New Gold Stock: Significant Margin Expansion Ahead (NYSE:NGD)
The fourth quarter earnings season for gold miners (NYSEARCA: GDX) fast approaching, and one of the first companies to release preliminary results was New Gold (NYSE:NGD). New Gold ended the year strong, reporting a quarter of approximately 70,000 ounces at Rainy River. Unfortunately, the company is still 2% above its guidance midpoint. However, while fiscal 2021 has had its challenges, significant margin expansion is on the horizon. Given the recent improvement in the balance sheet and the shift from limited free cash flow generation to significant free cash flow generation over the next five years, I would view any dip below $1.21 as a low risk buying opportunity.
New Gold reported fourth quarter and full year 2021 results earlier this month, reporting quarterly production of approximately 111,600 gold equivalent ounces. [GEOs], a decrease of 7% compared to the period of the previous year. This was linked to much lower production at New Afton, with lower grades and throughput over the period. However, Rainy River had its best quarter in years, producing over 70,000 GEOs, helped by higher grades and significantly improved recoveries. This helped the company end the year strong, with an annual production figure of around 418,900 GEO, just below the midpoint of the forecast (~425,000 GEO). Let’s take a closer look below:
As seen in the chart above, New Gold produced ~111,600 GEO in Q4, with ~70,500 GEO at Rainy River and ~41,100 GEO at New Afton. Unfortunately, this left production just below the midpoint of the guidance, but given the challenges, the results were satisfactory. These challenges included continued headwinds from COVID-19, the reconciliation of negative grades in some areas of the East Lobe Zone and the late receipt of permits in B3. However, with Rainy River ending the year on a high, the results exceeded my expectations.
Digging through the results at Rainy River, we can see that the operation averaged about 24,500 tonnes per day at an average grade of 1.03 grams per tonne gold. Although this throughput is below Q4 2020 levels (~27,000 tonnes per day), higher grades and recoveries more than compensated for this, with Rainy River’s gold recovery reaching 92%. This allowed the mine to record its best quarter in two years and end the year with production of approximately 234,500 GEO, up 2% year-on-year (FY 2019: 229,100 GEO). Going forward, East Lobe is expected to contribute just over 20% of tonnes in fiscal 2022 and 2023, with Q4 2021 benefiting from less reliance on this area.
Some investors might be disappointed with the slight lack of guidance, and that’s understandable, given that some miners have managed to outgrow guidance like B2Gold (NYSE: BTG) and Kirkland Lake Gold (NYSE:KL). However, the main news was the monetization of Blackwater Gold Stream for $300 million, significantly improving New Gold’s balance sheet. It was an example of CEO Renaud Adams making the most of an ill-timed deal to acquire Richfield Ventures near the top of the 2011 gold bull market. under the previous management. Furthermore, the best years are ahead for New Gold, with patient investors finally to be rewarded.
For those unfamiliar, Rainy River massively underperformed initial mine plan, which forecast production of approximately 325,000 ounces of gold at all-in sustaining costs below $800/oz. However, while investors have suffered from the mine’s poor performance, the grade profile is expected to improve steadily over the next few years. As shown in the table below, grades are expected to average ~1.22 grams per tonne gold over the next four years, an increase of more than 20% over the grades forecast for fiscal 2020 and 2021. This is aided by higher subsurface grades, with development of the Intrepid Slope progressing as planned.
Assuming that the company can benefit from a throughput closer to its authorized capacity of 27,000 tonnes per day, this should lead to a significant increase in production, with throughput up slightly and grades up by more than 20 %. The increased production should help reduce costs, with Rainy River finally poised to start generating significant free cash flow. As shown in the chart below, Rainy River’s all-in sustaining costs are expected to drop below $1,000/oz between fiscal 2022 and fiscal 2026, a massive improvement from over $1,400. over the past two years.
At the same time, New Gold is expected to experience a significant increase in copper and gold production once the C zone is commissioned, which is expected in 2023. Given the significant increase in production expected on the two assets, helping to reduce costs, New Gold Gold is one of the few producers to see a significant expansion of its margins over the next few years, regardless of the price of gold. Meanwhile, although probably not an immediate priority with two major projects underway (Intrepid, Zone C), the company could consider a complementary acquisition in the next two years, given the significant improvement in its balance sheet with the sale in cash from Blackwater. .
In summary, the New Gold story is finally reaching an inflection point, with a significant increase in free cash flow on the horizon. New Gold estimated it could generate $1.2 billion in cumulative free cash flow over the next five years, above its current market capitalization of about $1.1 billion. Let’s take a look at the valuation of New Gold below:
Evaluation and technical image
Looking at New Gold’s valuation below, we can see that the stock has historically traded at around 3.5 times operating cash flow (5-year average), which is well below his peer group. This much lower multiple can be attributed to New Gold’s higher costs, limited free cash flow generation compared to its peer group and a weaker balance sheet. At the current share price of $1.66, New Gold is trading at approximately 3.8x cash flow estimates for fiscal 2021, which is above its 5-year average.
However, if we look to fiscal year 2022, when cash flow per share is expected to increase significantly ($0.52 – $0.59), the valuation seems much more reasonable. Indeed, even at the low end of the estimates ($0.52), New Gold is trading at around 3.2x operating cash flow and a high double-digit return on free cash flow for fiscal year 2022. So , if the company can deliver and continues to see improving results in Rainy River, we could see further benefits from here. In summary, for investors looking for a company with a reasonable valuation operating in safe jurisdictions, New Gold is a name to watch, especially with the best years ahead of the company in Rainy River.
So, is stock a buy?
Although New Gold’s valuation has improved significantly and is showing a much better track record, the technical chart suggests that we are not yet close to a low-risk buy zone. This is evidenced by the chart below, showing that NGD is trading at the upper end of its 1-year trading range and just below its lower resistance zone of $1.80 and well above the support at $1.05.
As a general rule, I prefer at least a 4 to 1 reward/risk ratio to justify starting new positions in small cap companies. With New Gold having an upside of $0.14 up to resistance at $1.80 and a potential downside of $0.61 to support, the current reward to risk ratio is 0.23 to 1. Therefore, it doesn’t seem like an ideal buy point here above US$1.65. . For New Gold to dip into a low-risk buy zone, where it would have a 4-to-1 risk-reward ratio, the stock would need to fall below $1.21 per share. At this level, the stock would have a $0.60 upside at resistance and only $0.15 downside for support.
Between flooding in British Columbia, a tragic incident in New Afton and poor grade reconciliation in parts of the East Lobe zone, it has not been an easy year for New Gold. However, the company managed to end the year strong, and although the past few years have been difficult at Rainy River, the best is yet to come for the asset. Given recent balance sheet improvement and a move from limited free cash flow generation to significant free cash flow generation over the next five years, I would view any dip below $1.21 as a low risk buying opportunity.