- Aura Minerals shares have collapsed due to weak metal prices and the risky nature of its mining assets.
- The value of the company's assets far exceeds its current valuation.
- If management can bring this value out in a timely fashion the shares can generate triple digit returns in a short period of time.
- Investors who are looking for investments in high risk/high reward mining companies should consider taking a small position in Aura Minerals.
Aura Minerals (OTCPK:ARMZF) has been a disastrous investment. Since peaking in 2008 the shares are down 99%.
(Source: Google Finance)
Undoubtedly Aura Minerals is in a dark place right now. We see this by looking at both the company's projects and at its balance sheet.
An Overview of Aura Minerals' Projects
In this volatile metal price environment investors want stability when they are looking at mines and mining companies. Specifically they want low consistent production costs, minimal geopolitical risk, and a long mine life. Aura Minerals doesn't have any properties that satisfy all these conditions.
- San Andres is a gold mine in Honduras. While it has an estimated 10-year mine life it has had trouble turning a profit in this environment due to high costs. Furthermore, Honduras is a risky place to mine.
- Aranzazu is a copper mine in Zacatecas. It has a long mine life and Mexico is a low-risk mining jurisdiction. However, it has been losing money at the current copper price. While the company has a mine expansion plan that should result in lower production costs it needs capital in order to institute this plan.
- The Sao Vicente and Sao Francisco gold mines in Brazil are closing in 2014 and in 2015, respectively.
- The Serrote copper mine in Brazil will generate a lot of cash-flow at the current copper price once it is in production, and it has an estimated NPV 5-times greater than Aura Minerals' valuation, but the company needs $420 million to build the mine.
Aura Minerals' Balance Sheet
Aura Minerals has $220 million in shareholder equity versus a market capitalization of $24 million. The reason that the company has so much equity is that it has valued its mining assets at $228 million after depreciation has been taken into consideration. Thus if we remove the company's mining assets it has net shareholder equity of ($8 million). While the company's mines aren't worthless they are not generating any cash-flow and they have, in fact, been losing money. When we consider the company's balance sheet in this context the company has minimal assets--just $21 million in working capital. It also has roughly this amount in future liabilities due to the closure of its two operating Brazilian mines. Furthermore its credit facility is maxed out at $31 million, and this amount is due at the end of June.
The Bottom Line--Aura Minerals Is Down, But Not Out
As we will see the three projects here that have substantial lives are quality projects that will generate strong cash-flow going forward should metal prices remain where they are or increase. But two of them require more capital than the company has access to, and the third is located in Honduras, a risky mining jurisdiction.
With a $24 million valuation and assets that are potentially worth several hundred million Aura Minerals can trade at a substantially higher valuation. But the company needs to do something in order to bring this value out. Since it doesn't have any more access to capital it is almost certainly going to have to find a JV partner for its Aranzazu mine and for its Serrote mine. This means giving up a lot of the upside potential at these two properties. But given the company's current valuation doing so is well worth it. As we will see below Aura Minerals can trade at several multiples of its current market cap even if it sacrifices a significant portion of its projects' upside.
Given that the company is between a rock and a hard place financially I can understand why investors are ascribing so little value to it. At the same time, however, there is a way out, and presuming the company does what it needs to in order to bring out the value of its assets the upside potential is enormous and it remains unrecognized by the market.
The San Andres gold mine is located in western Honduras.
(Source: San Andres PEA)
While it is not the most valuable asset in Aura's portfolio it is a pillar of stability: it has been producing 60,000 ounces of gold for years.
(Source: Aura Minerals November 2013 Presentation)
Furthermore production is expected to increase in 2014, reaching 75,000 - 85,000 ounces.
The mine has an estimated resource base of 1.6 million ounces of gold, half of which are classified as mineral reserves that have been deemed economically feasible to mine. At 75,000 ounces of annual production this means that the mine life could potentially reach 20 years, although management is conservative in projecting 10 years of production.
Mining costs have been an issue at San Andres, with cash-costs at around $1,000/ounce. All-in costs have been somewhat volatile. For the first 9 months of 2013 this figure came in at $1,296/ounce, which is in line with the gold price. But the company was able to get costs under control in the third quarter, during which costs came in at $1,135/ounce. This was primarily due to a decrease in cash costs ($998/ounce vs. $1,083/ounce) resulting from a decrease in the ratio of waste mined relative to ore mined (0.47 vs. 0.61). While these expense figures are higher than those from 2012 we have to bear in mind that the company mined very high grade ore for the mine in 2012 (0.69 g/t in 2012 vs. 0.6 g/t in the first 9 months of 2013 vs. 0.53 g/t for the mine generally). While lower grades can put upward pressure on production costs going forward there are clear signs that the mine is operating more efficiently. This is seen in the company's most recent prediction that cash-costs will come in at $800 - $950/ounce in 2014.
This is a wide range, although it is prudent to err on the conservative side especially since the average ore grade will fall in the coming quarters. Presuming $1,150/ounce all in costs (cash costs of $950 plus $200 in added expenses, or $60/ounce more than what we saw in Q3) and 10 years of production at 70,000 ounces (this nearly depletes the project's gold reserves but not the resources), the following matrix gives an array of valuation estimates for San Andres at various gold prices and discount rates (assumes Honduras' 25% corporate tax rate remains stable). Keep in mind that $1,150/ounce is rather conservative considering that for cash-costs I am using the high end of the $800 - $950/ounce range and I am adding $200/ounce in added expenses rather than the $140/ounce figure we saw in the most recent quarter. But given the risk in Aura Minerals and the recent cost volatility we have seen at San Andres this approach is appropriate.
Amounts are in millions of dollars
|Discount Rate/Gold Price||$1,250||$1,500||$1,750||$2,000|
Given my production cost estimates San Andres doesn't have much downside protection should the gold price fall but the project has incredible leverage to the upside or those willing to bet that we have seen the bottom in gold. At $1,290/ounce using the above assumptions San Andres is worth $46.5 million using a 12% discount rate. This is in itself a substantial premium to the company's $24 million market capitalization.
The Aranzazu copper mine is in Zacatecas, Mexico.
(Source: Aranzazu PEA)
The Aranzazu Mine has nearly 600 million pounds of measured and indicated copper resources, as well as trace amounts of gold and silver.
(Source: Aura Minerals)
As we see on the chart these measured and indicated resources occur at 1.5% of the ore. However, if we look at the mine's recent production history we see that nowhere near this grade ore is being mined. In Q3 of 2013 the grade was 0.99%. In the third quarter of the prior year the ore grade was just 0.8%. This had a significant impact on cash-costs, which were $3.52/lb. for Q3 2013 and $4.48/lb. for Q3 2012. Note that Q3 2013 figures would have likely been better had the mine's crusher not shut down for 10 days.
Going forward the company is expected to institute an expansion plan for the mine that will dramatically lower costs. Right now the mine produces about 15 million pounds of copper and it does so by milling about 2,600 tonnes of ore daily. Assuming the company can fund the expansion plan (more on this point below) it will increase production dramatically. As outlined in the company's most recent PEA there are two possible expansion plans. The basic figures are outlined on the chart below in the two far-right columns.
(*Note that the NPV figures assume a copper price of $2.70/lb, a gold price of $1,216/oz., and a silver price of $21/oz.)
(Source: Aura Minerals)
According to the company's most recent presentation management expects to ramp up production to 4,000 tpd (the "middle" expansion plan). This will compound the anticipated increase in the grade of the ore (see the following chart from the PEA) that will be mined and copper production should more than double.
(Source: Aranzazu PEA)
Specifically the company estimates that it will increase annual copper production up from 15 million pounds to 25 million pounds next year and more than 30 million pounds annually going forward.
More importantly the expansion plan will lead to lower costs, as the updated mine will be more efficient and, as already mentioned, ore grades will climb dramatically. Ultimately the company believes it can lower cash costs from the Q3 figure of $3.52/lb. down to just over $1/lb.
(Source: Aura Minerals November 2013 Presentation)
Right now all-in costs come in at about $4.25/lb. which puts Aranzazu decidedly in the red with spot copper trading $1/lb. cheaper. If the company can really bring costs down by over $2/lb then with the price of copper at about $3.25/lb. this will be a profitable mine. With costs at about $2/lb on a cost per goods sold basis, and with 30 million pounds of production this mine can generate nearly $25 million annually in annual post-tax cash flow (taxes include the new 7.5% Mexican mining royalty). This is incredible for a company that has a valuation of roughly $24 million.
The catch is that the company needs $113 million in order to implement its expansion plan. The company simply doesn't have this at the present time.
For now let us just look at the valuation of Aranzazu going forward presuming $2/lb., 30 million pounds of copper produced, and 10 years of production at this rate. 2014 should be a transitional year for the mine and I will assume no free cash flow. After 10 years the mine should continue to operate but as the above chart shows grades are going to fall dramatically and so we would have to assume higher production costs. The decision to continue mining will be based on whether the company finds more copper and the copper price at that time.
Anyway with the given assumptions the following matrix gives the various valuations for the Aranzazu mine producing at 4,000 tpd at various copper prices. Amounts are in millions of dollars.
|Discount Rate/Copper Price||$3||$4||$5||$6|
At $3.25/lb (the current spot price) the valuation comes in at $50 million using an 8% discount rate and $25 million using a 12% discount rate.
Given that this mine is currently being marketed to investors as a copper mine with gold and silver by-products offsetting the cost of mining copper I think that the company should consider selling a royalty on the gold and/or silver mined at Aranzazu. At 4,000 tonnes of ore mined per day the company will produce about 32,000 ounces of gold annually. If the company were to sell a royalty on 60% of the gold mined at Aranzazu it could probably generate the capital it needs. Such a stream would be valued at $120 million using a 5% discount rate and a 38% tax rate. This would add about $0.83/lb of copper mined, meaning that the mine has less down-side protection should the copper price fall. However, because the company would be getting capital, the value lost in higher production costs would be offset. The following table refigures the value of the Aranzazu mine using a production cost of $2.83/lb. rather than $2/lb. It also adds the $120 million that the company would receive and which offsets the previous $113 million capex charge I included in my prior valuation matrix.
|Discount Rate/Copper Price||$3||$4||$5||$6|
From this matrix we see that this project has incredible value even if the company loses some of its gold offset by selling a royalty. The up-front cash is clearly far more valuable to Aura not only because we are using steep discount rates but because the company would not have to dilute shareholders or issue debt at a punitive interest rate in order to fund the expansion of Aranzazu.
At $3.25/lb. copper and at a 12% discount rate the project is worth a whopping $53 million in this scenario, or more than twice Aura Minerals' current valuation.
Sao Francisco and San Vicente
I will briefly mention the company's two Brazilian gold mines, although investors need to realize that these mines are closing in the near future. San Vicente, the smaller mine that produces about 40,000 ounces per year will be closing this year. Sao Francisco may make it to next year according the company's most recent (Q3) financial/MD&A release. Despite the fact that these mines are closing they have been operating far more efficiently and they could provide some much needed cash flow. The combined mines operated with costs of $1,120/ounce. With gold at $1,290/ounce and a corporate tax rate of 34% this still leaves $122/ounce. The mines are expected to generate 140,000 - 160,000 ounces of gold before they close, and it is going to cost the company about $21 million to close the mine. Thus at current gold prices the two mines are a $4 million liability. However, if the gold price rises and averages, say, $1,500, then the company can generate $14 million and use this towards developing Aranzazu. Furthermore, I should note that the company has plans to salvage the mining equipment at these two mines in order to try to generate some cash flow although management doesn't give a specific figure and for the sake of being conservative I will ascribe no value to these assets.
The Serrote project is located in Brazil.
(Source: Serrote Feasibility Study)
It is predominantly a copper project, although it has minimal gold reserves, as well as some magnetite (Fe3O4) although the company is not counting the magnetite towards the value of the property's ore.
In all the property has roughly 1.3 billion pounds of copper resources and 370,000 ounces of gold.
(Source: Aura Minerals)
Most of these resources--about 75%--have also been classified as mineral reserves, meaning that it has been geologically determined that they will be economical to mine.
The mine should generate about 66 million pounds of copper annually and the mine's life will be 13 years.
Unfortunately, the mine has very high initial capital costs--$420 million. We have already established that the company simply doesn't have this capital on hand. Nevertheless the property has a value of about $120 million using an 8% discount rate and a copper price that starts at $3.45/lb. and slowly falls into the $2.80s as the end of the mine's life is approached. Thus while the mine's value far outweighs Aura Minerals' market capitalization it does not have the means by which to bring out this mine's value.
Rather than financing it Aura Minerals may want to find a JV partner or consider selling the mine outright to a larger mining company with the means to develop it. Given the project's high initial capex relative to its estimated NPV Aura Minerals may not be able to get a lot for the property, but as I have been emphasizing it doesn't need a lot to send the shares soaring from where they are. For the sake of this discussion let us assume that the company can get $50 million in cash, stock, and retained royalties.
Valuing Aura Minerals
From what we have seen Aura Minerals has incredible hidden value relative to its market capitalization. Using current market prices and a 12% discount rate the company's producing properties have the following valuations.
- San Andres: $46.5 million
- Aranzazu: $25 million, or $53 million in my royalty financing scenario.
- Sao Francisco and Sao Vicente: ($4 million) including closing costs.
Adding this together with the company's ($8 million) in net assets discounting the carrying value of its properties, we get either $59.5 million or $87.5 million depending on which Aranzazu valuation we assume. If we ascribe $50 million in value to Serrote these figures jump to $109.5 million and $137.5 million.
Thus ignoring the salvage value of the company's Brazilian mining equipment as well as its minor exploration properties we have four potential valuations for Aura Minerals depending on which Aranzazu valuation we use, and whether we ascribe any value to Serrote or not.
From this it is evident that Aura Minerals shares have incredible upside potential.
Risks: What They Are and How They Impact My Strategy
Aura Minerals doesn't trade at $0.10/share for no reason. Financially the company is between a rock and a hard place, and it needs to find ways to bring out the value of its properties in order to survive without a massive secondary offering.
Thus there are two primary risks to Aura Minerals shareholders. The first is weakness in gold and copper prices. We saw that the San Andres mine has limited downside protection should the gold price fall. Recently the gold price and shares of gold mining companies have been rising significantly, and a lot of people are calling for the end of the gold bear market. However, in a recent article I suggest that, while I am very bullish on the gold price, there is downside risk. If the gold price falls not only will the company lose cash flow at San Andres but the value of a stream or royalty deal on the gold produced at the Aranzazu project declines. Similarly, if the copper price falls the value of the Serrote development project declines substantially. Furthermore a fall in copper prices would mean that Aranzazu is less attractive from the perspective of an Aura Minerals shareholder and from the perspective of a company looking to help the company finance the mine's expansion.
The second risk is that Aura Minerals is not able to find a royalty or a JV partner for the Aranzazu project. As we saw the mine is not profitable at $3.25/lb. copper, and while the company can lower production costs somewhat presuming it mines higher grade ore, this will likely not be enough to offset the high cost of production. Therefore, the expansion plan is more or less a necessity, and if it doesn't get done we can expect continued losses at Aranzazu that will force the company to issue stock at the current depressed price or to fire-sell some of its assets.
As real and as consequential as these risks are I think the market is pricing them in. In fact I think that the market is too pessimistic given the upside potential in a rosier scenario, and this is why I like the stock at the current price.
Nevertheless the best way for investors to account for this risk is to limit their exposure to Aura Minerals. I have taken a small position, and while I don't like to think like a trader I do intend to take profits on some of my position in the event of a short-term price increase even if I believe that there is more upside left in the stock.
Given that I think there are better opportunities in other metals, I don't normally invest in mining companies with a copper focus. However, given the upside potential Aura Minerals has I have made an exception. Aura Minerals has incredible value and the means by which to bring this value out. With a market capitalization of just $24 million investors are pricing in far too much risk considering the potential reward that can be realized if the company is able to raise the capital it needs to fund its Aranzazu mine expansion.
Furthermore now that mining stocks are in favor I think this stock can rise a lot in a short period of time. If we look at a daily chart of the Canadian shares [TSE:ORA], which are far more liquid than the American pink sheets, we see that the stock recently tested and bounded off of its upward turning 50-day moving average.
If gold and copper prices rise Aura Minerals has incredible leverage, and if there is a financing deal such as the one I suggest above this stock can really fly.
Ultimately Aura Minerals has a lot of short-term potential, as well as intrinsic value that can lift the stock substantially in a strong metal price environment longer term. Therefore investors who like to trade or invest in smaller mining companies should consider taking a small position in the stock.
I should note that Aura Minerals trades very thinly on the American pink sheet market, and so those investors who are able to are strongly advised to purchase the shares on the TSE.