At the beginning of the year, we stated that New Gold [stock_market_widget type="inline" template="generic" color="default" assets="NGD.TO" markup="(TSXV: {symbol} {currency_symbol}{price} ({change_pct}))" api="yf"] was our preferred intermediate play for 2020. We saw a leveraged gold miner with undervalued assets that was going to benefit from a higher gold price as they worked to optimize operations.
Today, New Gold made a series of announcements that were negative on balance, and investors responded accordingly with the stock down 11%. While disappointing, we don’t believe the underlying story has changed, and see the market’s response as an overreaction.
Specifically, New Gold reported 2019 year-end financials, provided a comprehensive update on the optimization progress at their Rainy River and New Afton mines, and provided guidance for 2020.
Below follows a summary of the key takeaways from today’s release.
Key Takeaways
In our view, the fundamental component of a mining company is its assets. By effect, the most important metric is the company’s P/NAV. That’s where we start our analysis.
Within the releases, New Gold announced life of mine updates for its Rainy River and New Afton mines. The net effect was a relatively unchanged net asset value for NGD.
As expected, Rainy River’s life of mine (and NPV) decreased as the company increased cut-off grades, focusing on profitability (and cash flow) over longevity.
This was largely offset by increases to New Afton’s NPV as they released a new mine plan incorporating the C-Zone development. Recoveries and mine life also increased on the back of decreased mill throughput.
Given the 10% drop in share price on today’s news, NGD is now trading at an even steeper discount to NAV. Further, we believe assets in a safe Tier 1 jurisdiction like Canada should trade at a premium to their peers. This increases the potential upside further.
In the end, we believe the one component holding back New Gold’s valuation is what makes this an attractive high-risk high-reward investment (see below).
For the quarter, financial results were soft as expected, based on the comments made by management in the release of their 2019 production results. On the year, New Gold managed to fall within the guidance for their consolidated 2019 results.
While 2020 production guidance largely met analyst expectations, some red flags did appear. Capital spend and AISC were higher than analyst estimates for 2020. While we believe this is associated with NGD’s attempt to expedite mine optimization, it does weigh on 2020 free cash flow.
The Debt-Opportunity
Currently, New Gold holds $715 million of debt on its balance sheet, with large components due in 2022 ($400 million) and 2025 ($300 million). In short, this is one of the most leveraged intermediate gold miners in the industry.
In an environment with rising gold prices, this leverage makes New Gold an investment with outsized torque compared to peers, similar to the situation with Detour Gold (takeout target) in 2019.
Operational Excellence Required
The risk associated with this type of investment is related to the company’s operations. New Gold must execute on their operational strategy with few hiccups (i.e. meet production and cost guidance) to capitalize on the higher gold prices.
We believe today’s drop in stock price was associated with higher than anticipated guidance on capital spend and AISC that ultimately shrunk New Gold’s operational leeway for 2020.
The Investment Play on Gold
The risks associated with a New Gold investment have increased based on these results, however, the upside has similarly risen.
While New Gold investors are relying on solid operations throughout 2020, the geopolitical risks are low, and the management team has demonstrated they are focused on driving near-term profitability to improve New Gold’s balance sheet health.
We believe New Gold represents a play on rising gold prices with substantial torque given its high financial leverage.
If you’re seeking a balanced approach to capitalize on gold’s rising prices, an investment with New Gold would be best paired with investments in more stable operators like Agnico Eagle or Barrick Gold. These companies offer lower-risk, lower-return investment opportunities.
