NovaCopper (NCQ)

[Tommy]

$NCQ - NovaCopper: Irrational ETF Selling Could Mean A Multi-Bagger

Dec 19 2013, 09:45 | 17 comments | about: NCQ
http://seekingalpha.com/article/1907141-novacopper-irrational-etf-selling-could-mean-a-multi-bagger?source=email_sto_edi_pic_3_3&ifp=0

Editor's notes: Selling pressure has driven NCQ shares down, but the long-term value hasn't changed. Hedge fund Kingsley Park Capital pounds the table, saying the miner could still achieve triple-digit returns.
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Disclosure: I am long NCQ. (More...)

We've been following NovaCopper (NCQ) for almost a year now, since well before our April 16th article. While the stock has sold off irrationally, intrinsic value is now at an all-time high. This is a uniquely attractive opportunity to buy the stock cheaply.

Over the last week, NovaCopper shares have fallen from $2.00 due to 1) an index ETF selling millions of shares 2) a misguided negative article 3) tax loss selling by outside investors. Together these events sent the stock down a whopping 30%.

This brought shares to an all-time low, yet NovaCopper is more valuable than ever before. The company's copper reserves continue to grow as drilling results have been strong and the company continues to build a strong relationship with key local stakeholders. Not only is NovaCopper executing well, but also the price of copper has been rising. This makes for an excellent entry point.

There is significant interest from value investors at these prices. Among them is Seth Klarman's Baupost, which purchased shares in the $2.00 range in 2012, 40% above current prices. These investors will likely move the stock back up with large buys up to the $2 range as they did in October.

This article will focus on the dynamics of the opportunity at hand. For background on NovaCopper, including a discussion of valuation and risks, please see our previous article. We note that an article from November 5th also provides strong background on the company.

Irrational Sell Off Leads to All-Time Low

NovaCopper has been advising investors that the Claymore Beacon Spin-Off ETF sold the bulk of its more than four million share stake in the days leading up to and including December 12th, likely playing the biggest role in the share price decline. The ETF is indexed to the Beacon Spin Off Index. This index rebalanced and caused the ETF to sell most of its stake. The ETF now holds just over half a million shares. The shares sold represent well over 10% of the float, creating an enormous price distortion for no fundamental reason. This selling was completely arbitrary and is creating an excellent opportunity to buy shares.

On December 10th, Seeking Alpha published a negative article that caused more selling. The author (who apparently does not have enough conviction in his analysis to go short) cites several reasons for his view, all of which we strongly disagree with. Moreover, the comments on his article and his lack of response speaks for itself. Nevertheless, we systematically address how each of his points is misguided.

His first point is skepticism on the access road and boils down to 1) the access road will be expensive 2) the access road is within 15 miles of national park lands. These points are incredibly easy to rebut. The nearby Red Dog Mine owned by Teck resources required both a port and an access road. This was paid for by the state of Alaska and cost (pg. 176) more than NovaCopper's access road on an inflation adjusted basis. This road is still in operation and is a very successful precedent for NovaCopper's proposed road. Concern about proximity to national park lands is baseless for the same reason. The Red Dog Mine is within a few miles of the Noatak National Preserve, and the mine's haul road actually traverses the Cape Krusenstern National Monument. As we discuss below, relationships with local stakeholders are excellent as most of NovaCopper's employees in Alaska are members of the local native association.

His second point is that NovaCopper's CEO had a few sharp words with a member of a non-profit environmental rights law firm. This is completely irrelevant to NovaCopper's business. Moreover, this non-profit's sole activity is providing legal help to organizations that need it. Local stakeholders are very much on board with NovaCopper's project, and therefore are in need of no legal help.

The author's third point is insider selling. While this likely made some investors nervous, it is no cause for concern considering the sales were for payroll-witholding taxes on a grant of restricted stock units that occurred on the same day.

Fourth is that given the early stage of the project all estimates at this point are tentative, and that there is a strong possibility that final numbers will deviate significantly from current estimates. This is hardly news to anyone, as the comments point out, and is precisely why we bake conservatism into our models.

In short, the author's points were very weak. However, his article came at a time when investors were already nervous, and sent the stock down significantly. This put the stock at an all-time low, meaning all shareholders had the option of booking a loss to reduce their 2013 tax bill. The resulting tax loss selling has suppressed the stock price.

Tax loss selling is a very real phenomenon that has been studied by academics in multiple countries across the world. It becomes an even more significant factor for a stock like NovaCopper that is at all time lows heading into the last two weeks of the year, the prime time for tax loss selling. This effect tends to create opportunities in general, and in NovaCopper it has been extreme, creating an excellent long opportunity.

Intrinsic Value Higher than Ever

NovaCopper is now more valuable than ever before. Since our last article the company has had a successful drilling season that likely expanded mineralization, and continued to build support in the region. In several press releases this fall the company reported results from its drilling program that pointed to increased resources. NovaCopper also just announced the results of a re-sampling program that confirmed historical data from Kennecott on high grade mineralization and likely added low grade mineralization. NovaCopper's goal has always been to discover 10 billion lbs of copper, and this drilling season likely played a significant part in realizing that goal.

An updated resource estimate should be completed in the first quarter of 2014, and will likely show significantly greater resources according to CEO Rick Van Nieuwenhuyse. Also, NovaCopper now believes the South Reef and Ruby Creek zones may be linked, which would improve the economics of mining as well as expanding resources.

NovaCopper's relationships with important stakeholders have continued to develop as well. In its third quarter results the company announced that 58% of project staff were Northwest Arctic Native Association (NANA) shareholders. NovaCopper also had several visits from local communities including school tours. These are the strongest indications yet of the large and increasing interest in the project from NANA.

Finally, the price of copper is higher than at the time of our last article, and has been moving up steadily over the last several weeks. NovaCopper is significantly leveraged to the price of copper.

With all of these positive developments in mind, the intrinsic value of NovaCopper is significantly higher than it was at the time of our last article.

Excellent Entry Point, Value Investors Looking to Buy Shares

We believe deep value investors have already begun to take advantage of this buying opportunity to accumulate shares. The strongest evidence of this is the extremely high volume between 2-4 pm on December 12th, but only slight change in share price during those hours. This was the highest volume day in the stock's history by far. The 3.7 million shares traded is roughly twice as large as the next highest volume day.

This price action means that there was enormous selling pressure and equally large buying pressure. As described above, the selling pressure was likely due to tax loss selling. On the other hand, the only buyers able to absorb the millions of dollars worth of stock that changed hands within that two hour period are almost certainly large value investors such as 10% stake holder Baupost (for those unfamiliar with Baupost, the fund is one of the best value investors of all time). These large value investors will likely continue to buy up to $2.00 per share as they did when the stock dipped in October. In fact, by examining Baupost's 13-Fs from 2012 and NovaCopper's price history, we can see that the fund bought much of its stake at a minimum of around $2.00 and possibly well above. By getting in at these levels, investors have 40% upside to Baupost's rough purchase price.

Valuation

As of the recent December 12th investor presentation, NovaCopper estimates a base case NPV with $2.90 lb/copper, $0.85/lb zinc, $0.90/lb lead, $1300/oz gold and $22.70/oz silver. At an 8% discount rate, this yields a pre-tax NPV of $927.7M and post-tax NPV of $537.7M. Notably, this NPV includes $717.7 million in startup capital and $164.4 million in sustaining capital.

In our view, this estimate is both aggressive and conservative in terms of NovaCopper's intrinsic value.

On one hand, the estimate does not take into account either NANA's interest (either 15% NP or 16-25% equity) in the project or the dilutive nature of financing for the project. NovaCopper can finance the project with several methods including equity, debt, or royalty interest. Given the significant stake owned by management, we believe that significant equity dilution is unlikely relative to other fundraising methods.

On the other hand, this NPV calculation only takes into account the Arctic Deposit (3.1B Cu indicated, 0.4B Cu inferred), assigning no value to either the Bornite Ruby Creek Zone deposit (0.9B inferred) or the Bornite South Reef Zone deposit (2.4B inferred).

Also, the price of $2.90 dramatically underestimates the current copper price of $3.32. If the same model were applied with copper at $3.32, the NPV would be dramatically higher as this article demonstrates. We believe that the long-term fundamentals of copper are strong given numerous mine closures that will dramatically reduce supply as well as rising demand from China and India.

Currently NovaCopper has 53 million fully diluted shares outstanding, however, to conservatively account for fundraising as well as NANA's interest, we use 80 million shares. Applying NovaCopper's own estimate for NPV yields a share price of $6.72, a multi-bagger return from today's levels.

Conclusion

In our last article, we placed a risk adjusted price target of $4.58. This is now more conservative than at the time of our previous recommendation given the numerous positive fundamental developments since then, including progress on the access road, positive drilling results, and increasing buy-in from the local community.

Based on this analysis, we could argue that this price target should be revised upward as the company continues to de-risk the project. However, in the interest of being conservative, we merely reiterate this price target. As value investors take notice of the significant price discrepancy, shares should appreciate dramatically in the near-term.

At today's bargain prices, NovaCopper is our best idea.