Amerigo Resources (OTCQX:ARREF) is a copper processing company operating in Chile. The company extracts copper from tailings delivered by one of the world’s largest copper producers, the El Teniente mine owned by Codelco. This year Amerigo is supposed to complete the construction of the second phase of the Cauquenes expansion project (the first phase was completed in 2015). As a result, the company’s annual copper production should jump from 62.5 million in 2017 to 90 million in 2019. In my opinion, this year is a turnaround period for Amerigo and the last chance to purchase its shares at a significant discount to the company’s intrinsic value.
Additionally, Amerigo shares are supported by an ongoing bull market in copper. As the chart below shows, after a medium-term downward corrective move (the red line on the chart below), a new leg up is in the making:
Note that a similar pattern was printed last year (the blue line on the chart above) so, if history repeats, there is a good chance for a positive scenario soon. Interestingly, as the green up-sloping arrow on the lower panel of the chart shows, since the beginning of 2017 Amerigo share prices have been the market leaders, outperforming the broad copper market represented by Global X Copper Miners ETF (COPX).
Amerigo is not a typical copper miner. Instead of running an open pit or underground mine, the company is focused on processing copper tailings under a long-term contract with Codelco. The business model is quite simple:
- Codelco is a classic copper miner – apart from a final product (copper) it produces waste, stored in tailings dams
- The term “waste” is a bit incorrect because tailings contain marginal amounts of the red metal (0.11% – 0.27%, in the case of the El Teniente mine), which can be converted into valuable material
- At this point Amerigo enters the scene offering technology to process the Codelco’s tailings and extract these marginal amounts of copper; the business agreement between Amerigo and Codelco (or, better said, DET, which is the Codelco’s El Teniente division) is called “tolling agreement”
- According to the tolling agreement, Amerigo is charged with the royalty on behalf of DET
- A final product of tailings extraction is the copper concentrate; the concentrate is owned by DET and Amerigo is rewarded with the so-called “tolling revenue”, calculated as the gross value of copper extracted by Amerigo, net of treatment and refining charges, DET copper royalties and transportation costs
- Once the tailings have been reprocessed, they are transported to the Caren tailings impoundment (owned by DET)
In other words, Amerigo is focused solely on its business (extraction of copper from tailings). Other issues as delivery of tailings or marketing the copper concentrate are DET’s responsibilities. It means that keeping costs of production as low as possible is a crucial factor for Amerigo. Fortunately, the company is very efficient and keeps its costs low.
Costs of production
In the case of Amerigo, its costs of production consist of the following issues: tolling and production costs, DET molybdenum royalties (apart from copper, the company extracts molybdenum), depreciation and on-site administration. As the chart below shows, after a large drop reported in 2014, costs of production have been generally stable. For better understanding, I have also plotted the costs of production expressed in Chilean pesos – Amerigo operates in Chile so its costs are incurred in the country’s national currency:
Source: Simple Digressions
Note: a large cost drop reported in 2014 had nothing to do with efficiency. It was the result of changes in reporting standards – the DET royalty was reclassified from costs of production to revenue.
It is easy to spot that between 2015 and 1Q 2018 the unit cost of production was standing at around CLP 1,220 per pound of copper (US$1.91 using the current exchange rate between the US dollar and the Chilean peso of 1:0.001568).
Cauquenes expansion project phase 2
As I have mentioned in the beginning of this article, this year Amerigo is going to complete the construction of the second phase of the Cauquenes expansion project. The first phase was completed in December 2015 at a cost of $66.6M; the second stage CAPEX is $35.3M. According to the company:
“Construction of Phase Two is on track for completion in Q3-2018, with full production in Q4-2018. MVC expects to complete the project within budget of $35.3 million including contingencies. Phase Two will improve flotation recovery efficiency, allowing MVC to increase production to 85.0 to 90.0 million pounds of copper per year”
Interestingly, in 4Q 2018, when the second stage of the project is fully operational, the company is going to show the first benefits (this year’s copper production should stand at 65 – 70 million pounds of copper vs. 62.5 million in 2017).
How it works
Amerigo extracts copper from two kinds of the El Teniente tailings: fresh and historic. Today the company’s processing plant has nominal capacity of 190 thousand tons of tailings per day, of which 130 thousand is deployed to fresh tailings and the remaining part to historic ones. Most importantly, historic tailings have much higher copper grades than fresh tailings (0.246% vs. 0.119% in 1Q 2018). Simply put, the old processing technology was not good enough to process historic tailings and a lot of valuable material was waiting for better times in the Codelco tailings as waste.
Now the main point – the company does not want to increase the mill’s capacity. No, the project is not about it. All Amerigo wants is to improve flotation recoveries from the current 34% to 49%. So the project is about efficiency.
The table below provides an explanation how the company wants to improve efficiency and what outcome we should expect:
Source: Simple Digressions
As the table shows, an increase in recovery rates from 31.6% (2017) to 49.0% (2019) should result in higher copper production (additional 21.6 million pounds).
The company’s value
According to the company, at current copper prices of $3.2 per pound the project’s net present value should stand above $389M (using a discount rate of 7%):
Now, apart from running the processing business, the company incurs off-site administrative expenses. I estimate these costs at $6M per year (the 1Q 2018 administrative expenses were $1.5M).
Finally, at the end of 1Q 2018 Amerigo carried net debt of $36M. The share count was 177 million.
The table below shows the way I have calculated the company’s value:
Source: Simple Digressions
Note: to arrive at the discounted value of corporate issues I have discounted an annual off-site cost of $6M over the life of the project (until 2037) using a discount rate of 7%
As the table shows, one share of Amerigo is worth $1.63. Today these shares are trading at $0.8 a share so the upside potential is significant (over 100%).
Exchange rate risk
Amerigo incurs its costs in Chilean pesos and presents its reports in US dollars. As a result, the exchange rate between the US dollar and the Chilean peso has some impact on the company’s results. For example, a stronger US dollar has a positive impact because the stable costs incurred in Chilean pesos are lower when expressed in US dollars, improving the company’s earnings. As the chart below shows, since the beginning of 2016 the US dollar has been weakening against the Chilean peso, negatively impacting Amerigo’s results:
On the other hand, this year the company’s results are supported by the exchange rate – the US dollar is much stronger than at the end of 2017.
Amerigo’s results depend on copper prices. Yes, I know it is truism but in the case of Amerigo this relationship is stronger than in the case of a classic copper miner. Simply put, the revenue the company shows depends not only on copper prices but also on the DET royalty, a fee the company has to pay DET to extract copper from El Teniente tailings. In other words, it is an additional burden lowering the company’s earnings. I do not want to go very deeply into the formula used to calculate the DET royalty but according to my calculations, when copper prices are around $2.20 per pound the company is very close to a break-even point. Today copper is in its bull market phase and the prices are well above $2.20 per pound so investment in Amerigo shares makes sense.
The table below depicts the company’s liabilities (as of the end of 2017):
As the table shows, this year the company should pay off $44.6M. However, excluding trade and other payables (which are rolled over each year) the actual liabilities are $31.6M. I am confident that the company will have no problem with meeting its obligations:
- At current copper prices the company is able to deliver the annual cash flow from operations of $24M
- As of the end of 1Q 2018 Amerigo held cash of $29.9M
- As a result, the company was able to cover obligations of $53.9M, maximum (as mentioned before, the actual obligations are $31.6M)
In my opinion, Amerigo Resources is one of the most undervalued copper plays. This year the company will complete the second stage of the Cauquenes expansion project, increasing its annual copper production from the current 65 – 70 million pounds to 85 – 90 million. This significant jump in production should drive the company’s value to $289M or $1.63 a share. Today Amerigo shares are trading at $0.8 a share so they are deeply undervalued.
What is more, the current bull market in copper has an additional, positive impact on the company’s valuation. The table depicting the project’s net present values is the best evidence that Amerigo is highly leveraged to copper prices.
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