- Dynacor has stopped accepting ore for its Peruvian gold processing plant due to a crack-down on illegal mining.
- Half a ton of gold has been confiscated in a major illegal gold bust. Reuters retracts press release about involvement of one of Dynacor's suppliers.
- The share price has suffered and we predict further headwinds.
- We consider Dynacor a SHORT at the present point in time.
Dynacor (OTC:DNGDF) has a pretty simple and seemingly fool-proof business model. So much so that a fellow author made Dynacor his overall number one stock pick for 2014. We sincerely hope that he hasn't acted upon his own advice.
The share price has been on a roller coaster of late and we have every reason to believe that the general direction for the coming weeks and months will be south.
The Business Model
Dynacor operates a gold ore processing plant in Peru. The company purchases ore, processes it and sells the resulting gold to the market. This business has been working very profitably and Dynacor has managed to generate substantial, and growing cash flow from this operation.
Cash flows from the processing business were used to finance the other part of Dynacor, which is a junior exploration company developing the flagship Tumipampa project.
Put simply, Dynacor is a self-funded junior precious metals explorer.
Illegal mining is a major problem in Peru generating $3B in revenue per year according to official figures, involving 40,000 illegal miners and up to 300,000 related workers. Peru is the largest coca and cocaine exporter, but illegal gold mining has become even more lucrative in this country.
Beside the obvious economical problems such as tax evasion and money laundering this shadow industry also creates significant environmental damage. Illegal miners typically use mercury to extract gold from ore poisoning surroundings in the process. Stanford University studied an area called Madre Dios and found that 75% of the people (and 69% of the children) were exposed to three times the tolerable level of this heavy metal.
Peruvian authorities have been cracking down on illegal gold mining with mixed success. Until now that is. A few weeks ago half a ton of gold was seized prior to being shipped to overseas refineries. And more than a ton of gold has been confiscated in total since the start of December.
Among the companies implicated in these seizures is C.G. Koening. Reuters reported that C.G. Koening is an ore supplier for Dynacor, but withdrew the story when Dynacor issued a news release stating that it had no connection to this ore supplier.
How Does This Affect Dynacor?
In response to these developments Dynacor has decided to suspend all ore purchases for its gold ore processing plant. There were stockpiles that providing feed for the plant for about three weeks, out of which two weeks have passed. The company will have to suspend processing ore within about another week.
The company insists that all its suppliers are registered in accordance with Peruvian laws and the purchase suspension is temporary and voluntary.
As of September 2013 the company reported $10.3M in cash. There are only minimal current obligations under the company's finance leases and no current debt payments. The company spent $0.3M on exploration activities in the third quarter, in line with previous quarters.
In a scenario of a prolonged processing plant shut-down we would assume the company to terminate exploration until the issue of sourcing legal ore for the processing plant is resolved.
Factoring in some costs to wind down exploration and to maintain the plant we estimate that Dynacor has enough cash to survive until the end of the year without renewed cash flow from the processing plant.
Perhaps more important is the issue of credibility. The company has stated time and again that it is sourcing only legal ore.
Furthermore, Dynacore has stated that the government crack down on illegal mining is actually working in its favor. The argument goes that ore processed at the company's plant is ore that is not treated with mercury.
However, doubts have been cast over this business model and its compliance with government regulations. We believe that Dynacor will have its work cut out to remove these doubts and resume purchasing local ore.
If authorities start to believe that Dynacor is involved in sourcing illegal ore, or has turned a blind eye on illegal mining, then we would suggest that all bets are off.
And There is Another Concern
Earnings from the gold processing business have been used to fund exploration at the Tumipampa project. Investors only stand to profit if this project turns out economical and can be developed into a mine. So far this has not been the case.
The most recent NI 43-101 report is dated 2012 and does not even contain a resource estimate. True, the project in general and some drill results in particular look promising but this project is still in its very early infancy and it will take years before an economical assessment can be made to base a development decision on.
Notwithstanding current turbulence, we therefore believe that investors will have to wait a very long time before they will be rewarded for their investment, if ever.
The ore processing business masks the fact that Dynacor's future hinges on the success of its exploration activities. As such the risk is just as high for Dynacor as for any other junior explorer.
Where to From Here
The company states in the latest news release:
"Dynacor is waiting for the authorities to complete their review of the export documentation supplied to the Customs officials and will resume its exports once this review has been completed."
Having had some first hand experience with Peruvian authorities and the "manana mentality" of bureaucratic proceedings in the country we find it hard to believe that Dynacor will be able to source ore once stockpiles run low in coming days.
We therefore expect another news release shortly announcing the temporary shut-down of the processing plant. It can be assumed that this will send the share price lower again.
Holding on to a Dynacor position at the current point in time is potentially a very risky and volatile affair. Investors with little risk tolerance might wish to step to the side lines until more clarity can be achieved.
Looking further ahead, and assuming that Dynacor can remain untainted by the current turbulence we could see an attractive entry point developing. Ore processing has been a profitable business for the company, and tougher legislation should increase the demand for Dynacor's services. We therefore see the potential for significant upside in the longer term.
We would much prefer it, however, if Dynacor redistributed some returns from ore processing to investors, instead of investing it all into the Tumipampa project.