Northgate: Mid-Tier Gold Producer with Strong Cashflow

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

Comments

[paultaut]

I am bleeding with Northgate, it got caught in the Subprime mess, $70 Million dollars worth of ARS which is being steadily written off. If they are able to get back their money, they won't have to go into the open market to increase the O/S shares.

That's why it plunged more than others. The other thing that would send it upward would be the Letter of Understanding rached with the Tribe which would add another estimated 4 mil.+ oz. to their reserves.

Strong cash flow only goes so far if you are not expanding your base.

[User 194742]

the way NXG management irresponsibly splurged 70 mil into the auction market for a lousy little interest rate differential as late as spring this year shows numbness to the world market

[bulletbob]

If Jp, Citi, Merrill all have had to buy back their ARSs is Lehman far behind.
NXG should sue Lehman and make them buy the 70MM back. Mass. AG just anounced tht Fidelity should buy back all their outstanding
ARSs also. If Lehman doesn't go under before hand, I think NXG will get their $ back.

That alone can't be the only reason 400k of unhedged gold is selling at $1.60. That price is ridiculoous. There are many explorers, etc. that trade above $1.60 and have NO cash flow. it is not an issue of reources. Between KS,Australia, and YD there is plenty. NO it is the naked shorts that are killing me and NXG. I have respected people in the precious metals market suggest that NXG s/b at $4-7/sh. Look at AQI, ANV,JAG,AZK,etc. all in the $4-7 range-but not NXG. Very confusing to me. Anyway I am long NXG, have been for years, because hope springs eternal - or at least a takeover does.

[paultaut]

Agreed to all, get Gold moving up and their will be a massive short squeeze.

[kurtdabear]

I've been in NXG for years--started buying at 97 cents/sh. when it was in the pink sheets. This is an extremely well managed company that made Kemess into a money-making mine after the previous owners had gone bankrupt. The fact that their financial advisors swindled them on auction-rate securities is not their fault, and they are suing for recovery (which may even turn out to be automatic under terms of one or more of the fraud reimbursement settlements reached this month.) I sold a few shares in the spring at $4 and bought a bunch back this week in the $1.60's. This is a good company that just keeps overcoming difficulties (i.e., the government denying their Kemess North project) and continues to improve its financial position. I firmly believe the patient investor will be richly rewarded.

[Lighthorse]

Why no mention of the real problems with Northgate: The huge "illiquid" funds Norhtgate bought on advice from scammer interprise, Lehman Brothers. "Illiquid" is a way of saying "no buyers:" "no buyers" is a way of saying "worthless."

[beabaggage]

Long term holder, have also been adding <$2. When the fed bails out FRE/FNM, that is like printing trillions of new money. A long position in NXG, PAL,SWC,CDE and other safe country juniors/mid tiers with little debt and good assets is a good anchor to a portfolio in troubled times. with Canada also starting to suffer with the rest of the world, expect mining and oil/gas to be good as well and have made big bucks in the Canroys, another long position for me and adding more.
"Oh Canada, glorious......" So what Kem North is a no-go for now, at some point someone is getting that copper out of there with the right plan, NXG, Xtrata, someone. That is not even in book value here.
Go NXG!!

[thomast2]

Thank you all for the comments. Some of you raised a few good points. Regarding ARS, I am cautiously optimistic. As bulletbob said, with JP, ML, C buying back at full price, likely NXG will get that deal too. Since NXG can borrow with ARS as collateral, so I don’t see liquidity is a big issue here. Plus they are generating cash from their productions, unlike many juniors.

The key for NXG is more for the future. They need to make up the declining revenue of Kemess South from Fosterville and Stawell in next 2-3 years, then 3 years from now, let Young-Davidson take over to replace both kemess South and Stawell. And they need to find another resource rich mining project soon in order to grow their business, top line and resources level. Once the whole PM industry is back on track with gold bull market resuming, NXG stock price will come back at much higher level than now.

[jasmts]

Northgate needs to take a good long look at GWR Resources, almost a neighbor, Lac La Hache,B.C. pinks GWRRF, a gold/porphery copper exploration, huge property. Not a good web site, nor a lot of info now, I think this is being done on purpose, they are keeping their overhead low, keep them on your radar screen. Don

[Exiled European]

It is not the end of the world for NXG and I just bought a block of shares in the company at 1.44. And I have traded this stock a dozen times before with considerable success (although I misjudged my timing a few times). This stock is deeply oversold and I expect it will rebound to 2.5 this Autumn. The trick with gold mining shares is not to buy and hold for years. Buy and sell as often as you can make money, pay your taxes and you will be still ahead. Don't be vane if your timing was off, admit it, sell and try again letter. After all, timing is essential.

[Exiled European]

Correction in the penultimate phrase "LATER" instead of "letter"