Constellation Copper CCU
October 31, 2005 - 1:36pm EST by
issambres839
2005 2006
Price: 1.09 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 185 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

With a mine in Utah starting production in February and another enormous mine being developed in Mexico, Constellation Copper represents the best way to invest in copper. CCU trades at just three times cash flow from just its Utah mine. Investors get an enormous mine in Mexico, a potential big copper discovery four miles from its existing Utah mine and potential for uranium for free. I expect CCU to at least double in price in six months, and if copper prices stay this high, the stock could triple.

Lisbon Valley Utah mine

Constellation’s Lisbon Valley mine is located in east-central Utah, 45 miles southeast of Moab. The mine has at least 10 years production of 60 million pounds. Management believes that the mine will be expanded beyond 10 years due to a new deposit nearby. Also, the size of the deposit will be expanding once they start production.

CCU plans to start full production by January or February of 2006, and they should be able to produce 54 million pounds of copper annually. The cash costs of the mine are $0.55/lb.

An eight cent premium to the price of copper

Since the Lisbon Valley mine is in the U.S., CCU will receive about an eight cent premium to the price of copper. CCU will receive this premium because most of the copper in the U.S. is imported in. There are freight charges associated with importing of about 10 cents. So, domestic companies offer a penny or two discount but they get to charge that extra freight charge.

So, at current prices of about $1.82 a pound of copper, CCU is actually going earn $1.90 a pound.

Expansion of Lisbon Valley – Flying Diamond

Flying Diamond is just four miles south of Lisbon Valley. Importantly, the property is over flat land, so it should be easy to access. This discovery announced in May shows approximately 200 million pounds of copper or 4 years of production. One analyst mentioned that additional drilling of the mineralized zone around this site could lead to an expansion of the resource by 10 times. The CEO is very enthusiastic about the upside from Flying Diamond.

Even just using the 200 million pounds, Flying Diamond extends the lifespan of Lisbon Valley to 15 years and possibly much more.

Currently the Lisbon Valley operation is set to produce 60 million pounds of copper, but an expansion to double the size of the plant could be achieved for just $25 million. More drilling will be done over the next six to nine months to determine how big Flying Diamond is. If it is small, then they will tack on this extra capacity onto the end of Lisbon Valley. If it is large, say 50 million tonnes or more, then CCU will expand their plant and produce as much copper as possible.

Uranium at Lisbon Valley?

There is uranium in a couple of spots in Lisbon Valley and it was mined for in the 50’s and 60’s during the last crazy uranium price jump. In fact, uranium miner, UEX (TSE:UEX) has a uranium mine close by.

Uranium prices have exploded in the last couple of years to $33 a pound from as low as $7-8 a pound. The company has ignored these uranium deposits until recently. While they have no immediate plans to drill and apply for licenses to mine it, there is an opportunity to partner up or to sell off the rights to someone. Again, uranium adds more sizzle to the story.

Terrazos Mine

The Terrazos zinc and copper project is located 45 kilometers north of Chihuahua City, in the state of Chihuahua, Mexico. This mine just went through a revised technical study, which raised the size of Terrazas by 63%. The report showed that the mine has 85.6 million tones of zinc and copper: 2.34 billion pounds of zinc and 608 million pounds of copper. This report was done considering long term copper prices at $1.20 and zinc at $0.50/lb.

That indicates a 15 year life producing 40 million pounds of copper a year and 150 million pounds of zinc. Estimated cash costs are $0.45 a pound for copper and $0.25 a pound for the zinc. I estimate that Constellation will start its Terrazos production in early 2008.

However, I have heard that Canadian mining giant Teck Cominco (TSE:TEK.mva) and Mexican miner Industrias Penoles are interested in the Terrazos mine. I think that there are two possibilities here. The first and most likely is that CCU partners in a joint venture with a much larger miner to split costs and expertise. The other possibility is that Terrazos is so attractive that CCU itself is bought out. Once the feasibility study comes out in Q1 of 2006, I think you will start to see activity on this front and by this time next year, I expect a big announcement due to Terrazos.

San Javier Mine

The San Javier mine is located in Sonoro, Mexico. The company has more drilling to do, but they believe that the mine could have 100 million tonnes of copper there. This is just upside and I assign no value to this property at all. Later next year, we should see more drilling.

Copper price sensitivity

The company has bought puts for production for 2006 and 2007 that protects them below $0.90 of copper, otherwise they have not hedged. In other words, it is extremely sensitive to the price of copper. (The following estimates only include the Lisbon Valley mine):

2006 cash flow estimates with copper at (in Canadian dollars in parentheses):

$1.20: $0.15 (C$0.18) a share in cash flow
$1.50: $0.24 (C$0.28) a share in cash flow
$1.80: $0.33 (C$0.39) a share in cash flow
$2.00: $0.39 (C$0.46) a share in cash flow

Basically, every ten cent move in copper moves CCU’s cash flow up or down three cents. This assumes 54 million pounds being produced. There are 169 million shares outstanding.

Valuations

Other copper producers trade at four to six times cash flow. At current copper prices, that would indicate a valuation of Constellation Copper JUST on the valuation of Lisbon Valley alone (without Flying Diamond) at C$1.56 to C$2.34 a share, or 36% to 103% higher than its current stock price. Again, that is just with Lisbon Valley.

Now when we look at Terrazos and use assumptions such as 2008 start of production and copper prices of $1.10/lb and zinc of $0.58/lb and assume a conservative life of 15 years and a $260 million construction price, and use a 10% discount rate, you get a NPV of $106 million. With 169 million shares outstanding, that gets you $0.63 (C$0.73) a share of value.

Adding those two together and you get a total value of C$2.29 to C$3.07 per share. And that valuation includes nothing from Flying Diamond, uranium or San Javier.

In a worse case scenario of plunging copper prices, what would CCU be worth? Say copper prices fell to $1.20 next year and cut in half the NPV of Terrazos, and give CCU a four times multiple. The stock would still be worth C$1.09 a share. And again that assigns no value to San Javier, uranium or Flying Diamond. CCU’s stock price is discounting some pretty dramatic price declines in the copper market.

Summary

CCU has tremendous upside, even if copper prices fall. I also feel that it is not as risky as other copper producers out there because production is starting very soon and because one of their mines is in the US, they receive a premium to the price of copper. On the valuation of only the Lisbon Valley mine, CCU is worth 36% to 103% higher than its current stock price.

Catalyst

1) Production start at Lisbon Valley
2) Joint venture of Terrazos
3) Update on San Javier
4) Beginning cash flow from Lisbon Valley
5) Acquisition of CCU
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