The Gold Report: Heiko, you cover many companies in Latin America. One silver miner in Mexico is challenging an eviction notice from its property in Chihuahua, Mexico, which is causing a stir in the mining industry. Does that give you cause to reevaluate Mexico as a mining jurisdiction or is this an isolated incident?
Heiko Ihle: Mexico is a more challenging mining jurisdiction than the United States or Canada, but it's also a much easier place than Bolivia, for example. There are some common challenges with mining there. One of the companies I cover, Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE), has some issues with the community in Oaxaca. This sort of thing happens all the time, and it's mostly business as usual.
TGR: What sort of gold and silver prices are you using in your models to evaluate these companies?
HI: I'm a stock analyst, as opposed to a macroanalyst, so I use conservative numbers: $1,600/ounce (oz) long-term gold prices and $34/oz long-term silver prices. In the long term, those numbers are likely to be a little too low, but they produce a margin of safety to our net asset value (NAV) and cash-flow models.
"I look at the microeconomic company-specific factors and make my decisions accordingly."
TGR: The silver companies you cover in Latin America are for the most part outperforming your gold companies. Does this make you more bullish on silver than gold, or are you evaluating specific cases and what those specific equities offer?
HI: I look at specific cases because the best gold company can't prosper if it can't get gold out of the ground at a decent cash cost. Similarly, the best silver company won't flourish if a community demonstration shuts down its plant. Again, I am an individual equity analyst; I look at the microeconomic company-specific factors and make my decisions accordingly.
TGR: What are three must-haves for the companies you cover?
HI: The number one thing is good management. Bad management can run the best company into the ground. I've seen it in stocks that I covered and in stocks that I owned.
TGR: How do you quantify good management?
HI: If I speak with a management team and I get the sense that it doesn't understand what's going on, then that would put it into the bad management category. If it continuously disappoints, if it continuously over-promises and under-delivers, that would put it into the bad management category. I worry, too, if there is no coherent team—even if the CEO, CFO and chief geologist are great people, there is a chance that they do not work well together. It sounds simplistic, but I always pay close attention.
TGR: What are the other must-haves?
HI: A company must have a good asset. Even if it has great management, if a company doesn't have a good asset, nothing's going to be pulled out of the ground. It needs to have a decent land package with room for expansion. The grades need to be right. The type of ore needs to be right. It needs to be permitted or have decent progress toward permitting. The third must-have is a functional mill with potential for expansion. The chain is only as strong as its weakest link, and if one of these factors is broken, the whole system is going to crumble.
"Bad management can run the best company into the ground."
I do a lot of site visits to evaluate the mills. I look for spare capacity, and I go through all the geological reports for permitting.
TGR: Does that mean you're looking only at producers?
HI: Not necessarily. I cover Romarco Minerals Inc. (R:TSX). It is still in the permitting phase, but it has made good progress toward a permit; it is so confident that it will get the permit that it already bought the ball mills.
TGR: What is Romarco's production timeline?
HI: The Army Corps of Engineers should let it know early next year. My gut feeling is that it will be in production in 2015.
TGR: Let's move into your coverage of precious metals companies in the Americas. Aurizon Mines Ltd.'s (ARZ:TSX; AZK:NYSE.MKT) earnings per share were less than half of what they were in the same period a year prior, Q3/11. The company's cash costs rose to $759/oz in Q3/12 versus $497/oz in Q3/11. Nonetheless, you have a buy rating on Aurizon.
HI: Yes. Aurizon is going through a transitional year. It is going through a shaft deepening at the Casa Berardi mine. Meanwhile, several other companies that can afford higher wages are poaching its workers. The shaft deepening frequently shuts down production at the site, and the same thing will happen in 2013, which is why my 2013 production numbers are lower. Cash costs are higher and may be even higher next year, when production will dip to 130,000 oz. However, this is temporary and ultimately will serve as an investment in the company's longer-term growth.
TGR: In a recent research report on Aurizon, you said you believed that, with about $200 million (M) in cash, "the firm will engage in favorable M&A activity." What sort of projects or targets is it likely to pursue?
HI: Several projects in the area are in the $40–100M market-cap range. Two in the same mining camp are fairly widely known.
TGR: What is your 12–18 month target on Aurizon?
HI: It is $5.20/share.
TGR: Endeavour Silver Corp. (EDR:TSX; EXK:NYSE; EJD:FSE) had a strong Q3/12, with production increasing by about a third. You have a buy rating and a 12-month target price of $11.70 on the company. After such an impressive quarter, will there be room for more growth?
HI: A good part of Endeavour's Q3/12 growth came from its recently purchased El Cubo mine in Mexico. That is where growth in 2013 and beyond should come from; the mine should produce 1.1 million ounces of silver next year, compared with about 400,000 oz this year. Endeavour also has some growth at Guanacevi and Bolańitos. This growth should lead to more cash flow and potentially more acquisitions for the company.
TGR: Endeavour bough El Cubo from AuRico Gold Inc. (AUQ:TSX; AUQ:NYSE) in July. What were your thoughts when that transaction occurred?
"If investors diversify by going across base metals, gold and silver, they will be doing themselves a favor."
HI: I liked the acquisition, and I liked it even more after I visited earlier this year, when Endeavour took a number of analysts down for a site visit—it really showed how much of a turnaround it has made. After it took over, Endeavour essentially doubled grades within six weeks because it started following the veins instead of randomly mining into the mountain and processing waste rock. I would expect Endeavour to have a good part of the transmission done next year, and my grades are improving for El Cubo as well.
TGR: Considering its growth, do you think Endeavour will introduce a dividend?
HI: No. It is more focused on growing the enterprise through more acquisitions. Endeavour has a very good track record for acquisitions.
TGR: Yes, Endeavour has made a number of badly performing assets perform.
HI: The day Endeavour closed on El Cubo, the NAV was already substantially above what it paid.
TGR: You also cover Fortuna Silver Mines, which had a great Q3/12 and is poised to exceed its production guidance for 2012. Do you expect similar performance in 2013?
HI: The company has good production numbers at its San Jose mine in Mexico, though there are community protests there. Offsetting that, however, is the Caylloma mine, which is in Peru. I visited it about a year ago. Labor costs are going through the roof at that site, so while production is very good, its cash costs have been rising more than everybody anticipated. The company should have a good 2013, but there will be some cash costs challenges, and it is already working on those.
TGR: In a recent research report, you said Fortuna continues to search for midsized acquisitions in Central and South America. Given the difficulties it has faced at Caylloma and the mine's higher than anticipated labor costs, which juniors in Peru or nearby might be a good fit for Fortuna?
HI: Fortuna is looking into private enterprise like smaller private mines that it can buy or privately owned land packages that it can attach to its mines. It probably will not buy a public junior company.
TGR: What is it looking for? Is it looking to bring more feet into Caylloma?
HI: Fortuna is looking for a separate project, which is what it should be doing because it diversifies risk. A good example is Aurizon, which has a single asset. Right now, that single asset is going through a tough time and that punishes the entire company. If a company has four assets and one goes through a tough time, it has much less impact.
TGR: What is the next catalyst for Fortuna that will get it to your $6.60/share, 12–18 month target price?
HI: It needs to get cash costs under control, which it should be able to do once labor pressures subside; labor is the biggest factor.
TGR: Is your $6.60/share target price a buy rating?
HI: Yes. That is an upside from here.
TGR: Great Panther Silver Ltd. (GPR:TSX; GPL:NYSE.MKT), on the other hand, had a poor Q3/12. Earnings per share were halved, and total revenues declined 6% year over year. You have a 12 month target of $2.20/share on the company, but it is trading around $1.60/share. What will push it higher?
HI: Great Panther is also experiencing challenges. The droughts in Mexico this year forced it to stockpile ore because the mill wasn't able to take on the capacity. Meanwhile, some thought Endeavour would take over Great Panther because it was a logical target. However, since it took over El Cubo, there is less of a chance of Endeavour buying Great Panther. Revenues should grow nicely next year. I was disappointed by 2012 results year-to-date, and my price target has gone down as well, but the NAV discount remains. In the longer term, it should hopefully be able to get those assets' value.
TGR: What is it trading at versus your NAV?
HI: My NAV is at $1.80/share. The 20% premium gets rounded, that is $2.20/share. That consists of $1.44/share for Guanajuato and $0.22/share for Topia, which includes the drought issues. That is $249M for the overall company, including cash and exploratory assets and such.
TGR: Rio Alto Mining Ltd. (RIO:TSX.V; RIO:BVL) operates the La Arena gold-copper mine in Peru, and its share price has trended higher throughout most of 2012. Can investors expect further growth?
HI: Yes. The second part of the company's project goes on-line in a couple of years, and a lot of copper is being taken from the site. The stock should fare well. Rio Alto is also doing something many others wish they could do, which is growing through internal cash flow, so it doesn't have to dilute shareholders. It doesn't have to issue a lot of debt or equity; it is using the free cash flow from its first site and using that to grow.
TGR: Could you give us an overview of Rio Alto? The company has done well this year, but it isn't widely known.
HI: It owns La Arena, which is about 1,000 hectares, in Peru. It is a gold mine currently and a future gold and copper project. It has an approximately 26,000 hectare land package around there, and it currently produces from the La Arena oxide project, the gold project I just mentioned. That is open-pit mining, and in about 2016, the sulfide project will come on-line. That is where most of its cash is going right now, and at that point it will also produce copper at the site.
TGR: When you met with management from Rio Alto, what stood out?
HI: It has performed so far, and many companies in this space can't say that. CEO Alex Black is a good guy and the team he leads with CFO Tony Hawkshaw has delivered on everything it said it would, including time tables, grades and proper sales of the metal. It also got lucky this year; the grades from the site were at least temporarily higher than the company and all the analysts had thought they would be.
TGR: You recently downgraded Sandstorm Gold Ltd. (SSL:TSX.V) to neutral. What was your rationale?
HI: That decision was due to valuation. The gold streaming business is still a good business. And I still like the company's management, which has achieved a lot in a short period. Right now, in a period of high gold prices and a fixed cash cost, many are selling gold for twice what it costs to take it out of the ground. It is a terrific business. Nonetheless, at some point, even the best business becomes fully valued, and I believe Rio Alto reached that point at $13.50/share. That is where it was when I downgraded it. Now the stock is a lot lower; it is trading around $11.50/share.
TGR: The company has royalties on quite a suite of mines. This is a highly profitable business, given the margins and the tax considerations in Canada, but as more people catch on, will more companies enter this space, growing the competition for those royalties and shrinking the margins?
HI: A lot of streaming agreements are like pawn shops: companies go there because they can't go anywhere else. That is what has held the industry's margins up. If everybody else were to come out and do the same thing, it could drive the companies' costs of funding a little lower—but that won't happen. Also, a streaming company can err and invest in mines that never reach production only so many times until it is broke.
Of course, there are more streaming companies now than there have ever been, and there are more juniors than before, too. All it takes is a project, a dream, an engineer and a geologist.
TGR: The share price for Sandstorm Gold shot up and people made money, and now you say it has come back to earth. Is growth coming from the price of these commodities—or how will a streaming company like Sandstorm grow from here?
HI: The growth will come twofold. The mines it has streaming agreements on are going to enter production or grow production; that is one way to grow. A second way to grow is to issue more capital, which Sandstorm has done this year, and then use that to buy more streams in their infancy.
TGR: Are you bullish on Colossus Minerals Inc.'s (CSI:TSX; COLUF:OTCQX) Serra Pelada mine, in which Sandstorm has a royalty, and when that comes on, will it be a significant contributor to Sandstorm's revenue?
HI: I don't follow Colossus, but I do feel good about that mine. I put out a report on it as well.
TGR: What segment of the precious metals market is going to provide retail investors with the best bang for their buck in 2013?
HI: I suggest people figure out what area they want to invest in, then narrow it down to a couple of companies. Go back to those three must-haves that I mentioned. Look into management, look into the assets and look into the permitting and the operational phase of the firm.
I would also say people should diversify. And if they just go across base metals, gold and silver, they will be doing themselves a favor.
TGR: So your advice is to evaluate individual companies and divide the portfolio up by commodity.
HI: Yes, and commodities shouldn't be your full portfolio.
TGR: Thank you so much, Heiko.
Heiko Ihle joined Euro Pacific Capital in November 2011 as a senior research analyst covering companies in the mining and engineering and construction (E&C) industries. Prior to joining Euro Pacific, Ihle spent over six years with Gabelli & Company, more than five of which as a research analyst. While at Gabelli, he was awarded second place in the 2010 Financial Times/StarMine Top Analyst Awards for the Engineering & Construction space. A native of Germany, Ihle received his bachelor's degree in finance and management from the University of Illinois at Chicago in 2004, and his Master of Business Administration from the University of Miami in 2006. He has been a CFA Charterholder since 2010 and is currently a member of the CFA Institute and the Stamford CFA Society.
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1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Fortuna Silver Mines Inc., Aurizon Mines Ltd., Endeavour Silver Corp., Great Panther Silver Ltd. and Colossus Minerals Inc. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Heiko Ihle: I personally and/or my family own shares of the following companies mentioned in this interview: None. I am personally and/or my family is paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.
4) Euro Pacific Capital may sell to or buy from customers on a principal basis the named securities.
5) Euro Pacific Capital owns warrants in Endeavour Silver Corp.
6) Further disclosure information can be found on our website at europac.net or by calling 1-800-727-7922.