By Kevin Michael Grace of The Gold Report
Despite headlines about deadly protests and the collapse of funding for juniors, Ricardo Carrión and Alberto Arispe of Kallpa Securities in Lima remain steadfastly optimistic about the future of mining in Peru. In this interview with The Gold Report, Arispe and Carrión highlight the mining-friendly government, the new production from many sources and point to several juicy projects that lack only the means to further unlock Peru's mineral riches.
The Gold Report: Canadian and Australian miners have realized a 25–30% premium due to the strong U.S. dollar. How has the U.S. dollar affected Peruvian miners?
Ricardo Carrión: Peruvian miners have realized a similar benefit due to currency exchange. This factor has resulted in lower costs for the Peruvian industry. In addition, miners have also benefited from lower prices in oil. But the question is has this cost reduction offset lower metal prices, and the answer is no. Lots of companies are still struggling with current market conditions.
TGR: How has the mining industry fared since President Ollanta Humala was elected in 2011?
Alberto Arispe: Humala ran in 2011 on a radical, antimarket platform. Presidential elections in Peru use the runoff system, so in order to win a majority in the second round of voting, he had to moderate his tone and make alliances with more moderate parties.
He then raised royalties and taxes on the mining industry. These were modest increases, however, made after much consultation with the industry. Given how radical Humala seemed at first, the industry was relieved. Since 2013, Humala's administration has become openly market friendly and has worked to solve the problems faced by, for instance, Newmont Mining Corp. (NMC:TSX; NEM:NYSE) over its Conga project.
TGR: The Peruvian government is more mining friendly, but what about the Peruvian people? Last month, several protestors were wounded and one was killed in the dispute over Southern Copper Corp.'s (SCCO:NYSE) Tia Maria mine.
AA: This is not a national problem. It is a more localized problem fomented by some NGOs, radicals and some politicians. Two or three big projects are having local difficulties, but many big projects are moving quickly to production without these difficulties. HudBay Minerals Inc.'s (HBM:TSX; HBM:NYSE) $1.8 billion ($1.8B) Constancia mine is almost finished. Next door, Las Bambas, a $5.2B project that MMG Ltd. (1208:HKSE) bought from Xstrata Plc (XTA:LSE), should be producing in 2016. Freeport-McMorRan Copper & Gold Inc.'s (FCX:NYSE) Cerro Verde copper mine is basically doubling its capacity. Peru's copper production will soon double from what it was in 2014.
TGR: President Humala is not eligible to run again in 2016. Is this a cause for concern?
AA: It's too early to worry about that. Let's see what the polls are saying at the start of next year. Right now, the leading candidates are very market friendly.
The main worries that Peruvian mining faces are lower gold, silver and copper prices and the collapse of financing for projects owned by juniors.
TGR: Will the dearth of financing lead to an increase in mergers and acquisitions?
RC: I already mentioned the Las Bambas takeover. It is rumored that Southern Peru Copper will make a move on Anglo American Plc's (AAUK:NASDAQ) large Quellaveco project. But this is only a rumor that was later denied by Southern Peru Copper.
Among the juniors, Indico Resources Ltd. (IDI:TSX.V) just got into an agreement for 70% of its Ocaña copper project to a private concern, Aruntani S.A.C., for $18.6 million ($18.6M). This is an interesting deal, which we have valued at about $0.10 per pound ($0.10/lb) of copper, which is high given current market conditions.
TGR: Which Canadian juniors are having legal problems with the Peruvian government?
RC: Bear Creek Mining Corp. (BCM:TSX.V) is running an arbitration process with the government of Peru over the license to operate the Santa Ana project, its 47 million ounce (47 Moz) silver project. Just to clarify, the government did not expropriate the project but revoked the license to operate in a border zone. All foreign companies need this permit to start a project. Barring a resolution, this dispute will be adjudicated in Washington, D.C., in September 2016. The legal experts will testify in favor of Bear Creek, but the decision to seize Santa Ana was a political one, and a decision to give it back would have political consequences.
I expect a good result for Bear Creek, perhaps by the end of 2015, which would be a good omen for the mining community in Peru. Santa Ana is an excellent project, with an after-tax net present value (NPV) of $80.2M and an internal rate of return (IRR) of 24.9%. Its capital expenditure (capex) is low, only $70.8M, and can start production very quickly.
TGR: How much of an overhang does Bear Creek suffer as a result of Santa Ana?
RC: When you analyze junior companies, you give higher valuations to those with good assets ready to start construction. In late 2010, Bear Creek shares were trading around $12. After the expropriation and the market crisis, shares fell to $1.05. Obviously the collapse in the silver price also affected Bear Creak heavily, along with many other companies in the industry.
TGR: Bear Creek has another Peruvian silver project, Corani. When will we get a feasibility study of that?
RC: Real soon. This will be an update of the 2011 feasibility. That showed a resource of 270 Moz silver, 3.1 billion pounds lead and 1.7 billion pounds zinc. It showed an initial capex of $574M, an after-tax NPV of $463 and a 17.6% IRR. The updated feasibility will adapt Corani to current market conditions and lower the capex.
TGR: Will Corani get financing?
RC: Bear Creek is talking to several parties and examining several strategies. There are various alternatives: streaming and offtake agreements, joint ventures (JVs). I'm pretty sure a combination of these will finance Corani.
TGR: Bear Creek's market cap is $112M. Is it a takeover target?
RC: Any small company with well-advanced projects—meaning good assets—could face hostile takeover attempts. Bear Creek is one example, Panoro Minerals Ltd. (PML:TSX.V: PZM:FSE; PML:BVL) is another.
TGR: Explain how the Peruvian government has regulated artisanal mining.
RC: There are two types of artisanal mining in Peru. There is flat-out illegal mining, which is often harmful to the environment. And there is also "informal" mining, which refers to miners seeking to fully regularize. The government has worked diligently to eliminate illegal mining and establish a process whereby all ore is processed by regulated mills. Progress is being made, but this will take some time.
TGR: Assuming that all or most of artisanal mining was regularized, how much bigger would the official mining industry become?
RC: We don't know exactly how large artisanal mining is, but it is big. I'll give you an example. Peru's main gold producer is not a company. It's a region called Madre de Dios where most of the gold produced comes from illegal and informal mining.
TGR: Has this new regulatory regime resulted in many companies processing artisanal ore on a tolling basis?
RC: Toll mining is growing everywhere in the world, not just in Peru. Mining companies are seeking lower risk, and processing ore presents lower risks than exploration and mining. Here in Peru, we have five or six TSX Venture-listed companies in tolling. Dynacor Gold Mines Inc. (DNG:TSX) has been doing this for a while, and it has been doing pretty well. The company has a market cap of $77M and processes in the range of 250–350 tons per day (250-350 tpd). Dynacor has one plant at Huanca and another on the way at Chala.
TGR: How much bigger will its operations be after Chala goes online?
RC: Dynacor is seeking to achieve 1,000 tpd and will become a very important player.
TGR: Dynacor also has a copper-gold exploration project, Tumipampa.
RC: When a tolling company reaches 1,000 tpd, it needs to secure a consistent supply of ore. This is Dynacor's plan for Tumipampa.
TGR: What are the margins for toll miners in Peru?
RC: It depends on where you are in Peru and what the grade is. Also, in order to keep the ore coming, toll miners must be fair with small miners. The industry standard is about 40–50% now, but that will probably fall over time to 35–40%.
TGR: What can you tell us about the other Peruvian toll miners?
RC: Inca One Gold Corp. (IO:TSX.V) has a good model and has built a 100 tpd plant. Equity financing was a problem, so the company elected to go with debentures and notes. It has $7–8M in debt, which it should be able to restructure in the near future. Inca One is in the middle now of a $1.5M convertible-loan financing, which will give it working capital. This is crucial for toll miners, because in order to build market share with small miners, you need to pay them quickly.
Standard Tolling Co. (TON:TSX.V) plans to achieve production in June with a plant processing 100–150 tpd. The company is fully financed and progressing very well. This story is similar to Inca One.
Anthem United Inc. (AFY:TSX.V) plans to begin processing this year. Its plant will cost around $10M. It's a big project, and the company intends to go immediately to 350 tpd. Processing above that level requires additional permitting. Anthem is also financing with debt.
Montan Mining Corp. (MNY:TSX.V) has an agreement to buy an already producing 150 tpd plant. It's a manageable deal in a nice location. Unlike its rivals, this company will have the capacity to process copper as well. This could be an excellent play.
Duran Ventures Inc. (DRV:TSX.V; DRV:BVL) has a location and basic permits but needs to invest $1–1.5M to build its plant from scratch. Construction is five to eight months away.
TGR: Duran has five exploration projects. Are they all on the back burner?
RC: Duran's long-term plan is to develop these projects, but first it needs cash flow, which is why it is going into tolling. Once cash flow is achieved, that money can be leveraged to pay for exploration.
TGR: Which Peruvian zinc producers are your favorites?
RC: There are two. The first is Trevali Mining Corp. (TV:TSX; TV:BVL; TREVF:OTCQX). It has the producing Santander mine in Peru and advanced-stage projects, Caribou and Stratmat, in New Brunswick in Canada. This is the only publicly traded zinc junior.
Caribou will begin production this quarter. Stepout assays from this project released in April included 5.08% zinc, 1.76% lead, 0.37% copper, 59 grams per ton (59 g/t) silver and 1.63 g/t gold over 50.9 meters. Canada will reveal Trevali's real value. In Peru, Trevali has an offtake agreement with Glencore International Plc (GLEN:LSE) but no such obligations in Canada.
TGR: And what is the other Peruvian zinc play you like?
RC: Sierra Metals Inc. (SMT:TSX) has Yauricocha in Peru, an extremely nice asset generating good cash flow. The company has two very good prospects in Mexico. Sierra has been flying under the radar because of liquidity problems, but I'm pretty sure the company will solve those problems. It published Mexico silver assays over 300 g/t in December, but few investors noticed that. It's hard to buy Sierra Metal shares, but it has good properties and also pays a divided.
TGR: Let's talk about other junior gold producers in the region.
RC: Luna Gold Corp. (LGC:TSX; LGC:BVL) has its asset in Brazil, but has many Peruvian investors. It was forced to suspend its Aurizona gold mine in Brazil because it was running out of mixed soft and hard saprolite ore. On May 8, the company announced a $30M financing with a fund called Pacific Road Resources, $20M debt, $10M equity. Luna also renegotiated its contract with Sandstorm Gold Ltd. (SSL:TSX.V), which previously held a streaming contract for the life of the mine: 17% of production at $400 per ounce ($400/oz). This has been replaced with a 3–5% net smelter royalty (NSR).
This is an excellent deal for the company as this will trigger more exploration work to improve the reserve calculation and restart the plant. There's still a big challenge to finance the expansion of the plant, but it is important to understand that there is already a sunk cost and it is only a matter of finding the necessary funding to have Luna up and running again—under a much better financial structure: the new deal with Sandstorm, a solid equity position and a debt with a better structure.
TGR: Which near-term junior gold producer do you follow?
RC: Lupaka Gold Corp. (LPK:TSX.V; LPK:BVL). It has the Invicta project, which is ready to produce gold at 10–15 g/t. This is a well-known asset in an excellent location near Lima. Lupaka does need a mill, however. It makes sense for it to get an agreement with an existing plant to process its ore while evaluating the construction of its own plant.
TGR: Let's discuss some other companies you follow.
RC: Minera IRL Ltd. (IRL:TSX; MIRL:LSE) invested over $40M in a project in Argentina. The company sold it for $10M, but given the conditions in Argentina, this was the best of a bad deal. In Peru, it has the 1 Moz Ollachea project. It's ready, but the capex is $164.7M, and that will be tough to raise for a company with a market cap of $20M. Doing it with equity would result in a tremendous dilution. Several financial institutions have told me they like Ollachea, so perhaps it will go ahead with a combination of equity, plus debt, plus a JV.
Panoro Minerals released a preliminary economic assessment (PEA) for its Cotabambas project last month. It forecasts annual production over 19 years of 143 Mlb copper, 88,000 oz (88 Koz) gold and 967 Koz silver at a cost of $1.26/lb copper, with credits. The after-tax NPV is $627.5M, and the initial capex is $1.38B. What is interesting about this is that there are nine targets, but the PEA focused on only one. I think this was a wise decision. From here on in, Cotabambas can only look better. But this is another company with a small market cap: $34M. This project needs about $40–50M to get to bankable feasibility.
TGR: Does it make sense for Panoro to bring on a JV partner or partners?
RC: It's a matter of valuation. It makes sense to bring in a JV partner based on the value of Cotabambas, not on Panoro's current market cap. It also matters who the JV partner is. If it's a well-known company with sufficient funding to develop a $1.38B project, that would be good.
TGR: What's the final company you wanted to discuss?
RC: Candente Copper Corp. (DNT:TSX; DNT:BVL) has the Cañariaco Norte deposit. This is another example of a company that is fighting with the market. Cañariaco is one of the most advanced junior copper projects in Peru. It's a big project, with a capex of $1.6B. Candente ran out of cash a year ago and is stuck in the middle of the feasibility study. The challenge for it is to go to the market to get $10M to complete it. I think the best way forward is to find a JV partner or sign a streaming contract. This project has faced social problems in the past, but we know that this region is not as difficult as it once was. Cañariaco is a nice project.
TGR: Despite the current financing problems for juniors, are you optimistic about their prospects in Peru for the rest of the decade?
RC: Absolutely. We are near the end of a cycle. I believe we will see a real recovery in the market starting in 2016.
TGR: Ricardo and Alberto, thank you for your time and your insights.
Ricardo Carrión is the managing director for capital markets and corporate finance for Kallpa Securities in Lima, Peru. He served as a senior analyst of Banco de Credito in the areas of corporate banking, corporate finance and capital markets and was an adviser to Lima's Stock Exchange. Carrión holds a bachelor's degree in business administration from Universidad de Lima with specialization in finance and capital markets.
Alberto Arispe is CEO of Kallpa Securities SAB, a Peruvian brokerage and boutique investment house. Previously, he was a vice president of emerging markets institutional equity sales at Fox-Pitt Kelton. Arispe has more than 18 years of experience in capital markets. He has a Master of Business Administration from the Stern School of Business at New York University and a bachelor's degree in economics from the Universidad Catolica del Peru. He is a professor of finance at Universidad de Lima.