Northgate Exploration NXG
December 17, 2003 - 12:24pm EST by
2003 2004
Price: 1.87 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 370 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Northgate owns and operates the Kemess South gold and copper mine in BC, Canada. Annual production thru 2009 will be about 290,000 ounces of gold and 75 million pounds of copper at a cash cost less than $150 per ounce. The company also owns the adjacent Kemess North deposit, which contains an indicated resource of 5.4 million ounces of gold and 2 billion pounds of copper. The feasibility study will be completed in Q1 '04 and is expected to indicate annual production of 230,000 ounces of gold and 120 million lbs of copper from 2010-2019. The cash cost will also decline to about $130/oz.

A gold idea is unusual for this site but I believe that Northgate offers compelling value for a less risky play in this sector. I am not a gold bug but favor some exposure due to the usual litany of reasons - negative real interest rates, a declining and wounded dollar, possibility of ruinous inflation due to the Fed's easy money policy and declining credibility of paper assets and central banks. I fully expect to make money in Northgate in the regular course of business but I also like the insurance aspect in case something does go wrong in the world.

Northgate purchased the Kemess assets in Feb 2000 using bridge financing provided by Brascan Financial. These assets were acquired from the receiver of bankrupt Royal Oak mines who had invested in excess of $450 million to develop the project. On Dec 1, Brascan's 41.5% stake of 82.5 mm shares was fully placed in the market at c$2.65/share through a bought deal led by RBC Dominion Securities. RBC was somewhat aggressive in the deal price (trying to buy market share) but this now provides an opporunity for buyers. The sale is very positive for Northgate investors:
A. Northgate now meets requirements for TSX 300 and gold index inclusion - about 6 mm shares will be bought on Dec 19 by index funds and a similar amount in March 2004.
B. Brascan's exit has removed a major shareholder and has created significant supply of the stock which is still being digested. Additionally, some investors are concerned about the reasons for Brascan's sale - Northgate for them was a merchant banking investment and not a core holding.
C. The sale allows the company to aggressively seek acquisitions. Currently, Northgate receives a copper-gold "hybrid" multiple - gold companies receive a high NAV and cash flow multiple due to the so-called gold optionality whereas base metal companies trade at a much lower multiple. Northgate intends to increase it's gold production thru exploration/acquisitions and close this discount. For example, on 2005 numbers, Northgate trades at a 11 P/E and 6 cash flow multiple versus a 20 and 13 multiple respectively for other intermediates (Agnico, Gold Corp, Cambior, Wheaton etc). Recently, Wheaton River has employed a similar strategy and has seen it's price increase over 200%.

There are several other reasons to like Northgate:

1. Copper: Even though Copper is regarded as a stepchild, the copper price has increased about double the gold price over the last six months - 30% vs 15% - page c14 of today's WSJ has a good summary/chart of this move. For Northgate, a $1 copper price has huge benefits and lowers the gold cash cost to $125/oz from $150 at 90 cent copper. It also greatly improves the economics of Kemess North which is 55% copper while Kemess South is 40% copper. Some analysts, in fact, are significantly more bullish on copper than gold due to the China/economic growth story, declining inventories and a strike at Canada's largest producer (highland valley).
2. British Columbia has elections in mid-2004 and due to the decline in the forestry business (US softwood lumber dispute) are very receptive to employment enhancing projects. This makes it very likely Kemess North will get fast track approval. BC also has very low political and technical risk for an open pit mine.
3. Hedge Book: The company has unfortunately hedged about 350,000 oz's at $307/ounce. True gold bugs don't buy hedged gold companies and this has penalised Northgate. Management is now exploring options to deal with the hedge book - for example, when Newmont closed out it's hedge book, it spent $180 million but had an accretion in market cap of almost
$2 billion.
4. The managment is operationally very competent - it has increased gold production by 20%/yr and copper production by 40%/yr since 2000 while driving down costs. They are also conducting active exploration in the Kemess vicinity to increase gold reserves and take advantage of existing infrastructure.
5. The initial infrastructure and pp&e will suffice for Kemess North also. A crushed ore pipeline, road and SAG mill will cost about $150 million.


Brascan Financial recently placed 82 milion shares in the market and this has created some indigestion offering a buying opportunity. Northgate will aslo be added to the S&P/TSX composite index on Dec 19. Additionally, copper broke thru $1 on Dec 15 - at this price, cash cost at the South mine declines to $125/oz and the viability of the North mine dramatically increases.
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