Description

Gold stocks and value usually do not go hand in hand. For decades, investors paid for optionality on higher gold prices and demanded growth at the expense of ROI. Times have certainly not only changed but reversed as gold stocks have been annihilated and sentiment is horrid. Before continuing reading this idea, if you are confident in the US economy and the ability of the Fed to continue to raise rates, then this stock, or any gold stock, should not be in your portfolio.  But if you have some hesitancy, continue reading. Unfortunately, many of the larger companies are still not inexpensive at today’s prices. However, thanks to depreciating currencies and cost deflation throughout the dirt moving industry, some gold stocks are appropriate for VIC readers. In A$ terms, gold is near an all-time high. Basically, by owning a gold stock in Australia, you are going long gold and shorting oversupplied iron ore/slowing Chinese industrial commodities demand. Newmarket Gold (TSX:NMI) is a company that was created in May 2015 through the merger of Crocodile Gold (TSX:CRK) and Newmarket Gold, where Newmarket was effectively a shell with a well-established mining management team.  Crocodile Gold owned three operating mines in Australia, the Fosterville and Stawell Gold Mines in the state of Victoria and the Cosmo Gold Mine in the Northern Territory. At the time, Crocodile had begun cutting costs and removed a problematic profit sharing deal with Aurico Gold (TSX:AUQ) but was undervalued due to a lack of market visibility, previous underperformance and a short mine life. The company produces over 200,000 ounces per year and has a major shareholder in Luxor Capital which owns 42% of the company. We believe that Luxor will look to reduce its stake in the company at some point but do not know timing.   The company currently trades at 0.9x NAV but only 1.7x EV/EBITDA compared to their peers at 8.3x at an $1,100 per ounce gold price[1]. This discrepancy is primarily due to the perception that the assets have a short mine life at 4.3 years and historically have been high cost assets.  The mine life is very common for this type of underground deposit and is even more prevalent in Australia where the investment community does not value having extensive resources drilled out and instead favor a “just in time” approach to resource inventory.  The Fosterville mine has been operating for ten years and the land package on which Cosmo is located has been producing for over 100 years.

Newmarket’s guidance for 2016 production is approximately 205,000 to 220,000 ounces at cash costs of US$700 to $750 per ounce and all-in-sustaining costs of US$950 -$1,025 per ounce.  Newmarket produces with an Australian dollar cost base which means that the current gold price for them is effectively A$1,600 per ounce.  This is something that investors are taking note of in Canadian-based producers but less so in Australian-based producers listed in Canada since there are so few.  In addition, the company has seen decreasing costs in consumables and has renegotiated its supplier contracts. Unlike many underground producers who sacrifice the future to generate temporary high levels of free cash flow, sustaining capital expenditures have not been cut. The company fills an important role as an intermediate producer, with a shortage of names that fit the mid-tier profile, as there is demand for names that are more than single asset producers but have more torque and fewer issues than the majors.  In addition, previous owners starved the company of exploration for years, creating an opportunity to find additional ounces at attractive economics.

The most interesting aspect of Newmarket is that layered on the solid production base is ongoing exploration.  The company has discovered another type of mineralization at the Fosterville mine, a structure that is bearing high grade, free gold.  Though it is early stage, the results are interesting with results including 7.35 meters (true width 4.94 meters) at 161 g/t and in the area where development already exists.  At Cosmo, the company has discovered what may represent a mirror copy of the current mine through the use of structural geology and the realization that they are in one limb of a fold.  Drilling in the other limb has returned results including 6.59 g/t over 6.4 meters and exploration is ongoing.  Though we like to air on the side of conservativism, these are the types of discoveries that have the potential to change the future of a mine and in the case of both these mines would be within the reach of existing infrastructure.

Despite assuming US$47 million of capex annually, Newmarket should generate US$15 million of free cash flow a year. Newmarket is probably the only company in our universe that has no net debt, operates in a world-class jurisdiction and produces over 200k ounces a year that trades at these low multiples of 1.7x EBITDA and a 10% FCF yield.  The valuation will move more in line with peers as it consistently delivers free cash flow and extends the mine life and over time will move in line with other companies such as Australian listed Northern Star Resources (ASX:NST), which began a similar process over a year and a half ago.

Catalyst

Catalysts for the company include the potential extension of the mine life, updated resources and reserves in Q1/16 and potential for cost and operational improvements