crisis investing

While the 2011 second quarter was negatively impacted by a rising N.Z. dollar and a 4000 oz. drop in gold production, OGC still managed to generate reasonable cash flows with cash operating margins of $625 per oz. Working capital increasing by $3.1 m, even with significant expenditures on long term assets ( Didipio $10.9 m, sheep farm $4 m, increase in long term inventories $7.5m). In terms of profitability, the rise in the value of the N.Z. dollar above U.S.$.70 baseline reduced profits by $7.6m while the decrease in production from a 66,000 oz. baseline reduced profits by $5.5m.

Since the end of Q2, cash operating margins are likely to have improved dramatically, through a combination of a rising U.S.$ gold price, a fall in the N.Z.$, and a fall in the price of oil.

Looking forward, and assuming a return to 66,000 oz. quarterly gold production and the present cost of oil, cash costs should fall by $61 per oz from Q2. With the present price of gold (U.S.$1790) $244 above Q2 levels, estimated cash margins would have increased from $625 to $930 per oz.

Looking forward the next 12 months, free cash flow prior to Didipio construction costs would be $142m or $35.5m per quarter. This assumes annual production of 264,000 oz at $930 cash margin less $55m for N.Z. capex, $14m for administration, $22m in lease payments, and $12m in net interest.

Construction costs for Didipio should average $27m per quarter over the next six quarters. This implies that OGC will be able to add to it�s present cash balance of $193m even as it builds Didipio. This estimate does not include any income from Didipio prior to full commissioning of the mine.

With Didipio fully operational, free cash flows will increase dramatically, with copper credits decreasing cash costs to $400 -$425 per oz. Assuming present gold price with 264,000 oz. from N.Z. and 100,000 oz. from Didipio, cash margins would be $506m. Allowing $50m for capex (most of N.Z. capitalized stripping is finished in 2012) and $20m in administration implies free cash flow of $436m.
I have not included any interest or debt as all debt will be able to be repaid from present cash, or about 5 months cash flow from mining operations.

A valuation of 8 times free cash flow would value OGC at $3488m, 665% greater than present market value of about $524m. With $193m in cash, and N.Z. cash flow sufficient to build Didipio without drawing down any cash, an investor buying OGC would effectively have to come up with $331m to buy OGC, which could be very good buying considering the free cash flow OGC will be generating within 15-18 months.

The major risks to the above forecast would be the future price of gold. With high government debts and deficits, large unfunded future entitlement programs and a world economy where growth has stalled, it is simply not possible for governments to ever repay there debts. This implies increased solvency risks on both governments and banks, which should support further increases in the price of gold. OGC should be seen as one of the few global companies that will benefit from a global financial crisis.

A conservative gold price of $2500 per oz in 18 months would imply gross annual cash flow of $764m to OGC.

Investors should perform their own research, and given the considerable decrease in OGC�s share price since January, other investors may have different opinions of OGC�s future financial performance, including possible short selling of the stock. It is interesting that on August 9, 2011, of the 2 million shares sold on the ASX, 1.2 million were reported as short sales (http://www.asx.net.au/data/shortsell.txt).