Description

All figures, except the stock price is in US dollars. The Company reports in in US dollars.

THESIS

Amerigo is a Canadian based company focused on the processing of mine tailings for Codelco in Chile. It is not a miner and as such its operations resemble a manufacturing plant. It has no mining or geological risk. Its tailing reserve provides an economic life to at least 2037. The Company has never been in a better position, however due to a number of operational issues, which I believe are temporary (described below), the stock price is near historic lows. If none of these issues are resolved and long term copper price is $2.50/lb, the Company trades at 30% free cash flow yield to equity, compared to copper miners that are in single digit free cash flow yield. At $3/lb copper price and operational issues resolved, Company trades at over 60% of free cash flow yield to equity. Our DCF valuation goes from C$1.70/sh ($2.50/lb copper price) to C$3.50/sh ($3/lb copper price). Four institutional shareholders and management own over 55% of the Company's stock and have been in it for a long time and highly incentivized for an exit which realistically can only happen through a sale.  I believe, once the operational issues are resolved (expected first half of 2020) and copper price stabilize around $3/lb (we expect this year), there is a high probability that the Company is sold. I believe the buyer most likely to pay the highest price would be a large manufacturer which is a heavy user of copper, that can not only hedge its copper exposure through such an acquisition, but also use its manufacturing expertise to optimize operations and lower costs. I expect the company gets sold between C$2 and C$3 per share next year, depending upon copper price outlook, a 4X to 6X return from current levels.

BUSINESS OVERVIEW

Currently, Amerigo produces copper and molybdenum concentrates in Chile through its 100% ownership of MVC. MVC has been producing copper concentrates since 1992 by processing fresh and historic tailings from Codelco’s El Teniente mine, the world’s largest underground copper mine. El Teniente has been in production since 1905. Amerigo acquired MVC in 2003 and has undertaken a series of capital expansions at the MVC plant that have increased production from approximately 26.0 million pounds of copper in 2003 to 65.0 million pounds of copper in 2018. Since 2005, MVC also produces molybdenum concentrates as a by-product. MVC has essentially completed a phased expansion of its operations to extract and process the high-grade historic Cauquenes tailings. Phase One of the expansion was completed in December 2015 on time and under budget and extended MVC’s life to at least 2037. The Phase One Capex was $66.6 million. Phase Two of the Cauquenes expansion was completed in December 2018, allowing MVC to reach record production of 65.0 million pounds of copper in the year. The Phase Two Capex was $40 million. These expansions were designed to lower costs and improve recovery efficiency, which would enable MVC to reach annual copper production levels of 80 to 85 million pounds of copper, at an estimated cash cost (costs before royalties) of $1.30 to $1.45/lb. roughly $0.50/lb lower than before. Metallurgical studies on Cauquenes in 2016 concluded that copper recovery can be increased from 34% to 49% through these expansions.

On March 25, 2015, MVC obtained a $64.4 million loan facility from Scotiabank Chile and Export Development Canada to finance the Cauquenes Phase One expansion. On August 3, 2017, MVC obtained a second financing tranche with Scotiabank and EDC for a $35.3 million facility to finance the Cauquenes Phase Two expansion. By September 2019, Amerigo had amortized approx $44 million of these loans through internally generated cash flows, leaving a balance of $56 million. On September 26, 2019, MVC completed a refinancing of this loan, extending the maturity to September 2023 and changing the amortization provisions from the former five remaining semi-annual payments of $11.3 million each to seven semi-annual installments of $4.7 million, starting on March 26, 2020. A final installment of $23.5 million will be paid upon maturity, early payments can be made without penalty. The new debt structure provides additional flexibility to the Company if a period of prolonged low copper price environment exists. 

WHY DOES THIS OPPORTUNITY EXIST

Other than being a microcap Canadian company lumped with copper miners, the Company experienced a number of unfortunate operational hiccups in 2019 that resulted in the termination of the CEO in December and installation of the CFO as CEO. The operational issues revolved around lower grade than expected in the first half and lower than expected recoveries in the second half of 2019. Also, there was some nervousness around Chile protests, which have not impacted the Company's operations and the the proposed tax increases are aimed at miners versus processors like Amerigo.

1) The Company realized in 2019 as the expansions became operational, that it needed to install a deeper sump to get to the higher quality ore. The new, deeper Cauquenes extraction sump became operational on July 6, 2019 and installation of a regrind mill, originally part of the Phase Two expansion was also completed in second quarter of 2019. These elements solved the low grade problem.

2) However, the plant recovery, instead of being 49% was 20% lower. A big reason for the lower recovery was due to a 60 year record drought in Chile in 2019 which lowered the amount of water available to optimally operate the plant. The Company is installing a a new pipe by 1st quarter 2020, at the cost of $2 million that should somewhat alleviate this problem. The other reason was the denser sludge due to lower water content stressed parts of the plant. while others were underutilized. Company is conducting comprehensive trouble shooting with over 30 fixes that include minor plant modifications, mettallurgical controls, plant testing of reagents, etc. to solve this issue. When the expanded plant started in the 4th quarter of 2018, recoveries were in the mid 40's, so the Company is confident as they proceed through the de-bottlenecking, they should revert to mid to high 40% recovery levels. Expectation is that the recoveries would start improving in second half of 2020 and revert to normal by 2021.

It is noteworthy that inspite of these issues and declining copper prices in 2019, the Company has remained cash flow positive. This is due to 1) low maintenance capex requirements of approx $5 million per year and royalty payments that decline with lower copper prices. Company's royalty to El Teniente is based on a factor applied to the LME copper price, above $1.95/lb. The factor varies directly with copper price based on a series of formulas and increases royalty percentage as copper prices increase. In addition, the company put into place a new 3 year labor contract in the 3rd quarter of 2019 and has a fixed price contract for electricity (its largest cost component) until 2031. 

BASE CASE 2020 FINANCIALS

I assume that copper prices linger around $2.5/lb and instead of 80 to 85 million lbs, the company only does 65 million pounds of production (operational issues are not resolved). Cash Costs are at the high end estimate of $1.30 - $1.45/lb. Under these assumptions, the numbers roughly come out as follows:

MVC EBITDA : $40MM

Corp G&A        : 3MM

Financial Exp:     5MM

Capex:               5MM

Taxes:                0MM (A @13MM NOL provides shield)

W/C change:      5MM

FCF:                 22MM

Debt Amort:      9 MM

Excess FCF:       13MM

Company has a 30% free cash flow yield to equity and trades at 3.7X TEV/EBITDA. DCF shows C$1.70 share price. Current share price is at 73% of book value. According to the Company, the replacement cost of its fixed assets approximated their un-depreciated value of $373 million versus book value of $202 million.

UPSIDE

I'm constructive on copper prices as we enter a second year of copper deficit, mine capex levels at 10 year lows, copper grades declining globally, Codelco expansion in doubt, trade tensions easing, inventories shrinking 37% from only 6 months ago to 300,000 tons (1.2% of global consumption), and secular tail winds for copper that range from third world industrialization to EVs. Copper has recovered to over $2.85/lb after bottoming out around $2.50/lb last year and general consensus is that prices north of $3/lb would be required to spur the necessary investment. Goldman is forecasting $3.50/lb. In a $3/lb scenario and production in the 80-85 million pound range, the numbers roughly come out as follows:

MVC EBITDA : $80MM

Corp G&A/other: 3MM

Financial Exp:     5MM

Capex:               5MM

Taxes:              20MM

FCF:                 47MM

Debt Amort:      9MM

Excess FCF:       38MM

Company has a 63% free cash flow yield to equity and trades at less than 1X TEV/EBITDA. DCF shows C$3.50 share price.

The Company can pay off most of its debt in one year, in this scenario. The cash flow generation potential of this business is massive at healthy copper prices. To run different scenarios, as a rule of thumb, approx 70% of incremental revenue increase falls to free cash flow, each 10 cents change in copper price is worth approximately $6MM in cash flow.

RISKS

- Global recession lowering copper prices and demand

- The tailing deposit is diverse with differing grades at different areas. This could cause some variability in quarterly results. For example, better grade and quality is expected in H1 2020 than H2 2020. 

- Continued drought conditions and lack of progress on de-bottlenecking issues

Catalyst

- Copper price increase

- Plant Recovery stabilization

- Sale of Company