Since obtaining the option to outright purchase at Galeno in mid 2005, the company has quickly moved forward with developing the property, with over 32,000 metres of diamond drilling done and the pre-feasibility study completed and published in January 2007. NOC is now working on the bankable feasibility study, expected early 2008.
The Hilorico property is located approx a mile from the Galeno property. An ongoing drill program is evaluating additional gold mineralization and base metal targets.
The remaining site at Pashpap 280 miles north of Lima, was originally 100% held by NOC, but has recently become a 51/49 JV with Japan’s state minerals body JOGMEC who bought in by pledging $5m of development money over the next 4 years.
The Japanese deal may point to revenues in the longer-term future for NOC and the Pashpap site certainly has a lot of unexplored potential, but of the three sites Galeno is by far the most advanced.
The Galeno Project
The January 2007 pre-feasibility study shows Galeno is potentially very lucrative. Using a cut-off of Cu at $1.00/lb, we have a probable resource of a whopping 14.6 billion Lbs copper (ex credits) and a mine life of 20.7 years mining at 90,000 tonnes per day production. From inferred resources at other grades we assume that the mine life can easily be extended to at least 30 years but we will use the current 20 year mine life for estimates. The resource is also open at depth. The thing is big, and can only get bigger.
The site is connected by dirt track road that will need upgrading on the 11km closest to the mine site. However the site has adequate water supply and a ready supply of labor in nearby towns. A possible spanner in the works may be power supply. Although close to the grid that supplies Yanacocha and other users present supply is at its limit, says Peru’s Ministry of Energy and Mines [MEM]. There are various solutions proposed, with extra electricity from Ecuador as early as 2008 being one and a new hydroelectricity generator as of 2010 another. However, the MEM cannot guarantee the supply will reach before the planned production start-up. The best we can report is the Peruvian MEM saying there “should be sufficient electricity available in 2010 to power the Galeno mine and other projects that might move forward at the same time in the region”. However, anyone with exposure to Latin American government assurances would be hard put to stop shudders of anxiety from such a statement.
Galeno is primarily a copper resource, but the company expects by-product credits from Gold, Silver and Moly. In the following chart, the company demonstrates the economic viability of the project using the lowball estimate of Copper at $1.35/lb
Capex to ramp the Galeno project to production is earmarked at $976m, with construction time at 2 ½ years from the final decision. With the bankable feasibility study due 1q08, the mine would be up and running in 2011 if all went to plan.
In the event of the project being brought to production, NOC estimates that it will also benefit from a higher grade starter pit that will deliver, on average, more than 200,000 tonnes of copper in concentrate in the first 5 years of the mine's operation. The Project will also produce, on average, over 103,000 ounces of gold per year for the first 8 years of the mine's life. Projected production of copper and gold is shown in the graph below:
It is very difficult to give hard and fast earnings estimates for Galeno at this early stage. However we put together a model to give a ballpark idea of the value offered by NOC shares at this point in time. In the interests of simplicity we average out production for all years, thus the higher grades of years 1 to 5 are incorporated into the figures for the total 20 year life of the mine.
The following graphs show the gross revenues per metal assuming a 90,000T per day mill rate. We show a range of metals prices to give an idea of the variations possible and throughout our calculations err on the side of caution.
Any future earnings projections must be recognized as guesstimate work, however we put together a model using caution at every turn except perhaps when pricing long term copper at a more robust $2.70/lb. We subtracted larger-than-normal percentages for transport, smelting/refining, operating costs, depreciation, amortization, and the whole works. So with a long term view of Cu at $2.70/lb, Au at $650/oz, Ag at $14/oz and Mo at $25/lb, we put annual revenues at NOC at $1.24Bn and $486m gross profit. This translates to a net profit of $229m per year under the present tax, royalties and worker participation regime in Peru. NOC currently has 31.2 million shares outstanding.
Likely Exit Strategy and Buyout Valuation
NOC management has made no secret of the fact that they would entertain buyout offers. This is our most likely exit strategy for NOC and therefore we do not expect the company to develop Galeno before selling out to a larger player in world mining.
There certainly is a market for large copper resources right now. Peru Copper (CUP) was recently acquired by Chinalco (ACH) for a fair premium to market price. Southern Copper (PCU) is on record as saying they are looking to expand via both organic growth and acquisitions. The mega buyout of PD by FCX also shows that big deals are being made in the sector. Only this week, Xstrata stated they are going to invest $10Bn in copper projects, of which half will be placed in Chile. As a resource, NOC and its Galeno concession would be attractive acquisition both from resource size and potential profitability for any one of the large world mining players.
The price that NOC might fetch at market would certainly be a substantial mark-up to the present valuation. With copper priced at $1.35/lb the NPV is $560m. If copper is priced at a more realistic $2.00/lb, the NPV rises to around $1.6Bn. If a suitor offered 50% of that project value this would value today’s shares at $25, with 70% of that price giving a buyout at $35. There is clearly much to like about taking a position in NOC even at this early stage if one is as bullish about the future price of copper as we are.
Another way of pricing NOC.to right now would be on a “pounds in the ground” basis. If we use the price the Chinese recently paid for CUP, which was 2.3c of copper under-the-ground, this puts the base case poundage as being worth around U$336M. At present dilution, this works out at U$10.76 per share. But this is most definitely only a base case, as it does not include the inferred resources at Galeno, or the other metal credits at Galeno, or the other assets held by NOC at Hilorico and Pashpap. Also, due to the differences in rock formation Galeno will be much cheaper to mine successfully than the recently sold CUP Toromocho asset. We therefore put a more realistic “pounds-in-ground” price target of $17 on NOC.
All investment in exploratory miners comes with its share of risk, but despite the present world financial situation and a latent menace of a lack of power supply on site, the risk/reward equation at NOC leaves little doubt that this is a good vehicle to play the future of copper mining, a sector in which we remain very bullish despite the recent turmoil in financial markets. We recommend NOC as a buy with a 2 year target of $20 per share, thus hitting a happy medium between the estimates mentioned above and represents around 250% of upside to today’s share price. We are adding NOC.to to our Latin America model portfolio as of today.