New Gold: Digging Into The FY2020 Reserve Update

Summary

• New Gold released its FY2020 Reserve & Resource statement in mid-February, reporting a sharp decrease in mineral reserves.
• The majority of the decline was related to the sale of its non-core Blackwater Project acquired from the Richfield Ventures deal, with New Gold retaining a stream on the project.
• While reserves are materially lower, New Gold still has a 10+ year mine life at New Afton, and a 9-year mine life at Rainy River based on reserves.
• Based on New Gold's copper exposure, and satisfactory reserve life for a smaller producer, I continue to believe that pullbacks below $1.50 will provide low-risk buying opportunities.

Photo by robas/E+ via Getty Images

The Q4 Earnings Season for the Gold Miners Index (GDX) has finally come to an end, and many companies are now busy releasing their FY2020 Reserve & Resource updates. One of the first companies to release its mineral reserve update was New Gold (NYSE:NGD), an intermediate gold producer with Canadian operations. On the surface, New Gold's reserve update looks disappointing with a massive drop in reserves. However, the majority of this decline was related to the sale of Blackwater, with New Gold retaining upside to the project. Based on New Gold's copper exposure and satisfactory reserve life for a smaller producer, I continue to believe that pullbacks below $1.50 will provide low-risk buying opportunities.

(Source: Company Presentation)

New Gold released its FY2020 Reserve & Resource update in mid-February and reported mineral reserves of ~3.6 million ounces of gold and 758 million pounds of copper in its project portfolio. This translated to a 69% decline in gold reserves on a year-over-year basis, based on gold reserves of ~11.81 million ounces at the end of FY2019. However, on closer inspection, reserves at New Gold's operating assets were down only modestly, from ~3.64 million ounces to ~3.56 million ounces. This suggests that the drop was nowhere near as alarming as it looked on the surface and was predominantly related to the sale of New Gold's Blackwater Project that was acquired in the Richfield Ventures acquisition at the peak of the previous bull market. Let's take a closer look at the update below:

(Source: Company Filings, Author's Chart)

As shown in the chart above, New Gold has seen a moderate decline in reserves since FY2018, with open-pit and underground gold reserves at Rainy River declining considerably, as well as total reserves at Rainy River. This comes as a result of an updated Life of Mine plan released in Q1 2020, focusing on a shorter but more profitable mine life. The updated life of mine plan shaved more than 1.5 million ounces of gold off the mine life (~2.64 million ounces vs. ~4.19 million ounces), with a large chunk of underground reserves being moved back into the measured & indicated resource categories. Fortunately, we did not see any material decline in reserves in FY2020, despite the production of ~228,900 ounces of gold last year. This was a positive development, maintaining the project's nearly 10-year mine life.

(Source: Company News Release)

Currently, the Rainy River Mine holds reserves of ~2.60 million ounces, with just above 10% of these reserves being lower-grade stockpiles. Based on FY2021 guidance of ~280,000 ounces of gold production and a similar annual production profile over the mine life, this translates to a mine life of more than 8 years at Rainy River. For an open-pit mine, this is relatively low and would normally be a bit of a concern. However, it is worth noting that Rainy River also holds ~2.01 million ounces of resources (measured & indicated) outside of the mine plan at a higher reserve grade of 2.49 grams per tonne gold. While it's unlikely that all of these resources will be pushed into the mine plan, a 55% conversion rate (~1.11 million ounces) would translate to at least another 4 years of mine life at Rainy River. So, overall, it was a decent year at Rainy River, and there are no major concerns here in terms of its mine life.

(Source: Company Website)

Moving over to New Afton, we saw another moderate decline in reserves on a year-over-year basis, with gold reserves sliding from ~1.01 million ounces to 958,000 ounces. Based on average annual gold production of close to ~90,000 ounces per year, with gold production increasing in FY2025, New Afton's mine life based on gold reserves sits at over 10 years. This is encouraging given that New Afton is New Gold's lower-cost asset, with life of mine all-in sustaining cost projections of $757/oz vs. Rainy River at $907/oz.

(Source: Company News Release)

In terms of copper reserves, New Afton ended the year with 758 million pounds of copper, down from 802 million pounds at the end of 2019. Like gold reserves at New Afton, copper reserves also support a 10-year mine life here, which gives investors strong visibility into future production at this flagship asset. It's important to note that like Rainy River, New Afton has significant resources in the measured & indicated categories, with ~1.18 million ounces of gold and just over 1 billion pounds of copper. Therefore, while the current life of mine plan projects production out to just 2030, this mine life could easily be extended by converting some of the resources to reserves and the potential for new discoveries on the property.

(Source: Company Website)

While some investors might not be happy with the divestment of Blackwater to Artemis Gold (OTCPK:ARGTF), it's important to note that this was a massive project, and it was unlikely that New Gold would be able to develop the project any time soon. There's no question that New Gold overpaid for the asset by paying over $500 million near the peak of the 2011 gold bull market, especially when considering that they picked up Silver Quest Resources for over $100 million to complete the Blackwater acquisition. However, those untimely decisions are in the past, and the fact that New Gold was able to monetize this asset has at least allowed them not to compound past mistakes.

As noted in the divestment news, New Gold will retain an 8% stream on Blackwater for the first 280,000 ounces (4% thereafter), and New Gold received over $160 million in shares and cash. This has strengthened the company's balance sheet, with New Gold sitting on ~$185 million in cash, with another ~$40 million in cash coming in August as the second payment for the Blackwater deal. This gives New Gold an enterprise value of just above ~$1.4 billion at current levels. Let's see how the company's reserve base stacks up against peers:

(Source: Company Filings, Author's Chart)

As shown in the chart above, New Gold has one of the smallest reserve bases among GDX-listed gold producers and is currently valued at over $480.00 per reserve ounce based on ~3.6 million ounces of gold reserves. While this might point to New Gold being a little overvalued, it's important to note that this calculation does not include copper or silver reserves, which stand at 758 million pounds, and 9.82 million ounces, respectively. On a gold-equivalent-ounce basis, New Gold is sitting on over 5.2 million ounces of reserves, which reduces its valuation per ounce to closer to ~$280.00/oz. This places New Gold below the trendline for reserves of this size and leaves the stock reasonably valued.

So, were there any negatives in the report?

(Source: Company Filings, Author's Chart)

The only negative to report was that New Gold increased its gold price assumption to calculate mineral reserves to $1,400/oz, from a previous level of $1,275/oz last year. This is one of the higher gold price assumptions used in the industry but is still relatively conservative given that gold is trading closer to $1,725/oz. Overall, I would not consider this a red flag or a reason to discount the company's valuation, but the key will be reserve growth going forward without further increases in metals price assumptions so New Gold can continue to maintain its nearly 10-year mine life at its assets. So, what's a fair value for the stock?

(Source: YCharts.com, Author's Chart)

As shown above, New Gold is expected to have an earnings breakout year in FY2021, with annual earnings per share estimates reversing from net losses the past three years to projections of $0.19. Earnings breakout years are bullish developments and occur when annual EPS consolidates for years before making a new high, and FY2022 estimates of $0.29 suggest that there's more growth ahead for New Gold. Based on what I believe to be a fair earnings multiple of 11, New Gold's conservative fair value is $2.09 per share, assuming it can meet FY2021 annual EPS estimates. Generally, I prefer to wait for at least 40% upside on small-cap companies to bake in a margin of safety, and this would mean looking to buy at $1.50 per share or lower.

(Source: Company Presentation)

New Gold had a solid year in FY2020 by cleaning up its balance sheet, completing significant work to turn around Rainy River, and finding a way to monetize Blackwater. Looking ahead to FY2021, it's expected to be a higher-cost year for the company at New Afton with cost guidance of $1,275/oz, though Rainy River's costs should partially offset this, given that they could drop below $1,150/oz if New Gold beats guidance. Based on New Gold's copper exposure which differentiates the company from its peers and a satisfactory reserve update, the company is a name that investors can feel comfortable owning. Therefore, if we see any pullbacks below $1.50, I would view this as a low-risk buying opportunity.

Analyst’s Disclosure: I am/we are long GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.