Thursday, April 12, 2007

Northgate Minerals: Undervalued

Northgate Minerals (NXG) is an intermediate sized copper and gold miner – approximately 60% copper and 40% gold in valuation by production -- and is undervalued on a reserve basis of proven and indicated ore reserves.

Ticker; Company; Primary Reserves; Sec. Reserves (2); Gross Value Reserves (1); (2)/(1)
NXG; Northgate Minerals; 1.88M Tons Copper; 8.5 M ou Gold; $15.9Bn; $622M; 3.9%
GSS; Golden Star; 4.15M ou Gold; n/a; $2.49Bn; $1.15Bn; 46%
EGO; Eldorado; 9.7M ou; Gold; n/a; $5.82Bn; $2.10Bn; 36.1%
ABX; Barrick Gold; 139 M ou Gold; 933M ou Sil & 6.2BlbsCu; $109Bn; $26Bn; 23.9%
PCU; Southern Peru; 33M Tons Copper; n/a; $198Bn; $23.2Bn; 11.7%

Assumed prices of copper: $2.50 lb, Gold: $600 ou

The number of pure play public copper miners is limited so comparisons are difficult -- Southern Peru is a large cap copper miner so is not directly applicable to NXG (note that large cap miners should trade at a premium to smaller miners). However, in general, gold companies sell at a higher EV/gross value of ore reserves. On either basis, comparison to gold or copper miners, NXG trades at a discount to reserves.

NXG has one medium sized gold and copper mine in production currently (Kemess South) – in production until 3Q09, and two medium sized mines in the works – Kemess South and Young Davidson. These mines are analyzed in more detail below.

The most important factors in the valuation of a mining company – in order of importance – are 1) geology of the mining properties, 2) the political situation of the country and local government and 3) local and transportation infrastructure.

1) Geology:

Northgate has 1 mine in production and 2 mines under development: Kemess South is in production currently and expected to end production at 3Q 09, Kemess North expected production in late-2007 and Young Davidson, which is expected to start production in 2009-10. Note that the main concerns are for the potential production of Kemess North, which is most likely not a geological problem, but a political problem (to be addressed below).

Kemess North:

There are proven and inferred resources of 4.1 million ounces of gold in only the Kemess North mine (for comparison, the largest gold miner is Barrick Gold with 140M ounces gold total). Also 1.3 billon pounds copper indicated at Kemess North (comparison: Phelps Dodge reports 46 billion ounces copper total). These numbers for Kemess North only are numbers comparable to the total reserves of an intermediate gold and copper miner.

NXG's Kemess North Mine is expected to begin production in late 2007, and will last for 11 years. Kemess North is only 7 km north of Kemess South, so the geology strikes me (a bit unscientifically though) to be similar. Apparently the grade is a bit lower but not much. Northgate refers to the North as the "Kemess expansion."

Production from Kemess North is projected at 250,000 ouces au a year, Kemess South is currently at 300,000 ou au a year, copper production from North is set at 112 M ou ag a year while South currently is set at 75 M ou ag per year. Kemess North is being delayed however currently due to potential pollution issues concerning an Indian Tribe, part of the First Nations Group. This issue is the most important issue concerning Kemess North, and is addressed in detail below.

An economic assessment by Mining Watch Canada – which mainly focuses on environmental issues in Canada, but is still provides detailed Net Present Values of mining properties – assessed the NPV of Kemess North at $C1.9Bn at conservative assumptions for prices of gold and copper:

“If one assumes Option 1 but with Gold/Copper prices of $US500/$US1.80 then after-tax earnings reach $1,911.5
million over the life of the mine with an IRR of 47.6%, far above the credit adjusted
risk free return of 5.625% and much higher that the generally-accepted
required return 10% - 15% of for projects of this nature.”

Young Davidson Mine:

Northgate has the Young-Davidson mine earmarked after 2008 (probably 2009 to 2011) -- 170,000 ou au a year albeit higher cash costs due to a lower grade of reserves. Indicated reserves at Young-Davidson have are approximately 2 M Ou Au

2) Political Situation:

As a general rule, the political situation concerning mining in Canada is favorable – however NXG has potential problems concerning an Indian Tribe – the Te Skay Tribe of the First Nations Group (the First Nations Group represents Northern Canadian Native American Tribes) – that is delaying the project due to the proposed contamination of a lake in northern British Columbia from the Kemess North project. First Nations isn't sure if it will contaminate the lake, so they have asked for and received 90 more days to see if the project will or will not be approved. Currently the trial is set for May 14th, 2007.

In the author’s view, this political problem is the most risky aspect of an investment into NXG. However I am mainly assured that the mine will be approved -- if I put a “probability” on the approval, 80% likelihood – for the following reasons.

- The mine is far removed from local cities and populations, in Northern British Columbia, as the Kemess Mine is a "major" employer providing only 450 jobs. The tax authorities and the town and of course company want the Kemess North Project, but the tribe may or may not want it, depending on how it affects the lake.

- Further, Northern British Columbia is very similar in territory and population density to Yukon Territory, which is approximately than 50% the size of Alaska but has only 29,900 people. Yukon Territory is much less densely populated than Alaska. Population density of 0.06 per km2 compared to Alaska, 1.09 people per Mile2. It is mainly empty space -- Indian "tribe" that the First Nations Represents does not live close to the project, but has ancestors who lived there, and the tribe is relatively small, approximately 350 people.

- There are no towns around Lake Duncan and if you look at a map there are a lot of Lakes the same size/larger right in the same area. It is pure wilderness around this mine for 100's -- more like about 500 miles. No roads, only can reach by plane/helicopter. One railroad there but that is almost entirely for freight (that's how NXG ships out the metals). Not a single person from the tribes lives within 50 to 100 miles of Lake Duncan -- well maybe one or two recluses who lives off hunting -- but the elders of the tribes all live in small towns and or Vancouver. Te Skay is actually originally centered as a tribe in Southern BC.

- Note that the Te Skay tribe reached a settlement with the BC government about a different project by BC Hydro which flooded the area: Payouts of about a million Canadian dollars a year and an upfront settlement.

- The final decision lies with the Premier (governor) Gordon Campbell and the government of BC -- the mine is located in northern British Columbia, but is very under populated -- there are no roads and the mine is a fly in/fly out operation.

- The First Nations appears to be mainly an economic grouping -- they operate several businesses in BC -- hotels, fishing places. Lake Duncan is not a direct economically beneficial tourist destination because no tourists go there or even get close to going there.

- Further to the above point, my impression is that First Nations views mining and other natural resource projects in BC as like Native American tribes in the US view gaming -- a way to make money. If Northgate pays them a million or so a year for Kemess North that will not affect the economics very much at all -- 4.1 million ounces of gold total and 120 million pounds of copper a year (estimates for Kemess North) are huge numbers – NPV mentioned above is $C1.9Bn.

- The Premier of BC Gordon Campbell has the final say on the Kemess North project. Campbell has run politically on an economic prosperity platform. The head of the BC Mining Council (also required signature for the project to go forward) has a background in the oil and gas industry. Both are, in my opinion, cognizant of environmental and Indian rights but place as a first priority economic growth. As Campbell likes to say “British Columbia is open for business.”

As a final note, if the Kemess North project does not go through, (I assess approximately at a 20% chance) then NXG can take the $C190M it costs to develop the mine and look elsewhere, probably Young Davidson.

3) Infrastructure:

Both Kemess projects have established infrastructure – ore is shipped by existing railways – and established transportation infrastructure for getting workers to the mine. See for more detail.

Young Davidson exists next to a traditional mining town – Matachewan in Northern Ontario with a population of les than 400 – but the town is apparently eager to see the mine developed. As far as I can tell, no railways are close to the north but roads access is available.


As there are few intermediate copper and gold miners in the investable universe, and fewer with existing and very promising properties in geopolitically stable areas of the world, Northgate Minerals is unique and represents a compelling buy at the current valuation.


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