Aurico Gold’s (AUQ) recent offer to buy Northgate Minerals (NXG) last week was greeted with skepticism as investors promptly sent AUQ down 18% on the day the bid was announced. But while the 40 percent premium for Northgate might seem like an overreach, my first reaction as a Northgate shareholder was that Aurico was getting a steal.
With Northgate ready to become a 350k ounce producer in its own right and with significant expansion potential at its ultra-low cost Kemess underground project, I had expected the stock to trade north of $6 long term. However, like many junior miners, Northgate shares have been persistently afflicted with the small-cap discount, resulting in a valuation so low that even a 40 percent premium is financially justifiable. And for Northgate shareholders, the tie up with Aurico creates a solid, mid-tier miner poised to deliver huge cash flows as early as next year.
The size and financial strength of the combined company offers a significant opportunity for a revaluation to bring Aurico’s shares in line with other mid-tier to senior gold miners, and that might bring faster share price appreciation than letting Northgate or Aurico continue operating independently.
The combination of Aurico and Northgate not only creates a mid-tier gold miner with strong production growth, but also a miner that is generating huge cash flows near-term. Based on anticipated production of 630 million gold equivalent ounces in 2012 at a cash cost of $555, the company will generate over $780 million in operating cash flow at a gold price of $1800 per ounce. Based on the combined market cap of Aurico and Northgate of $3.35 billion, this gives the combined company a price to operating cash flow in the neighborhood of 4.3.
In comparison to larger growth miners with a similar cost structure ($400-$500 per ounce), Aurico looks very inexpensive. Even the chronically underperforming Agnico-Eagle (AEM) sports a price to 2012 operating cash flow of 6x, and the more in favor El Dorado Gold (EGO) boasts a valuation of 9x operating cash flow. Thus, the possibility of a significant revaluation makes Aurico shares enticing for shareholders of both companies as Aurico moves from the speculative junior minor category into a steady, mid-tier growth miner.
The new company also boasts a strong balance sheet, which is only going to get stronger with huge cash flows over the next few years. The combined company will have over $300 million in cash on hand and a very manageable debt load. The capex required for Northgate’s flagship Young-Davidson mine, due to come online in Q2 2012, can be financed with cash on hand.
Meanwhile, the additional cash on hand and strong cash flows give the company flexibility for expanding exploration at its six projects or pursuing another acquisition among the many undervalued junior miners. By 2013, the company expects to produce 730k ounces of gold which should result in more than a billion dollars in operating cash flow at current gold prices. With cash flowing into the coffers, Aurico looks well positioned to make the next leap toward the million ounce producer club alongside Yamana (AUY), El Dorado, and Agnico-Eagle.
Overall, Aurico’s bid for Northgate creates a very promising growth gold miner and fills the relative vacuum of miners with valuations between $3 and $10 billion. With the merger vaulting both companies from the realm of speculative miner to financially stable growth opportunity, this looks like a win for both companies as Aurico is now suitable for a much broader investment universe. With gold miners on the verge of a breakout, the recent dip in Aurico shares looks like an opportunity to buy on the dip.
Note: All production and cost data gathered from corporate presentations found on each company’s website.