Amerigo Resources (ARREF) – Dividend Reinstatement – 75%+ Upside

Current Price: $1.02

Target Price: $1.75+

Upside: 75%

Expiration Date: Q4 2021

 

This is a cheap industrial metals bull cycle play – in a way, a bet for the copper price to remain elevated around current levels. Although there are several other similar seemingly cheap plays across various commodity industries, this one is particularly worth highlighting as the company has no leverage, has relatively safe business operations, and, most importantly has already started to return the newly-minted cash to shareholders. Overall, we think this is a really interesting case with a large upside, however, as our knowledge in the cyclical copper industry is limited and there are certain political risks involved, we’ve posted it in the Quick Ideas section.

Amerigo Resources processes copper mining tailings for the largest copper mine in the world – Codelco (Chile). The business is much more stable/safe than a typical mine and operates more like a low capex “copper factory”. Despite that, the stock currently trades at just 3x EBITDA, significantly below most miners, and is depressed likely due to being limited liquidity, Canadian micro-cap with no dividends/buybacks since 2012, recently failed expansionary investments, and exposure to volatile Chilean political situation. However, some of that is about to change – the company is a direct beneficiary of the copper industry tailwinds, is generating loads of cash, and just recently started returning capital to shareholders. The tender offer for 11% outstanding shares was been announced last week and management plans to finally reinstate dividends in Q4’21. At current earnings and share price levels, the expected dividend yield would be around 12% – as such, dividend announcement would be a catalyst for ARG to re-rate. Besides that, the market likely misunderstands certain nuances/issues regarding the Chilean political risks – uncertainty will be lower after the Novermber’21 elections. Insiders own 28%+. A re-rate to 4x EBITDA multiple would result in 75% upside from the current prices.

 

Quick business overview

ARG is a pure-play copper (and small amounts of molybdenum as a by-product) producer from fresh and historic tailings of Codelco. Codelco is located in Chile and is state-owned. It is also the largest underground copper mine with 11% of global production and 10% of known reserves. ARG has been in partnership with the mine since 1992 and has contracts until 2037. The operations are run through its Chilean copper factory – MVC. MVC produces about 60m+ tons of copper annually. CAPEX runs at just $6m annually.

The company trades on TSE and US OTC. Financials are provided in US dollars.

 

More background on ARG business can be found on this VIC write-up.

 

Copper price surge

The whole copper mining industry is in bull cycle at the moment as copper prices are hovering around all-time highs after the post-COVID economic rebound/global ESG initiatives/EV sector growth has hit the industry unprepared. More details on the copper industry can be found here and here. Copper price surged from the pre-COVID levels of $3/lbs to over $4/lbs in Feb’21, reached new all-time highs of $4.74+ in May, and now hover around $4.20/lbs. The general consensus is that the overall increased demand and ESG/EV investments should support the price at current levels – copper futures show prices above $4/lbs all the way to 2026 (Dec’22 at $4.19/lbs and Dec’23 at $4.06/lbs).

 

ARG capital return program

ARG financial performance depends on the copper prices, but it is also highly predictable. EBITDA guidance at different price points is provided below (presentation):

So the company should earn about $61m – $70m in EBITDA on $205m EV this year. Worth noting, that this could be conservative as so far ARG generated $23m both in Q1 and Q2 2021 for an H1’21 total EBITDA of $46m. H2’21 is expected to be impacted by annual maintenance shutdowns, however, the negative effect from these should be limited as it is only 8 days in September and 1 day in October. So unless I’m missing something big, the company could be earning $85-$90m EBITDA at the current run-rate, however, for the sake of conservatism I’m using the guidance numbers ($61-$65m EBITDA) for the calculations below.

Management has been talking about returning capital to shareholders for quite a while now and last quarter, a major condition – debt restructuring due to former loan constrain on cash utilization – has been completed, immediately adding $15m of excess cash and resulting in a total of $35m cash available for distributions. Last week, ARG announced a tender offer for C$25m (US$20m) or about 11% of its outstanding shares. The tender is priced at C$1.18 – C$1.30/share and ARG now trades close to the upper limit. It was also noted that the board is weighing further capital return options. A full dividend/capital return program was promised to be announced in Q4’21.

Going forwards, management expects to distribute 50%-60% of its previous fiscal year’s FCF with the condition being that $15m operational cash must always remain on the balance sheet. If the copper price stays around these levels, then after deducting taxes, CAPEX and debt service, the annual FCF is expected to amount to around $37m-$41m. Assuming the current tender will be priced at the upper range and the remaining $15m of excess cash is also returned to shareholders shortly, then the expected dividends would yield 12%-13% at the current price.

The company hasn’t decided on the exact plan yet, i.e. whether it would be paid annually/semi-annually, however, the decision to launch the program seems firm. From Q2 call:

Amerigo’s Board is actively working on determining a sustainable dividend policy and we expect to be able to issue an announcement within this quarter. Our intention is not to sit on a pile of cash indefinitely. A payout policy is of significant strategic importance to the Amerigo’s Board of Directors.

[…]

That is – yes, that is part of the discussion that is ongoing. It’s not just determining the dividend, the share buyback, or the combination of both. It’s when, for how much, what form of dividend, et cetera. So all of those elements are being discussed and analyzed.

 

Chilean elections and mining industry risk

One of the major overhangs on ARG is the volatile political situation in Chile. Since the massive anti-corruption/inequality riots in 2019, the situation hasn’t been very stable. The country wants change and in Oct’20 voted to rewrite its previous military-dictatorship-based constitution. Besides that, one of the calls for a change is to significantly increase taxes on the mining industry. More details can be found here, however, the main point is that if the bill is passed, depending on the production size, some mining companies would see their taxes increased by up to 80% with the profit margins dropping by up to 50%. The bill has already been approved by the lower house and Senate’s mining committee and is currently being reviewed by the Senate (upper house). Two-thirds approval will be required. The vote was initially set for July, however, it got deferred. Apparently, if Senate approves the bill, under the current constitution president can block/veto it. The current president is apparently against the new mining tax bill. However, this November Chile will have its general elections for the new president, Senate and Congress. Two current presidential election front-runners are the affiliate of the current conservative party (which opposes the new mining tax bill) and a relatively young center-left-wing representative, who speaks in favor of taxing the mining industry to finance various social projects and support the COVID-19 impacted economy. While the outcome is still uncertain, there is a chance that Chileans will not support the conservatives as the party did not even manage to get 1/3rd of seats in the recently elected new Constitution Assembly, which is supposed to draft the new constitution.

All of this political uncertainty is likely weighing down on ARG price. Canada listed microcap with no analyst coverage and operation in Chile is most likely viewed as having significant exposures to Chilean mining industry risk. However, it is important to understand the risks for ARG are much lower. First of all, Codelco is a state-owned mine, which generates significant tax income for the government, so it will keep running no matter the tax increase (the new bill will mostly impact private/foreign-owned operators). Secondly, the CEO has clearly stated on the latest call that the new tax regime will not impact the company as tailing processors are not miners (see quote below). Thirdly, the change will also not affect the current partnership with Codelco in any way either.

My uneducated guess is that once the current turmoil settles down, no matter the election outcome, both Codelco and ARG will continue to operate without any impediments. After dividends are announced in Q4’20 and the market realizes that the regular dividend is fully supported by stable cash flows, the stock will be quick to re-rate.

Some quotes from Q2 call:

CEO: However, as I mentioned in our prior call, MVC is not subject to the Chilean mining royalty tax, because it is not considered a mining company within the scope of this tax and we expect to continue to be unaffected in the future.

[…]

Analyst: But I’m wondering, if a change in taxation on Codelco would be the type of event that might reopen the contract?
CEO: No it is not the type of event that would reopen the contract and when we’re talking about whether any tax changes would affect Codelco? The answer is, no. Codelco essentially, returns all of its earnings to the Chilean state irrespective of, how it returns it via first income tax mining royalty tax or a special tax that is exclusive to Codelco. It is irrespective to them where in the order of taxation you put it it’s all part of the same bucke

 

Risks

There is one more potential political caveat, that I haven’t mentioned above as I believe the chances of it materializing are fairly low. The Chilean Senate is currently reviewing a glacier protection bill that would limit/restrict mining operations near glaciers. A similar bill was passed in Argentina back in 2010. Codelco stated that if the bill is passed, 40% of its output is at risk. The bill was introduced back in 2014 and with the vote pending since October 2019. Senate is still reviewing the bill.

Unlike in Argentina, copper mining is one of the major supports to Chile’s economy and has generated 10% of the GDP over the last decade, whereas total mining GDP accounts for just 0.25% of Argentina’s GDP. Codelco alone produces 30% of the total Chile copper, so the glacier bill would instantly cut almost 1.5% of the Chile GDP from Codelco alone, and potentially much more as there are likely many other mines that operate near glaciers (82% of all South Americas glaciers are in Chile).

The bill has already been passed around for a long time, which suggests that the current right-wing conservative party doesn’t support it. Left/central-left wing coalitions are talking about reinvigorating the economy through social projects/programs and mining tax increases. Passing the glacier bill will do just the opposite as Chile is already highly dependent on state-owned mines, especially, when the new tax scheme will likely put many private/foreign-owned mines out of business.

Other risks:

  • Valuation is somewhat uncertain as there are simply no comparable public peers available. The current 3.2x EBITDA (post-tender/at $61m annual EBITDA) is simply way too low, given the copper industry tailwinds, low debt, and upcoming dividend reinstatement.
  • Long-term major shareholders Rick Rule and Ross Beaty were exiting last quarter (sold around 16%, nearly all of their holdings). Background of the sellers adds a bit of unease – Rick Rule is a prominent mining investor/billionaire/CEO of Sprott US Holdings. Ross Beaty is also a prominent billionaire/mining entrepreneur. Management addressed this during the call saying that this wasn’t related to the performance of the company, but rather to the general investment cycle of these particular shareholders. Their positions were relatively tiny to them as well.

Finally, I would like to mention that we are aware that there has been selling pressure on our equity. During this year, approximately 30 million to 33 million shares of Amerigo held in two significant blocks have been sold into the market. These are not sales from Directors or Management of Amerigo, but from long-term investors who came into the stock at a price of CAD 0.28 per share in 2009, shortly after the global financial crisis. These investors have fulfilled their personal investment cycle with the company and I have no reason to believe their actions reflect the lack of faith in Amerigo. Whenever we are aware of this type of interest in selling, we will always look to accommodate crossing blocks to minimize the impact on Amerigo’s share price.

  • Additionally, it appears that one of the insiders, Michael Luzich, founder of Luzich Partners (owns 13% of ARG), will tender around 40% of his stake in the current tender. Aside from Luzich, other insiders/directors own around 28% of the company and will not participate in the tender.
  • Exposure to copper price volatility. This was addressed in the “Copper price surge” section above.

18 COMMENTS

  1. patrick

    “Amerigo’s Board is actively working on determining a sustainable dividend policy and we expect to be able to issue an announcement within this quarter.”

    Imo, when a company looks for a sustainable dividend policy its going to be small and slowly raised as cash continues to pile up. The last thing they want is to assume copper at $3+ and then have to cut or eliminate the dividend a year later. I could see something small like 3% per year to start and build on that every 6-12 months. Excess cash from copper at $3+ could go to buybacks/tenders if need be or used to pay down debt.

  2. Ilja

    The company has recently reported Q3 production results:
    – Copper production 9% over Q3 guidance due to higher fresh tailings tonnage and grade
    – Cash cost 8% below guidance and the lowest quarterly cash cost of this year ($1.62/lb – US dollars)
    – Annual maintenance shutdown completed on schedule.

    Q3 results will be released on the 3rd of November. Shares are 20% above the write-up price already. Probably a large part of that is copper price rising to $4.72 recently.

    http://www.amerigoresources.com/_resources/news/nr_2021_10_12.pdf

  3. Terence

    Tender at C$1.18-1.30, 11% of all shares, deadline Nov 12. Price now $1.49. Company will probably raise range and extend tender.

  4. g4734g

    I have never seen a Dutch Auction with the lower and upper limits BELOW the current market price. What is happening here?

    1. Lukas

      Yes, an interesting situation. When the tender was announced, the market was trading in the tender zone (although near the top) but is now trading above the range. My take is that this is a positive for this case as the market clearly believes shares are worth more.

    2. snowball

      Market price is dynamic and ARREF is very volatile.
      In fact, ARREF price moved down sharply to reach the upper limit in early trading Wednesday. (by the way, any news? or someone was forced to sell)
      The company may just act opportunistically and is not forced to raise the range:
      if price comes down sharply between now and 12 Nov, and many shareholders tender, then great.
      If not, extend the tender, do it another time, go silent, or pay a larger dividend.

  5. snowball

    If senate passes the bill, but the president vetoes it, can the senate override the president with a super majority?

    In the upcoming general election, which races should we be tracking? Are the conservatives likely to lose seats in the senate?

    The presidential race will most likely go to second round, which will be held on 19 December. So the uncertainty re future president is not likely to be resolved by the November election results.

    1
    1. Lukas

      I am NOT a political expert, but as far as I know, yes, the senate can override the president.

      “The effect of the presidential veto is to stop the bill from becoming law, unless the veto is overridden according to a constitutionally prescribed procedure which normally involves a super-majority decision in the legislature. The grounds on which the veto power may be exercised and the difficulty of overriding the veto vary between jurisdictions.”

      “The required size of the supermajority varies from country to country. A two-thirds majority is most common (e.g. Argentina, Chile, Costa Rica, El Salvador, Ghana, Mexico, Philippines, Nigeria, Zambia)”

      “However, some early and conservative constitutions, such as the 1833 Constitution of Chile, did provide for an absolute veto”

      also, yes, these elections are very polarising and hard to forecast results, especially with senate results.

      https://www.idea.int/sites/default/files/publications/presidential-veto-powers-primer.pdf

  6. dt

    Amerigo tender expired – priced at the upper limit of C$1.3 but only 7m shares were repurchased (3.91% of shares outstanding vs. 11% tender limit). Definitely a positive.

    http://www.amerigoresources.com/_resources/news/nr_2021_11_16.pdf

    The company also reported Q3 results (in line with expectation) and reinstated the dividend of C$0.02/share (far below our assessment). Given the undersubscribed tender, a high gross cash balance of US$64m (after accounting for tender) and continued cash accretion of $15m+ per quarter, I would expect another buyback/tender announcement shortly. In the call management referred to this a number of times:

    However, if a low number of shares are tendered, this will clearly indicate that this investors have changed their view of the relative value of Amerigo in their portfolios and we also think that would be a great outcome. In this scenario, we would also have additional capital for a normal course issuer bid in the near future should the Board desire to initiate one.

    <...>

    Cash balance in the range of $25 million to $30 million is good enough to guarantee operations and that potential back and forth with the copper price through the next three months.

    <...>

    So we obviously don’t want to be keeping a huge amount of cash on the balance sheet. We’ve already stated that before. So I think that the board will act opportunistically depending on the circumstances and will look at a normal course issuer bid how to grow that dividend, et cetera.

    <...>

    And general terms, if you look at the maintenance of a cash balance of $25 million to $30 million, you can see that there is a trend for that policy that I mentioned before of slowly, but steady growth into quarterly dividend that the company will have.

    <...>
    Dave Brown

    Okay. And I guess the final question is if the – this bid doesn’t result in a lot of cash going out to buy shares is a special dividend something that’s also on the table a onetime special dividend.

    Aurora Davidson

    I don’t know if the board would be amenable to a special dividend. The dividend policy that the Board has stated is stable, saved, secure dividends that can grow over time. The possibility of initiating a normal course issuer bid would also be on the table.

    What might have caused Amerigo shares to decline back to tender levels are continued drought conditions in central Chile. Water is required to mine operations to produce tailings as well as for Amerigo to process those tailings. 2022 production currently seems secure, hoever that might change if next season again sees rain shortfall. From the call:

    Here is an update on our water situation. The 2021 rainfall season in Chile is now over and marked a return to drought conditions. Although not as dire as in 2019, which was the worst drought in Chilean history. Notwithstanding MVC has been able to maintain healthy level of water reserves in U.S., which are currently 7.3 million cubic meters. This is down from a peak of 10.5 million cubic meters at the end of the 2020 rain season, because water content in our fresh tailing stream is critical to our processing, MVC has held discussions with El Teniente concerning their own water risk assessment for 2022.

    Given the latest defrost water flow reports prepared by Chile’s general directorate of water El Teniente does not currently expect any water supply shortages in 2022. So that is also excellent news for us. Water supply is very much on the radar of all miners in Chile, major such as Antofagasta, and Anglo American have publicly flagged ongoing drought conditions in their areas of operation as a substantial operating risk and have adjusted their own 2021 production guidance downward.

    During the plant shutdown, MVC completed most of the work to optimize its three water thickeners, which are core to MVC’s ability to recirculate water in the plant. All the new electrical equipment and measure pumps for the three thickeners are now in place. And one of the thickeners now has all the bells and whistles. The upgrades in thickener two will be completed during MVC’s plant maintenance shutdown in Q1 2022. The third thickener will not require a prolonged plant shutdown to be completed and MVC will assess the best time to do this next year without hindering our product plan.

    To sum up, well, there is no immediate water supply risk identified for 2022, MVC will continue to assess its mid and long-term water supply risk. We’re constantly striving to increase our water efficiency, and as some example, our team in Chile is evaluating ways of reducing water evaporation in [indiscernible] during the summer months. This initiative will not be the last of our efforts.

    https://seekingalpha.com/article/4466770-amerigo-resources-arref-ceo-aurora-davidson-on-q3-2021-results-earnings-call-transcript?part=single

    The company remains cheap trading under 3x run-rate EBITDA and gets cheaper every quarter. 2022 guidance will be announced in Jan together with Q4 results.

    Our initial thesis was for dividend reinstatement to lift the share price. However, as dividend came at very low levels that did not work out. As long as the company continues to churn out cash, we are tempted to wait till Q4’21 results and 2022 guidance announcement before closing this idea. In the meantime, the company is also likely to announce a buyback and we might even see an increase in regular dividends or another tender if drought risks recede.

    1
    1. snowball

      The Chilean election results turned out more favorable to free-market candidates than expected. Chilean stock market index shot up in response.
      Lawmakers from hard-right and conservative coalitions also took 23 seats in the 50-seat Senate, vs 22 seats for center-left and hard-left coalitions.

      “With nearly 97% of the vote counted, Kast had won 27.94% of ballots versus 25.75% for Boric, with a sizeable gap between them and the rest of the field, although both were well short of the majority needed to win outright.

      More moderate, center-right candidates performed well, a potential boost for Kast, who appears to be in pole position heading into the Dec. 19 runoff.

      “It was a better night for the right-wing than anyone expected,” said Gonzalo Cordero, a political consultant and columnist.

      “Today, the likelihood of Kast winning the presidential election is very high. Kast would have to commit very significant errors in the next three weeks to lose.””

      https://www.reuters.com/world/americas/chileans-head-polls-with-two-radically-different-visions-ballot-2021-11-21/

  7. Ilja

    Overall, I still like where this is going. Amerigo shares trade close to the write levels, whereas copper price has proved to be stable and went up even higher. Avg. copper price was $4.23/share in Q3 and should be at least 5% higher in Q4. ARREF now trades at 2.5x EBITDA assuming Q4 numbers are in line with the last quarter (should be a bit higher).

    I really wonder if management’s copper production/EBITDA guidance table is too conservative. 2021 EBITDA will be well above $80m on much lower avg. copper price than today. At these earning levels company continues to trade at a low 2.5x EBITDA multiple. FCF multiple now stands at around 4x. At these earnings, they can easily pay dividend at 14%+ yield. Post tender, the gross cash (including restricted cash) was at US$64m and in Q4 the company is likely to generate another $10m+ FCF. So even with the high range maintenance cash of $30m, they should be able to return another 20% of market cap.

    Even assuming a 24% decline from the current copper (well below strip prices for 2023-2026) price to $3.40/lbs, the company would still generate $48m in annual EBITDA (might be conservative) putting it at 4.3x EBITDA multiple. That level would easily allow to sustain the current dividend and the company would still have plenty of excess capital to return. So the downside seems protected pretty well, unless something really big happens in the sector or the drought causes serious water shortages and production halts (see dt comments above).

    Management might be waiting for the regulatory uncertainty to settle before initiating further capital returns or dividend increases. Now that it’s much more likely that the right wing will win, the perspectives seem brighter.

    1
    1. snowball

      Normal course issuer bid (NCIB) is very routine in Canada, and the announcement of NCIB commencement or annual renewal rarely more prices. It’s very “normal” for a company to acquire zero shares over 12 months under an NCIB that can purchase up to 10% public float.
      Substantial issuer bid (SIB) is what can move prices.

  8. Ilja

    After all, despite a favorable first round, the center-right candidate lost the elections. The new Chilean president-elect is leftist Gabriel Boric, who supports mining tax hikes. Interestingly, the Chilean mining sector showed very little reaction so far. Ultimately, as Amerigo provides services to a state-owned mine, the tax impact should be minimal. The copper prices are stable at $4.30+. The company should be generating plenty of cash and is still extremely cheap trading below 3x EBITDA. Amerigo should start to return cash sooner or later. Aside from the copper price exposure, the is some risk of water shortage due to drought. However, on the latest call management said that Amerigo’s water reserves should last at least 12 months. So it’s likely that current operations are not at risk for at least a few more quarters. We are keeping this idea open and will be waiting for more updates from the company, hopefully, some positive news regarding the capital return as well.

    https://www.spglobal.com/marketintelligence/en/news-insights/blog/2021-world-exploration-trends-infographic

    6
  9. Ilja

    We are closing this idea with a +33% gain in 3.5 months. Worked out nicely indeed, but the risk/reward is no longer attractive enough to keep it open.

    The company has reported 2022 guidance with EBITDA at $50m, assuming a $3.9/lb copper price. EBITDA guidance has dropped slightly (for that copper price level, compared to the previous guidance table in the write-up) due to increased cash costs. CAPEX is expected slightly higher at $10.7m due to additional maintenance projects. Overall, at $50 EBITDA levels, Amerigo should generate around $27m FCF, and a distribution ratio of 50% would only allow a dividend of US$0.08/share vs current US$0.064/share.

    There are no more short-term hard catalysts, so this is now mostly a valuation bet on copper prices staying elevated.

    If it does, the upside could be very material as EBITDA would jump 50% above guidance ($75m) leaving $46m in FCF, which would allow covering a $0.13/share annual dividend (at 50% distribution ratio). As before, copper futures don’t show any expectations of a price drop at all. Moreover, the company still has around $30m excess cash and at current prices would be able to buy 13% of the market cap.

    However, we don’t feel comfortable predicting copper prices one year ahead and at 2022 EBITDA guidance our 4x multiple target has been reached already. Amerigo management is clearly cautious and any dividend raises are unlikely in the short term. Regarding the excess cash, they might just continue to buy shares in the open market. There is a chance of a tender, but given the previous SIB last year, the premium is likely to be modest.

    Guidance – http://amerigoresources.com/_resources/news/nr_2022_01_13.pdf

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