Cheap Gold-Silver Producer Deserves Immediate Upward Re-Rating
By Michael J. DesLauriers
24 Jan 2007 at 05:34 PM EST
resourceinvestor.com
TORONTO (ResourceInvestor.com) -- Starcore International Ventures Ltd [TSXv:SAM] which closed today at C$1, is a story that we talked about in May of last year after the company arranged to finance the acquisition of the San Martin mine in Mexico.
Unfortunately the market went soft for a brief period and some corporate finance departments did not live up to their end of the bargain, but Robert Eadie, President of SAM, has since resurrected the deal, all of the financing has been lined up (oversubscribed), and the acquisition is due to close, if not by the end of this week, early next week. It is now a fait accompli.
Upon closing, Starcore will instantly become a gold-silver producer operating a mine with a history of consistent profitability for 12 years, and with a mine life of more than another 10 years ahead of it. All of this is on a property that has never been systematically explored (more on that later).
For that reason, and given the record of stable and predictable cash flows generated by the mine, we believe that Starcore should experience an immediate upward re-rating to set valuations more in line with producing peers.
We often talk about near-term producers that deserve re-ratings, but this story is an existing producer of gold and silver. Because Luismin owned the mine and was acquired by Wheaton River, and Wheaton River then acquired by Goldcorp [NYSE:GG; TSX:G], there is plenty of data on this ISO 9002-certified operation.
For that reason, we think that this is a ‘no-brainer,’ and could be one of the biggest lay-ups that we have come across in some time.
Reserves & Resources
San Martin is a vein mine and so reserves amount to never more than 4 years or so of production. What people don’t know, and what is made plain in the Technical Report, is that over the last 12 years, not just 100% of the material in the Inferred category has been converted to reserves - but 133%!
Just on the basis of 100%, at the current rate of mining, 11 years of material exists across all categories.
If one uses 133%, we are approaching 15 years - and this still does not include the nearby silver rich San Pedrito deposit that also came with this acquisition.
But it gets better. On top of having between an 11-15 year mine life ahead of it, just from what is already known, this property has never been systematically explored because Luismin was a private company, and was only concerned with always having enough feed for a few years of reserves. Wheaton and Goldcorp were focused elsewhere as this mine was essentially too small for them, which is why they sold it - Goldcorp was trying to reduce its debt load after the Placer Dome deal.
We believe that significant new discoveries of new veins and additional mine life could be the likely result, as Starcore gets to work.
Immediate Cash Flow
Starcore is presently producing 40,000 ounces of gold equivalent, at a cost of about $280 per ounce. About 33,000 ounces are gold, and there is about 350,000 ounces of silver production, which equates to roughly 7,000 more gold equivalent ounces.
Contrary to what some resource sector investors think, it should be noted that Starcore receives spot silver prices on all of their silver production. This was part of the deal and was confirmed with Silver Wheaton [TSX:SLW; NYSE:SLW] by your correspondent.
In terms of cash flow, Starcore would receive spot prices for half of its production, and has entered into a hedge which should secure the company a price about $125 per ounce above current spot gold prices for the other half.
Given that, and the fact that SAM will have 50 million shares outstanding and 100 million shares fully diluted post-acquisition, we see cash flow per share of between 18 cents and 36 cents depending on which number you want to use.
We believe that given that the majority of the difference between the outstanding and fully diluted number of shares, made up of warrants which will almost certainly not be exercised until the end of their lives of between 2 and 6 years hence, the market will apply a cash flow multiple based on something in between issued and fully diluted shares.
If one applies a number somewhere in the middle, we arrive at 27 cents of cash flow per share. The next question is what multiple to use.
On the plus side of the ledger, SAM is a gold and silver producer with a long mine life, in a safe country. On the minus side, they aren’t a huge producer and will have a hedge in the short term, albeit well above spot.
Given all of the above, we believe that the multiple will come in higher than the 5X that base metal producers tend to receive, but lower than the 10+X that junior gold producers are typically ascribed.
Using 7.5X cash flow of 27 cents per share, or the middle of the range between outstanding cash flow per share and fully diluted cash flow per share, we believe that Starcore should be trading at C$2 immediately, given the long track record of its existing producing mine, and to put it at a fair valuation versus peers.
There are a couple of things that could happen to make these numbers yet better, including clauses in the debt financing agreement which could see it cancelled and paid off from another equity raise at higher levels. That would eliminate the majority of the 20 million purchase warrants issued to Investec (quite a nice living they are making!) for their provision of the debt financing. Were this to happen, the multiple would also expand as the hedge came off.
Even without this though, Starcore could experience tremendous growth over the next 18 months.
Growth Profile
The company believes that over the next 18 months it can gradually increase production from 40,000 ounces gold equivalent now, to 58,000 ounces. At the same time, cash costs are projected to come down to around $230 per ounce.
Using the same gold price assumptions listed above, cash flow would rise to $28 million or between 28 cents and 56 cents per share, depending on whether one uses outstanding or fully diluted numbers.
This growth would come alongside an end to hedging commitments (roughly 30,000 ounces of production is all that is required to payback the entirety of the loan, if it is not bought-out beforehand).
With more production and no hedge, we believe that the company’s multiple could rise to 10X - and using the average between the cash flow per outstanding share and cash flow per fully diluted share, that would give us a target price of in excess of C$4 per share, in 18 months.
What this still is not factoring in:
1.
The fact that the fully diluted number may be lower, given a termination and paying out of the Investec agreement;
2.
The big upside potential of the Cerro Delores property which has been the subject of an internal scoping study that demonstrated that the property could produce over 1.2 million ounces of silver per year, plus abundant lead and zinc, generating over $15+ million in cash flow. The project currently has 550,000 tonnes of resource and subject to drilling to expand that to 1-2 million tonnes or better, Cerro Delores could be brought online within the same 18-month time frame for less than $5 million, or out of cash flow;
3.
An accretive acquisition - Starcore is on the prowl in Mexico, has excellent relationships there, and intends on making an acquisition of a producing or near-production asset within the next 12 months. Should this come to pass, the numbers would only look better.
If any of these things occur, and Cerro Delores is already sitting there, the C$4 target could be upped.
Either way, in addition to the fact that fair value versus peers for this mining company (with a long history of profitable production) should send shares to C$2 upon closing of this acquisition in the next few days, there are a number of significant upcoming catalysts that could push Starcore higher.
Catalysts & Conclusion
Over the next 3 months, with the majority very soon, Starcore should be able to announce:
*
New experienced operating management coming into the company to run the mine, and focus on development of other opportunities;
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A TSX listing;
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A production decision on Cerro Delores;
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The fact that Starcore is on the prowl for acquisitions;
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Potential new discoveries from the first systematic exploration program on San Martin, starting immediately;
In addition, we understand that the company intends on allocating a generous budget to marketing this story over the next couple of months.
To conclude, we believe that given San Martin’s consistent and profitable gold and silver production over the last 12 years from the safety of Mexico, which the market can see, and at least 11 years of mine life remaining just based on what can be seen now, Starcore should immediately achieve its full rating once its imminent acquisition closes over the next few days.
Using a cash flow multiple of 7.5X, which is less than comparable junior gold and silver producers, we arrive at an immediate target of C$2 per share, or nearly a double from current levels.
Beyond that, if the company can deliver its projected production growth from San Martin, that alone makes this a C$4 stock within 18 months, without even factoring in the potential of Cerro Delores to come on stream out of cash flow, or the likelihood of an acquisition which could prove accretive as well. As always, your correspondent’s stories assume flat metal prices despite the bullish prevailing environment for gold and silver.
Starcore appears to be one of the most obvious lay-ups that we have seen in some time, and we believe that the company deserves an immediate upward re-rating upon completion of the acquisition of San Martin, to catch up with producing peers - yielding a double right away. Beyond that, we see the potential for multi-bagger returns as growth leads the way over the next 18 months. |
