Featured Investment: Excelsior Mining (TSXV:MIN)
Excelsior Mining is a copper development company with the PFS-stage Gunnison Project in Arizona. At the current implied project value of $35m USD, Excelsior shares present significant value from a risk-adjusted NPV perspective. One could make a conservative case that expected fair value per share is 100-200% above current levels.
Risk-adjusted NPV investments only succeed if the company in question makes it into production within a reasonable time window. Excelsior seems to have a realistic chance of reaching production in early 2018, after taking into account the following:
(1) the excellent projected NPV, IRR, and payback period announced in last month’s Updated Prefeasibility Study
(2) the company’s opportunistic December 2015 acquisition of the neighboring Johnson Camp Mine, significantly reducing initial capex and shortening expected construction time
(3) the current mkt cap to initial capex ratio indicates that the company could be able to finance mine construction themselves without severe dilution
In April 2014 I was given an extensive tour of Excelsior operations by Executive VP Roland Goodgame – we visited the company’s core shed and the Gunnison project itself, located 65 miles SE of Tucson. The Partnership initiated a position shortly thereafter and we’ve added since, with an average cost of $0.24 CAD per share. As of April 29th, MIN was trading at $0.34 CAD. While the gains have been modest, those involved in the junior resource space can testify that positive share price performers over the trailing 24 months are few and far in between.
One possible explanation for the discrepancy between the current share price and expected risk-adjusted fair value is market skepticism over the economics of Excelsior’s proposed In-Situ Recovery (ISR) mining method. I start this Featured Investment piece by discussing the history of ISR copper mining in Arizona – as the state has already seen has already seen 40+ years of production between multiple IRS mines.
Next comes the chief risk that the Gunnison Project faces: permitting. Taseko Mines owns the other advanced-stage ISR copper development project in Arizona, which has struggled to receive permits in a timely manner. I’ll highlight the key differences between the Florence and Gunnison projects.
We conclude with the investment thesis for Excelsior, covering the company’s background, management team, and other company essentials. I then discuss three key assumptions I’m making as an investor, MIN’s upside as an investment, and expected company milestones over the coming two years.
In-Situ Copper Mining in Arizona
In-Situ Recovery (ISR) is an alternate mining method that differs from traditional “open pit” or “underground” mines. ISR involves leaving the ore where it is in the ground, and recovering the minerals from it by dissolving them and pumping the pregnant solution to the surface where the minerals can be recovered. Consequently there is little surface disturbance and no tailings or waste rock generated. The orebody needs to be permeable to the solutions used and below the water table for this method to work.
ISR is much more prevalent in the uranium industry – it is estimated that 30% of global uranium production comes from this style of mining. ISR is a far less significant portion of global copper production, but it has still known to be a commercially viable technique for at least three decades.
Arizona itself has a rich history in ISR copper production. The San Manuel copper mine, owned by BHP Billiton, was a successful operation that integrated ISR methods with open pit and underground mining and produced approximately 3.25 billion pounds of copper in 14 years of production. Another project owned by BHP, Pinot Valley, also used ISR to extract copper. Excelsior’s proposed ISR operation at Gunnison is nothing out of the ordinary for the state of Arizona.
Permitting: Gunnison vs. Florence
The Gunnison Project is often compared with the Florence Project – an Arizona-based ISR copper project that was bought in November 2014 by Taseko Mines (a $130m USD mid-tier copper producer). The Florence Project has been stalled for a few years now – quoting the company’s website “only two outstanding permits required to move forward with the Phase 1 Test Facility”. Unfortunately those two permits have been elusive thus far for Taseko.
The key question for Excelsior shareholders is whether or not Gunnison will face the same permitting headwinds that Taseko’s Florence has experienced. This is the key risk for Excelsior currently – if the company is not able to receive permits in a timely manner, then shareholders will be left disappointed.
My belief is that Excelsior will surprise the market with a relatively smooth permitting process. There are some massive differences (in terms of permitting) between Taseko’s Florence and Excelsior’s Gunnison Project. I’ve highlighted a few key differentiators below:
- The Florence Project is zoned within the Florence city limits and is located two miles from downtown Florence, Arizona (pop. 25,000). Gunnison is located about four miles north of an unincorporated town– Dragoon. The difference here is that Dragoon has a population that that is only 1% of Florence’s total– at 209 residents. I visited the Gunnison in April 2014 and can attest to the project’s remoteness. The below images nicely juxtapose these two projects; the first is Taseko’s Florence (notice the town of Florence in the immediate background) followed by Excelsior’s Gunnison.
- ISR operations use a sulfuric acid solution to separate the economic metal from its host rock. A key environmental worry is that this solution will escape the hydraulic barrier and contaminate local groundwater. Both the Gunnison and Florence deposits are located near groundwater aquifers, but with very different circumstances.
Gunnison is located in a basin where the aquifer is not “actively managed” by any county, state, or federal agency. This is due to the basin’s minuscule population and lack of economic activity. In essence, no one is using this water. For this reason, the Dragoon Water Company is in full support of the Gunnison Project – a massive vote of confidence given the nature of ISR operations.
The Florence Project, on the other hand, is located in a very populous basin. The aquifer in this instance is used for existing agricultural operations, is “actively managed” by at least one government agency, and is located near one of the main sources of water for Phoenix (the Gila River). For this reason, the Florence Water Company is in vehement opposition to the construction of the project. This opposition will continue to shape public opinion and hamper Taseko’s continued efforts to acquire the remaining two permits.
- After Excelsior’s opportunistic acquisition of the neighboring Johnson Camp Mine closed in December 2015, the Gunnison project in essence became a “brownfield project”. This means that the company can utilize existing mining infrastructure to both reduce capex and the operation’s environmental footprint. Indeed, the Johnson Camp includes the existing copper processing infrastructure: “a 4,500 gallon per minute solvent extraction plant, a tank farm, an electrowinning plant with 88 electrowinning cells with capacity for 25 million pounds of copper cathode per annum, solution storage ponds, a truck shop, core storage building, offices, warehouse, laboratory, mechanical shop, a primary and secondary crusher, and various other equipment.” All of this infrastructure has already been built, and can be utilized be Excelsior in their mining plan (versus sitting idle, as it has since the Johnson Camp halted operations in 2010).
This contrasts with Taseko’s Florence Project, which would fully be considered a “greenfield” operation. This means that the proposed mine is NOT located near existing mining infrastructure, and the company will have to construct their mine from scratch. Intuitively, greenfield operations can be difficult to permit – locals who are not used to nearby mining operations are more likely to balk at proposed mines.
In conclusion, permitting remains the key risk for Excelsior shareholders. Additionally, it is clear that Taseko’s struggles at Florence have turned off potential investors from backing Excelsior. The three points provided above demonstrate that the Gunnison Project differs in many ways from the beleaguered Florence Project, and I think permitting is far more likely than the market currently expects.
Excelsior shareholders should have an answer to this “permitting question” by mid 2017. According to an April 26th news release from the company:
Administrative Completeness Review (ACR) (“Administrative Review”) has been achieved for both the Federal Underground Injection Control (UIC) Permit and for the State Aquifer Protection Permit (APP). The UIC is issued by the Environmental Protection Agency (EPA) under the Safe Drinking Water Act; whereas the APP is issued by the Arizona Department of Environmental Quality (ADEQ) under the Environmental Quality Act. Administrative Review is the first stage of the permitting process. It confirms that the permitting application is administratively complete, meaning that all the required documentation and technical data are present. Excelsior is working closely with the State and Federal regulatory agencies to help advance the issuance of draft permits, which Excelsior expects will occur early next year. Excelsior has now entered the technical review component of the permitting process.
I expect the company to receive their APP and UIC permits in Q1 2017, and final operating permits in Q2 2017. Should they be able to acquire these permits in a timely manner, construction would commence in Q3 2017 – as well as a massive re-rating of Excelsior’s share price.
Investment Thesis for Excelsior Mining
Excelsior Mining is a copper development company focused on advancing their PFS-stage Gunnison Copper Project. The project has been the company’s sole focus for over seven years, and CEO Stephen Twyerould and Executive VP Roland Goodgame have been involved the entire time. Both are obsessed with the prospect of Gunnison reaching production. The two have done a commendable job in proactively to mitigating environmental and social risks. A recent example: In 2014, the company commissioned an independent study to demonstrate the economic benefits to Cochise County if the proposed Gunnison Mine is indeed built. The study was conducted by researchers from Arizona State University, the Seidman Research Institute, and the WP Carey School of Business; further details can be found here: http://goo.gl/4JZAiT
At current prices MIN shares present tremendous risk-adjusted expected value. What does this mean exactly? Here’s a simple hypothetical to demonstrate the point…
How much would you pay for a 50% chance to win $100?
On first glance, as long as you don’t pay more than $50 in the scenario outlined above, then you aren’t getting ripped off. That is absolutely correct. However, I presume that Benjamin Graham (the father of value investing) would provide a slightly more nuanced answer – $33 or less. Graham looked for a Margin of Safety of at least 33% in all of his investments to mitigate human error; while it is possible for a discerning investor to know the approximate chance of something occurring, it doesn’t take a genius to understand that real life probabilities cannot be predicted with the same accuracy of a coin flip. Hence, Graham’s insistence on a Margin of Safety.
The above hypothetical is relevant to Excelsior Mining due to the permitting scenario that Gunnison faces. In essence, this is a binary outcome similar in some ways to a coin flip – if Excelsior gets their permit then investors get their $100, if not investors get $0.
To go a bit deeper, below are three assumptions that I’m making as an Excelsior shareholder:
- If permitted, this mine will be fast-tracked to production, will be profitable at current copper prices, and will be a lowest-quartile producer. This story will not fail due to management ineptitude or project economics.
- If not permitted, the company’s market cap will drop to $0. This is not entirely accurate, but out of conservatism it is worth assuming entire loss of capital if things don’t work out.
- The chances of Gunnison being permitted are between 40-60%, as the amount of money and effort that has been put into the project suggests that there is at least a reasonable chance of a successful permitting issuance. Out of conservatism, I’ll use a 40% chance of SUCCESS for the rest of this piece.
Before I address the above points, I want to emphasize something that should be obvious at this point. Due to the nature of this investment, an investment in Excelsior should only take up a small percentage of one’s portfolio and would ideally be coupled with 10-15 unrelated investments that offer similar risk-adjusted expected value. Now on to the assumptions.
If permitted, this mine will be fast-tracked to production, will be profitable at current copper prices, and will be a lowest-quartile producer. This story will not fail due to management ineptitude or project economics.
As outlined in the introduction, Gunnison has the potential to be the next low-cost copper producer to reach production in the United States. Permitting worries aside, the project has a tremendous amount going for it:
(a) The company released an Updated Prefeasibility Study in February 2016 with stellar economics. This PFS was commissioned primarily to illustrate the tremendous impact that the Johnson Camp acquisition has on Gunnison’s economics, and also to adjust for the lower copper prices we have seen since Gunnison’s original PFS in Feb 2014. The main highlight of the study was that the project’s initial capex estimate dropped from $284m to $50m – a decrease of over 80%. Other headline numbers included an $829m post-tax NPV (using $2.75 copper and a 7.5% discount rate), an after-tax IRR of 26% at $2 copper, and projected All-In Cost of $1.24/lb.
(b) The company’s opportunistic December 2015 acquisition of the neighboring Johnson Camp Mine for a total of $8.4m. As mentioned above, this significantly reduces capex and in essence turns Gunnison into a brownfield operation. Another under looked benefit is that the construction time now estimated by management is a mere 9 months – 25% less than the 12 months projected in the original PFS. This near term production potential improves project payback and is another reason why Excelsior’s market cap should be much closer to Gunnison’s projected NPV.
(c) Excelsior’s current market capitalization of $36m USD is pretty close to Gunnison’s initial capex of $50m USD. This ratio indicates that the company could potentially finance Gunnison’s construction themselves without severe dilution. As a hypothetical, if the MIN’s share price rises by 50% between now and construction financing, the company could finance Gunnison 50% debt/50% equity and only dilute shareholders by 30%. Yes 30% dilution is not pretty – but the beauty of this optimistic scenario is that MIN shareholders can keep Gunnison’s value fully to themselves as the mine races towards production.
If not permitted, the company’s market cap will drop to $0. This is not entirely accurate, but out of conservatism it is worth assuming entire loss of capital if things don’t work out.
This assumption is admittedly conservative. For the sake of conversation, if permits are not granted for ISR production, the company still does have a large amount of copper in the ground that could be mined through traditional practices. However, in order to make the economics work, significantly higher copper prices would be needed and the value placed on MIN shares in this scenario would be significantly lower than where they are now.
The chances of Gunnison being permitted are between 40-60%, as the amount of money and effort that has been put into the project suggests that there is at least a reasonable chance of a successful permitting issuance.
Permitting is the biggest risk to this investment. There are reasons to doubt that permitting issuance in a timely manner will happen – the problems at Florence’s ISR project, a stricter EPA, and the general stigma surrounding ISR mining all loom large. However, as covered above in the Gunnison vs. Florence discussion, there are plenty of reasons to believe that Excelsior can successfully navigate the permitting maze. The following factors are also relevant: (i) management has had enough belief to focus on this project for more than ten years, (ii) a respected mining private equity firm has invested $22m into Excelsior over the past 18 months, (iii) two prominent Arizonans, Jim Kolbe and Steven Lynn, sit on the company’s board, and (iv) the company has proactively demonstrated that Gunnison has the ability to spur tremendous economic activity in a relatively depressed county.
Ignoring the permitting worries for a second, how much exactly is the Gunnison project worth? The recently released Prefeasibility Study provides us with a good place to start. I’ve included below an excerpt straight out of Excelsior’s February 9th news release discussing the PFS’s headline numbers:
Highlights of the North Star Gunnison Copper Project Updated PFS (United States dollars)
Net Present Value (“NPV”) of $1.2 billion pre-tax and $829 million post-tax at 7.5% discount rate using a life of mine (“LOM”) copper price of $2.75/lb;
Internal Rate of Return (“IRR”) of 57.9% pre-tax and 45.8% post-tax;
Initial construction capital costs of $45.9 million includes 20% contingency, 16% EPCM, freight, mobile equipment, owner’s costs and capital spares;
Payback period for initial capital of 1.8 years pre-tax and 2.6 years post-tax;
Average life-of-mine operating costs of $0.70/lb;
All-In Cost (all capital plus operating costs) of $1.24/lb;
Sensitivity analysis at a LOM copper price of $2.00/lb generates an IRR of 30.8% pre-tax and 26.2% post-tax;
Over 850 million pounds of copper added to the probable mineral reserve, an increase of 24%;
Mine life of 27 years;
Staged production profile: initial production rate of 25 million pounds of copper cathode per annum using the existing JCM facilities, followed by an intermediate expansion stage to 75 million pounds per annum and final expansion stage to full production of 125 million pounds per annum (includes the construction of an acid plant at full production). The staged production profile makes possible the funding of future expansions out of cash flow;
Staged production approach lowers initial capital costs, reduces financing risk and speeds the timeline to first production.
These are no doubt impressive numbers, but out of conservatism they need to be discounted.
Let’s focus on the project’s after-tax NPV, as this number tells us what the value of Gunnison would be if it were put into production today.
The company estimates an “$829m USD post-tax NPV $829 million post-tax at a 7.5% discount rate using a life of mine (“LOM”) copper price of $2.75/lb”. While I do believe that the long-term price of copper will actually be above this $2.75 number for the majority of the mine’s producing life, out of conservatism we need to adjust for the current copper price of roughly $2.20 per pound. As can be seen below, the company included a sensitivity analysis in their PFS that accounts for lower copper prices.
This adjustment for copper prices that are 20% lower than the $2.75 price assumption leads us to an after-tax NPV of $512m USD.
Additionally, my belief is that a 10% discount rate should be used for all mining companies across the board. While some would call this harsh, a particularly trusted friend of mine advocates for a 20% discount rate to account for (a) the uncertainty inherent in mining and (b) the significance of near term cash flow. With this perspective in mind, I think 10% is pretty reasonable.
Excelsior management used a 7.5% discount rate in the PFS, so we’re going to chop the $512m number by another 33% (our preferred 10% discount rate is 33% greater than the 7.5% used). This is an admittedly back of the envelope way of calculating, and is overly harsh to Gunnison’s value. Regardless, let’s discount the $512m by 33% to reach an after-tax NPV of $340m.
Next, we discount this $340m NPV by another 60% to reflect the permitting risk discussed in length above (aka only 40% chance of success).
This results in a risk-adjusted, after-tax NPV of $136m USD, or $1.07 CAD per fully diluted share of MIN. Despite the fact that this is 215% above Excelsior’s current share price, I believe this ~$1 CAD number is the company’s fair value per share at this time.
Let’s expand our outcome visualization a little further and speculate on what would occur if/when the permits are successfully obtained in H1 2017. While the company won’t be trading at Gunnison’s full NPV immediately after permit approval, it would be reasonable for the company’s enterprise value to equal the full $340m USD by the time Gunnison reaches production. Thanks to the accelerated construction time due to the Johnson Camp annex, this could happen as early as 2018. If the company’s EV does indeed equal the $340m NPV upon first production in 2018, this would result in a $2.69 CAD share price, or a 691% return over twenty-four months.
Drawing back to the coin flip analogy discussed earlier, I view this as the equivalent of paying $34 (i.e. MIN’s current share price) for a roughly 50% chance to win $269 (i.e. Gunnison’s adjusted NPV per share). As long as one can accept that a negative outcome is a distinct possibility, these are very good odds indeed.
Before we get too excited about the best-case scenario outlined above, we have to take into account a couple points. The first is that any equity dilution associated with project financing is not factored into the above numbers. My view on this is that the potential upside discussed above is so large that any potential equity dilution involved with project financing is a virtually a non-issue. Permitting is far and away the bigger risk here.
The second is that there is always the risk that Excelsior shareholders will not be able to realize the full value of Gunnison in the event of a takeover by an existing copper producer. This is always a risk inherent in deeply undervalued development projects. My opinion in the event of a takeover is that, as long as a reasonable premium is offered and management acts in the best interest of shareholders, it’s worth smiling, taking the money, and moving onto the next play.
To conclude this piece, I’ve provided below my expectations as an Excelsior shareholder for the coming two years:
$4m Financing (provides sufficient working capital through a production decision) by end 2016
Gunnison Feasibility Study Released by end 2016
APP, UIC, and Operating Permits Received by end Q2 2017
$45m Construction Financing Raised by end Q2 2017
First Production at Gunnison by end Q2 2018
Of these milestones, the most significant is surely Excelsior’s expectation that APP, UIC, and Operating permits will be received in H1 2017. If the company hasn’t announced a permitting success by July 2017, then it will be time to seriously consider liquidating your investment. If Excelsior does in fact defy the market and announce successful permitting, then I expect the share price to double overnight. Time will tell here – the good news is that we will know the answer to this permitting question within 1 year, which in the world of junior mining isn’t a particularly long time.
Matt Geiger has a diverse set of skills pertaining to early stage ventures – both in the world of natural resources and tech. He is currently General Partner of MJG Capital – a resource-focused investment partnership with 20+ LPs. He is also Cofounder/President of a venture-backed technology business with $10m in cumulative funding. Known for his exhaustive security analysis and intuitive grasp of contrarian investing, Matt is a rising star in the junior resource field.
Palisade Global Investments Disclaimer:
The views and opinions expressed in this article are those of the authors, and do not represent the views of Palisade Global Investments Ltd. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions.
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