Is Lundin Mining Misunderstood?

Sometimes the best investments are right under our noses and temporarily stink like bad milk. One of my favorite analysts, Chris Mayers at Capital & Crisis, wrote this about Lundin Mining (LMC) last Friday and it's still true today.

In that spirit, I’m going to take another look at LMC, which is one of the last of the mid-tier mining companies left and a deep value play.

Lundin Mining has given us one heck of a ride -- mostly an unpleasant one. Lundin is the only pure-play mining company we’ve ever owned in this letter. And there is one reason why: They are incredibly volatile businesses, whose fortunes seem to turn on all kinds of unpredictable twists.

But I like Lundin, for a variety of reasons, some big picture -- the hot demand for base metals -- and some specific to Lundin, which I’ll get to in a moment.

Lundin is mainly a producer of copper, zinc and lead. It has five operating mines located in Portugal, Sweden, Ireland and Spain. (The sixth mine, in Sweden, will close in the second quarter of 2008).

Lundin’s earnings are highly sensitive to copper and zinc. So the sharp drop in zinc prices since the middle of May, for instance, has not helped Lundin’s share price. Prices went from a buck per pound to about 85 cents. It was nearly $1.30 in March. Every 10 cent drop in zinc prices shaves off 8 pennies from Lundin’s earnings.

Lundin Mining also owns two interesting, but high-risk, projects. One is the giant copper mine in the southern half of the Democratic Republic of the Congo, called Tenke. Lundin owns 25% of this asset. Tenke should start producing copper in 2009 and has an estimated life of 40 years. The other is a zinc mine in Russia, Ozernoe, which could be up and running by 2011. I put no value on this latter project and would not be surprised to see it dropped.

Outside of these two, Lundin also has a grab bag of other projects and partnerships, some of which could turn out to be important. For example, Lundin owns 20% of Union Resources, which sits on the world’s largest known undeveloped zinc resource.

I believe that the core operations of Lundin -- those five operating mines -- support today’s stock price. In fact, I think those mines alone are worth about $10 per share. You get any upside from Tenke, Ozernoe and the grab bag for free. Tenke chips in another $2 per share. At $6.50, you’re getting Lundin for about 65% of the (lower) net asset value. That’s deep value.

The company should earn at least $1 per share this year and $230 million in free cash flow -- that’s after $360 million in capital spending. At $6.50, the shares go for 6.5 times this year’s earnings and 11 times free cash flow. Even at flat metal prices, Lundin ought to grow earnings at a double-digit rate for the next few years, because of internal growth from existing mines.

The shares have lagged Lundin’s mining peers badly. But the stock could catch up quickly. After the last earnings report, the stock went from $6.50 to $9 in about a month. I think that could happen again. I look forward to the next earnings report. As the company finally puts up a string of decent quarters, I look for the stock price to hit $11-12 -- possibly as early as late this year or early next.

One final note: The Lundin family still owns nearly 16% of the company. The Lundins have a great track record. As Warren Buffett likes to point out, no one can predict the future, but you can bet on track records. I think the Lundins will get this one right too, eventually. If you have the stomach for it, Lundin Mining looks like a good bet here.

For those of us who started buying LMC at $10, the current correction is gut-wrenching. Yet, as I recently added more shares to my portfolio, it struck me that this is a turnaround-play and a misunderstood-company-play at the same time.

Be not fooled though. A stock that trades under $6 a share at its 52 week low is usually fraught with risks. Yet the risk/reward ratio here is mouth-watering. I remember when a recently merged, struggling gold and copper company named Freeport McMoran (FCX) seemed to be having similar struggles and confusion.

Can you imagine how you'd feel today if you had bought FCX then, when it was selling around $15 a share? No, I don't think LMC will someday be worth $60 a share, but stranger things have happened.

I do believe that the stock is a takeover candidate and will someday be trading for at least twice what it's at today. Sometimes when opportunity knocks it also stinks, but if you can breath through your mouth, crunch the numbers, and go forward you could be greatly rewarded.

Am I the only one that remembers when Silver Wheaton (NYSE:SLW) was trading for $4 a share an no one wanted it? Catch my drift and not my scent.

Disclosure: Author holds a long position in LMC and SLW

 

Comments

[oroman]

the euro is a major reason for their woes...

[ritr54]

What about Horsehead (ZINC) as a value play?

[InvestingPennies.com]

Very well written piece. The sentiments of this writer supports our full recommendation of Lundin Mining Corporation which can be found here:

investingpennies.com/i...

[Norman Lepoff, M.D.]

I agree with the author.

[Carl Martin]

FCX owns the lion share of Tenke, strange that the company is mentioned, but not it's position in Tenke. I own both and agree LMC is quite undervalued. The market doesn't like it for some reason. Everything Lucas Lundin touches will eventually turn to gold, but this one might take awhile.

[tagthatstock]

zinc is the 'next oil' wallstreet and the auto makers just havent clued in yet.

lets say the current price of zinc is $0.85

how much would you pay to solarize your home and power your car for nearly energy cost free for life?

how much will the world pay to absorb all of the zinc stockpile to do such a thing? well i figure when they pull their heads out zinc some day will be $8-12 instead of its lowly $0.85 today.

LMC at 5.78 is very much a good risk value play to throw into your ira and forget about it

[Peter W]

Just a quick valuation question. You value the current operating assets at $10/share, could you briefly explain how you get that number? Are you using an intrinsic (DCF, NAV) or relative value?

Thanks

[Nan]

Having bought LMC at $13.59 / share on the advise of Jim Cramer, I'm just hoping it gets to $10 / share so I can dump this stinker and not feel so bad.