3 Terrible Reasons to Buy Northern Dynasty Minerals

By Maxx Chatsko Markets Fool.com

It's been a whirlwind year for Northern Dynasty Minerals (NYSEMKT: NAK). The stock has risen from obscurity to become one of the best-performing equities on the market. A deregulation-friendly environment has reignited hopes that the company can proceed with bringing its Pebble Mine in Alaska, one of the largest undeveloped deposits of copper and gold in the world, online and begin generating meaningful revenue and profits.

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At a market cap of "only" $500 million and a sea of mineral wealth underneath its feet, investors may be drawn to the long-term growth potential of Northern Dynasty Minerals. But that could be a bad idea given the company's track record and realities on the ground. With that in mind, here are three terrible reasons to buy the stock.

Image source: Getty Images.

1. Deregulation-friendly environment

The Trump administration hasn't been shy about its intentions to more fully utilize the country's vast resources. While politicians in Washington cannot drill through rocks, they can loosen various regulations to make the permitting process easier for those that can. That has already begun paying dividends for Northern Dynasty Minerals.

In April, the company announced that the Alaska Department of Natural Resources had issued a notice of approval of Miscellaneous Land Use Permit for the Pebble Project. It's a mouthful, but it simply allows Northern Dynasty Minerals to operate on state-owned land. The announcement pushed shares over 34% higher, although the company skipped over a few important details.

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State regulators are only part of the equation. Federal regulators, namely the U.S. Environmental Protection Agency, have been the real issue for the company in previous years. While the new Scott Pruitt-led EPA has smoothed over the permitting process in recent months, there's still a long road ahead for the company.

For instance, the most recent settlement with the EPA postpones the agency's decision on the project until the U.S. Army Corps completes an Environmental Impact Statement. While the Corps has four years to do so -- in line with previous timelines discussed by management -- the new mine plan will be smaller than those proposed in the past, and it promises to be accompanied by a raft of additional environmental measures. That serves as a reminder that much more time and money are needed before the Pebble Project even has the ability to make a sustainable impact on the share price.

NAK data by YCharts.

2. Clean balance sheet

It won't go unnoticed that Northern Dynasty Minerals has a squeaky-clean balance sheet. At the end of March, it sported $54.7 million in cash and not a penny of debt. While it has burned between $6 million and $7 million per quarter, investors should expect expenses to ramp up as the permitting process takes off. Management has previously reported that the entire process could take up to $150 million to complete.

Of course, with no revenue stream or operating cash flow, the company has a limited number of options available to it. Investors can probably expect a balance of additional share offerings, long-term debt agreements, and the courting of a partner or two. The last option may be the most attractive, especially if a major mining company pulls the trigger on buddying up with Northern Dynasty Minerals. It would de-risk development, bring in experts who know what they're doing (both with heavy machinery and regulatory applications), and provide much-needed capital.

But there are still too many unknowns for investors concerning the funding of operations. Even in a best-case scenario, the company will be completely dependent on outside financing for years to come. A partnership, assuming one materializes, would dilute the company's ownership of the Pebble Project and likely require the company to front a certain percentage of expenses. That includes permitting costs and much more expensive development costs down the road. Simply put, there's a financial tightrope that must be walked, and getting across safely will come with a healthy dose of debt and dilution.

3. But look at those reserves!

Let's assume Pebble becomes an active, resource-producing mine. While investors today have been hypnotized by the massive mineral deposits at the site, that's the wrong metric to focus on. The metric currently reported by Northern Dynasty Minerals focuses on resource estimates, which are comprised of three types: measured, indicated, and inferred. The level of confidence that the resources exist decreases with each category.

That presents some risk to investors, especially considering that the middle category includes over 60% of the copper, gold, and silver estimates.

Mineral

Measured

Indicated

Inferred

Copper

3.83 billion pounds

53.42 billion pounds

24.55 billion pounds

Gold

5.93 million ounces

64.62 million ounces

37.25 million ounces

Molybdenum

0.21 billion pounds

3.20 billion pounds

2.18 billion pounds

Silver

28.13 million ounces

315.5 million ounces

170.5 million ounces

Data source: Northern Dynasty Minerals 2014 estimate.

Importantly, resources aren't even the metric that matters for mining companies, which are made or broken by the total number of reserves. Northern Dynasty Minerals has yet to complete additional studies to upgrade its resources to reserves, and it is careful to state that estimates "potentially support a modern, long-life mine."

Worse, the gold concentration in the ore from Pebble (measured in ounces of mineral per ton of ore) is between four and seven times lower than other profitable mines around the world. That could hike up the costs of successful development and may even threaten the mine's ability to ever turn a profit.

Long story short

A simple narrative has propelled Northern Dynasty Minerals stock in the last 12 months. Traders and investors see a company that is sitting on a large deposit of valuable minerals that has suddenly encountered fewer barriers to development. However, the more nuanced take is that there are inconvenient realities facing the company as it attempts to successfully develop Pebble. The details should serve as a warning to investors looking for a long-term payday.

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Maxx Chatsko has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.