Primero Mining (NYSE:PPP) announced that it is delaying its decision to construct its third mine - Cerro Del Gallo. According to the news report the decision was made so that management can develop a higher grade ore region in order to optimize the project given the low gold price environment. Management reassures us that the project is moving forward as the company continues to permit the project, work on basic engineering, and explore. Despite what the press release says I think that the decision to delay construction of Cerro Del Gallo is related to the Brigus Gold acquisition from earlier in the year. This is the case because estimated production costs are far too low for Primero to be concerned about the low gold price. While further drilling may be able to cut costs somewhat, it is hard to believe that it can do so meaningfully from the $725/oz. level that I predicted in April.
Back in January I warned that this acquisition was not such a good idea. While it increased the company's gold production on an ounce-per-share basis it compromised the company's financial position in two ways. First, it increased the company's average production cost. Second, it meant that Primero would have to take on Brigus' debt load. Before this Primero was a low-cost producer with a large cash position and little debt, and it was in a position to develop Cerro Del Gallo. After the acquisition the company had jeopardized its financial situation and its ability to fund the development of its Cerrro Del Gallo Project. To quote my January article:
The new, weaker balance sheet becomes a heightened issue when we take into consideration the company's projected initial capex expenditures towards Cerro del Gallo, which, according to the NI 43-101 report should be $136 million. Now that Primero owns the property outright it is on the hook for all of this. If the gold price rises, then things are great--e.g. the company should generate roughly $100 million in annual cash-flow at $1,500/ounce gold, and it should therefore be able to internally fund the development of Cerro del Gallo. But if there is another down-leg in the gold price then Cerro del Gallo might have to go on the back burner, and the much anticipated production growth will be priced out of the stock. Further, unless the gold price rises there is a distinct possibility that Primero will need to raise capital to construct Cerro del Gallo. It might have to pay a high interest rate now that its debt position has weakened its balance sheet. It may also have to issue stock, further diluting shareholders and eroding the company's gold produced per share figure that I alluded to as a positive above.
While it is good that Primero is retiring its newly assumed debt it has come at a price. The company's production growth is now delayed, making the stock less appealing.
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