Canadian Zinc Has Enormous Upside Potential - Full Article Canadian Zinc Has Enormous Upside Potential
Aug 12 2013, 04:19
Disclosure: I am long
CZICF.OB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
(More...)
This article is about Canadian Zinc (
CZICF.OB). Canadian Zinc has a market capitalization of $100 million, or $113 million fully diluted. The company owns the Prairie Creek property in the Northwest Territories, which is a development stage zinc, lead, and silver mine. It also owns the South Tally Pond poly-metallic exploration property in Newfoundland.
Most of the company's value is in its Prairie Creek property, which is in the final stages of permitting, and will likely begin its two year construction process later this year. Management has done an excellent job securing its permits, as is evidenced by the company's recent
announcement that it received its land use permit, and its subsequent
announcement that it is near to receiving its water permit.
As a result the stock has performed incredibly well while other mining company shares have languished in the face of generally weak commodity prices. The following chart of Canadian Zinc shares in terms of the SPDR Metals and Mining ETF (
XME) illustrates this point.
(click to enlarge)
Assuming that the company receives its water permit, it will be in production by second half of 2015. While the company needs an additional $150 million in order to construct the mine at Prairie Creek, this figure is small relative to the mine's potential production given that a lot of the necessary infrastructure is already in place. In light of the company's potential $40 million in annual cash flow at current metal prices, it may be able to raise some of the money it needs through a debt offering and limit the number of shares it must issue.
Given the location of Prairie Creek, the high likelihood that Canadian Zinc will get the permits it needs to produce, and the company's potential cash flow, the shares appear to offer a lot of potential value at $0.61/share.
In addition to the value found in Canadian Zinc shares based on its cash flow potential, there is a good possibility that the company will be able to expand its resource base at Prairie Creek. If this occurs, and the company is able to develop a mine at South Tally Pond, then it can potentially be a $1 billion company.
Canadian Zinc's Properties
A: Prairie Creek
Prairie Creek is an underground lead, zinc, and silver mine (with some copper resources) in the Northwest Territory.
(click to enlarge)
The company is fortunate in that a lot of the infrastructure necessary to build the mine already exists.
(click to enlarge)
Nevertheless the existing infrastructure needs to be brought up to date, as it is from the 1980s. In all the company believes that it will need $160 million in order to develop the mine, and that this development will take about 2 years (which means production will be in 2015). The following chart itemizes these expenses.
(click to enlarge)
Resources
Prairie Creek has an enormous resource base given Canadian Zinc's market capitalization. It has roughly:
- 1.2 billion pounds of zinc reserves at 9.4%, and 2.2 billion pounds of inferred zinc resources at 14.5%
- 1.2 billion pound of lead reserves at 9.5%, and 1.7 billion pounds of inferred lead resources at 11.5%
- 25.4 million ounces of silver reserves at 151 grams per tonne, and 46.1 grams of inferred silver resources at 229 grams per tonne.
This information is detailed on the following tables.
(click to enlarge)
(*Note that resource data includes reserves data.)
Production/Sales/Cash Flow Data
When production begins the company will be able to produce:
- 76 million pounds of zinc annually, worth $65 million at $0.86/lb. zinc
- 90 million pounds of lead annually, worth $88 million at $0.98/lb. lead
- 2.2 million ounces of silver annually, worth $45 million at $20.50/ounce silver
Thus at current market prices the company will see an estimated gross sales figure of $198 million annually (I am assuming no copper production given that all of the company's copper is in the "resource" category, with none in the "reserves" category). Given that in May, the company sold a 1.2% net smelter royalty to Sandstorm Metals and Energy (
STTYF.PK) (
news release), this figure drops to $195.6 million. It will produce this by mining 1,350 tonnes of ore per day, or roughly 486,000 tonnes annually (using a 360 day year). According to the company's NI 43-101 it will cost a little over $200 for a tonne of ore to go from mining to final processing into sellable metal.
Assuming conservatively that it will cost $225/tonne, the mine's total annual production cost should be around $110 million. If we assume a $10 million annual exploration budget, $10 million for annual mine repairs and maintenance, and a 40% tax rate, then the company should have annual cash flow of 0.6 * ($195.6 million - $110 million - $10 million - $10 million) = $39.4 million.
The company needs roughly $160 million in order to develop Prairie Creek once it gets its final permits. Assuming it gets the additional $150 it needs (it got $10 million from Sandstorm Metals and Energy) through share dilution, it will have a valuation of $250 million, which means that it currently trades at roughly 6.3 times its estimated 2015 cash flow.
Canadian Zinc's Cash Flow in a Dynamic Metal Price Environment
In what follows I recalculate this figure based on changes in metal prices. Potential investors in Canadian Zinc are presumably bullish on the prices of one or more of the company's three metals. For the sake of simplicity I will lump lead and zinc together and assume that 1 pound of zinc is simply 0.88 pounds of lead (i.e. 157 pounds of "lead"). They are both industrial metals, and they both trade at roughly the same price. They also have similar price patterns, although not exactly similar, as the following charts illustrate.
(click to enlarge)
(click to enlarge)
The crucial difference between the two is that lead made a new high at the end of 2010, whereas zinc peaked several months earlier.
I will treat silver differently given that it is also a precious metal and therefore has different supply-demand fundamentals. This is reflected in the metal's price action, as the following chart illustrates.
(click to enlarge)
The following table estimates the company's cash flow assuming the following:
- 157 pounds of lead (i.e. lead and zinc) production at various lead prices
- 2.2 million pounds of silver at $20.5/ounce
- 1.2% NSR to Sandstorm Metals and Energy
- $110 million production cost
- $10 million mine repair cost
- $10 million exploration cost
- 40% tax rate
| Lead Price |
Cash-Flow |
| $1/lb. |
$41.75 million |
| $1.25/lb. |
$65 million |
| $1.5/lb. |
$88.3 million |
| $1.75/lb. |
$111.5 million |
| $2/lb. |
$135 million |
| $2.5/lb. |
$181.4 million |
| $3/lb. |
$228 million |
The following table calculates the company's cash flow making the same assumptions, except that it keeps lead and zinc prices constant while varying silver prices.
| Silver Price |
Cash Flow |
| $20/ounce |
$38.8 million |
| $25/ounce |
$45.3 million |
| $30/ounce |
$51.8 million |
| $40/ounce |
$65 million |
| $50/ounce |
$78 million |
| $100/ounce |
$143 million |
From this data it is evident that Canadian Zinc's cash-flow should be highly leveraged to the prices of lead and zinc, and that investors who are bullish on these metals should consider taking a position in the company's shares.
Exploration
Prairie Creek has a lot of exploration potential. The following map shows the location of the defined mine next to zones where Canadian Zinc has discovered some preliminary exploration targets. The key has been blown up and repeated in a separate image for the reader's convenience.
(click to enlarge)
(click to enlarge)
From this image there are two drill holes that indicate that mineral veins may extend north by northeast of the actual mine. In addition, there is another drill result (not shown) that is northwest of the mine that is 1.1 meters of 35% lead, 18% zinc, and 242 grams per tonne of silver (for the full image see page 20 of the company's
presentation). While there is no conclusive evidence from these early drill results, it is possible that the defined mine is just the tip of the iceberg of what will be found at Prairie Creek. Were this the case, the resource and production figures I give above would be a fraction of the actual figures.
B: South Tally Pond
South Tally Pond in Newfoundland is an exploration property acquired by Canadian Zinc through its acquisition of Paragon Minerals in September, 2012. It is a poly-metallic property containing the following resources assuming a 7.5% zinc equivalent cutoff grade (meaning that the company does not plan on mining any ore that it believes contains less than 7.5% zinc equivalents).
- Zinc: 119 million pounds of indicated resources at 3.7%, 160 million of inferred resources at 5.38%
- Copper: 13.2 million pounds of indicated resources at 0.41%, 17.3 million pounds of inferred resources at 0.58%
- Lead: 27.6 pounds of indicated resources at 1%, 35.4 million pounds of inferred resources at 1.19%
- Gold: 43,000 ounces of indicated resources at 1 gram per tonne, 40,000 ounces of inferred resources at 1.01 grams per tonne
- Silver: 2.2 million ounces of indicated resources at 50.51 grams per tonne, 2.4 million ounces of inferred resources at 59.17 grams per tonne
(click to enlarge)
This data, compiled by Paragon Minerals, indicates that there is not yet enough metal for there to be a mine, although the property has more exploration potential.
As a result Canadian Zinc has done its own drilling, and on April 17 it released the following drill results.
(click to enlarge)
There are some promising results here, particularly at LM13-73, LM13-74, and LM13-79. While there is not enough here to extrapolate additional resources, this data, coupled with the data previously compiled by Paragon Minerals, is promising.
Risks
A: The Prices of Lead and Zinc
As I have already discussed the prices of lead and zinc should have similar fundamental drivers. Both will do well if there is inflation and a booming global economy, and both will suffer during an economic contraction and if there is deflation. The prices of both metals have been building support: zinc around $0.80/lb. and lead around $0.90/lb. If this technical support breaks there is a good possibility that the prices of both metals will suffer, and this will weigh on Canadian Zinc's shares and retard its capital raising efforts. While I included 5 year charts above, these support levels are easily seen on the metals' respective one year charts.
(click to enlarge)
(click to enlarge)
B: The Price of Silver
The price of silver has performed terribly over the past two years, having declined from $48/ounce to around $20/ounce. While there is significant technical support at the current price the downtrend that began in May 2011 is still intact.
(click to enlarge)
Most silver producers cannot turn a profit at the current price, and this is a reason that the silver price has likely reached or is near a bottom. Still the downtrend is intact, and Canadian Zinc's share price should be somewhat correlated to the price of silver.
C: Canadian Zinc's Capital Needs
Canadian Zinc needs about $160 million in order to develop its mine at Prairie Creek. It already raised $10 million through its royalty deal with Sandstorm Metals and Energy, but it has yet to receive its final permits and it is burning through its already limited cash. Just recently the company
announced a $4 million private placement which is dilutive to existing shareholders. Assuming that it will have to raise only $150 million, the company will still have to raise 150% more than its current market capitalization. It has the following options.
- It can issue more stock.
- It can issue debt.
- It can sell another royalty.
- It can sell part of its Prairie Creek mine to a JV partner.
- It can sell itself to an acquirer.
- It can sell South Tally Pond
The fact that the company acquired South Tally Pond so recently indicates that management is trying to build a mining company with multiple properties in multiple jurisdictions, and so I doubt it will resort to the last three options. Further, since it has already sold 1.2% of its production at Prairie Creek, I don't think it will sell another royalty. Therefore it is most likely that the company will issue stock, and possibly some debt. Given the recent run-up in the shares this may not be so bad. Further, once the company gets its final permits the share price should jump, which will make dilution less painful for existing shareholders.
D: Canadian Zinc's Size
Most of Canadian Zinc's value is in its Prairie Creek property. If, for whatever reason, it cannot mine at Prairie Creek, it is essentially worthless.
Conclusion
Canadian Zinc has a lot of potential to become a major poly-metallic mining company in Canada. It operates in low-risk jurisdictions, in which it owns a lot of land in addition to its Prairie Creek mine. By 2015 - 2016 the company should have a lot of cash flow to explore its land further, and expand its resources. While the stock has run up as of late given the fact that it has moved forward in receiving its permits, it is still incredibly inexpensive relative to its cash flow potential, especially if it is able to expand its mine at Prairie Creek, and if lead, zinc, and silver prices rise. Ultimately for investors who are bullish on these metals Canadian Zinc appears to be an excellent investment opportunity.
https://seekingalpha.com/article/1627802-canadian-zinc-has-enormous-upside-potential?source=google_news