Description
Amerigo Resources is about to release some pretty substantial free cash flows. With a long lived asset, extremely low capital expenditure requirements and a low sensitivity to the price of copper, Amerigo offers investors a fantastic opportunity to receive low risk outsized dividends and capital gains. I expect later this year, they will announce an aggressive dividend policy that should propel the stock price and valuation higher. I estimate that Amerigo is worth at least C$3.50 a share and may be worth much more.
What does Amerigo do?
Amerigo’s facility, Minera Valle Central (MVC), produces copper from excess tailings from the world's largest underground copper mine in Chile, Codelco's El Teniente mine. The process works this way:
The El Teniente mine (2000 meters above sea level) extracts copper from the mine, then it sends the excess or tailings down the mountain in concrete channels (half open tubes). MVC(680 meters above sea level) processes these tailings which are about 50% solid and resemble sand, and extracts more copper out of these tailings. Think of them as a recycler so to speak.
Amerigo is adding an expansion that also extracts molybdenum (called Moly from now on). This plant will go online in the second quarter of 2005.
What is important is that Amerigo does not own the waste product when it is done. It simply extracts the copper and Moly, pays a royalty and sends the waste product further down the mountain. Codelco is the state run mining company of Chile and deals with it then.
Copper and Moly Supply Demand
This process normally has costs of $0.55 to $0.60/lb of copper. And it was marginally profitable when copper was at $0.65 to $0.70/lb as it was in 2002 and early 2003. However, copper prices have exploded higher due to the boom in China and the bull market in commodities. Copper now trades north of $1.40/lb. Such prices make this plant extremely profitable.
However, the bull market in copper has nothing on the bull market in Moly. Prices for Moly have exploded higher from $4/lb. to as high as $34/lb, making it one of the star commodity performers. But what is Moly?
Moly…What?
The Definition from the Molybdenum Insitute:
“Molybdenum is a metallic element which is most frequently used as an alloying addition in alloy and stainless steels. Its alloying versatility is unmatched because its addition enhances strength, hardenability, weldability, toughness, elevated temperature strength and corrosion resistance. Although Molybdenum is primarily used in steels, its complex and unique properties have proved invaluable in a constantly expanding range of other alloy systems and chemicals. One of the unique features of Molybdenum, as distinct from other heavy metals, is that laboratory tests have shown its compounds to be of low toxicity.”
Moly when added to steel makes a great combination of unmatched strength and durability to corrosive elements. This is one reason that oil tubular piping, especially for deep sea drilling uses Moly steel goods. Oil drilling and piping demands have been one source of renewed use of Moly in steel, especially as oil companies start to drill deeper and deeper. Besides specialty steel like oil country tubular products (piping), Moly is also used in chemicals and lubricants.
Moly is generally mined as a by-product to copper mining and production. For years, no one paid attention to it, much like no one paid attention to natural gas produced when all people cared about was oil.
Moly Supply/Demand
Thirty years ago, most Moly production came from independent mines, and only 30% came from being a by-product of copper production. Now 80% of all of the production of Moly is produced this way. After an exhaustive search, I could only find one public company in the world that announced it was going to develop an independent mine dedicated solely to Moly. This mine is scheduled to come online in 2007.
Moly consumption is about 140,000 tons per annum and its true demand will be linked to the demand for steel. If steel demand falls, the demand for Moly will fall as well.
New copper technology excludes Moly
Copper can be mined two ways. Copper ore can be concentrated, smelted and then refined as a separate process. Or Copper can be crushed and the ore extracted by dissolving the copper in acid and collecting the acid through electrolysis. This last process is called Solvent Extraction-Eltrowinning (SXEW). SXEW accounts for 15% of copper production. This technology has been around for 30 years and is one of the reasons that the price of copper has declined over the past 30 years.
Recent improvements in the technology enable higher recovery rates that have allowed many marginal and low-grade deposits to become economically viable. However, SXEW does not recover Moly. So, as SXEW has grown copper production, it has not grown Moly production, and in fact more SXEW mined copper, actually leads to less supply of Moly.
Copper Supply/Demand
Copper is used primarily in the electrical and plumbing industries. It is used to make wiring for such things as televisions, radios, and telecommunications equipment. Due to its high resistance to corrosion, copper is used to make radiators, cooling systems, and is used in solar heating applications. Copper is also used to make bronze and brass.
Copper is produced almost worldwide. Most is produced in Chile, Peru, South Africa, North America, and Russia. In the US, Arizona is responsible for about 65 percent of production. The three largest consumers are the US, Russia, and Japan. While the US and Russia produce a good deal of copper, Japan must import large amounts to meet its demand.
The demand for copper is very close to supply with about 12.5 million tons in demand and about 13 million tons of theoretical supply (assuming every mine runs at 100%). And demand has been growing rapidly due to the demands of China and India. Just think of all the wiring and plumbing that every new house/building in China needs, and you can understand why the price of copper is so high.
A big issue with supply is that it appears that much of the world’s copper deposits have already been discovered. Much like oil, most of the discoveries happened in the 1960s and the newer discoveries tend to be in remote (Mongolia) or very deep locations, such as 2000 meters down.
While not as dramatic as Moly, copper supply remains tight.
Long lived Asset, No Ownership of Tailings, and Very Low Capex
The El Teniente mine has a lifespan of 65 years at least, and it may be much longer. Amerigo has the right and contract to work for 18 years and will probably be able to extend on the contract for as long as the mine has a lifespan.
Amerigo also has no ownership of the tailings, and as such has no environmental obligations or handicaps.
And the best part of the Amerigo story is its extremely low capital expenditure (capex) requirements. After spending $16 million in capex to get their new Moly plant up and running, 2006 will bring $11 million in capex, and then in 2007 on, capex should be as low as just $1 million a year. Their process is not a technological marvel and mainly involves gravity, tubes, valves and some machinery. Also, the technology has been around for years.
Opportunity to duplicate El Teniente elsewhere
The big long term opportunity is to duplicate what they are doing at El Teniente elsewhere. There is a thought that Amerigo could go up and down the Pacific coast doing this for every mine. In fact, Amerigo could do this for several more Codelco mines alone. Remember, Codelco is the Chilean state run company that owns and operates El Teniente.
No one else is doing anything like this, outside of some very local operations at various mines.
I expect after the Moly plant is fully operational next year and the cash flows are jumping, there will be plans drawn up for Amerigo to use the cash flow not paid in a dividend to expand.
Heavy insider ownership and strong management team
Management owns 15.3 million shares, nearly 18% of the shares outstanding. So far they have not really sold any shares despite the stock rising from mere pennies two years ago to its current share price. Interestingly, the stock has consolidated the massive gains it made in 2003, by not really going anywhere in 2004.
Besides owning a big stake in the company, the management team boasts a resume and history that should impress any investor. Both the chairman and president come from Teck Cominco, an $8 billion industrial metals miner, producer and smelter in Canada.
Steven Dean, the chairman of Amerigo, was the president of Teck Cominco for three years. And Dr. Klaus Zeitler, the president of Amerigo, was a senior vice president of Teck Cominco for six years.
Cash Flow Estimates
(Note: All figures US unless denoted by C in front of $ for Canadian)
Amerigo does not hedge currency exposure or commodity exposure. The following estimates assume that Moly is at $25/lb., copper averages $1.25/lb., and that they produce 43mlb of copper and 0.4mlb of Moly. Assuming further that Amerigo would have a blended cash cost (includes royalties) of $0.79/lb. Amerigo’s costs outside of royalties at about $0.55 to $0.60/lb. in copper and $2/lb. in Moly. With Moly costs so low, the payback on their Moly expansion could be in less than two years!
Under those assumptions, Amerigo would produce C$0.38 a share in operating cash flow or C$32.2 million. **Remember that currently Moly is north of $32/lb. and copper is north $1.40/lb.** At current commodity prices, Amerigo would produce cash flow close to C$0.50 per share. (Amerigo has 86.2 million shares outstanding)
Now the upside to the cash flows comes in 2006-2008 as production of Moly ramps up from 0.4mlb to over 1mlb. Estimating that production of Moly is 0.7mlb in 2006 and that copper production 60mlb and copper is only $1.15/lb. and Moly is $20/lb, cash flow per share is over C$0.40 and free cash flow near $20 million or over C$0.20 a share. By 2006, even with a 50% FCF payout in 2005-2006, Amerigo will have built a $25 million war chest in cash.
Basically, Amerigo is a cash machine, once they get over the capex hump for 2005-2006, investors will be looking at free cash flow per share of near C$0.40 for the next 50 years (@$1.15 copper and $20 Moly). With no debt and management’s reluctance to overpay or be acquisitive, these cash flows will be returned to shareholders at a startling rate.
Amerigo is simply a cash cow.
A couple of side notes, $14 million in warrants will be exercised mid year, and that will boost the cash balance of the company. Those warrants are already is accounted for in the diluted share count.
Royalty Rate Make for Low Sensitivity to Underlying Metal Prices
The royalty rate is on a complex sliding scale for the price of copper with Codelco. The royalty simplified: 50% of the operating profits above $0.80/lb. are paid to Codelco and below $0.80/lb. Codelco receives no payment. So, if copper plunged over 40% from current prices to $0.80/lb., due to the absent Codelco royalty, Amerigo would still be able to pay a 4-5% dividend, and comfortably make money.
Valuation
Valuing it at 9.5 times 2005 cash flow, Amerigo is at least worth C$3.50. Why value a commodity company this high? First, it has no debt. Second, no other miner has sustainable capex of only $1 million or 3.5% of ongoing cash flow. Other miners have substantial capital outlays just to keep production flat. Third, due to its royalty structure, Amerigo can still produce 5% FCF yields even if copper prices plunge over 40%. Every other miner’s cash flows start losing money at such levels.
I expect that in 12 months, investors will eventually value Amerigo at 10 to 12 times free cash flow estimates of C$0.40 plus per share, that should continue for a lifetime, commodity markets permitting.
Finally, Amerigo should possess a premium because of the optionality for duplicating the El Teniente project elsewhere. With any kind of announcement of a new project at any of Codelco’s other mines or with another mining company, Amerigo would soar.
On copper production alone, this company is C$2 on a Net Asset Value (NAV) basis. Adding the Moly potential and you get C$3.50 easily.
Summary
Amerigo is a unique company with no real comparables. No other company does what Amerigo does. And this is what attracts me to it. And I feel that investors are not sure what to make of the company.
If you are looking for a copper sensitive play, Amerigo isn’t for you. But if you are looking for a low risk play, with no debt and substantial free cash flows ahead of it, then Amerigo is for you.
I expect that at a minimum, Amerigo will post a C$0.07 a share dividend this year (50% payout of C$0.14 in FCF this year). This will rise to 2007’s whopping C$0.21 (still a 50% dividend). By 2007, Amerigo even with that dividend will have accumulated C$0.50 in cash on the balance sheet. And those 2007 estimates are with copper at $1.15, and Moly at $20. At current commodity prices, the dividend would be over C$0.30 per share.
In short, expect dividends to be much higher than what I’m writing, and the possibility of large special dividends is high.
In twelve months, I expect investors will be looking at a stream of cash flows lasting as far as the eye can see and Amerigo will be trading over 60% higher than its current share price. Add in expected dividends and investors should see nearly a 65% return with an investment in Amerigo.
Hedging Options
If you are worried about the economy stalling or China experiencing a hard landing, I recommend shorting Phelps Dodge (NYSE: PD), which has a much larger expense base, higher capex requirements, and a shorter reserve life, with less volume growth potential. If copper falls significantly, PD will get crushed.
Another option is to short AK Steel (NYSE: AKS), which is a steel producer with substantial pension issues. Any slowdown in the economy and in China would adversely affect steel prices and AKS.
Catalyst
1) Dividend announcement
2) Realization of uniqueness of Amerigo’s model
3) Sooner than expected commissioning of Moly plant
4) Contract to Duplicate MVC elsewhere
5) Possible 2006 special dividend
6) New Analyst Coverage