Sherwood Set for Solid Cash Flow
By Ben Abelson
19 Nov 2006 at 07:19 PM EST
resourceinvestor.com
CHICAGO (ResourceInvestor.com) -- We first looked at Sherwood Copper [TSXv:SWC] this past summer, when a swoon in the price of base-metal producers left the company trading at C$2.84, just under 2 times its one-year forward pre-tax cash flow. While the shares have since rebounded to the C$3.50-range, continued progress on its wholly-owned Minto project means that Sherwood still remains a compelling valuation.
Project Financing and Hedging Secures Near-Term Cash Flow
Most importantly, the company was able to secure an C$85 million debt facility at the end of October, which will provide the bulk of the capital needed for the mine's construction leading up to commissioning in Q2 of 2007. While investors seeking maximum leverage tend to frown upon commodity hedges, Sherwood's decision to undertake hedges of 65% of its production through 2011 as part of the debt facility should ultimately prove to be a prudent move. By entering into forward sales of 91 million pounds of copper, 42,000 ounces of gold, and 467,000 ounces of silver (at respective prices of $2/lb-$3.17/lb copper, $636.25/oz gold, and $11.51/oz silver) Sherwood has ensured stable operating cash flows for the immediate future.
In fact, initiation of the hedges has substantially improved upon the base-case valuation scenario laid out in Minto's feasibility study. Copper cash costs over the life of the mine have fallen a penny to $0.59/lb, pre-tax operating cash flows average C$61.6 million/year over the first six years, and the project's pre-tax NPV is C$201.7 million. With the company currently only trading at an undiluted market cap of C$125 million, there definitely remains room for upside in the shares.
(The feasibility study also assumed metals prices of $2/lb copper, $550/oz gold and $9/oz silver for the remainder of the unhedged production.)
And, while the metal hedging has protected near term cash flows, it's still left decent upside commodity leverage for investors. While much of the currently expected production has been hedged, only 35% of Minto's total reserves of 300 million pounds of copper, 122,000 ounces gold and 1.8 million ounces of silver have been hedged. Given this, there's certainly upside leverage if the deposit can be expanded beyond its current feasibility study levels of production.
Expansion Potential Underscored by Recent Exploration Results
While the current mine plan calls for the bulk of Minto's production to be front-loaded in years 1 through 6 (with low-grade ore processed after that), recent drill results in the areas surrounding the main open pit region have underscored the project's expansion potential.
The most prospective zone is Minto's “Area 2,” where recent drill results have continued to uncover high-grade samples. Most impressive of these were a 33.4 metres interval grading 2.86% copper and 1.21 g/t gold and a 16.8 metres interval grading 3.97% copper and 1.73 g/t gold.
According to Sherwood, the overall drill results have led project geologists to conclude that the Area 2 intercepts are quite similar to main ore zone at the adjacent Minto deposit. While it still remains to be seen what will come of Area 2, the project's potential provides a nice option to the now predictable cash flows expected from Minto.
Conclusion
With 65% of its immediate-term production hedged, the commodity price risk of an investment in Sherwood have now gone down substantially. While many investors don't look favourably on these sort of transactions, Sherwood's hedging ensures stable and somewhat predictable life of mine cash flows, while still allowing for substantial upside appreciation on the back of its 35% unhedged production and the potential for expansion. Given this, an investment in Sherwood is probably about as low risk as a base metal junior can get. |
