- RBS Australia re-initiates coverage on OceanaGold - Stock rated a Buy given strong cash flows and growth prospects - Dipidio project the major growth driver

By Chris Shaw

Following an absence of a few years, RBS Australia has re-initated coverage on OceanaGold ((OGC)) with a Buy rating. The view reflects a number of positives associated with the stock, including strong cash flows and growth options.

Strong cash flows stem from OceanaGold's two operating mines in New Zealand – Macreas and Reefton, which are expected to produce 260-280,000 ounces of gold in 2011 at a cash cost forecast by RBS Australia to be around US$730 per ounce. Costs may in fact be lower, as guidance from management suggests cash costs will be between US$645-$685 per ounce.

Production from these assets should continue for several more years, Reefton at present having a five year mine life and Macraes an eight year life based on current reserves. Exploration offers the potential for reserves and mine life at both projects to be extended.

The most significant future growth option for OceanaGold is the 92%-owned Dipidio gold-copper project in the Philippines. RBS Australia estimates this project could deliver an equity share of production of 60,000 ounces per year at an average cash cost of US$260 per ounce, net of copper by-product credits. Currently Dipidio has an estimated 20-year reserve life.

Development work at Dipidio is scheduled to commence in the September quarter of this year, RBS Australia estimating capex will come in at around US$170 million. First production is expected in 2013 with OceanaGold guiding to a start in the first quarter and RBS Australia expecting output will commence from the September quarter.

Given a current valuation for Dipidio of 40c per share and forecasts of an 11-year mine life at Macraes and eight years at Reefton, both three years above current reserves, RBS Australia has a base case valuation on OceanaGold of $2.95 per share. Price target has been set at this level, which compares to a consensus price target according to the FNArena database of $4.08.

Along with RBS Australia, both Macquarie and Citi rate OceanaGold as a Buy at current levels. For Macquarie, a current share price for OceanaGold of around $2.60 implies essentially no value for Dipidio is being priced in by the market at present.

Citi's valuation and price target are set at $5.00, the broker viewing OceanaGold as the cheapest stock in its gold coverage universe. RBS Australia's numbers suggests something similar, as a 14% discount for the share price relative to net present value is the largest such discount among the gold stocks covered by RBS.

While RBS's valuation and price target are well below that of Macquarie and Citi, the broker concedes there is scope for upside. This stems from potential for a further increase in reserves, or the application of a gold premium by the market. As RBS notes, there is a tendency for high quality producers to trade at a premium to valuation.

While rating OceanaGold as a Buy, the stock is not RBS's preferred play in the sector, as among Australian mid-cap producers Regis Resources ((RRL)) remains the broker's top pick. The FNArena database shows Regis is only covered by RBS Australia and Deutsche Bank but both rate the stock as a Buy.

Over the past year OceanaGold shares have traded in a range of $2.18 to $4.17, the current share price implying upside of 64% to the consensus price target in FNArena's database.

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