How Much Is NovaGold Worth?

I was invited to NovaGold Resources' (NG) corporate presentation which was given by CEO Rick Van Nieuwenhuyse (their CFO RJ Don MacDonald was also present) on May 13 in New York City. I have owned NG for a long time, starting Feb 2005 and added to my position in May 2006. Obviously for anyone who follows its stock price, my first investment is only about break even and my second investment is around 40% under water.

NG, which reached as high as $20 in Nov 2007, used to be a darling in the junior mining sector. The higher it goes, unfortunately the faster it has been falling, and it is now around $7-8 per share. This case reflects the typical high risk associated with junior mining investment. It is a high risk and high reward business. The question however still remains: how much is NovaGold worth?

For a resources company, we should always focus on the properties and/or mining interest they own. If we ignore all the other small projects at NG, they own or partially own three core projects: Nome (100% owned), Donlin Creek (50% ownership with Barrick Gold), and Galore Creek (50% ownership with Teck Cominco). All of them are currently the biggest gold and copper mines in North America.

With metal prices going higher, political risk also increases in many developing countries since their governments have more incentive to keep and nationalize their own mines instead of letting Western companies explore and make a profit out of them. With many resource-rich countries or so called BRIC countries getting increasingly wealthy,like never before, they don't need capital from West to develop their mines anymore. In this regard, owning or partially owning the largest gold and copper mines in US and Canada puts NG in a very unique position as a junior mining company.

Nome operations is in Alaska, with 0.5 mil P&P (proven and probable) and 1.8 mil M&I (measured and indicated) reserves. Production is expected to begin in mid-2008, almost right away. The annual production is expected to be 0.1 mil ounces of gold and increasing. With an assumed $850 gold price, it is expected to generate $25 mil cash flow in 2008 and at least double that for future years. This should relieve some pressure on their future financing needs and reduce further dilution for existing shareholders.

How much is Nome operations worth if another company bought their 100% interest out? There are usually two quick and dirty ways to estimate this. One is by free cash flow. Assuming Nome generates $50 mil free cash flow after expenses for the next 10-15 years, the value is roughly 10 times free cash flow, or $500 mil.

Another way is to look at the value of similar producers. The market has valued about $250/oz for gold producers (not developers but producers) already under production. With 1.8 mil ounces of M&I (ignoring Inferred conservatively), times $250/oz, it indicates a value of about $400 to $500 mil, fairly close to the $500 mil calculated from free cash flow.

To be conservative, let us just use $400 mil, which is half of the current market cap of $800 mil for NG. In other words, the other two projects have to be worth more than $400 mil. As you can see below, they far exceed that figure by several folds.

Donlin Creek is also in Alaska, but is much larger than Nome. It is the largest undeveloped gold mine in the Americas, with 29.4 mil ounces M&I reserves of gold. But it is still several years from production, estimated around 2013. NG and Barrick are still conducting feasibility studies and permitting process. The gold value assigned in this case should be lower than $250/oz since: first of all, it takes time to get to the point of positive cash flow (production) so the present value should be lower with discounting; secondly, the discount rate should be higher due to uncertainty and risk involved; third, it takes a large capital expenditure to bring this mine into production.

How should we value Donlin Creek? Conveniently Barrick gold provided a methodology when they tried to acquire NG last year. Barrick offered $16 per share to NG shareholders which they thought reflected the fair value, but NG rejected the offer. The calculation by Barrick is repeated here (for Donlin Creek property only): assuming 30% ownership of Donlin (NG actually owns 50% now), with 16.6 mil ozs M&I of gold (now M&I has increased to 29.4 mil ozs), and NG's share of 5 mil ozs (16.6 times 30%), most importantly $110/oz of gold used by Barrick, which translated to 5 mil ozs times $110/oz or $550 mil value for Donlin Creek.

Please also keep in mind that Barrick made this calculation and offer when gold was only at $600/oz. If we use the same calculation and ignore the fact that gold is higher today, still $110/oz unchanged, but reflect the current M&I of 29.4 mil ozs of gold (or 14.7 mil ozs for NG's 50% share), we should get $110 times 14.7 mil or $1.6 billion. By adding $400 mil value from Nome earlier, we should have a $2 billion company.

With fully diluted 117.2 mil shares, it should have been worth $17 per share. In the above calculation, I totally ignore the Galore Creek property which has a M&I of 8.9 bil lbs of copper, 7.3 mil ozs of gold, and 123.1 mil of silver (you need to cut all the numbers by half for NG's shares, since they are 50/50 shared with Teck Cominco).

The doubling of capital expenditure estimates from $2.5B to $5B for Galore Creek caused both Teck and NG to re-evaluate this project, which is located very remotely in northern British Columbia. This decision caused NG's stock price to drop over 50% in a few days, severely penalized and probably quite over-sold. The increase of capital estimates is due to the dam they need to build which was not in the original estimate, Canadian dollar appreciation, increasing energy costs, and many other things.

The decision was also based on the assumption that the current $3-4 copper price was not sustainable, but would be at a much lower long term price of less than $2 for copper. However, I did a quick and dirty but conservative DCF analysis; if the copper price can maintain $3-4 long term, and it turns out to be even at $5B capital expenditure, this operation is still profitable and should add at least another $2 billion value to NG.

In other words, the previous top of $20 is not stretching at all. Conservatively, I totally discount Galore Creek and other projects not discussed here (such as Ambler), but only take into account the Nome and Donlin Creek properties. It seems to me that NG is quite undervalued right now and should be worth at least $17 per share, which is my price target when both gold and junior sector come back to life in the near future.

Disclosure: I have owned NG in my portfolio since 2005.

Comments

[StateofConfusion]

Thomas, thanks for the analysis. I also own NG but was wondering if I should buy more and I probably will now. Outstanding Investments newsletter had this as a pick in early 2008 and they have a good track record. Maybe you can do an analysis on CDE next.

[marco giacinto]

I am grateful to Thomas Tan for delivering such an informative assessment on NG: something I have been waiting for from NG's management. About OI, I was misled early last January by their incitement to buy "up to $ 12.3". To date, I have seen about one third of my NG shares crumble day by day, also due to the sinking dollar (I live in Italy, in the euro zone).
I was not happy to read in Tan's report that Nome is worth around $ 400 mil, whereas the market cap is currently ca. $ 800 mil, i.e. twice as much. Giving the probable start of cash flow from Donlin Creek in 5 years from now, how can we expect the shares to grow again in mid-2008, when cash will commence flowing from Nome operations? Shouldn't this be seen as a warning, alas, that $ 7-8 is double the current worth of NG, even after cash flow from Nome will start, at long last? I would appreciate an answer from Mr. Tan.

[Nawar Alsaadi]

Thank you for the thorough analysis, I certainly agree with you that the stock is extremely undervalued at those levels in light of the amount of resources it hold in the ground, as well as the fact that it is moving into production this quarter.

I believe the issue with the depressed valuation is partially market inefficiency and partially genuine worry about the management credibility in relation to mining, as well as a worry about the level of dilution the stock may suffer in order for GC and DC to reach production.

For the stock to reach its potential value, I believe management need to do the following:

- Produce a realistic plan to develop GC and DC without substantial dilution, a plan could be a combination of hedging, selling of none-core assets, selling some extra equity in the projects ..etc. Management has talked about all of the above, however I believe the market does need further clarification and better understanding of management intentions.
- The company has suffered multiple delays with RC, going forward they need to stick to their projections, and hopefully exceed them; a strong performance at Nome will go a long way in adding to management credibility when it comes to mining operations.

In addition to the above, I have recently written to management, about exploring the idea of a combination with a small/medium producer (something like the New Gold combination), in order to gain the scale necessary to develop the mega DC and GC projects, while assuring a certain cash flow in the mean time, I believe the combination of NG with its massive resources with a producer the size of EGO (just an example) can unlock massive value and catapult both companies market caps to the mid-tire level.

Nawar Alsaadi
Disclosure: I am heavily long NG

[Nawar Alsaadi]

Marco, if my answer your question, even though DC is not bringing cash flow just yet (and not likely for many years), you can not award it a 0 value, resources in the ground do have a value, but usually it is usually heavily discounted, based on a value of $100 oz per share, DC worth to NG is about $1.6 billion, this is if no extra resources is identified, which is highly unlikely in light of the finding at East Acma, management has indicated in March theoretically DC can go as high 40m oz to 50m oz, if management to add extra 5m oz, this alone should add an extra 500m to the marketcap.

Not to mention that Thomas has put $0 value on GC, Ambler, NovaGreen and all their other exploration properties.

Regards,
Nawar

[Clavis]

Interesting article, we learned a bit, thanks.

[Bering Boy]

Although Mr. Tan is quite correct in the math, the problem with NG is execution risk. Doing business in the Arctic that has no access for 9 months of the year, the logistics of operating any large scale mining are just plain difficult and wildly expensive. Add to this the environmental concerns of affected First Peoples who live and own the adjacent lands, and the likelyhood of development in any sort of quick and efficient manner is almost zero. My reccomendation is caution. My only exposure to NG and BG are in sector weighted mutual funds.

[Nawar Alsaadi]

Bering, don’t you think Barrick was aware of the difficulty of doing business in the arctic when they decide to offer $1.6 billion for the company in 2006?

Regards,
Nawar

[Raised in 3]

I just packed my truck with a pick, shovel and some dynamite. I'll get that gold out of the ground. Mining isn't easy. give it time and they will produce. I also packed some top ramen soup for the cold nights.

[seeksome]

The decision was also based on the assumption that the current $3-4 copper price was not sustainable, but would be at a much lower long term price of less than $2 for copper. However, I did a quick and dirty but conservative DCF analysis; if the copper price can maintain $3-4 long term, and it turns out to be even at $5B capital expenditure, this operation is still profitable and should add at least another $2 billion value to NG.
Love that last sentence another $2 billion that is billion with a B.NG is going back up.To get a deal on gold and gold bullion and anything else your heart desires at below wholesale visit:seeksomething.com

[REBEL]

Glad to see some serious number-crunching on Novagold , (NG). The author has brought out some good points. The recommendation from OI was at $8.43 and my broker couldn't get me in until NG hit $10.09. This one is a keeper - maybe the most undervalued gold miner on the planet. I have many reasons for holding it, one being that they are in the US and not subject to nationalization, (I hope). I have experience with forreign miners - Apex and Gammon. Apex has the largest probable Silver reserves in the world, but that didn't mean jack when El Presidente threatened nationalization. The stock dropped. Then he mounted the inaugural stage wearing a necklace made of Coca leaves and I headed for the exit. My point is this: Political Risk is very real and could make any foreign mine holdings drop 70% overnight. Especially since the US Geological survey says there is 20 years of Gold left, (less of Silver), on Earth.

[Bering Boy]

Nawar, concerning the knowledge Barrick had when pursuing NG: Barrick management was just done swallowing Placer Dome who had the institutional knowledge of the DC project. Driving Barrick's offer was a drop dead date on investment in DC or to take a 30% stake instead of 70% with NG. With very little in the way of feasibility planning, they tried to circumvent the deadline by buying out NG. In regards to their knowledge of the doing business at this isolated location at the time of the offer, I'll reiterate they had very little notion of the challenges.

[saba]

ok. If 50 million free cash flow for 10 years is worth 500 million purchase price why not put your money in the bank and receive 5 percent interest compounded and walk out with way more that buying this 50m cash flow for 10 yrs.????
To me the present worth of recieving 50m using 10 percent return is 250 m

[thomast2]

Thank you all for your comments.

Marco, a large property like DC needs to do a DCF analysis to put a value to such property. Reserves, even under ground and yet to be digged out, still have a value, and in this case, a good value.

Saba, you are correct from pure math standpoint. But you need to look their M&I reserve figure, which is increasing by the way once the inferred are qualified to be M&I. Even you don't count inferred right now, it is still 1.8 mil, with 0.1 mil per year, it is 18 years. So it is more likely 15 than 10 years of mining life. At the same time, I expect the output will increase which is typical for mining, this is why I said 10-15 instead of 18 years of life since you want to get them out more quickly which will realize a higher net present value. By putting alll these into your DCF calculation, I am sure you will get roughly $500 mil.

Thanks again to all.