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Hoping for a Copper Comeback
Posted by David
Background
Chile is probably the world’s #1 supplier of copper (~35%) through the state-owned entity Codelco and various foreign producers. The geology of the Andes lends itself to large-scale porphyry deposits rich in copper as well as gold, molybdenum, silver, rhenium and other metals. Such a huge drop in the prices of these commodities (with the possible exception of gold) has done serious damage to the Chilean economy. With copper exports representing such a huge portion of its GDP (US$37.6 billion, or 56% of total exports in 2007), Chile’s trade surplus for 2008 will appear puny indeed.
Gold vs. Copper
As with most base metals the price of copper has experienced a huge drop from about US$4.00/lb. in July to $1.29/lb. this Monday. This drop has caused any company that has copper as a significant component of its production to suffer serious revenue decreases. Good examples of these are VALE-INCO (NYSE-RIO) (although nickel and iron are to blame here as well) and Yamana Gold Inc. (TSX-YRI, NYSE-AUY, LSE-YAU). Yamana itself is an interesting case as although it is touted as a gold producer, a significant source of its revenue is from copper (e.g. Chapada, Brazil). This has caused Yamana to see a slower rise in share price than other more gold-oriented companies, such as Kinross (TSX-K).
Challenges for a Small-Cap Company
However, large companies have the obvious ability to weather these low metal prices and Yamana stock has still seen a rise from ~CA$5/share to just below $10/share in the past month, mainly due to interest in gold. It is the small-cap companies that have the most to worry about in the short term when metal prices slide. One such company in Chile that is feeling the pressure is Cu-Mo tailings processor Amerigo Resources. Things have changed for Amerigo since the last KIM Report article in April 2008, copper and molybdenum prices have tanked and most producers are happy if they are currently breaking even. At the time of that article, Amerigo was struggling with high energy costs due to a very dry season at the time as most electricity in Chile is hydroelectric in nature combined with high fuel costs. Now fuel costs are down, Chilean electricity is cheaper due to more precipitation, and electric generators running on cheap bunker oil have been installed at their facility near the Codelco-run El Teniente mine (from which they obtain the tailings for processing). Unfortunately, the timing of these energy-savings coincides with the drop in metal prices. Amerigo recently released news that it had incurred negative price settlements for sales of copper and molybdenum to smelter companies Enami and Molymet, respectively.
The Upside
The good news is that Amerigo believes it can reduce its production costs before royalties (which are tied to copper price) to $1.20-1.25/lb. The company has recently managed to partially defer energy, royalty (paid to Codelco), and negative copper price settlements. It is in the process of negotiating deferral for the negative molybdenum payments as well. Enami, a state owned entity, has an established mandate to support small to medium copper producers through price protection. How this will affect Amerigo has not been determined. Amerigo has also extended its banking line to US$5.6 million and has opened a new line with a second bank for $5 million. Negotiations are also occurring to open new long-term credit facilities of $10-20 million. On the shareholder end, management has enacted a shareholder rights plan – in essence a poison pill to dissuade any opportunistic takeovers.
Caveat Emptor
The real issue here is if Amerigo will maintain its CA$0.065 semi-annual dividend due this spring. Many shareholders considered a ~6% return to be excellent last spring when the price was around CA$2.25/share. Now with the share price at ~$0.35/share, this ~20% dividend is either an amazing opportunity, or indicative of extreme risk. Given the unclear forecast for metal prices, it appears to be anybody’s game. Amerigo’s future good financial health depends on its continuing good relations with its creditors and smelters.
Disclaimer: The author holds 500 shares of ARG and 200 shares of YRI. This article is based on the experience and opinions of the author. Please do your own due diligence when investing.
Small cap Cu-Mo producer gives steady payout
Posted by David
At the Prospectors and Developers Association of Canada (PDAC) convention this March, I stopped by the booth of a company that I had visited last year and remembered to have stood out amongst the rest. Amerigo Resources (TSX-ARG) operates a facility in Chile near a huge copper (Cu) porphyry mine run by Codelco. Codelco is a nationalized Cu-mining company that owns 20% of the world’s Cu reserves and is run by the Chilean government. ARG has an agreement with Codelco to process the tailings from current and past mining operations at the El Teniente mine. These tailings are processed for mostly Cu, but with some molybdenum (Mo) credits as well. The royalties paid by ARG to Codelco vary with the Cu price and are capped at 13.5 % for a Cu price of (US) $1.20/lb or higher. The current Cu price is over $3.50/lb.
What really attracted me to investing in ARG was their steady business model. They do not have any mining or crushing costs. Nor do they have any exploration costs as the old tailings piles represent around thirty years of stockpile, and El Teniente is expected to be in production and providing fresh tailings for at least another sixty years. As a result of their steady production, they can pay out a $0.065 (CAD) semi-annual dividend, an annual return of almost 6% at recent prices.
ARG management has a good record of getting tasks done on schedule. Their plant to recover Mo from the tailings was built in 3 months, ahead of schedule and was paid back in only three months. Current projects are the expansion of their main plant, the installation of generators to offset energy costs, and negotiations with Codelco to process the higher grade (older tailings are 0.3 % Cu vs. newer tailings at 0.1 % Cu on average) tailings from historic production (Colihues tailings pond and others).
Company representatives at the PDAC commented that 2007 profit was cut into by increasing electricity costs that have plagued South America recently. They are awaiting delivery of two large generators from overseas to combat this problem. The generators will burn relatively cheap bunker oil to produce the electricity. They also commented that they expect the negotiations regarding their access to the old tailings piles to wrap up by the end of spring.
In spite of increasing energy costs, ARG managed to increase Cu output by 35% last year from 2006 numbers. The company also increased its annual cash flow to (CAD) $0.33/share from $0.29/share in 2006. Good investments in juniors such as Chariot Resources (TSX-CHD) amd Candente Resources Corporation (TSX-DNT) have contributed to this strong cash flow. ARG also has zero long term debt.
I got in at this share price as it is near historic lows and gives a strong return. I do not personally know of any other base metal producers paying out such a high dividend. On the downside, ARG is sensitive to Cu and Mo price fluctuations (i.e. the occasional hand-wringing and incompetence south of the border), along with increaing electricty costs. These problems are tempered somewhate by the factors described above, and the long-term demand from growing economies (e.g. the BRIC countries). Of course, most mining companies have found new 52 week lows during these past 52 weeks and dividends are not set in stone, so do your own due diligence when investing.
Disclaimer: The Author holds 500 shares of Amerigo Resources. This article is intended for entertainment purposes only and is based on the author’s personal opinion and experience. Investors are responsible for their own due diligence when investing.