Company Profile
NovaGold is a development-stage precious and base metal mining company with one of the largest resource bases in the mid-tier of the industry. The company has successfully pursued a strategy of tying up large deposits when commodity prices were low, and is now bringing these toward production. Formed in 1987 and headquartered in Vancouver, B.C., the company has no significant operating revenues or earnings. The company is targeting modest production of gold in 2008 at Rock Creek at about 100 k oz per year. But the significant development projects are not expected to arrive until the medium term (+5 years). The key project is Donlin Creek, a massive refractory gold deposit in a remote area of Alaska where Barrick is the JV partner (50/50). The company also controls Galore Creek (British Columbia, 50% with Teck Cominco), a pre-development stage copper-gold project. The massive resource bases at these projects have considerable value, which is partially offset by daunting infrastructure requirements. The Ambler poly-metallic deposit and Forrest Kerr properties supplement.
Click here to view a BNN video interview with Rick Van Nieuwenhuyse, CEO of NovaGold on April 18,2008
Event
In a note entitled “1Q/08: De-Risking Resource Value ... Slowly” Hill explains the reasons behind his Hold/Speculative rating and target price of $10.00/sh.
Takeaways From The Event
Responding to a conference call held by Novagold coincident with their F1Q/08 reporting, Hill writes “Delays at key projects were consistent with past trends and didn’t seem to affect sentiment. The power decision at Donlin Creek was pushed back to Fall-08 (previously mid-year) and weather issues at Rock Creek pushes start-up to 2H08 (previous 2Q).” With regards to Donline Creek, Hill writes “The decision between wind/diesel on-site generation vs. grid inter-tie for Donlin Creek has again been delayed as studies continue. Barrick/NovaGold now aim to make the decision sometime this fall. This is a delay from the “mid-08” timeframe described during end-07 reporting. Feasibility study is targeted for 2009. NovaGold remains optimistic that ongoing drilling at the Acma zone will expand resources outside the current pit plan at grades ~20% higher. More power could enable 100,000 T/day throughput (2.48 mln oz/ yr). The company will use a $750 Gold price to update the pit shell geometry this year and are looking at non-refractory mineralization. Drilling results may be out in about one month.”
Pertaining to Nome/Rock Creek, Hill writes “Snowfalls have delayed excavation and infill of tailings storage facility and dry and wet runs of milling and processing facilities have been successful.”
Concerning Galore Creek and other projects, Hill writes “The company was terse on other projects, stating only that strategic initiatives were underway.”
Reporting the results of Novagold’s first quarter ending February 29, 2008, Hill writes “In the first quarter ending February 29, 2008, NovaGold booked C$15 mln from gains on the sale of US Gold shares plus C$15 mln in recovery of suspension costs yielding a GAAP EPS of $0.26/sh diluted. Operating cashflows less depreciation, SG&A and interest costs are likely to generate scant earnings for the ~130 mln shares diluted. Their 2008 Budget includes: C$20 mln to complete Rock Creek, offset in 2H by operating cashflow the company forecasts at $25 mln, bank financing may be able to offset any shortcomings, C$18 mln for the 100% of Donlin Creek expenses that NovaGold is funding through May-08, after which a new budget will be set, C$34 mln for the Galore Creek suspension; ongoing care and maintenance is expected to remain C$5 - $10 mln and C$24 mln might be realized in the Oct warrant expiry if shares stay +C$7.” In response Hill writes “NovaGold should be able to fund operations through Commercial production at Rock Creek, though an undetermined budget at Donlin lingers in 2H.”
Furthermore, amid market turmoil in March, NovaGold priced $95 mln of Senior
Convertible Notes due May 1, 2015 bearing a 5.5% coupon payable semiannually at the March 19th/08 closing price of $7.86/sh. Face value is $1,000 per note. The conversion rate is 94.2418 shares per bond, equivalent to a price of $10.63 and representing a small 35% premium considering the 7-yr duration of the “option”. For example, at a 10% return on equity shares would climb to $15.32 in seven years (+44%). A 15% return would put shares at $20.91 (+97%). Key highlights of the notes include: “Puttable at par for cash on May 1, 2013, Dilution protection via adjustable conversion rates: note holders would only receive shares worth less than face value in the event of a take over below $7.86/sh (see final prospectus filing for schedule) and A premium to par in the event of a takeover above $7.86; for example: a takeover at $10/sh would see convert holders receive 129 shares per $1,000 face value bond, worth $1,185 per bond (an 18.5% premium to par); a takeover at $12.50 adjusts to about 111 shares worth $1,389 (an 39% premium).” In response to the issuance of Convertible Notes, Hill writes “Noteholders appear to have significant upside potential with excellent downside protection, thus it is surprising the offer was initially undersubscribed. An over-allotment of $14 mln notes could still be added, though investors might be cautions with shares currently trading slightly below the $7.86/sh closing when converts were priced. Change of control at our target price of $10/sh (31% premium) would draw about 128 mln shares on a fully diluted basis, a cost of ~$1.28 bln dollars. Fully diluted share count is up 20% YoY.”
Valuation and Target Price
In light of the conference call, Hill writes “No change has been made to our target price of $10/sh and Hold, Speculative rating. We see value in NovaGold, particularly in a take over situation. Yet, overhang from capex uncertainties at Donlin and management credibility surrounding the expensive cancellation of Galore Creek may deter M&A. Meanwhile sustaining costs are likely to offset any cashflows at Rock Creek, while write-downs may loom, particularly at Galore Creek. The fundamental volatility in the shares is expected to remain high because a confidence interval surrounding reasonable possible high-low development costs at Donlin Creek is probably greater than the current $800 mln market capitalization.”
Hill values NovaGold on “a 50-50 average of two methods: discounted cash flow (DCF) analysis and market multiples per unit of payable metals, deriving an $10 target price. Funding decisions for major projects will be largely based on DCF valuation; however, we believe market multiples for similar companies are relevant, particularly for gold assets that tend to trade at significant premiums to DCFs. We value NovaGold assuming Donlin is owned 42.5%.
Sum-of-parts and DCF basis. Applying discounted cash flow analysis, a revenue blended beta (gold/silver beta is 0.2, copper beta=1.2) yields a cost of capital of 5.5%. DCF modelling is based on published studies on key development assets. Early/pre-development stage assets are valued at book or heuristic approaches. We adjust for dilutive securities and use the fully diluted share count. The target multiple is 1.0x, (based on a discount to producer gold multiples of 1.6x). This yields $9/sh.
Market Multiples. We estimate the payable metal value for comparable development stage companies with gold and copper, based enterprise value (market capitalization, plus debt, less cash) plus uncommitted capital cost relative to payable life of mine production estimates. This multiple is $230/oz for gold projects, a discount to recent deals, largely due to uncertain viability/capex costs at Donlin. This yields $10/sh.”
Investment Risks
Without limitations, some of the risks include reserves and resource risk, development risks, permitting risks, off-take agreements, commodity price risks, geo-political risks, exchange rates, weather related impacts etc.
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