New Gold – established jurisdictions

New Gold is an intermediate gold mining company and has a portfolio of four producing assets and two significant development projects. The company is forecasting production of between 405,000 and 445,000 oz in 2012 from its producing mines – Mesquite, Cerro San Pedro Mine, Peak Gold Mines in Australia and New Afton. Cash costs are forecast to be around $420/oz after by products ($700/oz total costs). New Gold also owns 30% of the world-class El Morro project located in Chile and 100% of the Blackwater project in Canada.

By 2017, New Gold could be producing 1m oz pa and would then be in the large cap producer league. However, production is likely to slowly increase up until then, so I would not be surprised if the company was to acquire further assets. New Gold has a total of 20.5m oz in the measured and indicated resource category and reserves of 7.9m oz. The company has a market cap of around $4.7bn and $230m in cash as at 30 June 2012.

One of my key investment criteria is management. I find it very encouraging that the Board and Management hold 15m shares in New Gold, which are worth around $150m at the current share price. The Executive Management team is chaired by the experienced Randall Oliphant and the Board comprises of industry heavyweights such as Pierre Lassonde, the ex CEO of Newmont Mining and Vahan Kololian, Founder of Terra Nova Partners.

New Gold announced Q3 results at the beginning of last month. Fully-diluted eps were $0.09 versus analysts’ consensus forecasts of $0.10. The variance was due to lower sales (realised in early Q4) and slightly higher costs. Gold production was 104,577 oz (sales 95,200 oz) and cash costs were $443/oz, down from $473/oz in Q2. To hit the bottom end of their 405,000 oz target, New Gold will need to produce 106,000 oz in Q4. The other key news was the start up of the New Afton mine. The company ended Q3 with cash of $148m (versus $230m at 30 June) and a total of $398m in debt. Subsequent to the Q3 end, the company announced the early redemption of its C$55m of subordinated convertible debentures that were due June 28, 2014 and 73.7m warrants were also exercised, which brought in $66m.

Here is an overview of their projects in more detail:

Cerro San Pedro (Mexico) – New Gold owns 100% of the mine through the Mexican Company, Minera San Xavier (“MSX”). The Cerro San Pedro Mine is located in the state of San Luis Potosí in central Mexico, approximately 20 kilometres east of the city of San Luis Potosí. The project property is a gold-silver, open pit, run-of-mine heap leach operation in the historic Cerro San Pedro mining district. At the end of 2011, the mine had 1.0 million oz’s of proven and probable gold reserves and 30.4 million oz’s of proven and probable silver reserves, with 1.8 million oz’s of measured and indicated gold resources, inclusive of reserves, and 55.9 million oz’s of measured and indicated silver resources, inclusive of reserves.

Mesquite (USA) – This is an open pit mine located in Imperial County, California, approximately 70 kilometres northwest of Yuma, Arizona and 230 kilometres east of San Diego, California. It is an open pit, run-of-mine heap leach operation. At the end of 2011, the mine had 2.8 million oz’s of proven and probable gold reserves and 5.5 million oz’s of measured and indicated gold resources, inclusive of reserves. New Gold acquired the mine in June 2009 as a result of a business combination with Western Goldfields Inc (‘WGI’). Prior to this, WGI acquired the mine from Newmont Mining Corporation in 2003 and subsequently completed a positive feasibility study in 2006. WGI commenced commercial production at Mesquite in January 2008. The mine is operated by the Company’s wholly owned subsidiary, Western Mesquite Mines, Inc. (“WMMI”).

New Afton (Canada) – The New Afton copper-gold mine is located approximately 350 kilometres northeast of Vancouver in the south-central interior of British Columbia. The property is only 10 kilometres from the regional hub of Kamloops and is easily accessible by paved road. New Afton achieved commercial production ahead of schedule on 31 July 2012. The underground operation is expected to produce, on average, 85,000 oz’s of gold and 75 million pounds of copper per year over a 12-year mine life. At the end of 2011, the deposit had 1.0 million oz’s of proven and probable gold and 1.0 billion pounds of proven and probable copper reserves, with 1.7 million oz’s of measured and indicated gold resources, inclusive of reserves, and 1.6 billion pounds of measured and indicated copper resources, inclusive of reserves.

Peak Gold Mines (Australia) – The Company’s Peak Mines gold-copper mining operation is an underground mine/mill operation located in the Cobar Mineral Field near Cobar, New South Wales, Australia and has been producing since 1992. At the end of 2011, the mine had 0.6 million oz’s of proven and probable gold reserves and 66 million pounds of proven and probable copper reserves, with 0.9 million oz’s of measured and indicated gold resources, inclusive of reserves, and 167 million pounds of measured and indicated copper resources, inclusive of reserves. Peak has continually replaced annual depletion with new resources.

The Peak Gold Mines comprise five commercially active mines and a copper-gold processing plant. The deposits, all currently mined from underground, include, from south to north, the Perseverance, Peak, New Occidental, Chesney and New Cobar. The Peak, New Occidental and Perseverance ore bodies are accessed via a shaft and surface decline located at the Peak site. The New Cobar and Chesney ore bodies are accessed via a decline near the base of the New Cobar open pit. The Peak site hosts the processing facility and administration buildings.

New Gold has two development/exploration projects:

Blackwater (Canada) – In June 2011, New Gold acquired Richfield and its flagship Blackwater project. New Gold added to its property holding with the subsequent acquisitions of Silver Quest and Geo Minerals in December, 2011. Blackwater is a bulk-tonnage gold project located approximately 160 kilometres southwest of Prince George, in central British Columbia, Canada. Blackwater has a mineral resource estimate of 7.1 million ounces of indicated gold resources and an additional 2.5 million oz’s of inferred gold resources. As part of the Silver Quest acquisition, New Gold also acquired a 100% interest in the Capoose Property, located adjacent to Blackwater, with an established gold and silver mineral resource. The Capoose indicated mineral resource is 0.4 million oz’s of gold and 26.6 million oz’s of silver. The inferred resource is 0.4 million oz’s of gold and 29.5 million oz’s of silver. There are currently 19 drills active at site aiming to expand the resource and New Gold is advancing the project toward completion of a feasibility study in 2014.

Blackwater is a huge project and will be fairly capital intensive costing $1.8bn to develop, including a 24% or $346m contingency. However, gold production will be 507,000 oz pa with cash costs of $536/oz. The IRR is estimated at 24%. There is year round access for drilling/development and Central BC is near infrastructure. Despite the scale of the project, I am reassured by New Gold’s track record with putting mines into production.

I do not believe that financing will be an issue. New Gold’s free cash flow will grow strongly next year and in April this year they raised $300m through a private offering of 7% senior notes due in 2020. They also did a further private offering for $500m in November via 6.25% senior secured notes due in 2022. The most important factor is that none of this debt is due before 2020 so Blackwater should be producing at full output by then.

El Morro (Chile) – This is a gold-copper development project in Chile with owner-operator Goldcorp Inc, in which New Gold has a 30% interest. El Morro entered the permitting stage in November 2008, in March 2011 received approval for the Environmental Impact Assessment from the Chilean Authorities, and in January 2012, Goldcorp’s Board of Directors formally approved construction. El Morro is located in north-central Chile, Atacama Region, approximately 80 kilometres east of the city of Vallenar. The project is expected to have low expected cash costs and there is plenty of organic growth potential as the current resource is entirely within the La Fortuna deposit. New Gold’s 30% share of the project gives them proven and probable gold reserves of 2.5 million oz’s, proven and probable copper reserves of 1.9 billion pounds, and 3.0 million oz’s and 2.2 billion pounds of gold and copper measured and indicated resources, respectively, inclusive of reserves. New Gold’s share of capital fully funded by Goldcorp and production is likely around 2018.

Conclusion

Over the last four years New Gold’s share price has outperformed the gold price, S&P 500 and XAU index by a wide margin and I would expect this to continue. The company has exciting growth potential and is well financed. The New Afton mine is now ramping up towards full production so free cash flow should increase strongly next year. It is possible that a maiden dividend will also be declared.

The company trades on a 2013 PE of around 14 and Price to cash flow of under 10x. This is not one of the cheapest gold producers but I believe the premium is justified given the company’s track record of meeting targets. Their assets are also in politically stable jurisdictions and there are not many comparable mid tier companies. The “game changer” will be the development Blackwater, as this will double production. Whilst there is execution risk, the management and the board have the expertise to deliver.