2012 was not a good year for precious metals stocks and with a number of commentators calling gold lower, December was another poor month. However TSX and OTC listed Aurcana Corporation (OTCQX:AUNFF) announced on 14th December that its second major silver mine, in Shafter, Texas, was now in operation and that has propelled it into the ranks of the mid-tier producers, something not recognized in a share price of US$0.94. As production ramps up during 2013 this stock is one that should enjoy a material re-rating. My target price is US$1.89 per share.
To date Aurcana's lead property has been the 99.9% owned La Negra silver mine in Mexico. This project also produces material quantities of copper, lead and zinc and if one includes the by-product credits the cash cost of producing an ounce of silver equivalent in 2012 will have been less than $1 and output will have been 2.5 million ounces. A JORC compliant resource estimate published in October 2012 showed a Measured and Indicated silver resource of 115 million ounces plus associated credits and there is still exploration upside on the property as the strike remains open in a number of directions.
The company intends to increase its throughput capacity by 20% to 3,000 tonnes per day during 2013 and the grades on the parts of the deposit now being mined are materially better than historic norms. Hence it is possible that by 2014 output will be between 3.5 million and 4 million ounces. There should be a new JORC resource estimate published for La Negra during 2013 but this is clearly a very long life mine.
On December 14th 2012 the company also brought into production the Shafter mine 375 kilometers South East of El Paso in Texas. Output is now running at 600 tonnes per day and so there will be a modest contribution to Q1 calendar 2013 numbers from Shafter. This project has a measured and indicated resource of 24 million ounces of silver with another 23 million inferred ounces. Once again there is material exploration upside as the resource remains open along strike but also, possibly, at depth.
The company aims to get annualized output up to 1500 tonnes per day by the end of the first half of 2013 and that would equate to 3.8 million ounces of silver. Thereafter phase 2 of the project will see an enlarged mill constricted capable of processing 2,500 tonnes per day of ore which should see the company producing at an annualized rate of 6.3 million ounces during 2014 making this the third largest silver mine in North America. The cash cost of production will be $9 oz at 3.8 million ounces but should fall by a couple of dollars on the phase 2 output.
Hence by 2014 the company should be producing 10 million ounces of silver a year at a blended average cash cost of less than $5 oz.
Aurcana had net cash of $13.5 million as at 30th September. This will have fallen slightly with the costs of bringing Shafter into production. It has no debt. With both mines now producing it will, notwithstanding its expansion plants at Shafter, be adding to its cash pile on a quarterly basis.
It also has 74 million warrants and 28 million share options outstanding. The warrants all expire during 2013 at prices ranging from 40 cents to $1 while the options expire on a rolling schedule up to December 2017 with a strike price of anything between 10 cents and $1.02. One would thus therefore assume that there will be material inflows from the exercise of warrants and options (notably from 45 million warrants with a strike price of 41 cents that expire on December 7th 2013). In my valuation I assume that all warrants and options are exercised and this will realize c$68 million. On that basis there would be 567 million shares in issue with a broad institutional base (including Sprott) and a 98% free float.
So what is this business worth? The silver price is $30 today and it is my belief that it will trend higher, outperforming gold on a medium term view. But prudently I will use a $25 silver price in my assumptions. On that basis by 2014 this company will be generating free cash flow from two mines producing 10 million ounces a year of $200 million. Given the length of the mine lives and the relative political stability in the areas of operations a five times cash multiple (plus cash) implies a valuation of $1.07 billion or $1.89 a share.
Put another way, on a fully diluted basis this company is valued, ex cash, at $500 million. It has 217 million ounces of reserves, although the new JORC study at La Negra will increase that number during 2013. Despite being a low cost producer it is being valued at just $2.30 oz. In its most recent presentation the company uses data from Factset suggesting that a peer group comparison showed an average valuation in October this year of $4.65 per ounce of silver equivalent.
Whether on the basis of peer group comparators on a cash flow multiple bases, Aurcana look cheap. In part that might recognize that with a current market capitalization of $438 million this is a relatively small company. Hence there are more liquid silver plays and shares in this company can move rapidly (in either direction) on relatively low volumes.
However Aurcana has a string balance sheet and will be highly cash generative at a silver price well below today's price or even the $25 forward price I have used in my model. The market does not appear to have realized the importance of its 14trh December announcement and to have realized how large the Shafter mine could become. At $0.94 the shares are a buy with a $1.89 one year target price.