This article was published on Friday, July 22, 2016 at MiningWEALTH.com.
Given that most of the stock's volume is on the TSX Venture exchange (TSX.v: TEN) share price and market capitalization data is provided in Canadian Dollar terms.
Terraco Gold (OTCPK:TCEGF) is a junior royalty company with a NSR royalty on Waterton's Spring Valley deposit. While this is a highly advanced, multi-million ounce gold deposit in low-risk Nevada, Terraco shares certainly don't trade as if the company owns a royalty on such a high quality asset. This is likely due to the fact that Spring Valley is owned by a private company that has no need to promote its progress in developing the asset or its overall quality. As a result, we believe that there is a market disparity worthy of exploitation by shrewd investors.
Such an opportunity is particularly unusual considering that Terraco is effectively a royalty company, and royalties and royalty-like streams (i.e. streams that are mathematically equivalent to royalties but which are structured as streams so as to eliminate ambiguities regarding the definition of "net smelter return") have become quite valuable: mining companies have seen the incredible value created by the likes of Silver Wheaton (SLW), Franco Nevada (NYSE:FNV), and Royal Gold (NASDAQ:RGLD), and recognize that this comes at the expense of the mining companies who have sold these royalties and royalty-like streams.
While investors are willing to pay generous premiums for the cash-flow streams generated by these companies Terraco shareholders have not been similarly rewarded.
More generally the company fits the investment criteria that we've established as increasing the odds of finding low-risk, high-reward opportunities-a growing rarity as sentiment has dramatically turned bullish in the precious metals space. These include the following.
Strong Management with Skin in the Game
The company is led by Todd Hilditch who masterminded the Salares-Talison deal. While this was a lithium deal note that the recent conversion of Terraco's option to purchase the Spring Valley royalty is attractive given its financial features and that it required no particular specialization in gold. We note also that Terraco's board is loaded with geologists with experience in gold. Management owns in excess of 13% of the outstanding shares on an undiluted basis and about the same on a diluted basis (the latter figure rises to >20% if we exclude Waterton's convertible debenture). Todd Hilditch owns more than 7% of the company and has been buying shares fairly regularly, having purchased 100,000 shares last week. CFO Bryan Mckenzie added shares last week as well.
Low Capital Costs
Terraco's primary asset is a royalty, which is a passive investment requiring no capital expenditure on its part. Skeptics will retort that passive investors face the risk that they do not have a say in how the investment asset will be developed. While this is certainly true in a general sense we believe that there is overwhelming circumstantial evidence that Spring Valley is a high priority asset in Waterton's portfolio.
The Spring Valley deposit is highly advanced, with ~$70 million invested in it thus far, and the latest resource estimate exceeds 5 million ounces. Recent statements out of precious majority owner-Barrick Gold (NYSE:ABX) suggest that it was at the pre-feasibility stage in its development as of 2015. Analyst Joe Mazumdar had suggested that it could produce 260,000 ounces per year in a research report on Midway Gold when it was a stakeholder in Spring Valley. The royalty rate, while variable (3% on some parts and 1% on others) is likely around 2.5% on average. Even at just 200,000 ounces of annual production this comes to 5,000 attributable ounces per year to Terraco, which at $1,340/oz. gold comes to $6.7 million in annual cash-flows for as far as the eye can see. This compares to an enterprise value of ~4X this figure. If we compare this to the 20-30X operatic cash-flow multiples investors are willing to pay for diversified royalty companies we see that Terraco is worth multiples of its current valuation in the hands of one of them: Terraco is a clear takeover target.
While Terraco incurs no operating risk on its end, being a royalty holder, we note that even Waterton (or whoever develops the asset) will face few operational challenges as Spring Valley ore is near-surface, oxidized and heap-leachable. Watertown is a well-capitalized company ostensibly run by former Barrick people, who have extensive operational experience, especially in Nevada. Spring Valley has been heavily de-risked, as it is it was at the pre-feasibility level of its development as of last year. It is also worth mentioning that it is in Nevada, which is considered to be among the safest jurisdictions in which to develop and operate a mine.
There are a couple of risks worth pointing out aside from what one generally finds in the resource space (e.g. falling commodity prices, shifts in the regulatory environment…etc.). The first is that Spring Valley is a former Midway Gold asset, and given the overly optimistic resource estimate at that company's Pan Project (which effectively bankrupted the company) we suspect that investors will be especially skeptical of the resource estimate on Spring Valley. Barrick's involvement and Waterton's vote of confidence serve to mitigate this, but investors should take a conservative approach with respect to assessing the Spring Valley resource. In our valuation assessment put forth for premium subscribers the resource and annual production are stress-tested to account for this.
The second risk is that Terraco has very few catalysts ahead of it. Since Waterton is a private company there will be no updates provided to the public as to Spring Valley's development. If Waterton were public we would see press releases highlighting favorable drill results, metallurgical test work and other feasibility study level work, and other signs that the project is moving forward. Terraco investors have to infer this. Meanwhile the gold market is heating up and junior gold companies are tripping over themselves to put out press releases, raise money, and to do other things that generate investor attention. The Terraco story could take 3-4 years to play out and such a long-term time frame will not appeal to many investors. But at the very least a portfolio full of "hares" should be complimented by at least one "tortoise."
Terraco Gold has a couple other assets, namely a 2% NSR royalty on the adjacent Moonlight Project, which Terraco sold to Waterton (minus the royalty) as a part of its financing of its Spring Valley royalty purchase, and the Almaden Nutmeg project in Idaho, which is a 900,000+ ounce deposit in Idaho with similar attributes (low grade but heap-leachable). We ascribed no value to the former for reasons specified to premium subscribers, but note that this land package is not only adjacent to Spring Valley (the best place to find gold is near known gold deposits) but substantially larger as well. There is exploration potential. We ascribed $10/oz. to Almaden Nutmeg considering what First Mining Finance (OTCQX:FFMGF) is willing to pay for deposits as an admittedly arbitrary but low valuation for such an asset. With gold trading higher nowadays this $10/oz. figure is low. Terraco is doing nothing to develop it at this time, so it offers investors with some in-ground optionality in another low-risk asset given its metallurgy, size, and jurisdiction.
The Bottom Line
We told premium subscribers that Terraco shares could double from C$0.12. Shares closed on Friday at C$0.155, so some of the upside is gone. However we note that not only was this a conservative estimate, but that the gold market has risen and appears to have entered a higher trading range. We further note that Waterton, which has access to more information regarding Spring Valley than any party out there, issued its convertible debenture to Terraco at an C$0.18/share conversion price at a time when gold was $75-$100/oz. lower than where it is trading today, meaning that at the very least we would expect them to value Terraco at C$0.20-22/share at today's gold price. At the very least if you purchase the shares today you can acquire the company at a notable discount to Waterton's valuation knowing that they are well-informed and likely very conservative in their valuation assessment.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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