Win us with honest trifles

Filtering a news release (from IKN276)

This was the main fundies part of IKN276 this weekend. The feedback received from subscribers was pretty positive, so just for a change and a one-off let’s stick it here on the open blog. You get thoughts on how to read and filter through mining company news releases, plus an example of the process, via the NR that came from Atacama Pacific (ATM.v) last week. Also, as an extra bonus the opportunity to show how little DD Canaccord does before offering you a trade idea is given (couldn’t possibly miss that chance now, could I?). So without further ado…
Fundamental Analysis of Mining Stocks
What is this life if, full of care,
We have no time to stand and stare.
No time to stand beneath the boughs
And stare as long as sheep or cows.
No time to see, when woods we pass,
Where squirrels hide their nuts in grass.
No time to see, in broad daylight,
Streams full of stars, like skies at night.
No time to turn at Beauty’s glance,
And watch her feet, how they can dance.
No time to wait till her mouth can
Enrich that smile her eyes began.
A poor life this is if, full of care,
We have no time to stand and stare.
WH Davies, 1911
Filtering a News Release
I’ve had the idea to run a piece like this one for a while, off and on. As market news and activity generally was low this week, plus the upcoming weeks look like being busy ones for both myself and The Weekly, plus an interesting and fairly typical example of the type of NR that needs to to filtered falling into my lap and nudging me into action, the opportunity is taken this weekend. So you’ve had an intro from the poem Leisure by William Henry Davies and now for a primer on what to look for in a NR.

The subject is simple in essence: With the amount of news and data available some sort of filtering system is needed to do the job of analyzing any given market or sector, else be bogged down by an overdose of information. We need to read like a critic and look for holes, because the faster we can get behind the inevitable and understandable company spin to decide whether a project, company, story etc is worth our time following and investigating more deeply, the better. To cut this intro as short as possible (yes, that means I’ve just edited out several hundred words of waffle in my Sunday afternoon edit) what we’re looking for is the fatal flaw, the piece or pieces of information that are enough to put us off looking more deeply, spending more time on a potential investment and maybe even eventually stumping up some cash and buying shares. The fatal flaw might be exaggerated numbers, or overstretching facts to suit the company’s pitch, or maybe it comes from a company pitching dead straight and offering conservative type numbers that don’t impress. On the odd occasion it may even be a straight fat lie. But our job is to find the flaw and if not, the project or company is probably worth more DD time. And be clear that you don’t need a dozen fatal flaws to draw a line under a project, a feas, pre-feas, PEA or company as one is more than enough, thank you very much. In short, find the flaw and save time, don’t find the flaw and the project or news release you’re currently looking at may be the one in twenty, or one in a hundred that catches your eye, gets you interested and make you want to read more.

Today’s example is about a pre-feas study and the news that came out last week, so it has more substance than most. But it’s a good example because one thing rings true about all junior exploration stage companies, and it’s the touchstone on which your investigations and DD should rest. These companies sell stories, no more and no less. The entire valuation of an exploration stage mining company, by which I mean absolutely every single dollar of value it is given by the capital markets (yes, underlined and blod typed), is based on 1) the value the market gives to the interest and trustworthiness of the story in question. No good project, no value. No trust in what they’re saying, no value. To keep it simple, here are four scenarios:

  • You have the management of a 100% straight and honest mining company telling you about a mediocre or uneconomic project.
  • You have the management of a 100% straight and honest mining company telling you about an exciting and potentially economic project.
  • You have the management of a dishonest mining company telling you about a mediocre or uneconomic project.
  • You have the management of a dishonest mining company telling you about an exciting and potentially economic project.
In only one of those four situations would you be put off at face value by the words spoken by the company. Yes for sure there are grey areas between those four corners of the argument, for example there are plenty of company directors who’ll swear blind they’re honest upstanding corporate citizens but it’s obviously their job to promote and make the best case for their property or exploration project.

The picture should be clear enough by now, it’s our job to separate the wheat from the chaff in the most efficient way possible. That’s what the process below will try to demonstrate.

Atacama Pacific (ATM.v) pre-feas news release
So to the example today, this NR (1) that was offered by Atacama Pacific (ATM.v) on Wednesday August 20th. Entitled “Atacama Pacific Delivers Pre-Feasibility Study for the Cerro Maricunga Oxide Gold Project”, it announces the completion of the PFS at that project and as that’s a pretty important step for any junior exploreco, it’s a fairly long and detailed NR that gives us an overview of the full pre-feas document (that’s not yet in the public domain). The narrative that follows below tries to capture in as close a manner as possible the thought process that I went through while reading the NR and as always, the main point of studying such a NR is to find the fatal flaw if it exists.

The first thing is a bit of background; this NR on the pre-feasibility study for ATM.v’s that the study is late. It’s not an immediate red flag of course, there have been examples where a late pre-feas has turned out to be a sparkling document, but the weight of history is against companies that drag their feet at these stages so with the already deferred study supposed to have arrived in July (ATC.v said so in June), the delay to late August is a factor.

But arrive it has (well, the NR with the overview details at least, we have to wait for the PFS itself and the company has the requisite 45 days in which to file it on SEDAR), so when opening up such a document the thing I do is scan the contents and the tables to see if it passes a smell test for the economics, because that’s what NRs that announce Scoping Studies, pre-feas studies, feasibility studies, etc are designed to do. In such an NR there are a bunch of numbers I want to see first. They are:

  • The post-tax IRR. Not the pre-tax (the one they’ll often throw sequins in your eyes with), because I don’t want to read the numbers of a company that assumes it won’t have to pay tax, I want to see the numbers of a company that lives in the real world and pays taxes on its earnings, it’s as simple as that. As for the number, the higher the better but usually I don’t want anything less than 20%.
  • Its base case metal price assumptions, which have (as in HAVE, must, got to, no exceptions) to be lower than the current spot price for the metal or metals in question.
  • The discount rate. I’m happiest when seeing an 8% discount rate offered in the literature, I’ll take 5% at a pinch if the project in question has a particularly good risk outlook.
With those three in mind, let’s go to the ATM.v NR and see how those “find them first” figures stand up. Here’s the paste of the Table 1 from the NR, which has all three available:

1)      The post-tax IRR of 25.0% is fair enough.
2)      Using a 5% discount on the NPV isn’t great, but I wouldn’t throw out a PFS NR on that alone.
3)      As for the metal price assumption for the base case, the first real red flag shows up (and that’s too early for anyone’s liking). As ATM’s project is a gold project, seeing the assumption at $1,350/oz with gold doing what it’s doing today is simply no good.

So at the first pass ATM already has a doubt cast on its PFS by that gold price. It’s the first thing I’d want to investigate further if I remain interested in this stock, so without either a) the full PFS or b) the will to run calculations of my own at this point (we’re filtering a news release and its the company’s job to impress me, not the other way around) I’m left with a quick scan of the NR for any further clues. And in this case ATM has given us calcs on an alternative, lower gold price further down the NR, which is U$1,250/oz (far more reasonable as an assumption) and ends up bringing the after-tax IRR down to 17.0%. Now that’s lower than I’d like but it’s not a disaster for a low-ish price assumption either; I haven’t discarded yet, I’m still interested enough to look around, but there’s enough to doubt here already.

The next thing I care about is the other side of the profit equation. This is a pre-feas NR, it’s all about the economics of the potential mine, we know about revenues, so what about costs? On this there are two aspects, the cash cost and the capex. In this case the first dataset I come across in the NR (reading from top to bottom) is about cash cost and here’s an excerpt:

Projected total gold production over the 13-year LOM is 2.96 million ounces at an average operating cash cost of $683/oz Au. All-in sustaining cost of $941/oz Au, including total cash costs of $864/oz Au, have been projected.

Now that sounds ok at first pass. Lots of gold, under $700/oz op costs, under a thousand for AISC, in theory at least that leaves plenty of free cash flow. I like the optics. So I keep reading and…

Gold will be produced from heap leaching 294.4 million tonnes (“Mt”) of ore with an average grade of 0.40 grams per tonne gold (“g/t Au”). Ore will be mined at a rate of 80,000 tonne per day and an average LOM strip ratio of 1.76 to 1 (517.4 Mt waste to 294.4 Mt ore) has been calculated.

Wait a moment, where did you say this project was located? Suddenly a small alarm bell is going off in my head on reading this. There are never any apples to apples comparatives to make, but when it comes to this type of heap or dump leach operation there are enough similar type of operations out there and one I know well (to the point of memorizing the numbers) is Rio Alto at La Arena. What Atacama Pacific is proposing to me here is that its mine will be every bit as cheap to run on a cash cost per ounce level as Rio Alto, even though:

a)      It’s in Chile, not Peru, and that’s a more expensive country in which to operate on many levels (wages, fuel, water, etc). What’s more, it’s in the Maricunga where it’s going to have to pipe in water supply, truck in diesel, pay extra to employees etc.
b)      The 0.40 g/t gold grade is lower than the 0.5% that Rio Alto runs. Add to that the recovery rate, which isn’t shown in that snippet but is planned at just over 79% while Rio Alto gets 85% typically.
c)       The strip rate, which at 1.76/1 means a lot of waste stripping compared to RIO.to’s levels nowadays.

Now I’m not saying those financial parameters are impossible, but I’m now more than a little leery about taking them at face value because they don’t look particularly conservative at first pass. What I want from a serious PFS is just that, a sense of the company not trying to wow the market with its numbers but in the process of trying to convince itself, internally, that the project in question is one that should move forward. Or a company trying to convince real operating mining companies with buildings full of geologists and engineers and accountants who’ve been through the project selection process many times and have the decision-making call on multi-million dollar investments.

And that above means I’m now actively looking for a fatal flaw in these cost assumptions. So rather than spend time on the preliminary capex data (under $400m to build the machine, which isn’t cheap but is bearable for a 200k+ oz annum operation) I now want to dig deeper on what I suspect to be “optimized” op-ex numbers that won’t stand up to scrutiny. It’s chasing the fatal flaw  and remember, you only need to find one of those and you can close the NR and go open another. As this isn’t the PFS document yet and only a NR things can be difficult to check but in this case we do have at least some financial parameters given, here in this table further down the document. Therein lies the fuel to reject this PFS:

So far it’s been a scanning process to pick holes in the offered project. On another day one part such as the operating cost economics may pass muster and I start wondering more critically about the capex criteria. But in this case my eyes have been drawn to the cash cost credentials and here at the bottom of the NR comes the table that crystallizes the growing suspicions.

First the forex assumption and, dear people at ATM.v, you can assume a USD/CLP forex of 1:600 if you want. Hell, you can assume 700 to one or whatever other number you care to imagine, feel free and be my guest, but when it comes to a pre-feas study you need to put in serious numbers and not ‘optimize’ (i.e. bullshit) them to suit your own ends. Right now we have a CLP that’s weakening against the US dollar, having moved from ~500 in mid to late 2013 and is up to 583 to the greenback as at Friday’s close. But that’s still a way from the 600 assumption and as this ten year chart makes patently clear, a 600/1 forex between this pair is very much the exception in recent times, by no means is it the rule.

Which brings us to the fuel price assumption, the second one in the list and basically as far as I got with this news release. As it happens I was already getting mightily suspicious about ATM.v and its way of presenting the best possible case for its project and I was pretty sure just on memory that fuel doesn’t come as cheap as that in the Maricunga. So a quick check (2) at the right site (official government data, you’ll note) and indeed diesel is currently selling at CLP703 per litre in that zone, i.e. U$1.20. As fuel is one of the biggest cost inputs of a heap leacher, making an assumption that’s 25% lower than the current going rate is going to “optimize” the merry hell out of your cash cost figures. You might also recognize that the two cost inputs I circled in red above are interconnected because if you play about with the forex you start bending other price assumptions in USD as well; the cheaper the CLP is per dollar, the better things are going to look in USD terms. In this case I got as far as the second number for fuel and that’s all I need to read, the NR is now closed and ATM.v with its Cerro Maricunga Oxide Gold project have been filed under “one less to worry about”, or “avoid”, or “somebody’s going to have to give me a darned good reason to care about these jokers again before I do”. However, I’d wager good money that the 1:600 forex ratio chosen for this Pre Feas skews out the price assumptions for energy, lime, cyanide etc in dollar terms and all in the favour of project economics.

Bottom line: A junior exploreco is selling you a story, no more no less. If you can’t trust their story they have nothing to offer, so the job is to try to pick holes in their promo and see whether their pitch stands up to a little critical thinking. In this case I’ve already seen enough (more than enough, in fact) and don’t have the slightest inclination to check out capex assumptions, check whether they’ve taken into account the changes in the tax code under the new Bachelet government, any number of other line items. I only need to be BSsed once in order to walk away and the way in which this company has stretched parameters away from the conservative, through the potentially acceptable and out to a world of perfect for their purposes is all I need to know. If they’re doing it to me with things as obvious as a “base case” for gold that sits $50/oz higher than current spot, or with a CLP/USD forex rate that has no connection at all with reasonable assumptions for the future, then I simply don’t want to know.
One final word: Thanks to reader M, on Saturday I received Canaccord’s regular publication “Mineral Exploration Review” (aka Metaland) for the week, in which I read in the covering mail blurb the following (author’s highlights)

Based on the improving “risk-on” environment, we have decided it is time to build a diverse, gold-focused basket for exposure to the small cap, pre-cash flow mining sector. For a good start, we have turned to the three mining constituents of the Canaccord Genuity Canadian Small Cap Focus List: Dalradian Resources (DNA-T | Speculative Buy | $1.65 TP) with its flagship Curraghinalt high grade U/G gold deposit in Northern Ireland, Premier Gold (PG-T | Speculative Buy | $4.10 TP) with its flagship Hardrock open pit gold project near Geraldton, Ontario, and Roxgold (ROG-V | Speculative Buy | $1.20 TP) with its flagship Yaramoko high grade U/G gold deposit in Burkina Faso. To these, we have added one conviction name under coverage in Canada, Atacama Pacific (ATM-V | Speculative Buy | $2.10 TP) with its Cerro Maricunga oxide gold project in Chile, and two from our Australian Metals & Mining team: Gryphon Minerals (GRY-ASX | Speculative Buy | A$0.34) focused on its 3.6 Moz Banfora gold project in Burkina Faso, andOrbis Gold (OBS-ASX | Speculative Buy | A$0.57) advancing its gold projects in Burkina Faso.

That got me interested enough to open the PDF and see what the house had to say about ATM.v. Here’s the relveant snippet from the Canaccord document:

Atacama Pacific (ATM-V | Speculative Buy | $2.10 TP) has delivered a positive prefeasibility study on the Cerro Maricunga oxide gold project in Chile. The study shows significant improvement through reduced capex and a solid production profile of 228,000oz/a at $683/oz cash cost over a 13-year life.

I’d agree that on paper ATM has indeed delivered “significant improvement”, but sadly mines are built of other things than paper. I wonder how long the people at Canaccord took to make a buy decision on reading that NR Wednesday evening, and even if they’d bothered to think about some of the cost inputs, do they really care? However, I must say that I agree with their call on Dalradian (DNA.to) and wish them every success with their investment in that one.

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