New Gold eliminates Mesquite hedges for US$65.7 million

VANCOUVER — Vancouver-based producer New Gold (NGD-T, NGD-X) has suffered similar market devaluation to its peers in recent months, with its shares dropping 40% or $4.44 since early January as gold prices have declined. However, the company has found a silver lining in weaker precious metal markets in the form of an opportunity to eliminate outstanding hedges at its Mesquite gold mine, 70 km northwest of Yuma, Arizona.

The hedges originated from a US$105 million project debt financing agreement with U.K.-based Investec Bank that was put together back in 2006 by Western Goldfields, which merged with New Gold in early 2009. The eight-year loan facility dictated that interest would be charged at U.S. Libor plus 2.20% pre-completion and 1.75% post-completion. Back in Oct. 2009, New Gold completed a US$15 million prepayment of the loan, which dropped the outstanding principle to US$45.8 million and allowed the company to amend the terms of the agreement.

“The [loan] allowed us to build the mine with minimal dilution to shareholders,” commented executive chairman Randall Oliphant at the time. “We are pleased with the amendments to the term loan facility and the strong business partnership with [Investec] and the lending syndicate. Our strong cash position, coupled with cash flow generated from operations, enabled us to make the loan prepayment, reducing our overall debt outstanding, strengthening our financial position and providing greater flexibility going forward.”

New Gold repaid the full value of the loan in 2010 — a full four years ahead of schedule — but the gold hedge program, which was a required condition precedent to the loan facility, remained active until the company eliminated it for US$65.7 million on May 15 to allow its production and resource base to have full leverage to the gold price.

By unwinding its hedges, New Gold removed a requirement to deliver 5,500 oz. of gold monthly at a fixed price of US$801 per oz. from May 2013 through the end of 2014. On an aggregate basis that adds up to 110,000 oz. of future saleable gold production at prevailing gold prices. The transaction with Investec was executed at an average spot price of US$1,396 per oz.

“Our constructive view on the gold price has led us to unwind the gold hedges,” stated Oliphant. “We believe the recent pullback in the gold price has provided us with a window to be opportunistic in eliminating the hedges. We look forward to the balance of 2013 and full year 2014 earnings and cash flow benefitting meaningfully as a result.”

During the first quarter New Gold produced 94,700 oz. at total cash costs of US$485 per oz. for net earnings of US$36 million, or 8¢ per share. Net cash generated from operations jumped 59% year-on-year to US$59 million, while cash costs dropped roughly US$58 per oz.

Mesquite contributed 25,500 oz. of gold at US$879 per oz., which was a significant drop off from first-quarter 2012 when the mine cranked out 44,400 oz. at cash costs of US$628 per oz.

According to New Gold, the decrease was expected due to mine sequencing resulting in below reserve grade ore being placed on the leach pads. The company expects grades and production to increase during the balance of the year, and should help Mesquite hit its production guidance of between 130,000 oz. and 140,000 oz. of gold in 2013 at cash costs of between US$830 and US$850 per oz. Two ore trucks have also been added to Mesquite’s mine fleet to increase the mining rate.

According to BMO Capital Markets analyst Andrew Kaip, the elimination of the Mesquite hedges is net neutral to New Gold’s net present value, but is on average 15% accretive to 2013 and 2014 earnings per share. He notes that the “elimination of the hedge also allows [New Gold] to benefit from future increases in the price of gold should they materialize.” Kaip maintains a stock “outperform” rating on New Gold and a $12 target price.

Like many gold producers, New Gold is looking at ways to utilize its cash position to drive shareholder value in the face of falling gold prices. Achieving further leverage to metal pricing is one way that producers can take advantage of strong liquidity — New Gold holds US$672 million in cash and equivalents along with a US$100 million undrawn credit facility — while offering potential value-added to shareholders.

New Gold has traded within a 52-week range of $6.38 and $12.50 per share, and the company sat near the floor of that range at $6.55 at the time of writing. New Gold has 477 million shares outstanding at press time for a $3.13 billion market capitalization.