US$140 million in annual cash flow and is currently holding over US$230 million in cash. David is a Professional Engineer (chemical engineering), has an MBA and is on the board of a number of resource companies.
Chairman - Mr. Robert Cross has more than 15 years of experience in the international natural resource equity markets. He is Chairman of Northern Orion Resources Inc., and Founder and Chairman of Bankers Petroleum Ltd. In 2002, he was Chairman of EAGC Ventures, which purchased a 120,000 ounce per year South African gold mining operation. The company was subsequently sold to Bema Gold Corporation (BGO) of which he is now a director. Between 1996 and 1998, he was the Chairman and CEO of Yorkton Securities Inc. From 1987 to 1994, he was a Partner - Investment Banking of Gordon Capital Corporation in Toronto. He has an Engineering Degree from the University of Waterloo, and received his MBA from Harvard Business School in 1987.
Risk vs. Reward
Northern Orion’s stock price is most directly tied to the price of copper. Copper prices have been sliding and this is reflective in their price chart, which has declined about 40% since their May high of $6. Sentiment toward copper is still bearish, with most analysts predicting further softening in prices. This is a major risk for Northern Orion and could be a determinant of whether they receive the necessary funding to move Aqua Rica into production. Their stated objective is to minimize share dilution, but they may not be able to avoid it if copper prices remain low. And the amount of funding required is nothing to sneeze at. Capital costs are estimated to be $2 billion and production costs are about $220 million per year.
Still another risk is that they will not receive the necessary permits to begin production. While we believe this risk to be relatively low, part of their current value and all of their speculative value is based upon the proven and probable assets within their 100%-owned Aqua Rica property. If they can’t get to those assets, the property value (and stock price) will lose steam rather quickly.
Another risk relates to the Socialist Revolution occurring throughout many parts of Central and South America. While the risk in Argentina is not on par with Bolivia or Venezuela, many have speculated that BHP (BHP) offloaded this property in part due to political concerns. It does make you wonder why an experienced miner such as BHP would let this property go for only $86 million. Then again, there are plenty of stories of this happening in the mining industry and this may be another to add to this list.
We aren’t expecting stellar fourth quarter results from Northern Orion, based on softening prices for copper during the back half of 2006. However, they could surprise with increased production and we can count on the stock price to jump on news that the permits are granted and financing has been arranged.
All things considered, we view NTO as somewhat of a speculative play. We also prefer owning companies with more significant precious metals exposure. Northern Orion derives only 23% of their revenues from Gold sales, with the remainder from Copper. While demand for base metals is projected to outstrip supply in the coming years, there is always the risk that the world economy will slow, dragged down by a sluggish US economy. Gold and to a lesser extent Silver, are somewhat shielded from this risk, as they are “monetary” and seen as a hedge against inflation. If the stock market starts heading South along with the dollar, gold is seen an attractive alternative for storing wealth and the price can be expected to hold or increase. Not true for base metals.
Northern Orion is currently trading out-of-the-money warrants with an exercise price of $6 (Cdn) and an expiry date of February 17, 2010. They can be found on the TSX under NNO.WT.A. Unfortunately, the warrants are scheduled to expire before Northern Orion begins production at Aqua Rica. Permits are expected to be granted sometime in late 2007, but construction might take nearly 3 years. Northern Orion’s timeline has production commencing as early as Q1 2010, so we have an outside shot at some new production before warrant expiration. But I wouldn’t count on it. We will look for warrant appreciation based on the granting of permits, securing of financing and beginning of construction on the Aqua Rica mine.
These events could push the stock price towards $10 US, for a gain of nearly 200%. Warrants would be expected to increase by nearly double that amount during the same time frame. But of course, leverage is a double-edged sword and they could end up worthless. We have a high risk tolerance at Gold Stock Bull, so the decision between buying the stock and warrants really depends on where you fall on the scale.
NTO has been on a steady decline since May of 2006, forming a descending triangle pattern. This pattern often forecasts a breakout and should be seen as bullish with clear support around $3.75. This support line has been tested three times over the past year and has held every time. Although it is still early to confirm, technical indicators are turning North for both the RSI and MACD, confirming the bullish sentiment. The past few days have been very strong for Northern Orion, pushing the stock up form $3.55 to $3.88 for a gain of over 8%.
If you believe the copper prices will rise in the coming few years, Northern Orion will provide some incredible leverage to the gain in copper prices. The warrants mentioned above will provide even more leverage for what could be some incredible gains. If copper prices rebound and Northern Orion receives the necessary permits and financing, the stock could easily reach towards $20 sometime before the end of 2010. A nice 5-bagger in the waiting. Their growth potential for production is truly enormous and could push earnings as high as $3 per share if/when the Aqua Rica project comes online. Despite the above analysis, we remain neutral toward NTO and will wait for some encouraging news before taking a position.
Northern Orion has a great website (www.northernorion.com), packed full with details about their properties and corporate strategy. Have a closer look yourself before deciding whether the company belongs in your portfolio. Another Canadian copper miner worth your consideration is Taseko Mines (TGB). Their recently reported earnings for 2006 and their stock jumped 2% in after-hours trading. Good luck and happy investing!
Disclosure: The author does not currently own NTO and was not compensated in any way to publish this article. The author does currently have a long position in TGB, but has not provided any analysis on the company to date.