Amerigo Resources (ARG.TO)
Written on April 22, 2021
Price at time of writing: CAD 1.07
Disclaimer: This report is not financial advice - please do your own due diligence.
BUSINESS DESCRIPTION
Amerigo owns 100% interest in Minera Valle Central (MVC), a producer of copper and molybdenum concentrates. MVC has a long-term contract with Codelco to process copper tailings from El Teniente. Essentially, Amerigo has access to process the tailings by paying Codelco a scaling royalty based on the current price of copper.
The stock is significantly controlled by insiders, with 55% of the float held by management. The stock trades on the TSX in Canada (ARG) and on the OTC exchange in the US (ARREF). On May 3, 2021 Amerigo had 181,790,378 common shares and 11,110,000 options (exercisable at prices ranging from Cdn$0.40 to Cdn$1.11 per share) outstanding. Given the stock's current CAD price of $1.08, this equates to a CAD 208 million fully diluted market cap, not accounting for proceeds generated from option exercises.
Amerigo Resources is a highly illiquid Canadian micro-cap stock that is sensitive to copper price movements, so this is a riskier investment than others so it is not a large % of my allocated capital.
VARIANT VIEW
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Amerigo's balance sheet has significantly improved
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Amerigo’s share price represents an unjustifiably depressed valuation relative to its forecasted cash inflow in 2021
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Amerigo is a direct beneficiary from the secular rise in copper prices
Point 1: Amerigo’s balance sheet has significantly improved
Amerigo is in solid financial standing as a result of aggressively paying down its debt. Amerigo has $38.6M in cash and equivalents, positive net working capital of $11.5M, and a $47M bank loan, which amounts to a 3M net cash position. The bank loan is due in September 2023, with semi-annual installments of $4.7 million.
There are two advantages to how the debt is structured: 1) Amerigo can make prepayments with no penalty, and 2) Amerigo received waivers with respect to current ratio covenants. Its improvement in its financial condition presents a catalyst for the company to begin paying dividends in the second half of 2021 as the company continue to accumulate cash in the balance sheet and refinances its debt.
Point 2: Amerigo’s share price represents an unjustifiably depressed valuation relative to its forecasted cash flow in 2021
Amerigo's share price is unjustifiably depressed relative to other copper manufacturers and processors due to operational inefficiencies in 2019 and 2020, where management failed to properly address a Chilean drought and did not produce adequate plant recoveries. Management, however, has invested significantly into the plant to increase its efficiency, as the plant is now fully operational and guided to producing its intended yearly 60M pounds of copper.
Amerigo's cost to produce its copper is relatively fixed at 1.9 $/lb, plus the royalty paid to Codelco, which is based on a sliding scale based on the price of the metal. In Q1 for example, Amerigo sold 15.1M pounds of copper at an average price of 4.08 $/lb, with total cash costs of 1.88 $/lb, royalties of 1.07 $/lb, and non-cash expenses of 0.28 $/lb, equaling a total cost of 3.23 $/lb.
Amerigo's other yearly costs for 2021 include $6 million in maintenance CapEx, administration costs of $7 million, and interest payments of $5 million, which are expected to be reduced after Amerigo refinances its debt this year.
Using these assumptions, a 4.5 $/lb of copper would net Amerigo $57 million in levered free cash flow in 2021, a 30% yield based on the stock's market cap. It is also worth mentioning that for the purposes of this analysis, I am not accounting for molybdenum sales to illustrate Amerigo’s clear path to free-cash-flow-land, which will prove to be the stock’s second catalyst.
Both catalysts (the debt refinance and cash inflow) will allow the company to resume its dividend payment, which I believe will propel the stock to 2 CAD/share, a more reasonable valuation. The resumption of the dividend is the most efficient use of capital as opposed to a buyback since the stock is so illiquid. The other more reasonable path is the outright sale of the company given how tightly insiders control the float.
Point 3: Amerigo is a direct beneficiary from the secular rise in copper prices
The elephant in the room regarding Amerigo is the question of whether the thesis breaks down with a decline in copper prices. Copper has entered a bullish cycle because it is a necessary component in the construction of electric vehicles and semiconductors. A gasoline-powered car uses only about 20kg of copper, whereas a fully electric car can use up to 100kg. Copper is also a core element in chips, which are undergoing a significant shortage as global demand is exceeding supply. The chip shortage is noticeable and is mentioned in earnings calls across several industries. Companies including car, computer, and cable suppliers have hinted that they are not able to meet their customers’ demand for their products because they simply do not have the raw materials available to build their product.
I am not an experienced commodities analyst nor am I a fortune teller, so it is useless to debate whether the price of copper will significantly decline before the end of the year. The decline in its price, however, still does not significantly change our thesis. As of writing, the price of copper stands at 4.5 $/lb. If copper were to decrease back to 3.8 $/lb before the end of the year, this would still represent a 24% levered free cash flow yield. This negative macro environment would still allow Amerigo to refinance its debt and resume its dividend.
CONCLUSION
Amerigo represents a highly asymmetric opportunity to capitalize on a significantly undervalued asset. Amerigo’s debt refinance and dividend resumption will significantly re-rate the stock to a more reasonable valuation of 2 CAD/share.