Friday, December 5, 2008

Western Goldfields – Strong Net Cashflow from Operations

Everyone remembers the California gold rush a century ago, but few know a large gold mine is currently under operations in the southeast corner of California near the Arizona and Mexican borders. This is the mining operations known as the Mesquite Mine managed by Western Goldfields (Amex: WGW).

This mine was actually operated from 1985 to 2001 by several mining companies including Newmont, but was suspended in 2001 when gold prices fell to the bottom. However, Western Goldfields acquired the mine in 2003, and production re-started in January of this year, the timing of which couldn’t have been better since the current turmoil in the credit market makes any financing very difficult if not impossible for some other cash stripped mining companies.

Western Goldfields (WGW) is headquartered in Toronto, Ontario. I met their President and CEO Mr. Raymond Threlkeld and Director of IR and Corp Development Mr. Hannes Portmann on November 20 in New York City. They discussed the details of the compelling value and low risk that their Company offered in comparison to their current low stock price.

Their major project, the Mesquite Mine, has 4.3 million resource ounces of gold including 2.8 million ounces in reserves. They are continuing drilling to find additional gold resources that could add 1 to 2 years of additional mine life beyond the current 14 years. Since it is a open pit operation, WGW can produce gold in a relatively cheap cost, with 2008 cost of sales averaging around $500 per oz. With the planned increasing production from 2009 and beyond, the cost of sales is expected to average around $420 per oz for the life of the mine.

This low cost is important during today’s gold correction and high production cost environment, comparing to many other mining companies. It enables WGW to make decent profit and generate substantial cashflow from operations. Even with today’s gold price, and expected 150,000 oz or more of annual production starting 2009, they can generate about $50 to $60 million in cashflow per year from operations. As a matter of fact, their current 3rd quarter 2008 has gold sales of 47K ounces at the cost of $390 only, with cashflow from operating activities at $16.5 million. Their stock price was trading at a ridiculous low level and temporary dipped below $0.50 per share late last month when the whole mining industry got hammered. However, it has since recovered nicely to $1.34 as of last Friday (11/28).

WGW has a very strong cash position of $45 million on hand including $7.5 million of restricted cash due to their loan covenants. At the same time, they are adding cash from their operations each quarter. This is why when their stock price dropped last month, they announced on Nov. 8 that they will buy back their shares up to 12.8 million shares, or 10% of their public float, maximum allowable by TSX. As Raymond said at NYC that in the current environment, cash is king and they definitely have the luxury of their vast cash position to do it. WGW does have $86 million loan outstanding, but since they will be generating strong cash, they are planning to pay it back in about 2 to 2.5 year’s time. By my rough calculation above, with today’s gold price, they should have no problem to pay $30 million toward their debt each year from their operations. Unlike many juniors, they don’t need to do any financing without pursuing any strategic acquisitions. Their management team seems to be very financially conservative in their business operations.

More importantly, if we believe the recent gold price is depressed and not supported by the dire macroeconomic situation and monetary inflation, we should see substantially higher gold price for many years into the future. The operating leverage provided by the Mesquite project will substantially increase the value of Western Goldfields. It won’t surprise me that WGW doubles or even triples from the current $1.34 price level to somewhere in the $3-4 range, which only brings them back to the price level this time of last year.

Disclosure: I don’t own Western Goldfields, but I believe WGW is currently undervalued and provides a good risk/reward opportunity for a diversified mining portfolio for long term capital gain.


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