Solitario Zinc Corp. (XPL, Financial) is a zinc-focused exploration company. It has no properties in operation but is working to develop two main properties in Alaska and Peru.
Solitario is a tiny company with a $20 million market cap. But it has joint-venture interests in two large zinc projects with strong partners:
- Florida Canyon Zinc project in Peru is a high-grade development asset held with Nexa Resources (NEXA, Financial), the world’s fourth-largest zinc producer.
- Lik Zinc project represents a high-grade, surface mineable development project in Alaska, developing in partnership with Teck Resources (TECK, Financial), the world’s third-largest zinc miner.
”‹Financial strength
Solitario’s financial strength deserves some consideration. Its balance sheet is clean and extremely easy to understand. There is in excess of $13 million in liquid assets. Remember, this is a $20 million market-cap company. However, if we consider the fact there is also quite a bit of cash burn at a rate of between $3 million and $4 million per year, these reserves don’t look bulletproof. After all, it may be a while before Solitario will receive positive cash flow.
Management
CEO Chris Herald and COO Walter Hunt have extensive experience in the mining industry and both have a background in geology. It would be better if they had higher equity ownership.
Total equity ownership by insiders is decent. Director Gil Atzmon holds about 5% of shares outstanding, taking the total insider ownership above 10%. He has over 30 years of experience in the industry and founded Zazu Metals Corp., which Solitario acquired, paying in shares, to get the Lik Zinc project.
The executives do have a generous option package that starts paying off with shares up about 100% in addition to generous salaries of $400,000 and $500,000.
Valuation
Florida Canyon
Solitario Zinc has a fantastic deal with Nexa. On the Florida Canyon property it is carried until production. Its partner has already spent about $60 million preparing this property and is almost done finishing an access road. When production starts, Solitario Zinc does have to contribute to costs. But it receives half of its share in operating cash flows even if costs would normally exceed its cut.
If you look at the preliminary economic assesment for Florida Canyon, it says Solitario could receive up to $130 million per year in operating cash flow. Solitario doesn’t need to invest anything to get there.
When this production starts gearing up, the company can very effectively reinvest the proceeds into its second project in Alaska.
The terms of the Solitario-Nexa joint venture and current status are summarized by the company as follows:
"Nexa is the Operator of the joint venture and currently holds 61% of the joint venture company, Minera Bongará.
Nexa will fund 100% of all costs through the completion of a feasibility study (with no payback) upon which Nexa will earn a 70% interest in the JV.
Nexa will fund all of Solitario’s 30% portion of construction costs under a loan facility (at Solitario’s election) which will be repaid through 50% of the cash flow of the mining operation."
Solitario provides us with NPV calculations as well. If we equate a 30% interest with a 30% interest of the economic value, and assume a long-term zinc price 20% below today’s price, this stake is worth approximately $59.4 million. I believe these are highly conservative assumptions because a carried interest to 30% is actually much more valuable and Zinc prices áre higher.
Lik project
The company also had a PEA done, back in 2014, with zinc prices 20% lower. This PEA got to an after-tax NPV of $83 million. This is likely a conservative estimate as no benefits from nearby mining infrastructure were considered, while these are actually present. Teck operates one of the largest zinc mines in the world just 14 miles to the north (Red Dog). Solitario has a 50% interest in this Lik project but will need to put up capital as this project develops in order to maintain this stake. Ascribing $40 million of net present value to the project seems conservative.
La Promesa
I’ll ascribe no value to its La Promesa holdings.
If we add up the liquidity on the balance sheet and the conservative NPV estimates for the two major mining projects, I get to an NPV estimate of $113 million.
Solitario Zinc trades at a market cap of $20 million.
Risks
- Zinc prices could fall, turning these project uneconomic. If that situation lasts for a long term the company will burn through all of its money.
- If Nexa takes its time starting up operations in the Florida Canyon, a liquidity crunch could ensue. If that needs to be resolved by stock issuance shareholders can be diluted.
- Prospects for these resources look good but in practice there can be disappointments or delays. If these are significant enough to delay mining, the value of the projects is considerably lower or nil.
- Management’s incentives aren’t perfectly aligned with minority stockholders. They own considerable options, but these incentivize them to swing for the fences and not necessarily to protect the downside.
- Management annual comp is fairly high. There is a risk they are bleeding the company’s cash reserves dry while projects go nowhere. The presence of a director with a sizeable interest mitigates this concern somewhat. Second, the acquisition of Zazu Metals last year doesn’t match that story at all. I think the risk of this being the actual playbook is small.
- To sum it up, Solitario Zinc has one extremely attractive stake in the Florida Canyon, but it is also highly vulnerable to drawbacks. Meanwhile, management doesn’t have the common equity ownership to alleviate my concerns when they are focused on managing the downside.
Outlook
Take note that the company’s projects do not include any reserves yet. Mining companies can book reserves only if resources are proven to be economically feasible to be exploited. To move resources from inferred and indicated status towards reserved these projects need to be moved further along. As that happens the share price will increase.
News flow out of the company is still somewhat limited, and I expect these projects to slowly inch along. As these projects get going important positive news events like additional deposit finds, a finished access road and drill results can function as important catalysts.
Ultimately, as projects are ramped up, the stock will start trading based off actual operating cash flows and/or earnings. By that time we are potentially talking about a multibagger from today’s level.
Disclosure: Author is long.
