The Gold Miners Index (GDX) first quarter earnings season is just around the corner, and one of the first companies to report results is New Gold (NYSE: NGD). In line with the forward-weighted forecast, production was quite weak in the first quarter of 2022, down 8% year-on-year. However, production and costs are expected to improve in the second half as mining is expected to move underground at Rainy River. Additionally, the long-term outlook remains strong, with Rainy River’s margins improving steadily. However, improved outlook or not, I think there is better value elsewhere after a more than 50% rally above the $1.90 level for NGD.

New Gold released its preliminary first quarter results last week, reporting quarterly production of approximately 87,700 GEO, down nearly 8% from the prior year period. That was despite relatively easy year-over-year competition, and it was the worst quarter for the company from a production standpoint in the past two years. However, this was partly related to COVID-19, which impacted equipment availability at Rainy River, with COVID-19 headwinds being a theme in the first quarter, with Eldorado (EGO) also reporting levels higher than expected absenteeism. Let’s take a closer look at the quarter below:

Starting in Rainy River, the mine had a decent quarter, despite the headwinds of COVID-19. As shown in the graph below, the mine produced approximately 59,900 GEO, a 6% improvement over the prior year period. This is despite lower tonnes mined in the first half of the first quarter due to lower equipment utilization (increased COVID-19 cases) and cold weather, which affected drilling productivity. As noted by the company, tonnes mined by open pit fell 22% year-over-year to ~118,700 tonnes, a sharp drop from the ~150,800 tonnes mined in Q1 2021.

Meanwhile, at the Rainy River mill, throughput was lower than last year, averaging around 24,300 tonnes per day. This figure was down 7% year-on-year and was related to mechanical maintenance of the SAG mill and crusher and adverse weather conditions which impacted inventory movement. Fortunately, the higher grades (0.92 grams of gold per tonne) and improved recovery rates (91%) more than compensated for the lower throughput, allowing the operation to report higher production from one year to the next.

The other big news for the asset was the significant increase in mineral reserves, with growth in underground reserves more than offsetting open pit mining depletion. In December 2021, Rainy River’s reserves stood at approximately 2.80 million ounces of gold, compared to approximately 2.60 million ounces in fiscal 2020. This was helped by the addition approximately 570,000 ounces of underground mineral reserves at Rainy River in the central area, extending mine life. It should be noted that Rainy River has an additional 1.35 million ounces of underground resources outside of reserves, suggesting the potential to further develop underground resources, potentially supporting a mine life closer to 2035.

Based on the current forecast midpoint, Rainy River is expected to produce approximately 280,000 GEOs in fiscal year 2022 at all-in sustaining costs of $1,320/oz. This will be a moderate improvement from costs of $1,415/oz in fiscal 2021 and $1,550/oz+ in fiscal 2019 and 2020 in the investment phase. However, while we should see a slight improvement in costs in fiscal 2022, operating costs should continue to decline, allowing this asset to generate significant free cash flow after 2023.

Combined with New Gold’s much stronger balance sheet (over $400 million in cash), this will give the company plenty of room to fund the initial investment in the boulder cave at New Afton, and it could also open the potential for a small acquisition if something comes up. It’s a much better position than New Gold years ago, with high net debt and no hope of M&A, with investors having to worry about potential stock dilution if gold prices remained below $1,600/oz.

New Afton

Unfortunately, with Rainy River in full swing, New Afton is in a capital-intensive period with major growth capital expenditures planned this year ($100-130 million) for BC assets. . This will result in high all-in sustaining costs north of $1,700/oz, which will reduce AISC margins for this asset. Thus, while Rainy River is expected to experience its fourth consecutive decline in AISC in 2022, this will be more than offset by New Afton, explaining higher cost expectations this year on a consolidated basis ($1,520/oz vs. $463/oz).

The good news is that while New Afton will be an anchor for New Gold from a mid-term cost perspective, production will increase significantly during the C-zone period, with C-zone production expected to begin. by 2024. Technical report, grades are expected to increase significantly in 2025 to 0.73 grams per tonne gold and 0.76% copper and improve further to 0.89 grams per tonne gold and 0. 93% copper in 2026.

So while there are large up-front investments to develop Area C, costs will improve significantly later this decade. At the same time, Rainy River will benefit from much lower costs (estimated FY2026 AISC: ~$960/oz), meaning New Gold will transition from a high-cost producer to a mid-cost producer, even at lower cost. This should help improve the company’s cash multiple against its peers, with an even bigger boost if the company can add a third lower-cost operation by 2026 to further improve its cost profile. and help further diversify the business. Let’s take a look at the review below:

Evaluation and technical image

Based on approximately 687 million fully diluted shares, New Gold has a market capitalization of approximately $1.31 billion at a share price of $1.92. This is a reasonable valuation for a dual-asset producer in a Tier 1 jurisdiction like Canada, especially when Wesdome Mines (OTCQX:WDOFF) has half the production profile and trades at a higher market cap. high (~$1.7 billion). However, the two are not entirely comparable. So while New Gold seems incredibly cheap compared to a name like Wesdome, it’s important to note the differences, including the fact that New Gold’s operating costs are well above the industry average ( see below).

Looking at the chart below, we can see that New Gold has traded at an average cash flow multiple of around 3.6 over the past four years, and it is currently trading above that level. at a share price of $1.91. This is based on FY 2022 cash flow estimates of $0.47, leaving the stock to trade at around 4x forecast cash flow. However, as noted above, New Gold has a path to higher margins by 2024 and a much stronger balance sheet (~$800m in cash), so I’d say the stock could easily command a multiple cash flow of 4.0.

Under this assumption, and assuming New Gold meets cash flow estimates for fiscal year 2023 of $0.55, this would translate to a fair value for the stock of US$2.20. While this translates to a 15% upside from current levels, I prefer to buy at a minimum discount of 30% from fair value for higher cost producers. After applying a 30% discount to this fair value, New Gold would need to drop below $1.54 for me to be interested in opening a new position. So while New Gold could trade higher from here, especially if gold pulls back above $2,000 an ounce, I don’t see this as a low risk buying opportunity. .

This view is supported by the technical picture, which shows that New Gold is trading at the upper end of its expected trading range ($1.35-$2.25). Based on a current price of $1.91, the stock has a potential upside of $0.34 at resistance and $0.56 downside at support, which translates to a reward ratio / adverse risk from 0.61 to 1.0. I prefer to buy at 5.0 to 1.0 reward/risk ratio or better for small cap producers which means NGD will have to go below $1.51 which would also be one point low risk buy from a valuation perspective. To summarize, I am neutral on the stock in the short term.

New Gold had a slow start to fiscal 2022, which was expected given that production will be weighted upstream. However, while the stock has better long-term prospects, especially with the mine life extension at Rainy River, it is now up more than 50% from its December lows. That doesn’t mean the stock can’t rise, but it’s hard to argue for paying NGD here above $1.90, especially since it’s a high-cost producer, At least for the moment. So while I wouldn’t be surprised to see more upside in the fall, I would view any rally above $2.17 before August as an opportunity to book. some profits.