Louis James, Casey Research: Silvermex Analysis 11-14-2011
Dear Speculators,
Today’s pick is a chance to get in on a new emerging silver producer in Mexico, before the market realizes what’s going on. Prices are down, due to skepticism (rightly) assigned to past management, but there’s a new team running the mine, getting good results, and the stage is set for a turnaround in more ways than one.
Louis James
Senior Metals Strategist
Casey Research
| Price |
Share: C
.465 |
MCap: C$110.5 million |
On: 11/11/11 |
| Shares |
SO: 237.7 million |
FD: 299.1 million |
As of: 8/31/11 |
| Warrants |
UnEx: 48.7 million |
C
.32 - C
.90 |
Exp: 2/12/12 - 12/16/13 |
| Options |
Open: 12.6 million |
Wt. Avg. C
.58 |
Exp: Avg. 3.0 years |
| Cash |
C$16.5 million |
Burn: C$400K/mo
+CapEx C$1.3M/mo |
As of: 6/30/2011 |
BUY FIRST TRANCHE—The primary virtue of Silvermex is that it’s much cheaper than our other silver producers. If you wish you could have bought a company like Endeavour, Fortuna, or First Majestic when they had the MCaps of junior explorers, this could be your chance to get in on that level. By the Ps…
People
Silvermex is run by several ex-Hecla Mining people with proven track records of building mines. SLX’s chairman is Arthur Brown, past chairman of Hecla, and the president is Mike Callahan, past VP for corporate development at Hecla. The GM for Mexico is Clyde Peppin, past project manager and chief engineer for Hecla, the VP for exploration is Robert Fraser, past VP exploration for Hecla. Hecla has its issues today, but there’s no doubt that these people helped build successful mining operations, and our usual due diligence on them, individually, has turned up nothing but endorsements.
We also note the presence of Ken McNaughton on the board, currently chief exploration officer at Bob Quartermain’s Pretium Resources and formerly with Silver Standard.
This is a team with a great pedigree, and, critically, getting results on the ground.
Property
SLX has five prospective properties in Mexico: Penasco Quemado, Lobos, Rosario, La Frazada and La Guitarra. The first two are in northwest Mexico, where we’d have concerns about security, but these are not the company’s top priorities nor where we expect near-term growth to come from. The main asset is the producing La Guitarra silver mine in southern Mexico, which struggled under previous management but is now cranking out operating profits.
La Guitarra is a historic Mexican mine, with operations going back to the 1550s. The current configuration is a typical 320-tonne-per-day (tpd) flotation circuit. Past reported 17.7 million ounces of open pit reserves averaging 165 g/t AgEq and P&P underground mining reserves (January 2010) tallied 20.4 million ounces of silver-equivalent at an average grade of 291 g/t AgEq (the “equivalent” is gold). That’s excellent grade, but the veins are narrow, and previous operators had a tough time keeping the mill fed. New management is reinterpreting all old data and plans to have new, more conservative 43-101-compliant resources and reserves to report to the market soon.
Previously, the mill was operating at about 50% of capacity. The new team appears to have fixed this, spending $13.4 million at La Guitarra this year, upgrading equipment, drilling off more mine reserves and resources, and developing more stopes. Head grade for the first half of 2011 was reported at 281 g/t AgEq, which is very rich in today’s silver price environment.
Last week, SLX reported that they have brought the mill up to 100% of capacity, which should be reflected in Q411 financial results. The mill was already up to about 85% of capacity in Q3 and achieving higher metal recoveries. With Q3 financial results due out soon and the mine already producing operating profits in Q2, we expect there to be good news.
To keep production up and growing, management say they have increased their exploration team from six to 25 people. Recent exploration efforts have discovered previously unknown veins parallel to the old ones – they’re narrow, but with mine development already in place, should be relatively low-cost to produce. Best drill intercepts from the most recent press release included 1.71 g/t gold and 509.1 g/t silver over 2.0 meters, 2.32 g/t gold and 476.1 g/t silver over 1.1 meters, and 1.09 g/t gold and 406.2 g/t silver over 2.2 meters.
More good news: La Guitarra is one of four past-producing vein systems along a 15-kilometer trend held entirely by Silvermex, so there is plenty of exploration upside that can quickly be turned into production, either by increasing the capacity of the existing mill or by building another (permitting should be relatively straightforward). Drilling to get the next areas ready for production is already underway.
Plus, the company plans to move towards production at the past-producing Rosario mine in west-central Mexico as quickly as possible. This is a recently past-producing mine, with water, power, tailings, surface rights, mining equipment and a 600 tpd mill already in place. It’s hard to say just what the scope of the opportunity here is, but Grupo Mexico, the major Mexican mining company that operated the mine in the 1990s, reported leaving approximately 900,000 tonnes grading 0.8 g/t gold, 192 g/t silver, 2.08% lead, 3.37% zinc, and 0.18% copper behind. That’s not a bad start.
Silvermex budgeted $1.6 million this year to getting a grip on that, and we should see results soon.
All of this and more is very bullish, but we have to caution that we have not been on site yet to verify. That said, given the nature of the People involved – and those who’ve vouched for them – we’re inclined to believe the story. Once the company publishes official figures and the impact of these improvements start showing up in the company’s financial statements, this story should be getting a lot more notice.
Politics
We like Mexico, politically, as a mining jurisdiction – the place has steadfastly resisted the hard left turns it was known for in the past and that have plagued countries farther south. The key assets are in quieter parts of Mexico, and the company is already operating without major political problems, so we see no red flags at present.
Push
Plenty of push here:
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More operational improvement milestones.
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Improving financial results, probably including greatly increased operating cash flow for Q3 and possibly, just possibly, net income for Q411. If not this quarter, we do expect net income in Q112, unless management seriously drops the ball. Assuming SLX delivers, we expect a revaluation by the market soon.
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More high-grade drill results.
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New discoveries beyond La Guitarra.
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Farther ahead, expansion of production well above the current 320 tpd.
Paper & Phinancing
The paper situation is this company’s weakest P. We generally don’t like seeing that much paper issued and outstanding; however, in this case, the bloat is largely due to missteps by previous management and the merger of Silvermex and Genco. On the bright side, the last financing was almost a year ago, so all paper is free trading – and largely out of the money, so all interested parties benefit with us as new shareholders, seeing the share price rise.
What matters now is that the company has good cash flow and can grow without having to go back to the trough. For example, management say they already have a bank of flotation cells on site for increasing the capacity of the existing plant – other elements like this make for low capex requirements for significant growth.
The bottom line here is the MCap; it’s low for a growing producer on the cusp of profitability.
Price
The current share price makes for a good entry point. Any good news from this company along the lines above could reverse the current slide and start the stock on an upward trajectory. On the other hand, unless there’s very good news that gets that trend reversed, tax-loss selling in the weeks ahead is likely to take the share price lower before it heads up.
So we do recommend a first tranche now, and then to look for second-tranche opportunities just ahead. We wouldn’t chase it, but we wouldn’t dally, either, as there is important news on the way.