Research Report: Scorpio Mining Corporation
Prepared by: Mike Kachanovsky
Monday, March 20, 2006.
The following report has been prepared based on information that has been disclosed on the public record by Scorpio Mining Corporation, and also from personal interviews I conducted with management and employees, and my own observations recorded during a visit to the Nuestra Senora Project in Sinaloa State, Mexico. The company is actively engaged in development work to advance the project to full production, and also to continue exploration efforts in order to increase the defined resources at their mines. This project represents an exceptional opportunity for investors to gain leverage to the rising trend for metals prices, through an unhedged, high grade mining operation, and offers tremendous upside potential for the discovery of new deposits on their large, 100% controlled property holdings covering most of the known mining district that has been in production during various intervals dating back 300 years.
During my two-day visit to the project, the company funded my travel expenses. I have not received any form of compensation to present this report, and have no paid relationship with Scorpio Mining Corporation. I presently own shares of the company in my personal investment portfolio.
Overview
Now that silver spot prices have risen to levels representing multi-decade highs, interest is beginning to intensify among investors to acquire shares in junior mining companies that can offer leverage to further price increases through primary production of silver resources. Many of these companies are currently operating, or advancing towards production, in Mexico. Currently ranked as the largest silver producing nation, Mexico is an attractive jurisdiction for junior mining due to the presence of large districts of favourable geology, strong economics and an environment of low operating costs. Support for mining development is strong at both the local community and state government levels. In recognition of these positive factors, Canadian-listed junior mining companies are aggressively acquiring some of the best prospects in the country to establish a new wave of mining operations.
Scorpio Mining Corporation is set to become the latest success story to gain control of a historic mining district (through their wholly owned Mexican subsidiary Minera Cosala S.A. de C.V.) and invest capital to fund modern exploration and new development, so that mining operations can be restarted. A focused, experienced management team has guided the company through several years of exploration work to outline new zones of resources, while ongoing development work has improved the infrastructure of the mines.
Exchange listing: TSX-Venture – SPM
Corporate Office Address: 511 – 475 Howe Street, Vancouver, BC, V6C 2B3
Telephone: 604-678-9639
Share Structure: Outstanding: 45 million
Warrants: 5.5 million
Options: 5 million
Fully Diluted: 55.5 million
Market Capitalization: $47 million
The Project
In 1998, Scorpio Mining secured 100% ownership of the Nuestra Senora Project, comprising ten mining claims amounting to 137 square kilometers. The district extends across an area of intensely altered geology, demonstrating widespread mineralization rich in precious and base metals that have been the target of mining activity for hundreds of years. The project is situated about 160 kilometers northeast of the City of Mazatlan, in the State of Sinaloa. The town of Cosala is the nearest population center, about 10 kilometers west of the property, providing the labour and service infrastructure to support operations. The project is well served with road access, and water and power supplies are secure. Current development work is focused on four past producing mines on the property.
The largest of the four mines, the Nuestra Senora occurs at the base of a river valley. The American mining company ASARCO formally operated it until 1965, when the company closed the mine due to the pending implementation of protectionist mining laws. The mine remained dormant until Scorpio gained control of the project, and the lower levels of the mine had become flooded with groundwater during the long period of inactivity. As part of the development currently underway at the mine, these levels are being dewatered, and geologists have recently been able to complete sampling along the workings. They were delighted to discover that a large tonnage of mineralization that had been opened to development by the former operator remains in place. In addition, Scorpio has also outlined numerous discovery zones through their exploration work, where development activity is underway to open up access to the new mineralized zones. The system remains open at depth and along strike.
The Candaleria Mine is situated near the top of a steep ridge, about 150 metres vertical elevation above the Nuestra Senora Mine. A decline ramp has been driven to access several levels of replacement style and breccia hosted mineralization, along with high grade skarn deposits, and hydrothermal veins. Much of the earlier exploration work completed by Scorpio identified discontinuous pods of very high grade sulphide mineralization that have the potential for economic extraction, but amount to only limited tonnage. Underground development work to extend the decline ramp to access lower levels revealed several new zones where additional deposits can be processed. The challenges of the discontinuous nature of the mineralized zones uncovered to date suggest that the mine is not suited to larger scale mining methods. The mineralized zones outlined so far however will certainly be of value when this mine resumes production, as they can be selectively mined and will contribute towards a larger volume of tonnage from the entire project.
Along the base of the canyon, at about the same elevation as the Nuestra Senora Mine, the Santa Teresa and the Santo Domingo Mines both exploited carbonate replacement mineralization along fault zones in the limestone host rock. Scorpio has not focused a great deal of exploration on these mines to date, and they remain promising targets for future work.
The geologists working on the project have come to realize that large, continuous zones of mineralization occur along fault zones trending across the property, which served as conduits for mineralizing fluids during extended periods of hydrothermal activity. Over time, the limestone host rock underwent significant alteration, resulting in the formation of replacement style mineralization along the contact zones, and widespread deposition of sulphides rich in silver and base metals, in fissures and brecciated zones. Based on their understanding of the geological controls governing the emplacement of the deposits, Scorpio has begun successfully targeting these zones of fracturing along the edges of thrust faults, to discover new deposits. When one considers the proximity of additional highly prospective geology on the property controlled by the company, that has yet to be explored, the true discovery potential for the district is extremely encouraging. The fact that Scorpio has been able to gain 100% control over such a district is an enormously attractive investment consideration.
A resource estimate has recently been prepared by the independent consulting firm Chlumsky, Armbrust and Meyer, that reported a combined inferred and indicated resource of over 2 million tons of mineralization, averaging over 200 g/t silver, and greater than 5% combined lead/zinc content, along with significant copper grades and low grades of gold. It should be noted that this resource was prepared using conservative reporting standards, in compliance with NI 43-101 regulations, yet it already exceeds the total tonnage processed by the previous operator, ASARCO, during the 10-year period that they operated the project. What is even more impressive about that estimate is that it did not include the tonnage that has been defined in the Candaleria Mine. The most recently uncovered intact mineralization at the lower levels of the Nuestra Senora mine was not included in data used to prepare the report. Once company completes additional sampling and drilling necessary to establish these zones, the total resource defined will be significantly increased, and could amount to an additional resource of over 1 million tons.
Operations
The management of Scorpio is committed to putting the Nuestra Senora Project back into production. The company has purchased milling equipment necessary to construct a recovery plant to process ore from the mine, that will have a capacity of 1,000 tons per day. They expect to successfully close the purchase agreement for a mill site within a matter of weeks, and then begin construction of their facility. The objective is for mining operations to resume with an intitial production level of 500 tons per day, while the operations are fine-tuned and a level of efficiency is achieved. Thereafter, production will be increased to capacity at 1,000 tons per day. The recovery plant is being designed to allow for additional capacity increases to eventually process up to 2,000 tons of feedstock per day.
Of the four existing mines on the property, which lie in close proximity to each other, the Nuestra Senora Mine has the best developed road access to allow for the transportation of heavy equipment and machinery. The Candaleria Mine relies on a winding road providing somewhat tenuous access to the summit of the ridge, and the other two mines have no road access in place. To ensure the most efficient service infrastructure therefore, the company has envisioned a plan whereby all four of the existing mines on the property will be connected by extending subterranean decline ramps from the main entrance point of the Nuestra Senora Mine. They have also decided to sink a shaft to reach the lower levels of the mine, where the majority of production will come from, thereby ensuring that the ramps remain in service to provide access for people and equipment, while the production ore will be transported to the surface via the hoist through the shaft. The result of this ingenuity is that the mine will operate with greater efficiency and safety. But there are added benefits that will be derived from the extension of the ramps. The potential exists for new mineralized zones to be encountered as the underground development advances. The plan will also open up access for additional underground drilling stations to improve opportunity for exploration and new discoveries. Also, much of the rock that is excavated during the development will come from mineralized areas, and this material will be stockpiled at the surface to become the first feedstock processed at the new mill and recovery plant.
The characteristics of the country rock into which the mines have been excavated are very favourable for underground development. The remarkable structural integrity of the host rock is demonstrated by the fact that past underground workings dating back over 100 years remain intact and serviceable at the mines. This is a consideration important both for the safety of the mine workers and also because there is less risk of collapse causing a disruption in production, and lower development costs as only minimal reinforcement measures need to be implemented.
While most of the resource tonnage from the mines will be sourced from the Nuestra Senora, there remains significant high grade mineralization to be produced from the Candaleria Mine that can be extracted on a smaller scale. Since several levels of both mines have now been developed, there is a greater confidence that production can be maintained to meet the full capacity of the mill site, and less downtime or delays will result during periodic maintenance intervals. Again, the mining plan is to maximize efficiency.
A number of intangibles are also worthy of discussion, as they will have a positive impact on the long term success for the company. The management team should be commended for their understanding of the importance to have strong local community support behind their efforts, and for their commitment to work with the community to ensure that the benefits of the mine extend to the people who are most likely to be affected by the operations. Scorpio Mining is one of the main employers of the Town of Cosala, providing jobs that are sought after, and paying above average incomes to their employees. The actual mine location is several kilometers from the town, in a sparsely populated area, much of which has been designated as a nature reserve. The company has the luxury of establishing their operations plans from the beginning to ensure that they can minimize the disruption in the lives of the local population. As such, environmental stewardship is a priority, and high standards will be in place during the construction of the recovery plant and tailings dump, along with baseline studies and careful monitoring of discharge, to ensure that no harmful impact on the area will occur due to mining activity. Even the road access to the site for the recovery plant will be routed so that it does not create heavy traffic through the existing rural neighborhoods. Scorpio helped to fund the construction of a new modern bridge across the river near the mine site and will be participating in other infrastructure improvements that will benefit the entire region. The company has also financially supported the local university to increase the classroom capacity for new students, and sponsors an apprenticeship program to help train and develop students for a career in mining. These initiatives will strengthen the community support, and greatly reduce the potential for environmental backlash that has proven so detrimental to other mining interests in the past.
Outlook
Perhaps the most attractive aspect of the Nuestra Senora Project from an investment point of view is the large tonnage of higher grade mineralization that the company has been successful to define so far. Assuming the company is able to operate their mine at full capacity to supply a 1,000 ton per day mill and recovery plant, the operation would still be in production a full 7 years after commencement. Since there is a very high probability that additional resources will be added through further exploration and development work, it is very likely that the company will be able to operate well above the threshold necessary to maintain positive economics for the project, for many years into the future. The risk profile is even lower due to the high grade of the resources outlined to date that ensures greater resilience to the impact of potentially volatile metals prices. Using the industry rule of thumb in consideration of economic viability, a minimum tonnage must be proven up to provide at least two years of production, at a minimum grade that will amount to double the expected operating costs per ton. Scorpio Mining appears to satisfy both by a comfortable margin.
On the exploration front, the inventory of unexplored property controlled by Scorpio across the remainder of the district is exceptional. There are numerous sites on the property where shallow workings indicate past mining activity, which will serve as targets for future exploration. The project geologists have begun to gain an understanding of the structural controls that govern the emplacement of mineralization, and the geological setting of the district would suggest that other economic deposits remain to be discovered.
Scorpio expects to begin full production at Nuestra Senora by the first quarter of 2007. Preliminary economic studies based on current metals prices indicate that operations could be generating positive cash flow in excess of $50 USD per tonne. This would be sufficient to underwrite the future exploration plans targeting discoveries elsewhere on the property, and allow the company to internally finance additional capacity at their mill and recovery plant.
It is very likely that some form of consolidation is imminent among the junior mining sector participants in Mexico. A number of the companies in production at the present time, or anticipating the commencement of production within the next year, are operating on a model defined by low mill throughput (less than 1,000 tonnes per day), and low proven resources (less than 500,000 tonnes). As a result, these companies are marginal performers even under the current regime of high metals prices. Such projects are unlikely to be of interest to senior producers, as their acquisition would not generate incremental growth for a larger established operation. However, it would certainly be an attractive option for smaller juniors to pursue business combinations within the sector, to achieve critical mass for improved economies of scale. Hostile acquisition or friendly mergers will both have the effect to enhance the speculative premium that investors are willing to value all companies within the sector.
Scorpio is well positioned among their peer group of companies, as they have defined one of the largest resource tonnages, and will be in position to generate strong operating results for many years. Despite the low risk profile of the company, the market capitalization remains at the lower end of the scale for the group. This discount to their peer group should be closed as the company approaches the start up date for production, and there are strong indications that SPM is capable of generating positive operating results that would justify a premium valuation in the future. As such, Scorpio Mining can be considered a value stock at the current time, with a bright future in a country that will also be attracting a lot of attention in the years ahead.
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