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My Best Pick - Northern Orion

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December 10, 2006 – Comments (5)

Northern Orion is my favorite stock these day. NTO - US, NNO - Canada

Fully diluted it has 221.5 million shares. At its current price of about $4 that gives a market cap of $886 million.

It has $180 million in the bank, the warrants that dilute the stock bring in another $160 million.

Its current cash flow from existing operations is about $150 million/year, and with copper at $3, earnings per share should come in around $0.50/year (Q2 earnings were $0.22/share when copper prices peaked, and $0.15/share for Q3). This cash flow should continue for about 10 years. There is a 20% royalty on their existing earnings from a 1/8th share of a mine which gives them 50 million pounds of copper/year and 75,000 oz gold.

They have completed a feasibility study to build a new mine at Agua Rica, and have a 3 year plan to build the mine. The mine costs about $2 billion to build and would have operating costs around $220 million per year.

The mine life is estimated to be 23 years and the first 10 years of production would give:

135,000 oz gold: About twice existing gold.

368 million lbs copper: More than 7 times the existing copper

15.4 million lbs molybdenum: A new metal for the company.

There will not be a 20% royalty on the new mine.

Cash flow from the new mine @ $2 copper, $400 gold and $12 molybdenum is

$736 + $54 + $185 = $975 million of additional cash flow.

Their current cash flow, money from warrants, and money in the bank gives them at least 1/2 billion towards building the new mine, and the financials are so strong, they can likely do this without dilution.

The cash flow from the existing and new mine could very well pay off the mine in about 2 years, so by 2012 they could be debt free with over $1 billion coming in and only $220 million in expense.

After taxes you have about a half billion in earnings for 221 million shares, or about $2.25 per share. To value the shares so earnings are 12%, well, that gives a share price around $19, and a strong share price, not one of these crap 2% crash and burn earnings, like say, Google. So, I give this stock a 5 year target price of $19/share, or 475% growth. And that's with highly realistic prices for the metals. At $3 for copper, or $20 for molybdenum, well, the earnings become even more stellar.

These target prices or strong buy valuations given on the market are a bunch of garbage. IMHO a strong buy recommendation has to define to what price the buy is strong, to what date, and the range of the expected rate of return. I frequently see a strong buy or sell recommendation, I look at the date, check the share price, and see that it has moved considerable, say 20%, from when the recommendation was given.

With Northern Orion's current valuation of around $4, the $19 target price gives an annual rate of return of 37%.

Here's how I do a strong buy - there is an expectation of a return 25% or more up until a certain date, in this case, for 5 years. That gives Northern Orion a strong buy recommendation up to $6.23/share prior to its Q4 report. That recommendation increases to $6.58/share prior to Q1/07 report, and it increase by 5.7% each quarter.

I give a buy recommendation with an expected rate of return between 20-25%. That gives a price between $6.23 and $7.63 prior to the year end financial report, and $6.58 to $7.99 prior to Q1/07, and an increase of 4.6% per quarter.

This stock is grossly underpriced because the market is bearish on copper. With this look at Northern Orion, copper is priced at $2, taking in the bearish consideration.

http://www.northernorion.com/s/home.asp

5 Comments – Post Your Own

#1) On December 13, 2006 at 12:46 AM, TMFSpiffyPop (99.44) wrote:

dwot,

First off, I seriously enjoyed reading your analysis and think it's great the amount of effort you have put in. This is an industry that I do not know well at all, which is why I've never invested in it (and missed out on quite some pretty profits these past few years). So I don't feel particularly skilled at assessing your analysis, unfortunately.

But maybe a couple perspectives I can share.

First, and this is really tangential to the point of your piece but is connected to my second point, so I'll mention it, and that is that you denigrate Google in an offhand shot about halfway through. For my part, I would not denigrate Google. Google has a tremendously rich future in front of it, and is already spinning out ridiculous amounts of cash at growth rates that few businesses, in the history of the world, have ever attained at such scale. So rather than condemn or write off Google, I think you should respect it, and you might even learn something from it. We've all missed a four-bagger (I too) in this stock in the past few years. I don't think this is a fluke; I *do* think we should make sure we've learned something, something more than just "crap crash and burn earnings."

Now, my second point is that you don't spend much time assessing risks in your buy recommendation. You denigrate Google (to hook back to the first point) but you do not spend any time denigrating Northern Orion. Mind you, it's your favorite stock, right? So I don't exactly expect you to call it "crash and burn." But your argument would be stronger if you were able to demonstrate recognition and knowledge of, say, "The Three Things That Could Go Wrong." Identify and call out those three things, and then (a) spend time explaining why you don't think they will happen, or even if they do it'll still be a good stock, or what are the probabilities of these happening, etc., and (b) ensure that the tone -- which should match your thinking, by the way -- ultimately allows for, and reflects, a willingness to believe you could be wrong.

Outside of those brief thoughts, I am going to do a bit more research on this stock itself, because I like your thinking and you've laid out a very compelling case.

Fool on! --David Gardner

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#2) On December 13, 2006 at 2:15 AM, dwot (45.74) wrote:

I am so thrilled by your comment.

I differ strongly in opinion on Google and perhaps I will do a post on my analysis on why.

I teach math and I think I can demonstrate some real concerns about Google by chasing the math.

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#3) On January 01, 2007 at 6:28 PM, dwot (45.74) wrote:

I've just looked at this again, and I think I've addressed downside in my analysis. $2 for copper is what I think is a highly realistic bottom price for copper.

Northern Orion has the potential to be a very low cost producer, much lower than most competitors. If copper prices go lower, the ability to pay for financing changes rapidly. The other players with higher costs are very likely to stop investing if copper goes below about $2.25 because they will have problems raising capital and paying it back.

I believe the Phelp Dodge deal values copper at $0.70/lb in the ground. Add $0.50 production costs and you have $1.20. Now there is also capital costs. Northern Orion's capital costs work out to $0.30/lb, bringing you up to $1.50. Now there is financing, administration, exploration, maintenance, depletion. Some have given a long term price of $1.25 or $1.50, but I don't think those prices are realistic at all.

Copper was around $1, capital costs had been paid for, exploration wasn't happening, land costs had been paid for. Those business simply weren't making money and depleting their reserves, kind of like when you've paid for a car, your costs of driving are much less, but eventually, you have a huge increase jump in costs again, and for a lengthy period. Those mines are coming to the end of their life and there will need to be constant reinvestment and ability to pay for capital costs, or supply will decline, raising prices again so I just don't see copper going as low as some estimate.

And, Northern Orion's production would still make it a small player, so it wouldn't have a huge impact on prices.

Phelp Dodge on the other hand is a big player and has much higher costs and would be reducing investment much sooner because of costs.

The other real risks would be government changes to policy, new taxes, cost over runs, higher than expected production costs.

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#4) On January 03, 2007 at 3:19 PM, dwot (45.74) wrote:

Crazy sell off today. Really shows that people don't evaluate what a stock is worth.

Copper went down to $2.65, and this analysis is done for copper at $2.

Copper is going down faster than I expected, but this will have a dramatic affect on future expansion plans.

From what I've read, few can make a go of building a new mine should copper go below about $2.25.

The sell off simply isn't taking into account the enormous reserve this company has.

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#5) On August 07, 2008 at 7:39 PM, dwot (45.74) wrote:

Today I have the 100% cap.  I had it earlier in the week as well.  Northern Orion was bought out at somewhere around $7/share.

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