Amerigo Resources Ltd. (ARG.TO) is a Canadian company that, through its subsidiary Minera Valle Central (MVC), processes tailings from Chile’s El Teniente and pulls out copper and molybdenum concentrates. El Teniente, the source of MVC’s feed material, is the world’s largest underground copper mine with remaining ore reserves expected to last decades. MVC is processing fresh tailings from present production at the mine which is owned by Chilean state-owned producer Codelco, the world's largest copper producer. The fresh tailings contract runs to 2021.
MVC also has the right to process higher-grade material from a 200 million tonne tailings lake (Colihues pond) near the plant. There is an agreement with Codelco in place to treat up to 45,000 tpd.
MVC was set up by former Codelco executives.
The company trades at Toronto ARG.TO and the US-market ARREF.
Fundamentals and Valuation
1) Amerigo has a market cap of $96 million so it trades below its book value (PBV=0.7) currently.
2) The copper production has been growing on average 10% to 15% year over year since 2006. it produced 43.7 million pounds of copper and 785,068 pounds of molybdenum in 2011 although this production was negatively affected by a two month strike in El Teniente.
The production in 2012 has been solid thus far. In the third quarter, MVC produced 12.7 million pounds of copper and 321,788 pounds of moly during the quarter. MVC's copper production in the third quarter 2012 was 15% higher than that of third quarter of 2011, and year to date 2012 is more than 20% higher than the comparable period in 2011. Molybdenum production was almost 73% higher than third quarter 2011, and year to date is more than 30% higher than in 2011.
3) The revenue for the nine months of 2012 are 10% higher than the comparable period in 2011 but the company incurred a loss of $2.9 million for the nine months of 2012. Actually this loss is a result of the net loss of $4.2 million in the third quarter 2012 due largely to a $4.6 million bonus payment related to a four-year labor deal and a one-time $2.5 million accounting charge. To analyze this further:
a) Gross loss was $2,053,814 in this year's third quarter, compared to gross profit of $3,143,435 in the third quarter of 2011. Excluding the signing bonuses, normalized gross profit was $2,505,513 in this year's third quarter.
b) Net loss was $4,188,947 in the third quarter of 2012, compared to a loss of $1,194,499 in the same quarter last year. In addition to the impact of the signing bonuses, financial results were affected by a $2,577,526 deferred (future) income tax expense mostly in connection with an increase in Chile’s corporate tax rate to 20%. So it must be pointed out that excluding these items, normalized net profit was $2,947,906 in this years third quarter.
4) The company’s trailing five quarters cash costs (dollar per pound of copper produced) ranged from $2.35 in the first quarter of 2012 up to $2.64 in the third quarter of 2012. The company’s trailing five quarters total costs (dollar per pound of copper produced) ranged from $3.48 in the first quarter of 2012 up to $3.77 in the fourth quarter of 2011.
5) Amerigo has positive operating cash flow every year since the plant was built in 1992. The operating cash flow remained positive in the third quarter of 2012 at $2.7 million. It was $13.5 million for the nine months of 2012 and it is expected to be between $17 million to $18 million for 2012. So it trades 5 times the FFO annualized for 2012.
6) The company has a very small bank debt equal to $2.5 million and it has almost $36 million cash as of September 2012. Therefore the DCF ratio annualized for 2012 is as low as 0.15
7) Amerigo reinstated a dividend in 2011 after having paid $33M in dividends from 2005-2008. With an annual payout of 4 cents a share and the stock at 55 cents, Amerigo’s annual dividend yield is almost 7% currently.
Recent Corporate Developments
1) In the third quarter of 2012, MVC successfully concluded in labor negotiations with its work force and a new four-year agreement is now in place with MVC's unionized workers.
2) The company's contract with its power provider changes on Jan. 1, 2013 from a variable to a much lower fixed rate. This will lead to significant power cost reduction starting 2013.
3) In June 2012, the company completed a plant expansion that has represented cash outlays of $29 million in the most recent 12-month period and led to a sizable reduction in the company’s cash balance at the end of the quarter. However, these expenditures include those made in preparation for a significant expansion of production in the next few years, which will beneficially affect Amerigo’s growth path and financial results going forward.
Management and Insider Ownership
The CEO Dr. Zeitler was a managing director of Metallgesellschaft AG, a German metals conglomerate and in 1986 founded and was a director and CEO of Metall Mining, later Inmet, a TSX listed company (IMN.TO) with assets of over $4 billion and base metal and gold mines in different parts of the world. He has been a director of Teck (TCK) and Cominco for many years. He joined Teck in 1997 as senior vice president and had responsibilities for the exploration and development of mines in Peru, Mexico and the U.S. Since his retirement in 2002 from Teck Cominco and in addition to being president, CEO and a director of Amerigo, Dr. Zeitler is also chairman and a director of Candente Copper Corp., a company listed on the TSX, and of Rio Alto Mining Ltd., a company listed on the Toronto Venture Exchange, and has been actively involved as a director in various junior base and precious metal companies. The CEO owns more than 2.2% of outstanding shares.
The COO Mr. Henderson is a professional engineer with 28 years of international experience in operating, building and acquiring mineral properties. From 2004 to 2012, he was with Kinross Gold Corp. (KGC) ultimately serving as senior vice president of Technical Services responsible for energy, mine planning, mineral resources and reserves. Prior to Kinross, Mr. Henderson worked in mine operations with Rand Mines and De Beers and then with SNC Lavalin and Hatch delivering engineering services to international mining clients.
The major shareholder is Vancouver mining magnate Ross Beaty, with a 17.4% stake which is held by his investment company Kestrel Holdings.
In June 2012, Geologic Resource Partners LLC, a Boston-based hedge fund, bought a 10.6% stake in the company.
According to regulatory filings, an insider (Steven Dean) has been selling his shares since August 2012. Mr. Steven Dean is a former employee who does not work in the company any more.
The Drop of the Share Price
I believe a lot of pessimism has been priced into the stock. The truth is that the shareholders have incurred a lot of pain during the last eight months. Amerigo shares sunk from a high $0.95 in February 2012 as a result of the correction of the markets along with the threat for a hard landing in China. Both reasons impacted the prices of copper and molybdenum which dropped in H2 2012.
The company estimates production of 50 million lbs. of copper and 1 million lbs molybdenum for 2012. The negotiations are ongoing for the rights to process old tailings from an additional tailings pond (Cauquenes) owned by El Teniente which will enable the company to significantly increase production from current levels during 2013 and later.
Catalysts for the Upside
1) The recent Chinese manufacturing data and the accelerated industrial production as of the latest data are signs of improved health and they provide a floor for copper prices. According to the HSBC economists Sun Junwei and Qu Hongbin: "The producers have started to increase prices in steel and cement in recent weeks on the back of increased construction activity. In addition, the price of gold is almost double what it was in 2008, the price of copper remains relatively high by historical standards, and both are well above average costs of production". However Goldman Sachs metals analyst Max Layton warns that: “A sharp decline in building completions in China would result in significant downside risk to copper prices in late 2013.”
2) The Chinese stimulus will play a significant role for the copper and molybdenum prices. The pressure mounts on the Chinese leaders to expand stimulus after seven consecutive quarters of slower economic growth. With the new leadership, we may see more of the infrastructure projects that a lot of people had expected in the third quarter of 2012.
3) U.S. housing sector seems to recover gradually and this could lead to a more sustained recovery in the economy and that will certainly be good for copper.
4) Amerigo ramps up operations so it is expected that production, revenue and profit will rise accordingly. Amerigo has laid the groundwork for higher production with an expansion to production capacity in anticipation of obtaining the rights from Codelco to process material from other tailings ponds with higher copper and molybdenum grades. Two additional tailings ponds, Cauquenes (adjacent to Colihues) and Barahona (near El Teniente mine), with higher grades than Colihues will provide an estimated total 700 million tonnes for processing. The negotiations are ongoing and the company hopes to obtain the rights to process the tailings from Cauquenes effective 2013.
5) The dividend looks sustainable for the next couple of years to say the least so the company will attract not only value investors but also income investors who are reaching for yield.
6) The change in MVC’s power contract as of Jan. 1, 2013 should mean substantial annual savings according to the company. Amerigo notes that this change on the price of the energy from the grind will result in savings over current levels of more than $20 million annually for the next five years significantly improving MVC’s operating cash flow.
7) The company also has in hand a four-year labour agreement with its unionized employees which provides labor stability and expenses' predictability.
8) The copper fundamentals seem to be strong for the next months. "The current production worldwide will continue to decline due to depletion of resources and lower ore grades,” BHP Billiton (BHP) said in its base metals briefing at the end of September. “Substantial investment in brownfield and greenfield capacity will be required to cover the demand gap. Therefore, on average, prices will need to remain high enough to induce new supply.”
The copper producer Grupo Mexico also said recently that “the fundamentals in our industry will remain solid, mainly due to the lack of supply, bad weather, strikes, the cancellation and delays in the startup of new projects, and lower ore grades worldwide.” The company’s president, Xavier Garcia de Quevedo, noted that "world supply of copper hasn’t been meeting demand and the company aims to ramp up production."
In addition, according to the International Copper Study Group (ICSG): a) world demand is expected to exceed production for third consecutive year. b) overall shortage of 240,000 metric tonnes for 2012.
ICRG also notes that there are many factors restricting supply, including: a) limited availability of trained labour and electricity. b) political instability in frontier countries. c) scarcity of project finance. d) tougher regulations.
1) A hard landing in China will drive down both the copper and the moly prices.
2) The looming so-called fiscal cliff in the US, which entails scheduled tax hikes and spending cuts that could hamper economic growth.
3) Operational disruptions at the plant of the company which can not be predicted in advance.