SVH Tracker - April 3, 2017: Recommendation Strategy for Arizona Mining Inc
Arizona Mining Inc was continued as a Good Relative Spec Value Hunter Buy at $2.45 on December 30, 2016 based on the expectation that a PEA in Q2 of 2017 would confirm the assumptions outlined in my Outcome Visualization as of Oct 31, 2016 for Hermosa-Taylor. On April 3, 2017 Arizona Mining released a PEA for a 10,000 tpd mining operation with a 19 year mine life that yields an after-tax NPV of USD $1.26 billion at 8% with an IRR of 42% using as base case prices $1.10/lb zinc, $1.00/lb lead and $20/oz silver. At an exchange rate of 1.34 CAD:USD this translates into CAD $1.7 billion, or $5.88 per share based on a 100% net interest and 289.3 million shares fully diluted. That is considerably less than the CAD $4.1 billion NPV at 8% in my Oct 31, 2016 OV which envisioned a bigger resource with better grade and which I retired effective March 31, 2017 after the PEA came out.
The PEA is based on a subset of the measured and indicated resource, 60.8 million tons of 4.4% zinc, 4.3% lead and 1.7 opt silver based on a 4% zinc equivalent cutoff grade. These are lower grades than I assumed. CapEx came in at USD $457 million, sustaining capital at $500 million, and OpEx at $48/ton. These are short tons, that vestige of British imperialism to which Americans still cling, but for which I have compensated by converting the figures to a metric tonne basis so that they are comparable to resource estimates and economic studies published in the rest of the world. My CapEx was low at $400 million compared to $457 million, and my $100 million sustaining cost was very much lower than the PEA's $500 million. However, my OpEx of $64/t was higher than the PEA's $54/t (adjusted to metric tonnes). I also erred in assuming Arizona Mining would get a lower treatment charge in light of the concentrate shortage facing refiners. I used $210 per tonne of zinc concentrate to reflect treatment charge and transportation cost. The treatment charge used by the PEA was $210 plus $13 manganese penalty for $223, plus $97 per tonne shipping cost (curiously the PEA uses metric data for the smelter and shipping costs). The PEA also lets the smelters retain 15% of the zinc content. There is thus room for lowering the smelter costs if the producers succeed in knocking back the high share smelters collect from zinc mines in comparison to other base metals.
I have incorporated the PEA assumptions into my OV which uses LOM averages rather than the PEA ore schedule's use of high grade ore in the first 4 years. The result is the April 3, 2017 PEA based Hermosa-Taylor Outcome Visualization. Using the OV LOM based model with spot prices of $1.25/lb zinc, $1.04/lb lead and $18.16/oz silver, the result is CAD $1.8 billion NPV at 8% with 47.8% IRR using 1.34 CAD:USD exchange rate. This translates into a $6.30 target price at production compared to the PEA's $5.88 target.
Arizona Mining's CEO Jim Gowans states that the company will continue with drilling to further delineate the deposit and upgrade resources to the proven and probable category, initiate permitting in Q2 of 2017, and possibly be in production by 2020. That is a very aggressive timeline, but it reflects the reality that the Forest Service, despite signals from Donald Trump that environmental concerns should not be an obstacle to development, has emerged as quite hostile towards any exploration or mine development activity on "public" land. The mining plan envisioned by the PEA is based entirely on the patented claims which are subject mainly to state permitting. Arizona Mining is heading straight from PEA into a full-blown feasibility study that takes into account mine permitting costs. If the company can deliver on this timeline, it would be a remarkable accomplishment. By advancing Arizona Mining into the feasibility and permitting stage, the fair speculative value range should be $3.16-$4.74 per share based on my OV (the blue channel in the chart above), reflecting the derisking accomplished by completing the PEA stage. The current $2.23 per share price thus represents Good Absolute Speculative Value, though in terms of the "irrational" Market S Curve (the yellow channel) the stock is parked right where we would expect it, namely in what Sean Roosen calls the "value trough" where the market discounts the proper value of a resource project stuck in the final permitting and feasibility demonstration stage.
So where do we go from here? Arizona Mining was initially flagged on December 31, 2015 as a bottom-fish accumulation target in the $0.30-$0.49 range on the basis of evidence that drilling at the base of the Hermosa-Central oxide deposit during 2015 had established the presence of a substantial high grade zinc-lead-silver carbonate replacement sulphide deposit whose geological context suggested a world-class qualifying geological footprint in the 100-200 million tonne range (see Bottom-Fish Recommendation Strategy - Feb 18, 2016). After the junior released a resource estimate on February 1, 2016 I completed an outcome visualization which expanded the resource to support a 7,000 tpd underground mining operation which led me to upgrade Arizona Mining to a Good Relative Spec Value Buy recommendation at $0.46 on March 4, 2016. I also made it one of my 3 top picks during my PDAC 2016 BNN Market Call appearance.
While Bay Street fretted about the zinc price and a "Warke Factor" somehow linked to the fact that this "Shy Guy" had delivered $2 billion in buyout value after the 2008 crash involving two juniors, Ventana and Augusta, Sean Roosen's Osisko Gold Royalties, probably heeding the urgings of Bob Wares who also served on Arizona Mining's board, financed the junior a couple weeks later by buyng a 1% NSR for $10 million and helping with an additional $5.6 million through a private placement at $0.56. (I have included Richard Warke's photo above so that I have a remote chance of recognizing him should he ever show his face in a public venue such as a conference podium or booth.)
Bay Street finally got onto the wagon in late May 2016 when it underwrote an $18 million financing at $1.29 with no warrants. With the zinc price developing an uptrend and drilling confirming the hypothesis of a world class discovery, Bay Street underwrote another $36 million at $3.05 in November 2016, just in time for a UK online magazine to jettison its credibility by conflating a minor metallurgical issue involving the level of manganese in the zinc concentrate with an allegation that Hermosa-Taylor was a fraud on a par with Bre-X whose dimwit management supposedly failed to notice that a gang of low level technicians had constructed an elaborate salt job despite owning only a fraction of the issued stock. Nevertheless, the preposterous suggestion that the top notch team Warke had assembled would try to salt a massive sulphide base metal deposit in the style of a low grade gold deposit meshed perfectly with the "fake news" juggernaut the Russians had unleashed in their campaign to make America UnGreat. The subsequently modified assertion that the manganese content was a "show-stopper" has been discredited by management, but the Arizona Mining uptrend was broken and the Trumpian seed of doubt lingers.
Less well appreciated is the fact that as the drill stepped westwards it encountered a thrust fault which stopped the westward projection of the Taylor Sulfide stratigraphy which rematerialized as the deeper and richer Taylor Deeps system that now exists as an inferred resource. An ultimate resource in the 100-200 million tonne range remains plausible though a good chunk of it will be deeper than initially expected. Taylor Deeps has been encountered at a depth of about 2,000 ft (600 m). The long section below indicates Taylor Deeps is open up and down dip, though I am not sure one would be optimistic about the shallower updip potential. The company has also established the presence of northwest striking high grade veins. For Arizona Mining to avoid just tracking the zinc price from here onwards and gaining incrementally as an FS and permit come closer for hermosa-Taylor, it must either convert into proven and probable category higher grade ore that does not entail a corresponding OpEx increase, or it must end up in a position to avoid spending $84 million CapEx on a shaft that limits hosting to about 9,000 tpd (metric).
There is a good chance the first will happen over the next 12-18 months, but the second depends on third parties with a mind of their own. Absent an upwards raging zinc price or the arrival of a "Chunnel" solution, the target price for Arizona Mining Inc is $3.50-$4.00 between now and delivery of a feasibility study that confirms PEA assumptions. Arizona Mining Inc is converted from a Good Relative Spec Value Buy to a Good Absolute Spec Value Buy with a $3.50 plus target by the end of 2017. The big gains were harvested last year by Bottom-Fishers and Spec Value Hunters. The main message Spec Value Hunters should take home is that by applying the rational speculation model to create a plausible outcome visualization I was able to identify Arizona Mining's Hermosa-Taylor discovery early on as a seriously undervalued new discovery in late 2015. This approach has been incorporated into The Share Collective, an online platform which will allow me to retire after the current 3-5 year discovery cycle runs its course because it empowers the crowd to do on its own what it now pays me to do. Yes, it renders me obsolete because it clones me endlessly, but it does not eliminate the fun I have rummaging around in the discard bin for diamonds in the rough that an outcome visualization can polish up for everybody to appreciate.