What the market interpreted as bad news drove this mining stock down, but our contributor thinks there’s more to the story. Note, this is a speculative buy.
New Gold (NGD)
From Jack Adamo’s Insiders Plus
New Gold (NGD) reported preliminary production data and announced a three-month delay in its highly anticipated Rainy River project. It will need additional work and investment to get it fully running. That, of course, will lower revenues for the year and increase costs per ounce of gold, since assets will be underutilized. Analysts now expect 2017 earnings to be about 5¢ per share.
To top it off the bad news, the company said it is about $100 million short of funds to complete the work on Rainy River. It said it was considering all options, such as selling non-core assets, seeking an increased credit line with its banks, issuing subordinated debt and issuing additional equity. These options may be used in combination.
The possibility of shareholder dilution through an equity issue on top of the lower earnings sealed it. The market dumped shares like they were leprous. One analyst dropped his target price on the shares from $4.50 to $3.00. The shares closed Friday at $2.91.
Let’s look at these bad points, then go over some good ones that were lost in the shuffle, then weigh the pluses and minuses.
As prelude, let me remind you of what I’ve been saying for years: Mining is and always will be a lumpy business. The unknowables inherent in the mining process make that inevitable. In fact, the analyst who just dropped her price target on New Gold, has changed her price target 17 times in the last 3 years, including two instances in which she changed it twice in the same month. Between January and June of 2016 she raised estimates 3 times advancing from $2.00 to $5.50/share, a total increase of 175%. I wish I could say she’s atypical or stupid, but she’s not. She’s a Certified Financial Analyst, which is a tough designation, and she’s probably better than most. It’s simply a lumpy business.
I certainly have no better understanding of New Gold’s business than the analysts who cover it. However, I know that I don’t know. That’s a lesson these folks could learn. I also know that herd instinct drives markets to overreact on the upside and downside. That fact sometimes presents opportunities to make good investments. American Express (AXP) is our latest example; it’s up 8.2% for us in just 10 weeks after an overreacting market’s sell-off. Our killing in Lorillard a few years back is another great example that comes quickly to mind.
Now let’s look at the good news about New Gold.
People whose opinion I respect say there’s a good chance the project financing will be done without issuing new equity. If that occurs, that alone will give the shares a boost. However, as is usually the case, the reaction was way overdone. Even if the financing is done entirely with new common equity, it would increase the share count by about 7%. That’s hardly justification for a 27% sell-off.
Despite 12% lower gold production (not good) in 2016 than 2015, the company expects to earn 5¢ to 6¢ in GAAP earnings for 2016, versus a loss of 97¢ per share in both 2014 and 2015. This was driven by a $117 (14%) decrease in all-in sustaining costs to a company record low of $692 per ounce. Note that $94 of the decrease in total cash costs, was primarily driven by significantly lower costs at the Peak Mines property. The manager of that property, Greg Bowkett, is taking over operations at Rainy River this year.
That mine is not targeted to open until September, so there’s only so much he can do for now. The delays and additional costs will kill overall company margins in 2017, but the trend should again improve when that mine is open for a full year in 2018, especially with a new captain at the helm. To ensure against any further delays, the company has engaged Pierre Légaré as the Project Director for the balance of construction at Rainy River. Mr. Légaré has over 30 years of experience in project development
Management expects total gold production this year to be between 380,000 ounces (flat with 2016) and 430,000 ounces, a year-over-year increase of 13%. Management realizes the business is lumpy. You can only predict so much of “what lies beneath.” But the increased earnings quoted earlier could do better than expected if production comes in at the high end.
The company has an excellent CFO. Why does this matter? The near-month price of gold right now is $1220. In October, the company hedged 120,000 ounces of its early 2017 production so that it will get at least $1300 an ounce for it. The cost of hedge: $1million. The net value of the hedge at the current gold price: $95 million extra in the company coffers.
Although the current gold price is $1220, Comex gold futures march steadily upward to $1279 in two years and $1354 in four years. Of course, there’s no guarantee those prices will hold, just as there’s no guarantee they won’t rise considerably higher. The point is, the professional traders and commercial producers who hedge or speculate via the futures market, see a steady rise in gold prices for the next four years. I’ll add to this supposition the fact that the CEO of Goldcorp (GG) said recently that the grade (grams per tonne of ore) of gold strikes over the last ten years has shrunk by two-thirds. In addition, according to Moody’s, gold miners’ reduced capex by two thirds from the 2012 level, so I would not be surprised if the futures market is undershooting significantly here.
When I looked up from all these facts at about 6:45 PM Friday, I looked at the closing price, then went through my brokerage accounts until I found one with after-hours trading in the stock. When I found one, I tripled my position in it. This is not a sure thing, low-risk investment, but if your risk-tolerance is above average, I recommend you do what I did. New Gold, Inc. is a Speculative Buy up to $3.20 for this position.
Jack Adamo, Jack Adamo’s Insiders Plus, www.jackadamo.com, February 3, 2017