Description

Invest in what may be the only reasonably large gold miner that is growing production faster than operating & capital costs.  HRG is undervalued on an NAV acquisition basis and on a forward cash flow multiple.  The company is generating positive cash flow so it shouldn’t require financing.  Shares have 60%-100% upside in the next twelve months.

First, and more generally, HRG is cheap because it has been around forever (for a small gold mining company) and has not delivered on its own or investor expectations.  In fact, at CAD $2.50/share, it is worth little more (in CAD) than it was 1993.  Every Canadian mining investor has heard of or invested in this stock.  All have been disappointed, SO FAR.

What’s changed?  They hired Daniel G. Vanin, the COO, and are poised to deliver not one but two producing mines in the next two quarters.  For anyone who knows of HRG, this a remarkable feat after a decade of anemic production growth and project delays.

What are the important stats and metrics:

1)      Production ramping:  2006 production = 129,828 ounces.  2007 production = 230,000 ounces.  2008 production = 365,000 ounces.  2011 production 700,000 ounces equivalent (w/ silver).

2)      Reserve growth/development pipeline:  there are two development projects will bring the company from 365,000 ounces to 700,000:  Bissa and Prognoz.  Bissa has already surprised with exploration upside and Prognoz is very likely to as well since it is a world class silver deposit (in Russia, but you can’t have everything).

3)      Cash costs in line with the majors at US $333/ounce in 2006 (majors averaged US $337 in 2006), but declining in 2007/2008 as lower cost production comes on-line in the US $265/ounce range.

4)      Company is cash flow positive and unhedged.

HRG Valuation:

The investment community values mining companies in two ways:  an NAV based on discounted future cash flows (minus any mine CAPX remaining) or on a multiple of cash flow if the market believes that management team can competently manage a portfolio of mines on an ongoing basis.  HRG is discounted on both metrics and has a good chance of moving from an NAV based valuation to a cash flow based valuation if they can perform well over the next 18 months.

Mines:

Mine Name                  Reserves                     Cash Cost                 CAPX remaining

Zun Holba                       300,000[1]                      $352                            $0

Irokinda                          300,0001                      $269                            $0

Taparko-Bouroum      1,400,000                    $280                            $0

Berezitovy                    1,150,000                    $245                            $0

Advanced Exp.            Reserves                     Cash Cost                 CAPX remaining

Bissa                            1,500,000[2]                               ?                                  ?

Prognoz                        1,300,000[3]                               ?                                  ?

Acquisition Value (NAV):

Using an acquisition value of $500/ounce of resource – the cash cost – any CAPX required to build the mine yields a reasonable estimate of the value of these mines to an acquirer.  For reference, Agniko Eagle just bought Cumberland’s 2,900,000 ounce deposit for $475/ounce – cash costs – CAPX or $150/ounce in the ground.  Cumberland’s deposit is larger, but there is significant risk to the CAPX number in the rapidly escalating cost environment.  HRG has no more CAPX risk on much of its production/reserves.

Mine Name                  Reserves (oz)              Value/ounce                 Total Value

Zun Holba                       300,000[4]                      $150                            $45mm

Irokinda                          300,0001                      $200                            $60mm

Taparko-Bouroum      1,400,000                    $230                            $320mm

Berezitovy                    1,150,000                    $225                            $260mm

Advanced Exp.            Reserves (oz)              Value/ounce                 CAPX remaining

Bissa                            1,500,000[5]                   $100                            ?

Prognoz                        1,300,000[6]                   $100                            ?

Totals                           5,950,000                                                        $965mm

                                                                                          Shares:   250mm

                                                                                          $US/shr:    $3.86/share

                                                                                      $CAD/shr:    $4.10/share

Cash Flow Multiple:

Gold miners that have demonstrated ability to sustain and grow production trade at multiples of cash flow (EBITDA).  Using a gold price of US $600/ounce, the majors (Newmont, Goldcorp, Barrick, Kinross) trade at about 15x projected cash flows.  The mid-tier players (IAMGOLD, El Dorado, Agnico-Eagle, Meridian, etc.) trade at 12x projected cash flows. 

HRG is going to produce 365,000 ounces in 2008.  To simplify the math, let’s say the average cost is US $325/ounce (conservative with the two new lower cost mines) which gives us US $275/ounce of margin or  US $100 million ($CAD107 million).  HRG’s G&A and exploratory drilling might be CAD $12 million.  This means HRG will have about CAD $95 million in cash flow in 2008, or CAD $0.38/share.  This implies a cash flow derived value of about CAD $4.56 at US $600/ounce gold in 2008.

Catalyst