Valuation - A comparison of two mines - Northern Orion and Goldcorp
No question that I'm "hot" on Northern Orion. I see the growth prospects as monsterous, and the actual reserve valuation is also monsterous with respect to market cap.
I didn't intend to "bash" Goldcorp, but rather, the difference between the fundamentals of these two companies is such that Northern Orion is being valued at about 10 cents on the dollar compared to Goldcorp. It doesn't mean that Northern Orion is worth 10 x what is it trading for, but Goldcorp is in the range as over valued as Northern Orion is under valued.
Northern Orion is copper and copper prices are rapidly declining. Fear and greed run the market and fear is what leads to under valuation, at least in the case of Northern Orion.
1) What is the market cap?
Northern Orion - diluted $760 million, with cash $340 million, net of cash -- $420 million
Goldcorp - (reported wrong in on CAPS and everywhere else since the Glamis merger, 702 million shares x $26.44 = $18.6 billion), but it has some debt, not a lot relative to market cap, but around $400 million more than cash assets, so net of debt, -- $19 billion.
Ratio of market caps: Goldcorp has about 25 times the valuation to investors than Northern Orion.
2) What are the mineable reserves and what are they worth at bearish prices?
Northern Orion - two properties
Alumbrera - 0.5 billion pounds copper, 750,000 oz gold
Agua Rica - 7.6 billion pounds copper, 3 million oz gold, 360 million pounds molybdenum
Copper 8.1 x $1.35 = $11 billion
Gold 3.75 x $425 = $1.6 billion
Molybdenum 360 x $12 = $4.3 billion
Total Reserves $17 billion at bearish prices, enormous in comparison to market cap.
They have many properties and interests, some of which aren't reported at this time. This is where there may be hidden value in Goldcorp. This is overstated in comparison to Northern Orion in that it is the reserve, and when mined some won't be recoverable. Northern Orion gave reserve and what could be expected to be mined after taking into account what couldn't be recovered in the mining process. Both also have resource, that which is considered economically unfeasible to mine. From the 23 properties they have listed on their website:
40.5 million oz gold @ $425 = $17.2 billion
687 million oz silver @ $10 = $6.9 billion
1.5 billion lb copper @ $1.35 = $2 billion
3.7 billion lb lead @ $0.50 = $1.9 billion
8 billion pounds zinc @ 1.25 = $10 billion
Total Reserves $38 billion at bearish prices, tiny in comparison to market cap.
Ratio of assets: Goldcorp has 2.2 times the assets of Northern Orion.
If valuations were equitable either Goldcorp would have a market cap of $1.7 billion and a share price of $2.38, or Northern Orion would have a market cap of $8.4 billion and a share price of $38.17, both of which are absurd as Northern Orion is under valued and Goldcorp is over valued.
3) How should valuation on assets be calculated?
That is such an individual question, and it is subject to mining capital considerations, production cost considerations, etc., etc., etc. An asset with a feasibility study is worth more than a property that has had some good drills in terms that it far more ready for development. It can take years to properly assess a property for economic feasibility, both in reserves and in mining costs. Northern Orion's Agua Rica property has gone through that process.
Personally, I'd start with market cap worth 1/10th of bearish asset base, so for Northern Orion, that gives 1.7 billion, and a share price of $7.67. For Goldcorp that gives $3.8 billion, but they do have unknown properties, which Northern Orion doesn't. At best, I'd give a 50% premium for those unknown properties for $5.7 billion market cap and share price of $8.12. The value of that "premium" is $2.70/share. Considering the unknow properties are years from determining whether they can be mined, the premium is generous.
4) What are the growth prospects like?
Northern Orion's current production is:
50 million pounds copper
75,000 oz gold.
When the new mine is built the production goes to:
418 million pounds of copper - 660% increase
195 oz gold - 160% increase
15.4 million pounds molybdenum - completely new, but it alone would come close to paying for production costs, and would give cash flow comparable to what gave Northern Orion its P/E of 6 right now.
At $2 for copper, $425 for gold and $12 for moly cash flow would increase around $1 billion per year, far in excess of market cap. Production costs are about $220 million per year and capital costs are $2 billion.
The growth prospects means that earnings per share would increase to somewhere between $2-3 per share at the $2 for copper, $425 for gold and $12 for molybdenum.
Gold 2.8 million ounces to 3.5 million ounces -- 25%
Copper 150 to 168 million pounds - 12%
Lead - new
Zinc - new
There is some growth for Goldcorp, it is simply very small relative to Northern Orion's growth prospects. In the longer term, after 5 years one and sometimes 2 mines per year come to the end of their mine life. 60% of production disappears in the next six years due to mines coming to the end of their lives, so Goldcorp potentially faces a serious declining production without replacement mines.
5) What do earnings look like?
For Northern Orion, when the new mine gets built earnings should go from $2-3/share. In the shorter term they will decline. Currently they are at about 16%, and with declining copper prices should go down to about 8% at the current share price. At $2.37 price for copper they were about 9-10%, or $0.31 per share.
For Goldcorp, guidance for 2007 shows this picture:
Cash net of gold credits, $1.3 billion, take off another $0.8 billion for capital costs and exploration costs. That leave 1/2 billion of pre-tax income... Take 1/3rd for taxes and you have earnings at about $0.48/share, or about 1.8%, increasing the P/E to 56.
My estimate is coming up about $0.30 less than analysts I'm reading, so at the great estimate of about $0.88, you get earnings of 3.3% and a P/E of 30 at the current price of $26.44. Copper was $3.40 for that estimate and now it is $2.58.
Goldcorp before Glamis and copper declines had net cash credits give gold a price of -$43/oz for the first nine months. Guidance is showing $150/oz net of cash credit, or about $200/oz increased costs.
6) What do depletion rates look like?
To start for current reserves of copper, Northern Orion's depletion rate is less than 1%. When the new mine is built it goes up to 5% for 5 years, and then down to 4% for five year when Alumbrera finishes, and then 3.7% for 13 years as lower grades are mined.
Goldcorp's depletion starts at 6.9%, increased to 8.6% gradually over 5 years, and then it starts to decline as mines come to the end of their life and production declines.
Goldcorp's current depletion rate grossly exceeds it earnings rate.
7) What do replacement costs look like?
For Northern Orion, the work is focused on building the new mine rather than going after new properties. Once they have the new mine, they have a 23 year time-line to work towards new growth before Aqua would reach the end of it's life. About 12% of the world's copper reserves have been estimated to have been mined. This means there are lots of prospects out there, it is just a matter of taking the time to analyse and do feasibility studies to get the properties ready to mine. For Agua, this process started about 10 years ago. It also means that replacement costs can be expected to be reasonable providing there is time to develop the resources. Currently there is a "scramble" for properties that have had the assessment work complete so mines can be built quickly.
For Goldcorp the quality of replacement properties has been declining for 8 years, and the costs are increasing. Early they had acquisition costs under $50/oz, and the Glamis merger put a price of $175/oz, dramatically increasing these costs. Few new properties are being found with more than 2.5 million ounces. Lower grades of gold cost more to mine, to mining cost can be expected to increase.
Goldcorp had enormous success because it was in a rapid growth stage going through a period where costs were low and income was increasing due to gold prices increasing. Current market condions are that gold may still go up, but copper has declined, and costs have increased dramatically. The fundamentals for improvements in earns are working against Goldcorp practically everywhere you look
Northern Orion will see earnings decline over the short term due to declining copper prices, but the reserve valuation alone makes Northern Orion grossly undervalued. The growth potential for production is enormous and earnings should increase to the $2-3 range when the new mine is built. Northern Orion's fundamentals more than make up for the decline copper prices.