Silver Juniors with Cash Flow

Silver Stock Report

by Jason Hommel, March 4, 2004

    Silver Exploration Companies Aim for Positive Cash Flow
    Mining is a risky business. Mining is an impossible business if the prices of the metals are too low.

    Silver mining has been especially risky during the previous 24-year bear market in silver, from 1980 to 2003. At $5-6/oz., there are no major, public, silver mining companies that are cash flow positive. Most silver mining is a byproduct of other metal production, such as gold, copper, and zinc, which are profitable to mine. The little silver that comes to market from primary silver mines is mostly mined at a loss by the silver miners. A few profitable silver mines exist in the world, but they are owned by very large companies such as BHP Billiton, which you can’t really buy for the silver exposure, because silver is such a tiny portion of the overall value of the company. BHP has a market cap of $61 Billion. Or, other profitable silver mines are so small, or privately owned, that you can’t buy stock in them, either.

    Silver exploration mining companies are inherently risky, because silver mining simply is not profitable for the vast majority of silver companies, and silver mining projects, at current low silver prices. To survive until higher silver prices arrive, a silver exploration company must be able to continually raise capital for ongoing exploration expenses by issuing new shares. If it cannot, the officers and directors must forgo salaries, or live off of savings, or even in many cases, loan money to the company just to keep things going and keep from going out of business! I know of at least four companies whose presidents and principles have loaned money to their companies out of their own pockets to keep the company going. Such is the devotion, dedication, belief, and support these brave men have given to be in the hard business of exploring and developing a silver mining company.

    But things are changing. Now, the silver price has risen from $4.50/oz. in June 2003 up to $6.95 as of Monday, March 1, 2004. And many silver exploration companies have just completed share offerings, or private placements, for exploration and development.

    My investment outlook is one of much higher silver prices, up to and over $50/oz. I believe that silver mining will once again be a fantastically profitable business, the kind of which builds family dynasties and massive fortunes. I think the best way to invest based on my outlook is to buy silver companies with title to the most ounces of silver in the ground, because that is where the leverage is obtained. My investment strategy will not be the best strategy if silver prices will level off around $6-7 or even $9-10/oz.

    But this article will not focus on my investment strategy. The purpose of this article is to point out silver junior exploration companies that are, or are soon to be, cash flow positive. The reason I’m focusing on this aspect is that not everyone is as bullish on silver as I am, and may have different concerns. Other investors may be more timid about investing in silver junior exploration companies due to the high risks inherent in the business. But a lot of other investors may be looking for explorers that are cash flow positive, as this tends to reduce risks.

    Before I start, let me discuss why silver junior mining companies present such a good investment opportunity right now. Most of the investment world has completely ignored silver and silver miners, and for good reason. There were no profits to be made from silver mining for a long time. To stay away from the sector was a wise decision for the short term. And this fact has caused the prices of silver mining properties and companies to be driven to extremely low levels, bankruptcy levels.

    However, there are widely different prices for silver properties. I believe the most expensive silver properties to invest in are the ones held by the biggest and most widely recognized companies that you can buy stock in, such as Hecla mining (HL), Barrick (ABX), and Cour d’Alene (CDE). The PE (price to earning) ratios of these companies are very high, around 40-50 or higher, meaning the price or market cap of the company is significantly higher than what they earn. I believe the properties that are among the cheapest (besides those that become available during bankruptcy proceedings) are those historical silver mines that have never been properly explored, and are privately owned. Some of these properties have recently been sold for a projected PE of about 1-3, which I find amazingly cheap.

    For example, Pan American Silver (PAAS), on February 9th, 2004, announced that they bought the Morococha silver mine in Peru for US$35 million. See http://biz.yahoo.com/djus/040209/0815000390_2.html According to the press release, the historical production of this mine was 3.5 million oz. of silver per year, at a cash cost of below $3/oz. This means that at $7/oz, the cash flow of this mine will be the following: 3.5 mil x $4/oz. profit = $14 million per year. Not bad for a $35 million purchase price, especially if the price of silver continues to go up as I expect. That PE ratio would be $35/$14 = 2.5 (Just in case the purchase price was in Canadian, the deal is even better as follows: $26/$14 = 1.85)

    As another example, Mexgold (MGR.V) on Feb 27th, 2004 issued a press release proposing to buy the El Cubo gold and silver mine. See http://biz.yahoo.com/cnw/040227/mexgold_el_cubo_mine_1.html According to the press release, the purchase price for the mine is $13.5 million plus an additional $7 million. With capital spending and upgrades, Mexgold expects to produce up to 100,000 oz. gold equiv/year at $190/oz. cash cost. At $400/oz, that may mean $210/oz. net profit, or $21 million positive cash flow/year, and yet, the purchase price was $21.5 million. This gives a PE ratio of about 1.

    Now, I don’t present these examples to show that PAAS and Mexgold are the best investments out there. For example, if you buy Mexgold stock, the market cap of Mexgold is about $125 million at $3.19 Cdn/share, not the $21 million they are paying for their mine, so your projected PE price if you buy Mexgold stock, if you only consider that one acquisition, is about 6.

    Although that may well be an excellent investment opportunity, the point of presenting these examples is to show you that you can do what PAAS and Mexgold and other silver exploration companies are doing, and you can buy cheap silver mines, too, just as they are doing. But if you are going to do it the easy way, by buying stock, (as opposed to traveling to Mexico yourself to scout out properties) you have to buy the juniors or explorers to do it.

    So, my point is that if you buy the silver junior explorers, then you, too, may find opportunities to acquire silver mining companies at projected PE ratios of about 1-2 or maybe even less!

    And the reason why these investment opportunities exist is that silver mining has simply not been profitable during the 24-year bear market in silver prices. And not all silver mining property owners believe we will ultimately have much higher silver prices, as they have been discouraged by the long bear market.

    To survive during the bad times in the silver market, several companies have had plans in place to become cash flow positive so they would not have to rely on share dilution and financing to fund development and company growth. A company that is “cash flow positive” means that it:

        * should be safer for investors.
        * will be less likely to go bankrupt.
        * will be able to fund their own growth and development of projects.
        * will be more likely to attract investment capital for further development.
        * will be less eager to raise capital that dilutes the value for current shareholders and management.

    So… Here are a two explorers that are cash flow positive.

    Golden Eagle (MYNG.OB) (I own shares.)
    Market Cap –I have not been keeping track… about $50-100 million?
    Golden Eagle is the last gold stock that I own. It has the lowest grade gold ore, and the largest exploration potential size of resources that I’ve ever seen. And yet, they recently became cash flow positive from their start-up gold mining operations. They have one single 3500 ton per day plant, and could potentially build 20 such plants on their huge properties. I bought the stock due to the potential size of their resources, which should provide the greatest leverage as gold prices increase. Golden Eagle has been intending to release resource and reserve estimates since mid-December, but they have not yet released complete resource data, as was explained on March 1 here: http://biz.yahoo.com/prnews/040301/lam088_1.html

    I’m holding until I can get a better picture of their reserves, and market cap.
    –Cash flow positive from gold mining.

    TVI Pacific (TVI.TO TVIPF.PK) (I don’t own shares.)
    www.tvipacific.com
    Dianne (IR) Phone: (403) 265-4356
    344 mil fully diluted Oct. 7th, 2003
    @ $.305/share Cdn x .75 US/Cdn = $.228 US
    $79 million Market Cap
    –TVI Pacific is one of the only silver mining companies that I know of that actually is cash flow positive from selling silver. They produce a dore silver bar. They own a drilling company with 20 rigs. They have many silver properties in the Phillipines. They also have a 2.5% royalty on the Rapu Rapu project that they project will bring in about $1 million/year in revenue. Due to my difficulty in attempting to quantify their resources, I passed on investing in TVI. I should note that at the time I first investigated TVI Pacific, it was at $.08/share, and now it’s at $.30/share.

    Here are six explorers that should, or may, quickly become cash flow positive within the year or sooner with specific projects (listed by market cap, biggest first).

    Sterling Mining (SRLM.PK) (I own shares.)
    www.sterlingmining.com
    RDemotte@aol.com Ray DeMotte 208/676-0599
    just under 10 mil shares fully diluted (early Jan. 2004)
    @ $13.00/share
    $130 million Market Cap
    –Sterling Mining announced on January 26, 2004, a plan to acquire the “Baroness Silver Tailings Project” in Mexico, see http://biz.yahoo.com/bw/040126/265110_1.html
    Important quote: “The Baroness Tailings Project, should it meet our investment criteria, offers the exciting possibility of near-term silver production. Any Sterling profits realized from Baroness operations would be reinvested in additional silver exploration efforts, principally at the Sunshine Mine.”

    I did not buy Sterling for this particular cash flow project, I bought it for their underlying silver properties, and for their acquisition of the Sunshine Silver Mine.

    Clifton Mining (CFTN.PK) (I own shares)
    www.cliftonmining.com
    clifton@cliftonmining.com 801-756-1414 (303) 642-0659 Ken Friedman
    45 mil shares fully diluted (Oct. 2003)
    @ $2.08/share US
    $94 million Market Cap
    –Clifton has 25% ownership of a biotech firm that makes a colloidal silver. On Feb 27th, 2004, Clifton announced their colloidal silver product was successfully tested “effective against all… ailments” such as ” malaria, fungal infections, ear infections, measles, septic ulcers and a number of serious viral problems” in human subjects in West Africa. See http://biz.yahoo.com/prnews/040227/ca091_1.html

    If or when this amazingly effective medical product reaches wider market acceptance and use, it should provide great cash flow positive potential to fund development of Clifton’s mining properties. Clifton has a silver deposit that may have up to a billion oz. of exploration potential that is currently being explored by their joint venture partner, Dumont Nickel.

    Formation Capital (FCO.TO FCACF.PK) (I own shares.)
    www.formcap.com/frhome.htm
    inform@formcap.com 604-682-6229
    Over 150 mil fully diluted, Dec. 2003
    @ $.56/share x .75 US/Cdn = $.42
    $63 million Market Cap
    –Formation Capital bought the Sunshine refinery in Idaho. They own a large cobalt project, and bought the famous Sunshine silver refinery to process the cobalt. But before they get started mining cobalt, they will again process silver and gold at the refinery, as they announced on Jan. 13, 2004 here: http://biz.yahoo.com/bw/040113/135256_1.html

    First Majestic (FR.V FMJRF.PK) (I own shares.)
    www.firstmajestic.com/s/Home.asp
    info@firstmajestic.com
    15.8 mil shares fully diluted (Jan 30th, 2004)
    @ $1.49/share Cdn x .75 US/Cdn = 1.12
    $17.65 million Market Cap
    –On Jan 13, 2004, they acquired the La Parrilla Silver Mine, in Mexico, which they expect to be producing in a few months. The total purchase price was for $3 million. See http://biz.yahoo.com/cnw/040113/first_majestic_mexico_1.html They expect to produce within 4 months, producing 175,000 tonnes a year at 300g/t silver. Translated, this is 1.8 million oz. of silver per year, at a cash cost of $3/oz. At $7/oz. silver, this could be a profit of $4/oz., or 4 x 1.8 million, or $7.2 million per year. Not bad for an acquisition cost of $3 million! That’s a PE of less than one, or .41 for the acquisition, and a PE of $18/$7 or 2.6 for investors who buy stock! Important Quote: “Management is very excited by this opportunity to acquire the first cash flow producing asset for the Company.” The company’s web site contains a very important quote on the main page. This latest acquisition is “anticipated to be the first of several acquisitions over the coming months.”

    Nevada Pacific Gold (NPG.V NVPGF.PK) (I own shares.)
    www.nevadapacificgold.com
    dhottman@nevadapacificgold.com (604) 646-0188 David Hottman
    43 mil shares fully diluted (Nov 26th, 2003 including recent PP)
    @ $1.19/share Cdn x .75 US/Cdn = $.89 US
    $38 million Market Cap
    — Nevada Pacific Gold, on Jan 7th, 2004, announced the pending acquisition of two gold mining properties that will be cash flow positive. See http://biz.yahoo.com/ccn/040107/e2092fcd7484fe968a63b27a2a72060c_1.html Important quote from article, “Cash flow from future gold production will create a solid foundation for the Company and fund gold exploration in Nevada.” Their press release indicates 2003 production of 45,000 oz. of gold. If their cash costs were, on average, $200, then the cash flow could be about $9 million per year. Cash costs for the smaller of the two mines was “reported to average US$108.” If Nevada Pacific earns $9 million for 2004, that gives a projected PE of $38/$9, or 4.2.

    I bought Nevada Pacific Gold for their silver exploration property, Amador Canyon, which may have an exploration potential range of from 200 million to 1000 million (or a billion) ounces of silver.

    Cabo Mining (CBE.V CBEFF.PK) (I own shares.)
    www.cabo.ca
    jav@cabo.ca (604) 681-8899 John Versfelt, President
    18.9 mil shares fully diluted (Feb 9th, 2004)
    @ $1.15/share Cdn x .75 US/Cdn = .86
    $16.3 (to $33.5) million Market Cap
    –Cabo recently announced two private placements for $5 million, one at $.75/share, the other at $.83/share, for a total of $10 million. The first PP will add 10 million fully diluted shares, the second will add another 9-11 million shares, depending on if it is $5 million or $6 million. Adding in those shares will mean there will be up to 38.9 million fully diluted shares x $.86 US, or $33.5 million market Cap.
    –Cabo has two Drilling Companies under contract to be acquired. Drilling companies make money in the risky world of mining, whether they hit a strike or not. The drills don’t turn unless they are paid. With the metals prices rising, and a lot of capital being raised to drill projects, drilling companies should surely be “cash flow positive”.

    I didn’t buy Cabo for the drilling companies, my focus was on their silver property in Cobalt, Ontario. But many who invested in Cabo were excited by the prospect of a company quickly becoming “cash flow positive”. And this is why I was motivated to write this article, to focus on the “cash flow positive” explorers.

    Klondike Gold (KG.V KDKGF.PK) (I own shares)
    www.klondikegoldcorp.com
    70 mil fully diluted (Nov. 2003)
    @ $.22/share Cdn x .75 US/Cdn = .165
    $11.5 million Market Cap
    — Klondike has many silver and gold properties. Some of the people are also involved with GNG.V, Golden Goliath. Klondike has one silver property that could be producing within weeks.

    I’m not an investment advisor, and this article is not intended as investment advice. This article is intended to motivate you to do further research into silver mining stocks as you may feel appropriate. Always do your own research to confirm what you read on the internet.

    None of the companies in this article has paid me to write this article. I own shares of MYNG.OB, SRLM.PK, CFTN.PK, FCO.TO, FR.V, NPG.V, CBE.V. I do NOT have any shares of BHP, HL, ABX, CDE, PAAS, MGR.V, or TVI.TO.

    Prices for this report are accurate as at the close of Tuesday, March 2, 2004.