Back in January 2017, I wrote an article regarding three emerging mid-tier primary silver producers. At the end of March, there was a significant development for one of them - Golden Arrow (OTCQB:GARWF).
Silver Standard Resources (NASDAQ:SSRI) exercised an option for the creation of a joint venture company with Golden Arrow which will hold the Pirquitas and Chinchillas projects in the province of Jujuy in north Argentina. Golden Arrow will get a 25% interest in the JV and the project is expected to have an operating life of eight years, producing an annual average of 8.4 million silver equivalent ounces. According to the 2016 edition of the World Silver Survey, this will put the Pirquitas-Chinchillas project as the 8th largest primary silver mine in the world just behind the Greens Creek mine in the US (note that Pirquitas was the seventh largest in 2015).
Source: World Silver Survey 2016
Now, primary silver producers are very rare and Silver Standard itself is expected to get below 20% of its revenues from the metal in 2017. That's why the joint venture will effectively transform Golden Arrow into one of the few pure silver plays on the market, with its share of the output equal to around 2.1 million silver equivalent ounces.
Source: First Majestic Silver
Since Golden Arrow has been covered in several articles over the past two months here, here and here, I will focus on analyzing the recently released pre-feasibility study of the Chinchillas project, the funding options for its development as well as a valuation of Golden Arrow based on primary silver producers with a similar size.
Source: Silver Standard
The project has a very decent post-tax rate of return of 29% and the development capital is low since the JV company will use the Pirquitas mill, fleet and related infrastructure. The cash costs and all-in sustaining costs are also impressive and the project is expected to generate a post-tax cash flow of USD 267mn. Payback is just 3.5 years and the post-tax net present value with a 5% discount stands at USD 178mn. What's more, the development capital includes a very high contingency of USD 16mn.
Golden Arrow assumes silver, lead and zinc prices of USD 19.50 per oz, USD 0.95 per lb and USD 1.00 per pound, respectively. As of time of writing, silver is at USD 18.08 per oz, lead is USD 1.04 per lb and zinc is USD 1.26 per lb. This means that the study assumes average revenues of USD 164.5mn per year while at current prices they would be USD 162.2mn. Therefore investors should not be concerned with the lower silver prices since lead and zinc compensate the difference. Still, let's take a look at Golden Arrow's sensitivity analysis (unfortunately it doesn't include zinc):
Source: Golden Arrow
As we can see, the project has a good leverage to silver prices and really shines above USD 20 per ounce.
Regarding the Pirquitas mill, the study assumes a processing rate of 4,000 tpd. However, the facility has proven that it can boost operating throughput to over 5,000 tpd. In the fourth quarter 2016, o re was milled at an average rate of 5,175 tpd:
Source: Silver Standard
Chinchillas seems like a really solid project with good economics - good IRR, low AISC and short payback period. Construction is expected to begin in the third quarter of 2017. According to the presentation of Silver Standard at the 2017 edition of the European Gold Forum, construction will take about a year and first production is expected in the third quarter of 2018 (from 14:00 mark, talk about Chinchillas starts at 11:21 - thanks Shawn Perger from Golden Arrow for the link).
Pirquitas is currently processing stockpiles and is expected to produce 4.5 - 5.5 million ounces of silver at cash costs of between USD 13.50 - USD 16.00 per ounce in 2017. However, according to the presentation of Silver Standard at the European Gold Forum, the real cash costs are actually closer to USD 10.00 - USD 12.50 per ounce and a 5 million ounce output could generate around USD 30mn with a USD 6.00 margin per ounce. Since Golden Arrow is getting 25% of the earnings from Pirquitas from January to March, we can assume that the remaining nine months of 2017 will net the new JV company some USD 22.5mn, which will help finance part of the development capex.
Source: Silver Standard
Stockpile processing is expected to continue throughout the remainder of 2017 and the exercise of the JV means that Silver Standard will evaluate the use of small-scale, high-grade ore feed from the Pirquitas property. A 2015 drill program showed good results, including:
- 3.16 meters at 1,436 g/t silver
- 1.93 meters at 1,890 g/t silver
- 0.83 meters at 2,670 g/t silver
According to the presentation of Silver Standard at the European Gold Forum, the underground operation could feed the mill with 400-500 tpd and lift the grade of the overall operation.
Source: Golden Arrow
Note that resources are inclusive of reserves. The reserves are based on data from 31 December 2016, while the resources are based on data from 2 October 2016.
What I noticed is that the resources in the new tables are lower compared to the study from April 2016:
Source: Golden Arrow
So where does the difference come from? Well, the cut-off grade is 60 g/t AgEq and the estimate is based on metal price assumptions of USD 22.50/oz silver, USD 1.00/lb lead and USD 1.10/lb zinc. Metallurgical recoveries are assumed to be 85% silver, 93% lead and 80% for zinc.
In the previous study, the cut-off grade was 45 g/t per AgEq based on USD 19/oz silver, USD 1.00/lb lead and USD 1.00/lb zinc. Also, recovery was assumed as 90% silver equivalent.
This means that the new study is based on a higher cut-off but also higher metal prices. Also, we must take into account that the resource estimate is based on data from 2 October 2016 and Silver Standard funded around USD 1.6mn of work on the Chinchillas project in the fourth quarter of 2016.
With the Chinchillas property area around 70% under-explored, the resources are likely to increase substantially but I will use the current numbers for valuation purposes.
Source: Golden Arrow
The JV agreement also includes exploration within a 50-km radius on an area of 785,000 hectares - lots of potential for more discoveries:
Source: Golden Arrow
The big concern for Golden Arrow shareholders seems to be the financing of the project. Let's keep it simple, ok? The development capital including the contingency is USD 81mn, meaning that the company's share amounts to around USD 20.25mn. Golden Arrow will get around USD 15mn as part of the JV agreement and the company had cash and cash equivalents of CAD 8.8mn (USD 6.6mn) as of 30 September 2016.
Golden Arrow plans to spend USD 2mn on exploration on Antofalla in 2017, meaning it's USD 0.67mn short of the USD 20.25mn. However, Pirquitas is still producing and if we assume conservatively that the new JV company will be formed in May and produce 2.63 ounce of silver for the remainder of 2017 (low end of 4.5 million ounces from Silver Standard estimates for seven months) at cash costs of USD 12.50 per ounce, we get cash flow of USD 14.5mn at silver prices USD 18 per ounce. This decreases the development capital including the contingency to USD 66.5mn - 25% of which is USD 16.6mn. Without the contingency, it stands at USD 50.5mn, meaning Golden Arrow's share is just USD 12.6mn. This is below the amount that the company is getting from the exercise of the JV, leaving it with more than enough cash. Also, there are currently over 9.6 million Golden Arrow warrants exercisable at an average price of CAD 0.57 per warrant - that's another sources of funding for the project.
And then probably all of these assumptions are wrong, but in a good way. According to a SA user with a nickname BretK, Golden Arrow's IR said that the company currently has CAD 8.4mn in cash on hand. It's also responsible for just 10% of the capex in the first year up to USD 10mn and then 25% after that. What confuses me here is that construction is scheduled to take just one year. So when does the second year start? Is the first year the 2017 calendar year? The year starting from 31 March (date of exercise of JV)? Or is it somewhere in May when the JV is expected to be completed? And how is the capex split between year one and two? If we use the basic USD 81mn estimate and 50:50 split between two years, Golden Arrow's share of the capex falls from USD 20.25mn to USD 14.13mn. It's definitely a large difference.
According to Golden Arrow's April 2017 corporate presentation, the company has capital expenditure commitments of around USD 10mn in the first year. If the company is responsible for 10% of capex in the first year, that means that the first year total capex is around USD 100mn. This makes no sense.
I sent an email to Golden Arrow to try to clarify how much of the capex is the company expected to contribute for the project but I still haven't received an answer as of time of writing. If I get an answer, I will post it in the comments to this article. However, I think that Golden Arrow will be able to finance Chinchillas without a capital increase. Sure, the company will at some point want to raise funds for the drill programs at Antofalla and other projects from its 200,000 hectares of property holdings in Argentina, but for now it has enough cash.
According to Golden Arrow's latest corporate presentation, the company's worth close to CAD 100mn (USD 74.6mn) with upside and exploration potential expected to boost this to over CAD 140mn (USD 104.5mn):
Source: Golden Arrow
I think it's a fair valuation - not too aggressive nor too conservative. It takes the middle of the range of Pirquitas' 2017 expected output and a 10-year operation at Chinchillas which is easily achievable at current silver prices with some exploration and the addition of the high-grade underground area at Pirquitas. This CAD 100mn (USD 74.6mn) estimate values each Golden Arrow share at around CAD 1.03 (USD 0.77), a pretty nice upside potential from the current USD 0.53 level.
Still, I want to compare Golden Arrow's valuation to some sector players. I think the size of the Chinchillas-Pirquitas operation is close to the operations of Endeavour Silver (NYSE:EXK) while Golden Arrow's 25% interest in the project is close to the size of Avino Silver (NYSEMKT:ASM). Let's go very conservative and assume that Golden Arrow' cash is gone and all of it was used to finance Chinchillas. This means that the enterprise value would be equal to the market cap.
As a reminder, Chinchillas has an initial eight-year life at an average annual production of 8.4 million ounces of silver equivalent (6.1 million ounces of silver plus lead and zinc) at cash costs of USD 7.40 per ounce and AISC of USD 9.75 per ounce net of by-products. M+I resources inclusive of reserves stand at 140 million ounces of silver equivalent while inferred resources are 63 million ounces of silver equivalent. I consider these to be the key metrics and just to be conservative, I will not take into account Golden Arrow's other projects as well as the underground resources at Pirquitas.
Endeavour Silver currently has three producing mines and several development and exploration stage projects in Mexico. The company's 2017 production guidance is for 8.9-9.7 million ounces of silver equivalent (5.2-5.7 million ounces of silver plus gold).
Source: Endeavour Silver
AISC net of gold by-product credits are estimated at USD 14.00 - USD 15.00 per ounce of silver. Cash costs net of gold by-product credits are expected to come at USD 6.50 - USD 7.50 per ounce of silver. So we have higher silver equivalent production but lower silver output. Cash costs are close to those of Chinchillas but AISC are much higher.
Regarding reserves and resources, Endeavour Silver's proven and probable reserves plus measured and indicated resources currently stand at 142.7 million ounces of silver equivalent for all projects and 66.9 million ounces of silver equivalent for the producing projects. Inferred resources for all projects are 64.8 million ounces of silver equivalent and 45.4 ounces of silver equivalent for the producing projects. That's calculated based on the initial mineral resource estimate for El Compas and the updated mineral resource at Terronera.
Total reserves and resources are close to 4.5 million ounces of silver equivalent higher that Chinchillas, but those of the producing mines are over 90 million ounces of silver equivalent lower.
Endeavour Silver currently has a market cap of USD 436mn and an enterprise value of USD 372.7mn. If we assume that the Chinchillas's operation should be valued close to that, then Golden Arrow's 25% interest based on the enterprise value would be USD 93.2mn, or close to USD 0.96 per share.
Now, let's take a look at Avino. The company currently has two producing projects in Mexico and Canada plus another in trial production. Silver equivalent production totaled 2.68 million ounces (1.61 million ounces of silver) in 2016 and the company is ramping up operations. Total cash costs were USD 8.48 per silver equivalent ounce while AISC was USD 10.34 per payable silver ounce. Compared to Golden Arrow's share in Chinchillas, Avino has higher silver equivalent production and similar silver output. However, both cash costs and AISC are higher compared to Golden Arrow.
Regarding reserves and resources, Avino has around 16.8 million troy ounces of silver equivalent measured and indicated resources at its two producing mines as well as some 42.4 million troy ounces of silver equivalent inferred resources. The trial mine, in turn, has measured and indicated resources of 91,528 ounces of gold and inferred resources of 83,900 ounces of gold. At a 75:1 gold to silver ratio, that equals to 6.86 million ounces and 6.29 million ounces of silver equivalent, respectively. Golden Arrow's 25% interest of Pirquitas equals measured and indicated resources of 35 million silver equivalent ounces and inferred resources of 15.8 million silver equivalent ounces. This means that Avino has much less measured and indicated resources than Golden Arrow, but around 21.6 million more total ounces when we add the inferred resources. Combined with the higher production costs, I think that Golden Arrow's interest in Chinchillas should be worth more than Avino.
Avino currently has a market cap of USD 93.9mn and an enterprise value of USD 96.4mn. If we assume that Golden Arrow's 25% interest in Chinchillas should be valued close to that, then based on the enterprise values this would translate into USD 0.99 per Golden Arrow share.
Golden Arrow's own valuation of USD 0.77 seems fair, but primary silver producers seem to be trading at premiums to their fair values. Therefore I think that it would be logical for the company's shares to trade in the USD 0.95 - USD 1.05 range once the market re-rates it from an explorer to a producer in 2018. That's of course assuming current precious and base metal prices and smooth permitting and construction. In any case, a USD 0.53 share price seems unfair.
In any case, I know that you can say I'm comparing apples to oranges, but even if that's the case, Golden Arrow seems too cheap at current levels.
Another important point is that Golden Arrow provides a unique opportunity to gain exposure to a top 10 primary silver mine. It thing that the share price definitely deserves a premium for that.
And then out of the top 10 largest primary silver mines in the world, there is none with a junior miner as a shareholder. That makes Golden Arrow a nice takeover target and since Silver Standard has deep pockets and has been vocal how much the investment environment has improved in Argentina, it seems logical that the company would like to acquire Golden Arrow's stake in Chinchillas at some point.
The only thing that concerns me is how long will the Pirquitas mill stay idle once stockpiles are depleted - can it find material to process until the third quarter of 2018? I don't worry about financing since all estimates and scenarios show that Golden Arrow has enough cash to finance initial capex. Future capital increases are pretty much a certainty as almost all mining companies raise cash now and then to fund projects or repay debts, but at least for now it seems very unlikely.
Disclosure: I am/we are long GARWF.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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