Imperial Metals III.TO
August 05, 2007 - 9:07pm EST by
2007 2008
Price: 18.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 612 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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III is a 20% fcf yielding, growing, debt free copper, gold and silver producer in Canada with two producing operations, Mount Polley (100% owned) and Huckleberry (50% owned), and multiple developing ones.

On today’s copper, gold, silver, and CAD/US fx futures curves, III trades at 0.5x NAV, making it the cheapest producer I see globally, not to mention on a politically-risk-adjusted basis.
Murray Edwards, co-founder of Canadian Natural Resources, Ensign Resources Service Group, and Penn West Energy Trust, owns 41% of III and significantly influences capital allocation. Bruce Berkowitz of Fairholme, a 20% owner of III, is a fan:

"Fairholme-owned companies are strong cash generators and have rock-solid balance sheets. But what Berkowitz and company really seek are outstanding managers who not only align their interests with those of their shareholders but also invest capital shrewdly. 'We've put together a group of young Warren Buffetts,' says Berkowitz. (Buffett's Berkshire Hathaway is a large holding.)
Berkowitz thinks he's found a Canadian Buffett in Murray Edwards, a billionaire who's tied up in three oil-and-gas holdings in the Fairholme fund. 'Murray is off-the-charts great, a brilliant capital allocator,' says Berkowitz. (Kiplinger’s, “The 25 Best Mutual Funds”, June 2007, )

Investors should pay a premium for Edward’s investing savvy, not the world’s deepest discount.

III has been underappreciated because of onerous Cu hedges, production problems due to weather, and lack of information about Huckleberry, which will be consolidated in 2007 for the first time. Mt Polley began significant metal production in mid 2005.
The onerous hedges have been eliminated and weather’s effect on production, mainly in winter, is in my numbers.  Essentially, III trades near NPV@10% of Mt Polley and Huck, implying no value for multiple developing operations, which combined are worth at least $20/share at today’s curves.
NPV of III’s ownership in Mt Polley and Huck:
The NPV/(fully diluted share), at 10% discount, of Mt Polley and Huck’s cash flows at today’s curves is ~$20 +/- 10%, assuming Huck runs out of ore in Oct 2010, which may not happen as they are drilling targets that may yield more ore.
III’s 2007 production guidance is 68.0 million pounds copper, 55,000 ounces gold and 445,000 ounces silver at Mt Polley and 60.0 million pounds copper, 7,700 ounces gold, 302,000 ounces silver and 420,000 pounds molybdenum at Huck, half of which is III’s. I’ve assumed III hits 90% of these numbers, assuming  Mt Polley avg daily mill throughput 17.5k for 2007. Per Q1 2007 financials:
“Ore milled per calendar day during the March 2007 quarter decreased to 15,939 tonnes from 17,025 tonnes in the 2006 first quarter as problems in feeding ore, related to winter weather, in crushing plant continued. By March, improving weather lessened crushing problems and throughput increased to 17,887 tonnes per day, and by April the mill throughput increased to average 20,797 tonnes per day.”
Total cash costs (excluding depreciation, amortization etc) at Mt Polley should approximate C$120MM, with capex ~C$12MM and exploration ~$20MM on top of cash costs. Mt Polley 2007 revs should be ~C$265MM and pre-tax income ~C$113MM.
Total cash costs at Huck should approximate $80MM, with capex and exploration of $20MM combined on top of cash costs. Huck 2007 revs at the curve should be $230MM, yielding $130MM in pre-tax profit, $65MM belonging to III.  
Total pre-tax income should be ~$178MM. Discussion with III suggest effective/cash tax rate in mid teens because of tax benefits from exploration and capex, suggesting fcf ~$150MM or $4.30/(fully diluted share).
In 2008 Huck grade will decline by 20%, causing its profit, at same prices, to decline by 20%. Assuming current Cu curve and moly price exceeds $15/lb through 2010, the NAV of Huck discounted at 10% is ~C$3.50/share +/- 10%.
In 2008 Mt. Polley should repeat 2007 production except increase gold production more than the decline in silver production. I estimate III fcf of $3.50/(fd share) in 2008, the drop versus 2007 stemming from Huck.
In 2009-2017 Mt Polley Cu production should expand by at least 20%, while gold should remain steady at 70koz and silver at 100koz annually.  This increase will stem from a 50% expansion of the mill; Cu payable production increases by ~20% because Cu grade declines by 25%. If enough ore is found, however, a 100% mill expansion is reasonable.
Red Chris and Sterling: the underappreciated value in III
In early 2007, III acquired Red Chris project in northwest British Columbia for $70MM, after a bidding war with Taseko Mines. Per III’s President’s 2006 annual letter, Red Chris is III’s most ambitious project.
In simple terms, per a Dec 16, 2004 Techinical Report on Red Chris (p.190) the pre-tax NPV@10% discount of Red Chris @ $2.00/lb Cu, $675/oz Au, and today’s CAD$/US fx is C$1BN. If apply a 50% tax rate, which the report suggests, the NPV after-tax is C$500MM, or $14/(fully diluted share).
This Technical Report can be found on under bcMetals, which III acquired, filing date Dec 20, 2004. III believes Red Chris can be in production in early 2010.
For several reasons, however, Red Chris’s value could be greater than $14/share.
  1. The technical report assumed a 30ktpd (30,000 tons/day) operation, with years 1-5 averaging 105MM lbs/yr Cu (at 0.49% Cu grade) and 71.6k oz/yr Au (at .358 gpt Au). III may run a 40ktpd at higher grades than the feasibility assumes for years 1-5. As the grade declines, III should expand mill, boosting throughput to prevent metal production decline.
    1. bcMetals was cash poor and so did not drill out Red Chris comprehensively. III believes drilling will show a larger ore body, suggesting long life at higher mill throughput
    2. Per 2006 annual President’s letter: “Recent exploration at Red Chris demonstrated that the deposit has significant potential for expansion. Diamond drill hole 06-324, drilled in 2006, showed the deposit extends to depth by intersecing 271 meters of mineralization below the depth of mineralization drilled in earlier exploration programs. The average grade of this 271 meter intercept was 0.87% Cu and 1.12 g/t gold.”
  2. Red Chris will be a low-cost operation because of gold by-product credits. The technical report suggests total cash costs of $0.35/Cu lb assuming gold and silver of $375/oz and $5.50/oz, respectively. Costs have risen dramatically since Dec 2004 but less so than rise in Au, Ag, and Cu prices (note stock prices of most Canadian miners since Dec 2004). Mt Polley is currently a high cost producer, ~$1.50/Cu lb cash cost net of credits; Red Chris production should transform III into a low cost producer, justifying a higher multiple of NPV and free cash flow than most (higher cost) peers.
  3. If Red Chris production, at higher mill throughput and grade, produces profit double that of III’s current production, and III is valued on free cash flow/earnings rather than NPV, then Red Chris alone would triple III’s stock price.
    1. If cash costs doubled to $0.70/lb, and Red Chris were run per assumptions in technical report, it would still generate $4.00/share +/-10% in fcf at today’s curves in 2010/2011.
    2. At such curves, in 2010 and 2011, Mt Polley should generate $3.00/share +/- 10%.
  4. Without Red Chris, III may be perceived as a 2 mine operator soon to be a one mine operator, with perhaps a minor gold operation (Sterling—more on it later) because Huck may run out of ore in 2010. Assuming Huck dies, Red Chris is another major mine that allows III to cash flow even with a catastrophe at Mt Polley and makes III one of the few mid-tier Cu producers in North America.  Such producers tend to trade at free cash flow multiples lower than majors and thus are attractive take out candidates.
III describes Sterling as follows in 2006 annual President’s letter:
“At the 100% owned Sterling gold property, a former producer located near Beatty, Nevada the excavation of a 1200 metre underground ramp into the 144 Zone is now underway. The ramp will provide access to the 144 Zone for the exploration of the zone from underground and for the restart gold production operations. Equally encouraging, a regional exploration program at Sterling resulted in the discovery of several new surface showings with grab samples grading up to 5.4g/t gold. Several promising targerts were identified for drilling…additional ground was acquired increasing our mineral rights holdings in this play to 12,620 acres.”
Sterling could be a 100koz annual producer within 2-3 years. If this happens, III could be producing 150k-200koz/year among Mt Polley, Red Chris, and Sterling. 200koz/year gold producers in US trade over 10 times free cash flow.
If Sterling can start producing 100koz Au at $300/oz by 2009, when futures predict Au trades at $750/oz, free cash flow should be ~C$35MM. A 10x multiple provides $10/share in value.
Conclusion: Red Chris and Sterling are worth more than III’s current share price.
Free yet valuable optionality:
At today’s price, one is paying nothing for:
  1. Expanding Mt Polley payable production by more than 20% through a >50% mill expansion.
  2.  Heap leaching as another source of Cu from Mt Polley, i.e. in addition to mill. Per Q1 2007 MD&A:  “a 250,000 tonne test of heap leaching to recover copper from the highly oxidized near surface mineralization in the Springer pit will be conducted this summer. The heap leach will be loaded with copper oxide mineralization and sulphur beginning in May 2007.”
  3. Developing a large underground mine at Mt Polley with Cu grade of 1-2% and high silver values
    1. Refer to July 3, 2007 news release stating III intersected 1.12% Cu Equivalent over 400M
    2. If this intersection leads to 6ktpd underground mine at 1.5% Cu, payable metal production would increase 15% without any expansion of the mill.
    3. If overall grade increases and mill expanded 100%, production more than doubles
  4. Huck finding new ore that extends life materially beyond 2010, allowing for III to have 4 simultaneous operations by 2010: Mt Polley, Springer, Red Chris, and Huck
  5. III redesigning Red Chris such that NPV is materially higher than in Dec 2004 Technical Report
  6. Further discoveries at III’s Bear and Giant Copper properties.


2Q2007 results
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