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.