Will Wall Street Discover Endeavor's Mines? Part I

| About: Endeavour Silver (EXK)

This is the 1st part of a three part series on my Tour of Endeavour Silver Company in Mexico

I was part of a group that visited two major mines owned by Endeavour Silver Corp (EXK) in Mexico last week. The 1st mining project is at Guanajuato, and the 2nd one is at Guanacevi. Both are in the historically silver-rich central Mexico region. It was an intensive 4 day trip with 2 days of busy schedules. Our visit to both mining operations was adventurous, educational and exciting.

Mexico is the 2nd largest silver-producing country in the world next to Peru, and may potentially overtake Peru to become #1 in the future. It has over 400 years of silver mining history, dating back to the Spaniards in the 1500s. Both Mexico and Peru are relatively geopolitically safe; Mexico has an even lower political risk, since it is a NAFTA member. In 1993, Mexico revised its mining regulations and codes and since then, it has become a mining-friendly and favorable country. Mexico is also one of the fastest growing emerging economies in the world with low taxes to attract foreign investment.

The silver mining area in Mexico is mainly along the rich Sierra Madre belt through the center of Mexico where both Guanajuato and Guanacevi are located. Given its long history of rich silver reserves and its geology, you will find that most publicly-traded silver companies have operations in central Mexico. Some people call it the modern day silver rush, similar to the good old days of Gold Rush in California. Except this time, Mexico has a longer history and a lot more silver reserves than case of the California Gold Rush. Should we call it the Mexico Silver Rush?

Endeavour Silver (NYSE:EXK) is a Canadian junior silver mining company with its headquarters in Vancouver. However, almost all its manpower, assets and resources are in Mexico. Its main focus is to grow its silver reserves, resources and production and generate cash flow and profit in Mexico. The two main operating and producing mines are the Guanacevi project near Durango and the Guanajuato project at Guanajuato. We started with the Guanajuato, the smaller of the two, then proceed to Guanacevi the next day.

A. Guanajuato trip

I spent more than half a day flying from New York City to the Leon airport which also serves the city of Guanajuato. We all got up early the next morning to start our tour. The mining operations of Guanajuato are about 30 minute drive from the city. Endeavour owns properties on two veins in this area, one is called the Veta Madre vein and the other is the La Luz vein. After a presentation in their office, we started with the tour and inspection of their San Jose shaft and vein exposure along the La Luz vein. This area is still under exploration but has great potential for increasing reserves and production in the future.

Then we toured the exciting Bolanitos plant now owned by Endeavour. This plant takes the ore, crushes it in several steps, and reduces it from an over 14" size ore to fine particles. Then there is a chemical process which separates the silver from the rest and creates high concentrations of silver mud. The mud is subsequently shipped to and processed by an outside plant and turned into silver bars. This processing plant has a capacity to produce 500 tonnes per day, but currently is running at only 100 tonnes per day. The goal is to increase the current volume by threefold and to be at 300 tonnes by year's end and to reach its full capacity of 500 tonnes next year.

The next stop was even more exciting. We all squeezed into a small elevator that barely fits 4 people, and went 180 meters underground into San Elias Shaft at the Veta Madre vein area. This is one of the 3 main shafts operated by Endeavour for this project. It is a great experience to go under the surface and to see how the actual mining operation works. During the whole visit, most of us had collected many beautiful mineral rocks.

Endeavour owns some large properties here, and what we visited is only a very small portion. Two similar shafts will be operational and should triple the current output by the year's end. An area with even more potential is the adjacent section 3785 where Endeavour is drilling holes and exploring at the moment. A tunnel can be built from the existing mining area for easy access, if it turns out to be feasible. If this potential materializes, Endeavour can easily increase its silver reserves from current 7.3 million ounces of reserves and expand the Guanajuato production substantially.

Endeavour acquired their Guanajuato project from Industrias Penoles only recently in 2007, along with the Bolanitos processing plant mentioned above. Endeavour is investing capital to ensure the safety of the mines and to improve efficiency of the plant, and this is why both of them are not fully operational yet. This reflects a higher working standard and long term commitment by Endeavour management.

Due to the current low volume at 100 tons, the silver production cost is actually very high at the moment, about $24 per ounce. However, by tripling its production to 300 tons, Endeavour should bring the cost down to around $11 per ounce as we were told, since they are now fully staffed for full capacity or quite overstaffed at the current production level. In other words, they don't need to go out and hire more workers in order to triple their production.

A large component of the production cost is fixed and includes workers and depreciation. This will remain relatively stable in the future with fixed labor cost and decreasing capital expenditure, but there will be incremental increases in costs of fuel, power, chemicals, explosives and supplies. I did a quick calculation on this. At $11 per ounce, if Guanajuato produces 400K silver out of their 2.5M oz of total production estimate for 2008, it will cost them a cash outflow of $11*0.4M = $4.4M (excluding depreciation).

However, if Endeavour can triple its production next year to 1.2M ounces (their goal is 1.5M ounces), but their cash cost only doubles to $8.8M due to labor costs staying flat, the cash cost will be only $8.8M/1.2M = $7.3 per ounce (excluding depreciation). This is consistent with management's target of $6-7 cash cost for 2009, since the cash cost may not need to be doubled. If cash cost only increases by 50%, or $6.6M, the unit cost will only be at $6.6M/1.2M = $5.5 cost per ounce.

This operational leverage gives management a great incentive to control costs. $7 per ounce seems to be a doable target. If silver price stays at a current level of $16, as an average for 2009, an almost $10 net cash flow for an annual production of 1.2 million ounces, or $12 million, just at the Guanajuato project, the smaller of the two core mining operations, is a very positive prospect for Endeavour. And I won't be surprised to see the real production higher at 1.5 million ounces, which is Endeavour's target, next year.

Look for Part II of Thomas Tan's Endeavor Silver Series.

Disclosure and Disclaimer: I am long Endeavour Silver in my portfolio since December 2007. My basic travel expenses to tour Endeavour mining operations were covered by Endeavour. However, I receive no compensation whatsoever for my time or for writing this report. The contents of this article represent the opinion and analysis of Thomas Tan, who cannot accept responsibility for any trading losses you may incur as a result of your reliance on this opinion and analysis, and will not be held liable for the consequences of relying upon any opinion or statement contained herein or any omission. Individuals should consult with their brokers and personal financial advisors before engaging in any trading activities. Do your own due diligence regarding personal investment decisions.

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