Amerigo Resources ARG CN
December 04, 2007 - 2:58am EST by
rasputin998
2007 2008
Price: 2.21 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 210 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Amerigo Resources (ARG CN on Bloomberg) is a copper and molybdenum producer whose enterprise value is trading below 5 times free cash flow on a trailing basis.  The company has no debt and pays a 5.9% dividend at current prices.  While a buyback program is in place, I’m not touting it because management doesn’t seem to want to pursue it with any vigor.  Because a significant production ramp has just begun after the end of the third quarter, Amerigo’s next 12 months’ free cash flow multiple is under 3 times.  Amerigo’s ore source includes the tailings from El Teniente, the world’s largest underground copper mine, as well as ore that had been deposited in two nearby tailings ponds over five decades.  Therefore the depletion issues relative to production that challenges virtually every other copper producer today is not a problem here.  Further, Amerigo’s highly experienced management team has demonstrated an impressive ability to consistently deploy the company’s enormous free cash flow into low risk, high ROI projects.

 

Issambres introduced Amerigo to the VIC almost 3 years ago.  Since then, the company has constructed a large-scale molybdenum concentrating circuit, completed plant upgrades to increase annual copper production capacity from 35mm pounds to 65mm pounds, and printed $1.00 per share in earnings.  With the price of copper up from $1.20 per pound to $3.00 per pound, and molybdenum prices virtually unchanged at about $34 per pound, it’s hard to believe that you can buy Amerigo today (in Canadian dollars, at least) for the same price that you could back at the beginning of 2005.

 

There are several reasons for the multiyear share price stagnation – none of which contradicts the original investment thesis that Issambres presented.  While my discussion here will include a brief overview of Amerigo’s fresh tailings processing operation, I want to focus more on recent events, projections, and our valuation analysis for highlighting why the stock remains such a compelling investment.  I strongly encourage readers to also review Issambres’ excellent writeup for more background.

 

 

Background

 
Amerigo’s primary business is processing the fresh tailings from Codelco’s El Teniente mining operation.  As previously mentioned, El Teniente is the world’s largest underground copper mine.  It started production in 1904, and has an estimated 60-year remaining mine life.  Crushed ore flows from the mountaintop El Teniente site down a concrete chute for over 20 miles to Amerigo’s Minera Valle Central (MVC) facilities.  The copper grade in these fresh tailings is approximately 0.11% (eleven basis points) and the moly grade is approximately .002% (two tenths of a basis point).  Amerigo currently receives and processes approximately 130,000 tons per day (tpd) of fresh tailings flow from El Teniente.  After copper and moly extraction, the tailings flow another 30 miles to their final resting place at the Caren dam.

 

Amerigo had also been extracting and processing tailings from the nearby Colihues pond since 2004.  The Colihues pond is where El Teniente’s tailings were impounded during the period from 1977 to 1985 before the construction of MVC.  There are approximately 1.3 billion pounds of contained copper within the 200mm tons of tailings deposited in Colihues.  Amerigo had targeted extracting approximately 10,000 tpd of these tailings in 2005, and growing throughput from this source to 45,000 tpd by the end of 2006.  Importantly, the copper and moly grade of these “old” tailings are three times as high as the fresh tailings received from El Teniente.  Therefore the production from the 45,000 tpd Colihues throughput could be expected to be approximately equal to the production from the 130,000 tpd of fresh tailings from El Teniente.

 

Here is where Amerigo drifted a bit off course, and perhaps initiated the turnover in its investor base that continues today.  Chairman Steven Dean had set a target to ramp annual copper production to 60mm pounds and moly production to 1mm pounds by the end of 2006.  While plant capacity was constructed in time to accommodate these goals, equipment procurement issues prevented extraction from Colihues from ramping according to plan during 2005. 

 

Then they were really blindsided:  just as new hydraulic monitors were deployed to increase Colihues’ throughput, Codelco announced in April 2006 that it needed to reduce the flow from MVC to Caren in order to reinforce bridgework along that route.  Not only was Amerigo forced to completely curtail the Colihues operation until further notice, the fresh tailings flow from El Teniente was reduced by 25%.  Intermittent curtailments continued through the beginning of 2007, and full flow was not restored until March 2007.  Colihues extraction remained prohibited through the third quarter of 2007.  Instead of ramping toward 60mm pounds of production, Amerigo’s copper sales actually fell from just under 30mm pounds in 2005 to 24.6mm pounds in 2006.

 

 

Production Ramp

 
Amerigo announced during its Q3 07 conference call that it has restarted processing the old tailings available to it at the MVC site.  While management did not specifically state that they had gotten the “all clear” from Codelco, it was obvious from the language during the call that Colihues is finally back online, and a more formal announcement was not made because of Codelco’s sensitivity to public communications about its operations. 

 

Because the tailings currently being processed from Colihues are actually fresh tailings that had been deposited into the pond while the flow was disrupted during 2006, the ore from the extraction during Q4 07 and Q1 08 will be similar to the lower-grade fresh tailings from El Teniente rather than the higher-grade old tailings that had been deposited in the late 1970’s and early 1980’s.  We therefore expect a slow production ramp from last quarter’s 8mm pound copper production rate to Amerigo’s target of 15mm pounds per quarter by Q4 08.  Historical and our projected quarterly copper and moly production estimates look as follows:

 

                             Q2 07A        Q3 07A     Q4 07E     Q1 08E     Q2 08E     Q3 08E      Q4 08E      FY 09E

Copper (mm lbs)       9.31           8.05           10.00         10.50       12.00         13.50        15.00          60.00

Moly (mm lbs)          0.20           0.13             0.19           0.20        0.22          0.23          0.25           1.00

 

Note that copper and moly production dipped in the Q3 07 because of a Codelco-wide strike that resulted in significantly reduced tailings flow for approximately two weeks during the month of July.  Amerigo will undoubtedly continue to be impacted by temporary, one-time issues such as this, and we expect the actual production ramp to be lumpier than what is presented above, but nonetheless trending steadily upward to the 60mm pound copper/1mm pound moly production goal.

 

 

Copper Price Sensitivity

 
As Issambres pointed out in his writeup, Amerigo’s profits really aren’t sensitive to copper prices.  This fact is clear when production costs and royalty fees are analyzed in the context of the realized copper price each quarter.  Codelco is entitled to a 13.5% royalty on the copper revenue generated from fresh tailings.  The fact that this is a revenue share rather than a bottom-line share has a dramatic effect on Amerigo’s operating margins at elevated copper price levels.  As many analysts have now noted, much of the rise in the market price of copper is due to higher production costs faced by major producers.  Thus the jump from $1.50 copper to $3.00 copper over the last few years did not translate into as big a windfall for producers as one might have thought, since much of that price increase was effectively a passthrough of higher energy and labor input costs. 

 

Amerigo’s processing costs have increased from 36 cents per pound in Q1 2005 to $1.72 per pound in Q3 2007, primarily as a result of higher energy prices.  Further, as copper prices rose from $1.50 per pound in Q1 2005 to $3.50 in Q3 2007, El Teniente’s royalty fee rose from 19 cents per pound to 58 cents per pound.  In other words, as copper prices rose by $2.00 per pound over this period, production costs rose by $1.36 per pound and the royalty rose by $0.39 per pound, for a total expense increase of $1.75 on these two items alone!  It is easy to see that only modest increases in smelter costs, taxes, and administration would gobble up most of the remaining 25 cents in margin advantage offered by the higher copper price.  Our analysis suggests that if the correlation between energy prices and copper prices continue to hold, Amerigo’s earnings will be virtually unaffected by copper price movements between $2.00 and $4.50 per pound.

 

 

MVC Cashflow

 
As production ramps from Colihues, we expect copper margins to increase as the total cost per pound declines on modest economies of scale, lower unit costs from the richer grade in throughput, and the fact that the Codelco royalty only applies to half of the production from Colihues (in contrast with a full production royalty against the fresh tailings flow).  Moly production will also become an increasingly significant contributor to profits.  In fact, moly production may well surprise to the upside, as the technical assessment of Colihues estimated moly content at 0.01%, which is five times the grade of the fresh tailings.

 

Our 2008 and 2009 cash flow projections for MVC are as follows:

 

                                                   2008                               2009

Copper Production (mm lbs)         51.00                              60.00                      

Moly Production (mm lbs)              0.90                                1.00

 

Copper Price ($/lb)                         3.00                                3.00

Moly Price                                   25.00                              15.00

 

Processing cost ($/lb)                      1.30                                1.20

Royalty                                           0.45                                0.43

Admin                                             0.03                                0.03

Transport                                        0.03                                0.03

Overhead                                        0.02                                 0.02

Moly byproduct credit                     -0.44                               -0.25

 

Net Costs ($/lb)                               1.39                                 1.46

 

Net Cash profit/lb                             1.61                                1.54

 

Operating Cashflow                         82mm                             92mm

 

Tax (17%)                                     14mm                              16mm

 

Maintenance Capex                        5mm                                5mm

 

Free Cashflow                                63mm                              71mm

 

Growth/Optionality

 
Amerigo’s management team has demonstrated considerable aptitude at investing the cash harvested from MVC.  Recent examples of their effectiveness at deploying capital include:

 

1.  The molybdenum circuit completed in March 2005 took 3 months to construct with a capital cost of $4.4 million.  The project returned its full capital cost in 3 months, and will deliver at least $15mm in cash value annually for the foreseeable future.  This project will therefore deliver a virtually perpetual return on capital of over 240%.

 

2.  During the second quarter of 2006, Amerigo acquired 31.8mm shares and 11.5mm warrants in Chariot Resources, a development stage copper operation, for $12.5mm.  These securities were sold within 5 months for $21.3mm, generating a pre-tax profit of $8.8mm.  Although the purchase was intended as a longer-term strategic investment when it was made, the 70% pre-tax absolute return and 250% annualized equivalent return on capital they realized when their overtures were rebuffed provides some evidence that these guys know what they’re doing when they choose projects in the space.

 

3.  During the second quarter of 2007, Amerigo acquired 6.9mm share of Candente Resources, a development stage copper operation, for $8.6mm.  At today’s price of $1.91 per share, this stake is worth $13.2mm, representing a gain of $4.6mm, or 53% over a 6 month holding period.  While I acknowledge that this represents a possibly ephemeral mark to market gain, it is worth noting that this share appreciation equates to a 135% annualized return on capital.

 

4.  In the third quarter of 2007 the company began the installation of two 10-megawatt generators to reduce reliance on rising grid electricity costs in Chile.  At current grid prices, this $9mm capital investment is expected to achieve full payback within about a year of the project’s completion in mid-2008.  Thus, in addition to the strategic value of achieving energy self-sufficiency and diversifying the company’s ultimate energy source from natural gas to bunker seed oil, the investment is likely to realize an ongoing 100% annualized return on capital.

 

Likely future large-scale investment opportunities include extending the strategic relationship with Candente to move their extensive Canariaco copper resource in Peru into production, as well as integrating Codelco’s Cauquenes tailings deposit into the MVC operation.  The tailings in Cauquenes were deposited between 1935 and 1975, and have copper grades similar to the ore in Colihues.  At a copper grade of 0.30%, there are an estimated 3.3 billion pounds of contained copper within the 500mm tons of tailings in Cauquenes.

 

 

Valuation

 
Amerigo’s balance sheet has no debt and $40mm in cash and securities.  With 95mm fully diluted shares outstanding, Amerigo’s market cap at $2.21 per share is $210mm.  Subtracting the cash leaves an enterprise value of $170mm.  Using our projected $63mm in 2008 free cash flow, Amerigo’s enterprise value is approximately 2.7 times forward free cash flow.  Using our projected $82mm in 2008 EBITDA, we get an EV/EBITDA multiple of 2.1 times.  A comparison of Amerigo against its copper producing peer group is presented below:

 

                               2008 EBITDA         2008 EV/FCF         2008 EV/EBITDA

Amerigo                        82mm                        2.7x                         2.1x

Antofagasta              3,106mm                        7.1x                         6.0x

Anvil                           270mm                        4.2x                         3.4x

First Quantum           1,653mm                        4.1x                         3.0x

Frontera                     135mm                         3.0x                          2.1x

Inmet                          806mm                        5.0x                         4.2x

Quadra                       278mm                         3.2x                         2.6x

Taseko                       233mm                         4.2x                         3.6x

 

Average                                                          4.2x                         3.4x

 
Source: Raymond James, Company Filings (used to determine maintenance capex)
 
Arguably Amerigo’s EBITDA multiple should be higher than these comps given that it is debt-free, is far less sensitive to copper price fluctuations, has a virtually inexhaustible resource relative to current production, and has an advantageous tax rate.  Further, while many of these comps have better growth profiles, much of this growth relies on large capital outlays and risky developments of new resources, whereas Amerigo’s growth involves lower-risk fine-tuning and expansion of existing operations.  At 5 times 2008 free cash flow, Amerigo would trade at $3.75, which is almost 70% over the current price.

Catalyst

- Production and earnings ramp, beginning Q4 2007

- Steady profitability through fluctuating copper prices

- Rapid value accrual as large cashflow relative to marketcap continues to be deployed into high ROI projects
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    Description

    Amerigo Resources (ARG CN on Bloomberg) is a copper and molybdenum producer whose enterprise value is trading below 5 times free cash flow on a trailing basis.  The company has no debt and pays a 5.9% dividend at current prices.  While a buyback program is in place, I’m not touting it because management doesn’t seem to want to pursue it with any vigor.  Because a significant production ramp has just begun after the end of the third quarter, Amerigo’s next 12 months’ free cash flow multiple is under 3 times.  Amerigo’s ore source includes the tailings from El Teniente, the world’s largest underground copper mine, as well as ore that had been deposited in two nearby tailings ponds over five decades.  Therefore the depletion issues relative to production that challenges virtually every other copper producer today is not a problem here.  Further, Amerigo’s highly experienced management team has demonstrated an impressive ability to consistently deploy the company’s enormous free cash flow into low risk, high ROI projects.

     

    Issambres introduced Amerigo to the VIC almost 3 years ago.  Since then, the company has constructed a large-scale molybdenum concentrating circuit, completed plant upgrades to increase annual copper production capacity from 35mm pounds to 65mm pounds, and printed $1.00 per share in earnings.  With the price of copper up from $1.20 per pound to $3.00 per pound, and molybdenum prices virtually unchanged at about $34 per pound, it’s hard to believe that you can buy Amerigo today (in Canadian dollars, at least) for the same price that you could back at the beginning of 2005.

     

    There are several reasons for the multiyear share price stagnation – none of which contradicts the original investment thesis that Issambres presented.  While my discussion here will include a brief overview of Amerigo’s fresh tailings processing operation, I want to focus more on recent events, projections, and our valuation analysis for highlighting why the stock remains such a compelling investment.  I strongly encourage readers to also review Issambres’ excellent writeup for more background.

     

     

    Background

     
    Amerigo’s primary business is processing the fresh tailings from Codelco’s El Teniente mining operation.  As previously mentioned, El Teniente is the world’s largest underground copper mine.  It started production in 1904, and has an estimated 60-year remaining mine life.  Crushed ore flows from the mountaintop El Teniente site down a concrete chute for over 20 miles to Amerigo’s Minera Valle Central (MVC) facilities.  The copper grade in these fresh tailings is approximately 0.11% (eleven basis points) and the moly grade is approximately .002% (two tenths of a basis point).  Amerigo currently receives and processes approximately 130,000 tons per day (tpd) of fresh tailings flow from El Teniente.  After copper and moly extraction, the tailings flow another 30 miles to their final resting place at the Caren dam.

     

    Amerigo had also been extracting and processing tailings from the nearby Colihues pond since 2004.  The Colihues pond is where El Teniente’s tailings were impounded during the period from 1977 to 1985 before the construction of MVC.  There are approximately 1.3 billion pounds of contained copper within the 200mm tons of tailings deposited in Colihues.  Amerigo had targeted extracting approximately 10,000 tpd of these tailings in 2005, and growing throughput from this source to 45,000 tpd by the end of 2006.  Importantly, the copper and moly grade of these “old” tailings are three times as high as the fresh tailings received from El Teniente.  Therefore the production from the 45,000 tpd Colihues throughput could be expected to be approximately equal to the production from the 130,000 tpd of fresh tailings from El Teniente.

     

    Here is where Amerigo drifted a bit off course, and perhaps initiated the turnover in its investor base that continues today.  Chairman Steven Dean had set a target to ramp annual copper production to 60mm pounds and moly production to 1mm pounds by the end of 2006.  While plant capacity was constructed in time to accommodate these goals, equipment procurement issues prevented extraction from Colihues from ramping according to plan during 2005. 

     

    Then they were really blindsided:  just as new hydraulic monitors were deployed to increase Colihues’ throughput, Codelco announced in April 2006 that it needed to reduce the flow from MVC to Caren in order to reinforce bridgework along that route.  Not only was Amerigo forced to completely curtail the Colihues operation until further notice, the fresh tailings flow from El Teniente was reduced by 25%.  Intermittent curtailments continued through the beginning of 2007, and full flow was not restored until March 2007.  Colihues extraction remained prohibited through the third quarter of 2007.  Instead of ramping toward 60mm pounds of production, Amerigo’s copper sales actually fell from just under 30mm pounds in 2005 to 24.6mm pounds in 2006.

     

     

    Production Ramp

     
    Amerigo announced during its Q3 07 conference call that it has restarted processing the old tailings available to it at the MVC site.  While management did not specifically state that they had gotten the “all clear” from Codelco, it was obvious from the language during the call that Colihues is finally back online, and a more formal announcement was not made because of Codelco’s sensitivity to public communications about its operations. 

     

    Because the tailings currently being processed from Colihues are actually fresh tailings that had been deposited into the pond while the flow was disrupted during 2006, the ore from the extraction during Q4 07 and Q1 08 will be similar to the lower-grade fresh tailings from El Teniente rather than the higher-grade old tailings that had been deposited in the late 1970’s and early 1980’s.  We therefore expect a slow production ramp from last quarter’s 8mm pound copper production rate to Amerigo’s target of 15mm pounds per quarter by Q4 08.  Historical and our projected quarterly copper and moly production estimates look as follows:

     

                                 Q2 07A        Q3 07A     Q4 07E     Q1 08E     Q2 08E     Q3 08E      Q4 08E      FY 09E

    Copper (mm lbs)       9.31           8.05           10.00         10.50       12.00         13.50        15.00          60.00

    Moly (mm lbs)          0.20           0.13             0.19           0.20        0.22          0.23          0.25           1.00

     

    Note that copper and moly production dipped in the Q3 07 because of a Codelco-wide strike that resulted in significantly reduced tailings flow for approximately two weeks during the month of July.  Amerigo will undoubtedly continue to be impacted by temporary, one-time issues such as this, and we expect the actual production ramp to be lumpier than what is presented above, but nonetheless trending steadily upward to the 60mm pound copper/1mm pound moly production goal.

     

     

    Copper Price Sensitivity

     
    As Issambres pointed out in his writeup, Amerigo’s profits really aren’t sensitive to copper prices.  This fact is clear when production costs and royalty fees are analyzed in the context of the realized copper price each quarter.  Codelco is entitled to a 13.5% royalty on the copper revenue generated from fresh tailings.  The fact that this is a revenue share rather than a bottom-line share has a dramatic effect on Amerigo’s operating margins at elevated copper price levels.  As many analysts have now noted, much of the rise in the market price of copper is due to higher production costs faced by major producers.  Thus the jump from $1.50 copper to $3.00 copper over the last few years did not translate into as big a windfall for producers as one might have thought, since much of that price increase was effectively a passthrough of higher energy and labor input costs. 

     

    Amerigo’s processing costs have increased from 36 cents per pound in Q1 2005 to $1.72 per pound in Q3 2007, primarily as a result of higher energy prices.  Further, as copper prices rose from $1.50 per pound in Q1 2005 to $3.50 in Q3 2007, El Teniente’s royalty fee rose from 19 cents per pound to 58 cents per pound.  In other words, as copper prices rose by $2.00 per pound over this period, production costs rose by $1.36 per pound and the royalty rose by $0.39 per pound, for a total expense increase of $1.75 on these two items alone!  It is easy to see that only modest increases in smelter costs, taxes, and administration would gobble up most of the remaining 25 cents in margin advantage offered by the higher copper price.  Our analysis suggests that if the correlation between energy prices and copper prices continue to hold, Amerigo’s earnings will be virtually unaffected by copper price movements between $2.00 and $4.50 per pound.

     

     

    MVC Cashflow

     
    As production ramps from Colihues, we expect copper margins to increase as the total cost per pound declines on modest economies of scale, lower unit costs from the richer grade in throughput, and the fact that the Codelco royalty only applies to half of the production from Colihues (in contrast with a full production royalty against the fresh tailings flow).  Moly production will also become an increasingly significant contributor to profits.  In fact, moly production may well surprise to the upside, as the technical assessment of Colihues estimated moly content at 0.01%, which is five times the grade of the fresh tailings.

     

    Our 2008 and 2009 cash flow projections for MVC are as follows:

     

                                                       2008                               2009

    Copper Production (mm lbs)         51.00                              60.00                      

    Moly Production (mm lbs)              0.90                                1.00

     

    Copper Price ($/lb)                         3.00                                3.00

    Moly Price                                   25.00                              15.00

     

    Processing cost ($/lb)                      1.30                                1.20

    Royalty                                           0.45                                0.43

    Admin                                             0.03                                0.03

    Transport                                        0.03                                0.03

    Overhead                                        0.02                                 0.02

    Moly byproduct credit                     -0.44                               -0.25

     

    Net Costs ($/lb)                               1.39                                 1.46

     

    Net Cash profit/lb                             1.61                                1.54

     

    Operating Cashflow                         82mm                             92mm

     

    Tax (17%)                                     14mm                              16mm

     

    Maintenance Capex                        5mm                                5mm

     

    Free Cashflow                                63mm                              71mm

     

    Growth/Optionality

     
    Amerigo’s management team has demonstrated considerable aptitude at investing the cash harvested from MVC.  Recent examples of their effectiveness at deploying capital include:

     

    1.  The molybdenum circuit completed in March 2005 took 3 months to construct with a capital cost of $4.4 million.  The project returned its full capital cost in 3 months, and will deliver at least $15mm in cash value annually for the foreseeable future.  This project will therefore deliver a virtually perpetual return on capital of over 240%.

     

    2.  During the second quarter of 2006, Amerigo acquired 31.8mm shares and 11.5mm warrants in Chariot Resources, a development stage copper operation, for $12.5mm.  These securities were sold within 5 months for $21.3mm, generating a pre-tax profit of $8.8mm.  Although the purchase was intended as a longer-term strategic investment when it was made, the 70% pre-tax absolute return and 250% annualized equivalent return on capital they realized when their overtures were rebuffed provides some evidence that these guys know what they’re doing when they choose projects in the space.

     

    3.  During the second quarter of 2007, Amerigo acquired 6.9mm share of Candente Resources, a development stage copper operation, for $8.6mm.  At today’s price of $1.91 per share, this stake is worth $13.2mm, representing a gain of $4.6mm, or 53% over a 6 month holding period.  While I acknowledge that this represents a possibly ephemeral mark to market gain, it is worth noting that this share appreciation equates to a 135% annualized return on capital.

     

    4.  In the third quarter of 2007 the company began the installation of two 10-megawatt generators to reduce reliance on rising grid electricity costs in Chile.  At current grid prices, this $9mm capital investment is expected to achieve full payback within about a year of the project’s completion in mid-2008.  Thus, in addition to the strategic value of achieving energy self-sufficiency and diversifying the company’s ultimate energy source from natural gas to bunker seed oil, the investment is likely to realize an ongoing 100% annualized return on capital.

     

    Likely future large-scale investment opportunities include extending the strategic relationship with Candente to move their extensive Canariaco copper resource in Peru into production, as well as integrating Codelco’s Cauquenes tailings deposit into the MVC operation.  The tailings in Cauquenes were deposited between 1935 and 1975, and have copper grades similar to the ore in Colihues.  At a copper grade of 0.30%, there are an estimated 3.3 billion pounds of contained copper within the 500mm tons of tailings in Cauquenes.

     

     

    Valuation

     
    Amerigo’s balance sheet has no debt and $40mm in cash and securities.  With 95mm fully diluted shares outstanding, Amerigo’s market cap at $2.21 per share is $210mm.  Subtracting the cash leaves an enterprise value of $170mm.  Using our projected $63mm in 2008 free cash flow, Amerigo’s enterprise value is approximately 2.7 times forward free cash flow.  Using our projected $82mm in 2008 EBITDA, we get an EV/EBITDA multiple of 2.1 times.  A comparison of Amerigo against its copper producing peer group is presented below:

     

                                   2008 EBITDA         2008 EV/FCF         2008 EV/EBITDA

    Amerigo                        82mm                        2.7x                         2.1x

    Antofagasta              3,106mm                        7.1x                         6.0x

    Anvil                           270mm                        4.2x                         3.4x

    First Quantum           1,653mm                        4.1x                         3.0x

    Frontera                     135mm                         3.0x                          2.1x

    Inmet                          806mm                        5.0x                         4.2x

    Quadra                       278mm                         3.2x                         2.6x

    Taseko                       233mm                         4.2x                         3.6x

     

    Average                                                          4.2x                         3.4x

     
    Source: Raymond James, Company Filings (used to determine maintenance capex)
     
    Arguably Amerigo’s EBITDA multiple should be higher than these comps given that it is debt-free, is far less sensitive to copper price fluctuations, has a virtually inexhaustible resource relative to current production, and has an advantageous tax rate.  Further, while many of these comps have better growth profiles, much of this growth relies on large capital outlays and risky developments of new resources, whereas Amerigo’s growth involves lower-risk fine-tuning and expansion of existing operations.  At 5 times 2008 free cash flow, Amerigo would trade at $3.75, which is almost 70% over the current price.

    Catalyst

    - Production and earnings ramp, beginning Q4 2007

    - Steady profitability through fluctuating copper prices

    - Rapid value accrual as large cashflow relative to marketcap continues to be deployed into high ROI projects

    Messages


    SubjectProduction Costs
    Entry12/06/2007 04:33 PM
    Memberbritt12
    You mention that you believe that the cost component of their copper production is highly correlated with the spot price of copper, and that any move between $2 and $4.50 copper would be basically a net zero to their cash margin per lbs. How did you come to this conclusion? Company management mentioned that while Chilean energy costs do affect the overall supply in the longer term (people are hesitant to invest in new mining operations), there are a number of exogenous factors, particularly a reduction in natural gas importation from Argentina, that have been keeping Chilean energy prices high.

    That being said, great work, very interesting idea.

    SubjectQuestions
    Entry12/06/2007 07:53 PM
    Memberissambres839
    Thanks for this follow-up of my write-up so long ago.

    1)Why do you think management doesn't own more shares of this? Or why aren't they buying? They actually large sellers earlier this year.

    2)Have you met with management, talked with them? What is your opinion?

    3)What do you think management does with the excess cash? I'm not sure I like them speculating on copper juniors. And this question actually relates to question #1. If they owned a lot of shares, dividends would be their highest priority.

    SubjectProduction Costs
    Entry12/07/2007 10:55 AM
    Memberrasputin998
    Hi Britt -

    Thanks for the very good questions.

    A regression of the company's production costs per pound produced against the average selling price in each quarter yields a correlation of almost 70%. That is, 70% of the variance in production cost per pound could be explained by the price of copper itself. A good portion of the remainder of the variance in this cash margin is eaten up by the royalty, which at a given production level increases and decreases with 100% correlation to the copper price. Using this model and playing with different copper price assumptions showed a net cash income swing of about $800k at the 8mm pound quarterly production level, which seems neglible relative to the impact of throughput and grade levels (particularly with regard to moly grades) on cash profits.

    You correctly point out that the high cost of natural gas in Chile is largely country-specific. However, since Chile represents over 35% of the world's copper production , the need for Codelco to pass through these higher costs undoubtedly influences the global price.

    I think the cost factor influences short term prices as well as long term, particularly when the industry is operating at the high capacity utilization levels we have seen in the last few years. In essence, the balance of the negotiating power has moved to the side of the producers, who can now insist that they recover all of their costs plus a decent profit margin without fear that new supply can easily come on as prices rises.

    While admittedly overly simplified and probably has a variety of explanations, it is instructive that regressing the monthly copper price against oil prices over the last 2 years shows a 20% R-squared, whereas it was under 2% over the last 20 years, which includes the long period of high capacity relative to demand.

    SubjectIssambres
    Entry12/07/2007 04:41 PM
    Memberrasputin998
    Issambres -

    Thank you for your questions.

    1. I see bloomberg showing Klaus having sold 200k of his 3.2mm shares in April, when the stock traded to its all-time high and broke $3 for the first time. I have a call in to Klaus and will ask him his reasoning. I would guess that he's just taking some chips off after watching this thing trade up to $2.50 in early 2004 and meander for 3 years. Klaus and Steven do have an additional equity interest in the form of their Class A shares, which gives them 1c per pound of copper sold and a small take of moly revs, which arguably only partially aligns their interests with shareholders. They are not young, and they don't pay themselves much beyond what they garner from the Class A Shares. They have also operated through a long, depressed commodity cycle, which undoubtedly influences their mindset.

    2. Steven and Klaus have been to our offices several times. I find them as credible as their impressive resumes would make you expect. They seem serious and almost the opposite of promotional, which I like but probably wins him few friends within their longtime shareholder base.

    Mr. Dean tends to get very sensitive and cantankerous when investors make suggestions for enhancing shareholder value, and this may explain some of the discount on Amerigo shares. I find Klaus Zeitler much easier to speak with, and he seems have much more detailed information on the operation in any case.

    These guys clearly want to do bigger things, and I think they have the capacity to accomplish their goals. I also strongly feel that they will bide their time, find the right opportunity, and move only when they feel they have a sure thing. They are clearly on the conservative side of mine operators.

    3. Related to the last paragraph, I think they want to manage a bigger, more diversified producer. Obviously the tailings pond opportunities are large resources that they could pursue, but after their experience in 2006, I think they want to have a non-Codelco project in their portfolio. They tried this with Chariot, and now Candente. Joanne Freeze and Fredy Huanqui apparently have a very strong reputation in the industry for finding large resources. Candente's starter pit alone has 1.4 billion pounds of contained copper. Production is expected sooner (late 2009) than any of the other development companies we've seen. With potential capacity starting at 80mm pds per year and growing to 250mm, you're looking at $100mm in initial runrate cashflow growing to four times that on a company with no debt and a $180mm market cap (but also a $200mm - $300mm construction capex spend, which could be mostly bankable).

    In almost every case, I like dividends and when a company is really undervalued I like a real buyback even more. However, if they can find projects with even higher IRRs than the free cashflow yield on their stock, and they're conservative, I'm fine with them deploying my capital. We think the junior mining space is full of opportunities with multibagger upside, but also full of dogs, and we feel we're too generalist to vet most of these properly. Here we have two conservative experts that seem to understand risk and capital allocation very well to do it for us.

    SubjectInsider Selling/Update
    Entry12/18/2007 03:36 PM
    Memberrasputin998
    I just spoke with Klaus Zeitler to ask him about his share sales in April. He said he hasn't sold any of his original shares since the inception of the company and the only shares he has sold were from option exercises. The exercise early in the year was to generate some cash for personal reasons (daughter buying a house, etc.) and unrelated to his view of Amerigo's valuation or prospects, for which he expresses a very bullish view.

    He confirmed that Colihues is online and they are drawing a modest 10-15k tons per day, which they expect to increase steadily throughout 2008. Recall that the current draw is from the lower grade tailings that were deposited at the end of 2006 as the Caren bridge was being reinforced, so it will take a few months to get through this before they will see the benefit of the higher grade ore that was originally deposited in Colihues 25 years ago. The operation is running well and electricity prices have receded somewhat from the seasonal spike that impacted last quarter's results.
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