TEXT - S&P rates New Gold's proposed notes 'BB-'
Overview -- We are assigning our 'BB-' issue-level and '3' recovery ratings to New Gold Inc.'s proposed US$500 million senior unsecured notes. We assume that the proceeds from the notes will be used to advance the company's growth aspirations rather than for any major shareholder-friendly initiatives. -- At the same time, we are affirming all our ratings on New Gold, including our 'BB-' long-term corporate credit rating. -- The stable outlook reflects our view that New Gold's expanding production profile at declining cash costs should support financial flexibility and credit measure generation in the next 12-18 months. Rating Action On Nov. 8, 2012, Standard & Poor's Ratings Services assigned its 'BB-' issue-level rating and '3' recovery rating to New Gold Inc.'s US$500 million senior unsecured notes. A '3' recovery rating indicates our expectation of meaningful (50%-70%) recovery in a default scenario. We expect the notes will rank equally with all of New Gold's existing and future unsecured and unsubordinated indebtedness. We assume that the proceeds of the notes will be used to advance the company's growth aspirations rather than for any major shareholder-friendly initiatives. At the same time, Standard & Poor's affirmed its ratings on New Gold, including its 'BB-' long-term corporate credit rating. The outlook is stable. Rationale The ratings on New Gold reflect Standard & Poor's view of the company's limited operating diversity, exposure to volatile metals prices, and short reserve lives at its gold mines. These risks are counterbalanced by what we consider the company's attractive first-quartile cost position, low political risk, and expected double-digit growth rates in gold production. New Gold operates four gold mines in Canada, the U.S., Mexico, and Australia, and holds interests in several development projects in British Columbia and Chile. Standard & Poor's considers New Gold's business risk profile as weak due to the company's limited operating diversity and its reliance on volatile and generally correlated gold, silver, and copper prices. This is counterbalanced, we believe, by its attractive first-quartile cost position and assets that are located in low-risk mining jurisdictions. New Gold's operating diversity is limited by its narrow asset base with only four producing mines despite unusually low cash flow concentration levels for an issuer with such a narrow asset base. We expect that the current ramp-up of commercial operations at New Afton will improve operating diversity modestly heading into next year, adding a high-quality asset to New Gold's portfolio, but eventually concentrating its cash flows as New Afton's attractive earnings contribution significantly outweighs the other three assets. New Gold's fair geographic diversification is enhanced by the relatively low political risk of the countries in which it operates. We take this view on the company's geographic profile given that it operates in jurisdictions with relatively stable and predictable regulatory and tax regimes, which we believe reduces country risk relative to other similarly sized mining companies with expanding global operations. In our opinion, New Gold's position on the lower end of the global cost curve supports its overall business risk profile. On a consolidated basis, we believe that its byproduct cash costs, averaging about US$420-US$440 per ounce (oz) in the past few years, position the company in the industry's first quartile. Moreover, we believe that, unlike some other speculative-grade mining companies, New Gold's cost profile should allow it to maintain its output in a potentially weaker metals price environment. Despite possible inflationary and foreign currency cost pressures, we expect that consolidated unit costs will decline as the low-cost New Afton mine ramps up production and joins its Mexico-based Cerro San Pedro asset as the company's lowest cost mines. That said, we believe that New Gold's heavy reliance on byproduct credits (comprising more than 30% of forecast 2012 revenues assuming an annual price of US$1,400 per oz of gold, US$3.50 per pound of copper, and US$25 per oz of silver) compared with other gold producers we rate, exposes the company's profitability to more volatile copper and silver prices. We believe that the El Morro project could enhance New Gold's business risk profile by adding diversity and further extending the company's overall reserve life. However, the potential benefits to the business risk profile are long term in nature as the project is several years away from achieving commercial production. As such, we expect that New Gold's 10-year reserve life is supported by the individual mines' track record of converting resources into reserves. We base our operating performance expectations for New Gold on a base-case scenario that incorporates the following: -- A gold price of US$1,400 per oz, a copper price of US$3.50 per pound, and a silver price of US$25.00 per oz. We believe these prices are about the minimum levels that would compel the company to advance its growth plans without materially diminishing its financial risk profile. -- New Gold's profitability will improve heading into the next year, as higher production and low cash costs drive EBITDA generation to more than US$500 million in 2013. In particular, the New Afton mine's low production costs will likely increase overall EBITDA margins above 50%, given our expectation that the mine will generate disproportionate operating income at contemporary gold and copper prices. New Gold's financial risk profile is significant, based on growing funds from operations (FFO) and improving financial flexibility. That said, we do believe that its higher pro forma debt burden (New Gold's carried funding at the El Morro project is treated as debt) makes the company much more sensitive to both output stability and gold price fluctuations. We expect that any prolonged production disruptions at its New Afton mine--by far the company's most profitable operation going forward-- would lead to a sharp deterioration in credit metrics with its adjusted debt-to-EBITDA leverage ratio rising beyond 3x. Moreover, we estimate that its adjusted debt-to-EBITDA leverage ratio would increase by more than half a turn for every US$200 per oz decline in the company's gold margin (realized gold price less cash costs). Nevertheless, in our base case scenario we expect New Gold should generate an adjusted debt to EBITDA close to 2x and an adjusted FFO to debt of more than 40% through next year. In the next several years, we believe that stronger free operating cash flow should translate into significant increases in the company's cash balances, which should enhance New Gold's financial flexibility at a time of industrywide cost pressures. A considerable portion of the free operating cash flow increase is due to an expected 50% reduction in capital expenditures, partially related to the winding down of major construction activity at New Afton this past summer, and takes into consideration that New Gold's share of cash outlays for El Morro will be funded by Goldcorp Inc. (BBB+/Stable/--). Conversely, it is unlikely that New Gold will receive any significant cash flows from El Morro before the end of this decade as the project's five-to-six-year construction time line is followed by several years of mine-level cash flows repaying New Gold's carried funding obligations. Liquidity We view New Gold's liquidity as strong in the next 24 months, based on the following factors: -- We expect that sources of liquidity will be greater than 1.5x of uses in the next 12 months and greater than 1.0x in the ensuing 24 months. -- We expect sources would be greater than uses even if forecast EBITDA declines by 30%. -- New Gold should begin generating positive free operating cash flow through the next few years as the recent completion of the New Afton mine ushers in a period of lower capital expenditures that is skewed toward maintenance spending. -- The company has no debt maturities through 2012 and most of 2013. The largest maturity in the next two years occurs when its US$150 million revolving credit facility--currently undrawn--is due for repayment in December 2013. New Gold has several financial covenants in its revolving credit facility including a maximum 3x leverage ratio and a minimum 4x interest coverage ratio, with which it was in compliance as of Sept. 30, 2012. We estimate that headroom on its leverage ratio covenant can withstand a 70% decline in EBITDA relative to our base case operating performance expectations. Recovery analysis For the complete recovery analysis, see the recovery report on New Gold to be published on RatingsDirect on the Global Credit Portal following this report. Outlook The stable outlook reflects our view that New Gold's expanding production profile at declining cash costs should support financial flexibility and credit measure generation in the next 12-18 months. Under our base case assumptions, we expect New Gold to generate fully adjusted debt to EBITDA of about 2x and an FFO to debt of above 40%, with increasing free cash flow after the second half of 2012 as New Afton growth capital spending subsides. We could lower the rating if unexpected operational disruptions, higher costs, or weaker metals prices compress the company's gold margins while credit measures deteriorate sustainably with an adjusted debt to EBITDA of more than 3.5x and an adjusted FFO to debt below 25%. We could consider a positive rating action if New Gold continues to enhance its operating profile by adding producing assets that optimize cash flow diversity and reserve life, while maintaining its significant financial risk profile. Related Research -- Criteria | Corporates | Industrials: S&P Lowers Its Nickel And Aluminum Price Assumptions For The Rest of 2012; Other Metals Price Assumptions Unchanged, July 12, 2012 -- Methodology and Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Methodology And Assumptions On Risks In The Mining Industry, June 23, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List New Gold Inc. Ratings Affirmed/Recovery Rating Unchanged Corporate credit rating BB-/Stable/-- US$300 million notes BB- Recovery rating 3 Ratings Assigned US$500 million notes BB- Recovery rating 3