Northgate: Mid-Tier Gold Producer with Strong Cashflow

| About: AuRico Gold (AUQ)

Northgate Minerals (NXG) is a mid-tier gold producer with mining operations and resources in Canada and Australia, both geopolitically stable and safe countries. The Company is projected to produce 385K ounces of gold this year and to maintain gold production of 350K-400K ounces in future years. Just like every other junior miner (even though NXG is not a junior), Northgate's stock price has been on a downward trend since late last year, which was traded at one point over $4.50 back in May 2006. This pressure, however, has not been caused by equity financing or risk of refinancing, as in the case of some juniors. In fact, Northgate has not done any equity financing since 2002.

Mr. Ken Stowe, the CEO of Northgate minerals, was in New York City to talk about the Company last Thursday (8/14). Financially, he says, Northgate is very strong right now. With its production estimate of 385K ounces of gold, and average cash cost of $350 per ounce, with today's gold price of $800, It is expected to generate strong net cashflow about $170MM from operations this year, with the latest Q2 report showing $41MM for the quarter. This free cashflow in 2008 is more than a third of its current market cap at $440MM. One reason that Northgate's stock price has been under a lot of pressure for the last two years, besides the slump of the mining sector in general even with higher gold price, is that its major mine of Kemess South will reach the end of its mine life in mid-2011, which accounts for over half of the company's gold production in 2008.
However, Northgate has been very active in acquiring and developing future resources in the last several years. They now have 3 other mining operations ongoing, Stawell and Fosterville in Australia and Young-Davidson in Canada, besides Kemess South mentioned above. The production in Kemess South is expected to be around 200K ounces this year and next, but to decline to 100K in 2010, and reach its end life in mid-2011. However, production on Stawell and especially Fosterville is likely to offset the shortfall in Kemess South, if not more.

Northgate added both Stawell and Fosterville mines through acquisition of Perseverance Corporation in February of this year. Fosterville is the bigger of the two, has a much longer mine life of 8 years, and is likely to be extended in the future. The output of Fosterville will probably ramp up from the 70K ounces this year to a much higher production, possibly 200K-300K ounces per year. The strategy of Northgate is to use Stawell and Fosterville to offset the declining production in Kemess South for the next several years to at least maintain the 400K ounces of production. This should generate enough cashflow to fund Young-Davidson (discussed below) and other potential development.

Another major project for Northgate is the Young-Davidson project in Canada. Current 43-101 preliminary assessment indicates 2.11MM gold resources, with drilling programs ongoing to target a higher resource base possibly at 3MM by year's end. Northgate's target is to produce gold at 170K ounces per year with cash cost of less than $400/oz with 15 years of mine life starting 2011.

In order to evaluate this project, I put together a quick spreadsheet with the following assumptions: today's $800/oz gold, $300M capital expenditure, $450/oz operating cash cost conservatively (instead of using the $400/oz target from Northgate), discount rate at 10%, and only use 12 years of mine life instead of 15. The net cashflow will be $350/oz, or with 170K ounce production per year, $60M per year for 12 years starting 2011. Based on my NPV model, it gives a value of $50MM, which is not very large but still a decent return. Also to keep in mind, it is very sensitive to the future gold price as expected. For example, if we use $900/oz gold instead of $800, the NPV increases to $140MM, almost 3 times higher. This is typical for gold producers due to its operation leverage.

If Northgate's strategy of buying underappreciated assets and then turning them into production works, we should easily expect this Company to maintain a net operating cashflow of $170M or higher per year for a very long time, even if gold stays at today's price. This is good news for the shareholders since they don't need to face additional equity dilution, as is encountered at other junior miners with no production that are relying on equity financing.

Northgate is not a typical hot company with high production growth in the near future (even its resources are expected to grow through expanding existing mines and future acquisitions), as in the case of some juniors, but it has a unique business model of self-funding, not relying on outside financing, and seems financially strong with ability to generate lots of cashflow in the current difficult market for the mining sector. As we can see, if they can maintain this operating cashflow, their stock price vs. yearly cashflow is about 2.6:1 ($440M market cap vs. $170M operating cashflow), quite undervalued. More importantly, Northgate acts as a long term call option of gold, giving investors a high operating leverage if this gold bull market continues.

I believe NXG is undervalued and provides a good opportunity for a diversified mining portfolio for -capital gain.

Disclosure: I am long NXG