Below is an extract from commentary posted at The Speculative-Investor on 3rd July 2003. Note that when this commentary was originally posted at TSI NovaGold was trading at C$3.25 and Desert Sun was trading at C$1.00. The stocks have made significant upward progress since that time, but the analysis remains valid and both stocks are good candidates for accumulation on pullbacks.
In last week's commentary we included a valuation comparison of junior gold stocks and mentioned that NovaGold Resources (TSX: NRI) was the one stock covered in our comparison table that currently wasn't in the TSI Stocks List and that we would add to the List if we weren't already overloaded with gold stocks. Overloaded or not, having done some more research on NRI we are going to add the stock to the List now. The below review of NRI explains why.
First, some introductory information.
Historically, markets have valued exploration/development stage companies based on the stage of advancement of their projects to production and/or the likelihood of a takeover prior to production. For North American based companies the average adjusted market cap (market cap plus debt minus cash) per ounce of the total MI&I (measured, indicated and inferred) resource for a producing company is a little more than $100/oz. At the Feasibility stage it is typically $30-50/oz, at the Pre-Feasibility stage it is around $20 per ounce, and at the resource definition stage post discovery it is typically $5-10 per resource oz. These values appear to reflect the market discount that the project will make it to production, that is, Feasibility-stage ounces attract a 50% discount to a production valuation, Pre-Feasibility ounces a 50% discount to the Feasibility level, etc. Takeovers such as Francisco Gold by Glamis have tended to be somewhere between Feasibility and production valuation levels on a per resource ounce basis.
Using this approach a systematic progression is seen in increased value as a project goes from initial discovery and resource definition to eventual production or takeover. In fact, based on this approach there is potentially as much increase in value from the resource definition to production stage as there is in the initial discovery phase but with a much higher likelihood for success and therefore lower risk since a gold deposit has already been found. Depending on how many shares a company will need to issue to progress their project from stage to stage this could represent as much as a doubling in share price at each development milestone.
With the above in mind, let's now take a look at NovaGold.
Below is a chart that shows the estimated stock price of NRI at various stages of development assuming a) a gold price of $325, and b) that NRI will need to issue an additional 10M shares to fund its portion of the Donlin creek construction costs. The black vertical line indicates the current amount of NRI's total gold resource (assuming NRI ends up owning 30% of the Donlin Creek project), so the point on the left-hand scale corresponding to the intersection of the black vertical line with one of the coloured lines shows what the NRI stock price will potentially be at a particular stage of development.
The current development schedule for the Donlin Creek Joint Venture is to complete the Pre-Feasibility Study in Q4 2003. Therefore, the above chart suggests that a reasonable value for NRI at the end of this year would be US$5/share (C$6.60/share) assuming the current schedule is achieved and a gold price of $325/ounce. In other words, there appears to be substantial upside potential in NRI over the next 6 months even if the gold price does not rise. Another way to look at the situation is that there is a substantial margin of safety built into NRI's current stock price.
The Feasibility definition drilling is scheduled to be completed during 2004 with the Feasibility Study anticipated to be complete in late 2004. Final permitting and design work would be targeted to begin in early 2005 with a construction decision no later than 2007 (most likely in 2006) for Placer Dome to earn its additional 40% in the project. Due to the size of the mine, construction will likely take 12 or more months with first gold production coming in 2007 or 2008. Total gold production is currently anticipated to be 1.0 to 1.2 million ounces per year with NovaGold's share of production anticipated at 300,000 to 400,000 ounces per year.
Note that under the joint venture agreement between Placer Dome and NovaGold, Placer will finance the project from now until the point where a construction decision is made. In fact, NRI's involvement in Donlin over the next 2-3 years should be minimal, enabling the company to focus on its other projects. Speaking of other projects, prior to Donlin Creek coming on stream NovaGold will be advancing its two wholly owned projects in Nome, Alaska to production decisions. At the Rock Creek Project the 1.1 million ounce deposit is anticipated to produce 100,000 ounces per year from an open-pit operation. An independent Scoping Study is expected by mid-summer 2003 with on-going feasibility drilling through the fall. A revised resource estimate is expected after final assays are complete late in 2003. The Feasibility Study is anticipated to be complete by mid-2004 with a production decision shortly thereafter. Permitting would likely take 12 months or less, so construction could then begin in mid-2005 with the first gold production in late 2005.
Concurrently, NRI is reviewing restarting gold production on its Nome Gold Project. The deposit hosts 2.3 million ounces of gold that is anticipated to begin production at 50,000 ounces per year with by-product sand-and-gravel production. The project would be very scalable with increased production easily added. An independent engineering evaluation is currently underway with results anticipated to be ready by fall 2003. With positive initial results Feasibility engineering work could be completed in early 2004. A Production decision, final permitting and construction could then be possible by late 2004 or early 2005.
NovaGold is also working with TNR Gold on the 1 million ounce Shotgun project south of Donlin Creek to expand the current resource and target the potential for a multi-million ounce Donlin Creek type system. A lot of junior gold companies have great potential, particularly given the very bullish outlook for the gold price, but they are too risky to be considered 'investment grade' (an investment grade opportunity is one where the upside potential is good and where the downside risk is sufficiently low that making a sizeable commitment is feasible). Companies that have yet to establish a proven resource base are especially risky. Such companies sometimes provide their owners with spectacular profits, but the risk of failure is so high that they are only ever suitable for small speculations. Near its current price NRI, in our view, represents an investment-grade opportunity.
Update on Stock Selections
The Feasibility Study(FS) for Desert Sun's Jacobina gold project in Brazil is due to be completed in August. If the current FS confirms the resources and reserves that were previously established for this project then Desert Sun (TSXV: DSM) is dramatically under-valued at its current stock price. For example, using the US$30/ounce figure mentioned in the NRI discussion above for Feasibility-stage resource ounces, the 3M ounces at Jacobina would be worth around US$90M (C$120M) assuming a successful outcome for the FS. DSM's fully-diluted share count is 36M, so this suggests a potential stock price of C$3.30 following completion of the FS. There is more risk associated with Brazil than North America, but a stock price in excess of C$2.00 certainly seems reasonable for DSM over the next several months assuming no increase in the gold price.
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August 16, 2003