High-Flying New Gold Asks: What Recession?

By Marc Davis, www.BNWnews.ca

These are boom times for Vancouver-headquartered New Gold Inc. (TSX: NGD (NYSE-AMEX: NGD). Indeed, this emerging mid-tier gold producer has gone from strength to strength over the last couple of years. The company even posted record annual production of more than 301,000 gold ounces for 2009. Remarkably, this has happened against a backdrop of the worst financial crisis in over 70 years, as well as a deep and protracted recession.

So what is New Gold’s secret to success amid the wreckage of North America’s pronounced economic malaise? By committing the company to an aggressive growth strategy, mostly by way of acquisitions, it has been able to continuously ratchet up gold output in a rising tide environment for bullion prices.

In hindsight, this strategy seems deceptively simple. But it has required impeccable timing and the vision to understand that New Gold will only truly shine when it reaches a certain critical mass. This involves reaching the milestone of a minimum output of one million gold ounces in per annum, which New Gold intends to reach by 2012. And the fastest way to get there so far has been by way of buying out other small emerging gold producers.

This has been the company’s modus operandi since mid 2008, when it acquired two other gold mining juniors – Metallica Resources and Peak Gold – in a friendly merger valued at $1.6 billion. In so doing, New Gold has since then made the quantum leap from being an aspiring gold miner in 2007 with no output to a formidable gold aggregator with three globally diversified mines in operation just two years later.

They include the open pit, ‘heap leach’ (inexpensive to run) Cerro San Pedro gold-silver mine in central Mexico, as well as the underground Peaks Mine is in southern Australia, and the most-recently acquired Mesquite open pit, heap leach mine in southern California. All of which are on-target to produce up to 360,000 gold ounces in 2010. 

Last summer’s $280 million merger with Western Goldfields – the former owner of the Mesquite mine – should continue to add up to an additional 150,000 ounces to New Gold’s combined annual output. And this nearly doubling of New Gold’s revenues will act as a big boost to the company’s bottom line, according to the company’s hard-driving but soft-spoken CEO, Bob Gallagher. And such exponential growth is resonating very favorably with the investment community.

“Our share price has doubled since our transaction with Western Goldfields. So our financial ratios have gotten much, much stronger which means that there are a much broader number of potential targets that we can acquire,” Gallagher recently told BNWnews.ca.

“Growth is good as bigger companies tend to receive better valuations than smaller companies but the real growth comes when you can acquire an undervalued asset. So your growth on a per share basis is accretive (it acquires greater value per share). That’s what we’re targeting. And we accomplished that in a huge way with Western Goldfields. But we’ll continue to pursue other opportunities out there when we find the right assets.”

In recent headline-grabbing developments, New Gold stuck a strategic joint venture deal in January involving its 30% stake in the sizeable Chilean El Morro deposit, which hosts 6.7 million ounces of gold and 5.7 billion pounds of copper. New Gold now has a new partner in the guise of world’s fifth largest gold producer, Goldcorp (TSX: G) (NYSE: GG). The latter beat out the dominant player in the gold mining business, Barrick Gold (TSX: ABX) (NYSE: ABX), in a fight to snatch up El Morro’s rich gold assets.

This comes after a high stakes bidding war to buy-out the project’s former majority owner, Xstrata Plc (LSE: XTA). In return for supporting Goldcorp’s bid, the mining heavyweight has agreed to a $50 million up-front cash payment to New Gold, as well as waiving New Gold’s estimated $225 million portion of the overall cost of building the mine.

Meanwhile, Gallagher concedes that his company still has a long way to go before reaching the much-envied status of a well-established mid-tier producer, which represents the Holy Grail for all emerging gold producers. That’s because the mid-tier status offers major strategic and competitive advantages, he says.   

“There’s a space in the gold industry that we call an intermediate space which are producers in the half million ounce to two million ounce range. What’s special about that intermediate space is the big potential for growth,” Gallagher says.

“By comparison, large gold companies seem to struggle to maintain production and to maintain their reserve base. Also, smaller companies generally are not of much interest to most investors due to a lack of liquidity. So, where growth and value are best offered is in that intermediate space where you can continue to grow.”

“That’s the space we entered in 2008. We did a three-way consolidation of single mine producers last year,” he adds by alluding to New Gold’s acquisition of Metallica Resources and Peak Mines. “Last year we added a fourth company with Western Goldfields. So we’ve grown from a collection of less than 100,000-ounce producers to approximately a 300,000-ounce producer.”

“We also have an asset that we’re building in Kamloops (the New Afton project in southern British Columbia) that will add about another 100,000 ounces, which gets us nearly half way to that million ounce target. We think we can get to a million ounces by 2012. We’ll do that by incremental growth in our existing assets and continue our consolidation of producing mines. As an intermediate, we will then continue to consolidate junior producers.”

In other words, Gallagher has no intention of taking his foot off the accelerator any time soon. Especially since he envisions even more lustrous times ahead for gold prices as the yellow metal continues to act as an inverse proxy to the increasingly anemic US dollar. 

“More and more people are investing ingold as a currency and as protection against today’s financial issues. When you look at the overhang in US dollars that countries like China have accumulated and the ongoing deficits that the US is incurring, I think there is a strong case to be made for countries and banks switching from US dollar reserves to commodities like gold. We’re already starting to see it with China,” he says. 

“So for a number of reasons gold is going to continue to strengthen as we move forward.  In fact, I think we’re in a very exciting sector of the cycle. Whereas commodities like gold tend to have cycles in the 10-year range, we’re probably only in about year six. So the fundamentals are very favorable for continued growth in gold pricing.”

Investors who want to get the maximum leverage from rising gold prices are better off buying gold mining stocks than gold bullion, according to Gallagher. For instance, it’s easier at this stage to envision a modestly priced, expansion-oriented emerging gold producer to double in price within the next year than it is to imagine bullion’s spot price rising to over $2,000 during this time frame.

“Emerging mid tier gold producers by far represent the best investment opportunities. Right now this space is more or less empty as previous intermediate gold companies have moved on to become major mining companies. The most recent examples would be Kinross and Agnico Gold Eagle. And Goldcorp and Barrick Gold are great past examples.”

Gallagher believes that the relative absence of mid tier gold producers – of which there are currently only a tiny handful – means that New Gold will have meager competition from its peers in the quest to continue to absorb other junior gold miners.

“Because we’ve got a great solid foundation of assets generating cash flow and a great balance sheet and a strong proven board and management, I believe we really are the ‘go to’ consolidator,” Gallagher adds.

Ultimately the absorption of gold mining juniors by larger companies is beneficial for the industry and for investors, alike, Gallagher assets.

“The issue is small companies with single producing assets are not attractive investments. Over this last bull run for gold you’ve seen the share prices of intermediates and the seniors appreciate significantly. The juniors haven’t,” he says.

“That’s because the juniors primarily have a lack of liquidity and limited market capitalization. Serious investors can’t move in and out of them; so they shy away from them. Single asset producers also have good quarters and bad quarters and don’t have the benefit of the portfolio effect that comes with having a number of producing assets,” he adds. 

“Furthermore, new emerging single asset producers struggle when they come out of the exploration stage and into production. They generally have tended to disappoint the (stock) market and don’t live up to expectations.” 

Having recently received a solid endorsement from the financial community by way of the completion of a Cdn. $115 million equity financing, New Gold now has a more than adequate war chest to continue along a steep growth curve. (The company already had $140 million in its treasury). That also translates into more acquisitions without compromising the company’s commitment to commercialize its in-development New Afton mine, which is scheduled to produce 85 million gold ounces and 75 million pounds of copper per year, starting in 2012.

“New Afton has all of our existing cash committed. So when we wanted to grow by way of acquisitions we have been really limited to projects that are already producing cash,” Gallagher says.

“With this $115 million in cash, it broadens the expanse of opportunities that we have. For instance, we can now acquire near-production projects which need a little more cash to get them over the hump. And you always add more value when you take something from pre-production into production. So with a stronger balance sheet, this further broadens our list of potential takeovers.”

All of this means that New Gold’s high-octane growth formula promises to continue power’s ascendancy for the foreseeable future.

“In five years time I think we’ll be through a million ounces. And I think you’ll see us with six or seven mines and a much stronger pipeline of mine development projects. Also, you’ll see the actual quality of producing assets going up-market,” Gallagher says.

“Again, it’s a historical reality that when companies build themselves this way you start with reasonable assets and then as you strengthen you are able to acquire better and better assets. And that translates into lower cost producers.”

Or in other words, New Gold’s ever-improving balance sheet is sure to make investors ask the same question: What recession? 

Disclaimer: Marc Davis does not directly or indirectly have any stock positions in New Gold.