Looking at Lead - ADA, BN, BWR, TAM, Zinifex

Lead has reached an all time high, about 6 times its low since the start of this bull run. It is a strong price, but it isn’t as strong as say molybdenum which peaked about 18 times its low, or nickel, which peaked at around 12 times its low, or uranium which is about 15 times its low. Strong lead prices will mean unexpected profits for lead producers.

The market is tight for lead Lead Rises to Record for Third Day in London.

Lead deposits tend to exist with zinc deposits, this post looks at 5 companies that have some lead, Acadian Mining, Blue Note, Breakwater, Tamerlane and the Australian Zinifex. Metal prices are highly volatile and many calculations giving metal values are done here. They are intended to give a relative magnitude for comparison purposes--how good are grades relative to each other; how big are deposits relative to market cap; how much gross income can they bring in relative to each other. Higher grades and larger deposits tend to be more profitable. I have given valuations for metals in the ground at today's prices. In general, I believe that is a poor way to assess the value of a mining company and I look at it purely for a relative valuation. Prices used for metal values per ton calculated are $650/oz for gold, $12.40/oz for silver, $1.50/lb for zinc, $3.50/lb for copper and $1.20/lb for lead.

Zinifex

Zinifex is the largest of the companies and it produced about 5% of the world's 2006 zinc supply, 1.4 billion pounds of zinc, and about 230 million pounds of lead. As with the Australian mining practice, they maintain about a 6-year life-of-mine, and they have one mine has had a six-year LOF since 1893.

Few mines have a higher resource grade than their Rosebery mine, with an average resource of 15.3% zinc, 4.7% lead, 180 g/ton silver, 2.5 g/ton gold and 0.5% copper for an amazing $800/ton in metal values. They have 7.1 million tons of measured, indicated and inferred reserves for close to $5.6 billion in metal values at this grade. The reserves they are currently mining have about $610/ton in metal values.

Their other big property is their Century mine. The resources averages 12.7% zinc, 1.4% lead and 34 g/ton silver, for $470/ton metal values and with 60 million tonnes that’s $28 billion in metal values. Their reserves suggest metal value currently being mined are about $420/ton.

Zinifex’s properties are exceptional and they have further development prospects with their recently acquired Wolfden in Canada’s north, which has properties with metal values per ton of $250-700. They also have Dugald River and South Hercules for development.

In Australian dollars, last year the revenues were over $3 billion and of that $1.1 billion was profit, making $2.20 per share and shares are currently priced at about $19, for a P/E of about 8.6. Zinc prices peaked during this reporting period and have declined, but lead prices are up.

In the US, under the ticker ZFEXF.PK, it trades at $15.90/share and with 488 million shares, it has a US market cap of about $7.7 billion. At $1.50/lb zinc and $1.20/lb lead 1.4 billion pounds of zinc and 230 million pounds of lead would fetch $2.4 billion US gross revenue, or $2.9 billion Australian. Gross revenue potential is close to 1/3rd of market cap. Relatively speaking, with lead production potential of 230 million pounds their leverage to lead is not high; they are about six time more leveraged to zinc, but there is no question that lead’s ascent will be contributing nicely to their bottom line.

Tamerlane

Tamerlane is a junior explorer with a fully diluted market cap of about $67 million. Their prize property is the old northern Pine Point Mine, which historical records show they mined 64 million tonnes from 52 deposits with an average grade of 3.1% lead and 7% zinc, or about $310/ton metal values at today’s prices. Currently they have 34 known deposits from non-compliant historical data indicating 70 million tonnes of ore with 4.19% zinc and 1.59% lead, or about $180/ton of metal values at today’s prices. The grades and sizes of the deposits vary greatly.

Their flagship deposit, R190, has grades of 6.3% lead and 12.1% zinc for about $570/ton metal values and there are about 1 million tonnes of ore in this deposit, or about $570 million in metal values.

Tamerlane has plans to start building the mine in Q4/07 and to be in full operation for Q1 2009 and to mine the 240 million pounds of zinc and 120 million pounds of lead from R190 in 12-15 months, or half a billion at today's prices. Six of the 34 deposits are close by and have metal values/ton about $290/ton, so without milling upgrades their second year of production rates would be about half what they get with the R190 deposit.

Financing the mill construction has not been arranged. They are looking to forward sell some of their production to prevent further dilution, and appear to be looking at issuing 30 million in equity and 100 million in financing to move the project forward. They have already run into obstacle in terms of implementing their plan as in April 2006 the plan was to start building in January 07 and be producing in December 07 of this year.

Tamerlane was closed down due to declining metal prices and increased costs due to flooding, and the high cost of maintaining a town for workers in the north. They plan to deal with the flooding by implementing freezing technology around the deposits. As the size of a deposit decreases the relative cost of the freezing technology increases exponentially, just as a ratio of surface area to volume increases as the volume decreases. The economics of each deposit will be highly variable.

Breakwater Resources

Breakwater Resources has a fully diluted share capitalization of 460 million shares for a market cap of $1.5 billion. Their 2007 production forecast is 268 million pounds zinc, 18 million pounds copper, 28 million pounds lead, 2 million ounces silver and 43,000 oz gold or total metal values of $550 million. They also have an interest in Blue Note, which can be taken as shares or as 20% interest of their Caribou mine. At current metal prices that interest could bring an additional $30 million in gross revenue for 2007. Gross revenue has the potential to be around 40% of market cap.

Their Langlois property starting production this year and has a reserve with 10.1% zinc, 0.8% copper and 49g/ton silver, for metal values of $410/ton, for about $1.5 billion in metal values. The resource has comparable metal values/ton and is about twice as big as the reserve for a combined total of about $4.5 billion. The goal for this property is 62 million pounds of zinc, 3 million pounds of copper and 12,000 oz of silver. Metal values per ton mined in Q1 were about $250/ton.

El Toqui has 8.9% zinc and 1.3g/ton of gold for $320/ton in metal values and is also projected to start production for 2007 with a goal of 61 million pounds of zinc, 6 million pounds of lead, 10,000 oz of silver and 2,600 oz of gold. Metal values per ton mined Q1 were about $300/ton. Total reserve/resources is about $4.5 billion.

El Mochito has 6.7% zinc, 2.8% lead, and 97 g/ton silver for $330/ton in metal values. It is projected to produce 60 million pounds of zinc, 20 million pounds of lead and 1.1 million ounces of silver. Actual grades mined in Q1 had metal values of $300/ton. This property holds about $3 billion in metal values.

Myra Falls has resource with 7.2% zinc, 1.2% copper, 55g/ton silver, 0.6% lead and 1.7g/ton gold for metal values of $400/ton and has about $7 billion in reserves/resource. It is projected to produce 84 million pounds of zinc, 15 million pounds of copper, 2 million pounds of lead, 660,000 oz of silver, and 17,000 oz of gold. Actual grades mined in Q1 had metal values of $220/ton.

For Q1 prices Breakwater obtained in $US were $1.56/lb for zinc, $2.70/lb for copper, $0.81/lb for lead, $647/oz for gold and $13.03/oz for silver. Earnings on $78 million of gross revenue were $15 million. They are about 9-10 times more leveraged to zinc than to lead.

Blue Note

Blue Note is an almost producer, currently in the start-up phase of their newly refurbished/built Caribou mine that Breakwater has an 20% interest in. Figuring out their “true” fully diluted market cap is more complicated than for other companies because of the Breakwater interest, which gives Breakwater choices about how they cash in on their interest, either 20% of Caribou or about 42 million shares, and there are hidden shares with debentures that are easily missed. Breakwater must make a decision within one year providing Blue Note does $1.5 million in further exploration on the Caribou property. Fully diluted excluding Breakwater’s interest Blue Note has a market cap of about $172 million. As shares Breakwater’s interest adds an addition $22 million to the market cap.

For 2007 projected production is 68 million pounds of zinc, 35 million pounds of lead, 0.8 million pounds of copper and 850,000 oz of silver, for total metal values of $157 million of which 80% is $126 million or about 3/4rds of the market cap excluding Breakwater. For 2008, with full production, the projection is 104 million pounds of zinc, 57 million pounds of lead, 1.3 million pounds of copper and 1.3 million ounces of silver for $245 million, of which 80% is $196 million and exceeds the market cap.

Metal values per ton in the Caribou/Restigouche reserves are about $370/ton with a total reserve value of about $1.8 billion at today’s prices and the resource, where the life-of-the mine is extended beyond 5 years from, has about $380/ton in resource metal values and about $1.4 billion at today's prices. There is no measure for copper values in the resource, which is 0.34% in the reserves. The cut-off grade used was a profitable 9% combined lead and zinc.

Breakwater previously had problems with poor recovery rates and poor metal prices. Metal prices were low when they decided to sell. Blue Note has installed a milling process shown to dramatically improve recovery rates developed in the last 15 years by Xstrata. Xstrata has used the technology long enough to prove it works and Blue Note has a contract with Xstrata to buy half its zinc concentrate and all of its lead concentrate. Blue Note is still very much priced as a junior explorer. It is in start-up operations currently testing their milling process and will soon be a producer eligible to move to the Toronto exchange. As a new start-up it runs the risks that things will not go as management plans and there are no operational financial reports to review and evaluate.

Blue Note has several exploration properties in the vicinity of the Caribou mine including Armstrong, California Lake, McMaster, Orvan Brook, Rio Road and Woodside Brook.

Blue Note’s relative leverage to metal prices means that every 2c change in lead price has about the same effect as 1c change in zinc price.

Acadian Mining

Acadian Mining is a small new producer with 159 million shares fully diluted as of May 31, 2007, giving it a fully diluted market cap of $191 million. They have two main projects of interest, Scotia Zinc and Scotia Goldfields, and they own about half of Royal Roads, which owns about half of Buchans River.

Scotia Zinc has a 2007 production target of 23 million pounds of zinc and 8 million pounds of lead and a 2008 production target of 45 million pounds of zinc and 19 million pounds of lead, for $44 million of gross revenue in 2007, 1/4 of market cap and $90 million for 2008, almost half of market. The reserves have a zinc grade 3.6% zinc and 1.7% lead, for $160/ton metal values. Total reserves are about $750 million to be mined over 7.5 years. As a new start-up it runs the risks that things will not go as management plans and there are no operational financial reports to review and evaluate.

Goldfields has several properties with about 1.35 million ounces of gold contained in resources that have metal values ranging from about $60/ton with the Beaver Dam property which has about 600,000 oz of gold, to about $350/ton with Goldenville with about 265,000 oz. The metal values may be worth about $900 million, but low grades spread out in several deposits means high extraction costs.

The Royal Roads holding has given them an interest in the Tulks North property. It currently has inferred resources with metal values of about $530/ton, or about $900 million in metal values. With the 1% zinc cut off instead of a 2% zinc there is 2.5 times as many tons of ore, but metal values per ton of ore decline to about $250/ton. This only adds $100 million in metal values to the deposit for an extra 2.5 million tonnes of ore that would need to be processed. This extra could quite possibly cost more to mine and process than the value of the recoverable metals. Acadian's interest is about half of this deposit.

How do they compare?

Zinifex by far has the best grades and looking at their financial data, you can see that about 1/3 of the gross sales ended up as earnings. Contrast that to Breakwater's lower grades and about 20% of their sales ended up as earnings, although Breakwater's earnings were pulled down by Myra Falls' lower grade during the quarter and will likely increase to more like 25% of gross revenue. Zinifex's higher grades and endless deposits justify a higher P/E than Breakwater, but both are nice looking companies. With strong prices there is always more downside risk that prices will decline, so commodity companies in this market commodity companies should never be priced the way a company like Pepsi might be priced, with an expectation the prices will generally always increase. So, 5% earnings might be great for Pepsi, but is a good way to potentially lose your capital with commodity companies. Zinifex currently has earnings of about 11%, which has a safety margin built in and gives them cash flow to fund future growth and exploration.

Breakwater has lower grade and is priced lower relative to market cap. Earnings for Q1 were low, about 5%, but should improve, most likely doubling when their new production that has started shows up in the financial reports. Also, Myra Falls contribution to operational earnings was relatively small as the grade they actually mined for the quarter was much lower than the overall grade their reserves/resources indicate they hold. Breakwater has a safety margin built in and they have good cash flow to fund future growth and exploration.

Tamerlane has a beauty deposit with that R190 deposit but they have a lot of steps to go through to actually get that deposit producing and any revenue possibility is about two years out. The economics of the R190 deposit at today's prices are nice, but it is a minimum of two year out and the further out you go, the more likely projections on everything are going to be wrong.

Blue Note has high grade to mine, an exceptionally high gross revenue potential relative to market cap and good reserves/resources relative to market cap. On this basis it is currently priced at about 1/3rd to 1/2 of the valuation given to Zinifex or Breakwater. The metal values per ton are very comparable to Breakwater's grade, so the simplest projection on earnings by contrasting is that they will be about 20-25% of gross revenue. Octagon has an estimate of 15c/share, or about 30% for this year, and 25c next year, for about 50%, or a P/E of about 2.

Acadian Mining has the lowest start-up production relative to market cap and the lowest grades, less than half that of the other companies profiled. Blue Note has combined open pit and underground mining operation, as does Acadian. In general high grade is what makes a company profitable and low grade is what limits profitability. For Acadian the gold deposits also tend to be low grade and/or small deposits, both of which rarely make money. It has a grade that with a large operation and economies of scale can make money but from reviewing many financial reports of other operations my conclusions are that its small size makes it questionable as to whether it can make money. This one I'd definitely want to see proof of earnings because of the lower grades.

Other details I picked up from looking at the relative deposit size is that Acadian's information indicates that they expect to recover about 90% of their deposit in 7.5 years. Blue Note's numbers indicated about 60% of their deposit will be recovered in 5 years. It is strictly a perception it gives me that there is not much room for error built into Acadian's numbers. Blue Note uses a 9% zinc-lead equivalent cut off which builds in a safety margin for investors in their evaluation. The 1% zinc cut off used for Royal Roads does not.

Note: I am not an investment adviser and I write about investments to help me to evaluate my own investments or potential investments or to better understand investments as a whole. For this post, because I own Blue Note, it was time for me to re-assess it's valuation relative to other companies in the sector. If you've seen something of interest you need to do your own due diligence. Current prices, Blue Note 53c, Acadian $1.20, Breakwater $3.19, Tamerlane $1.62.

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Paladin Resources Ltd - A Near Term Uranium Producer

On my post on Cameco, which has little ability to take advantage of uranium spot prices because of long term hedge contracts, I was asked about uranium producers able to take advantage of the current spot prices like near term/new uranium producer Paladin.

Fully diluted Paladin Resources Ltd has 600,989,245 shares (May 14, 2007). Today it closed at $8.12 giving it a fully diluted market cap of $4.9 billion, or almost 1/4 of that of Cameco. For a near term or new producer investors have given Paladin a lot of valuation. Paladin Resources has a market cap about 17 times bigger than Roca, which is a near term molybdenum producer, and about 26 times bigger than Blue Note, which is a near term zinc producer. For a new producer Paladin has a very substantial market cap already.

Paladin new mines are Langer Heinrich, and Kayelekera. Kayelerkera is projected to reach full production of 3.3 million pounds in 2009 and Langer Heinrich 3.7 million in later 2008, for a total of 7 million pounds per year for 2010. 7.5 million pounds is committed to contracts from 2007 to 2012. Cumulative production to the end of 2012 is projected to be 31 million pounds and their reports all use a "conservative" price of $90/lb for Uranium to give $2.8 billion in revenues from now until the end of 2012, or 57% of the market cap. Keep in mind the "conservative" $90/lb is about 10 times the 2001 price of uranium and they do not reach their full production until 2010.

Langer Heinrich was officially opened March 15, 2007, and is currently operating at 70% of its "design capacity." It was projected to mine 2.6 million pounds for 2007, but is now expecting to be between 400,000 and 600,000 lbs by June 30th, and reaching that rate after June 30th, so about 1.8 million pounds for 2007.

Paladin does not give clear guidance as to how they get their 31 million pound production figure. My estimates are:

• 2007 - 1.8 million pounds (Langer)
  
• 2008 - 3.1 million pounds (Langer)
  
• 2009 - 5.2 million pounds (3.7 Langer, 1.5 Kayelekera)
• 2010 - 7 million pounds
• 2011 - 7 million pounds
• 2012 - 7 million pounds

This year's production at best will give 2007 gross revenue of $125*1.8 = $225 million, or about 4.5% of the market cap before any expenses. Paladin does have some hedge, the 7.5 million pounds over 5 years the banks required, but the price of the hedge is well hidden, so $225 million is mostly likely an over estimate of gross revenue.

For 2008 at $125/lb would be $388 million, and at $90/lb would be $279 million, 7.9% and 5.7% of market cap respectively.

For 2009 at $125/lb would be $650 million, and at $90/lb would be $468 million, 13.2% and 9.6% of market cap respectively.

For 2010 and beyond at $125/lb would be $875 million and at $90/lb would be $630 million, 17.9% and 12.9% of market cap respectively.

Out of that comes production costs, administrative costs, royalties, exploration, technical reports, stock based compensation, capital costs, maintenance, taxes and so on all have to be paid.

They have other projects they can develop, but they have to change some policy and laws to get approval.

On long term price, the further out you go, the more likely the prediction will be wrong and the bigger the gamble, either for upside or downside. What I found when searching long term predictions:

The same is true of Raymond James analyst Bart Jaworksi, whose latest estimates show an average uranium price of $90/pound for 2007 and an average of $100/pound for 2008 and 2009. But, Jaworski did not budge from his price forecast of an average uranium price of $60/pound for 2010.

Prices may average $100 a pound in 2007 before easing to $85 in 2008 and $75 in 2009, Toronto-based RBC Dominion Securities Inc. said Nov. 17.

The team at GSJBW seems to acknowledge all these risks. The broker has a long term price forecast of US$45/lb but the figure doesn't figure anywhere in the outlook for the next few years. Average U3O8 spot price forecast for calendar 2007 is US$90/lb, for next year it is US$95/lb, after which a gradual decline is assumed to US$80/lb. (2011 sees a rise to US$85/lb, however).

Paladin's "conservative" $90 average price is not conservative relative to analyst predictions. Using Jaworski's forecasts the average price assuming the $60 remains constant would be $74.44/lb. Using $125/lb for 2007 the RBC averages to $78.89. The third one averages to $85.23. $90/lb is not a conservative price, but a strong price. Use that $60/lb for 7 million pounds and gross revenue is a mere 8.6% of market cap.

Paladin currently has a very small production profile able to cash in on the current strong uranium prices.

Strong prices are simply vulnerable to downward price corrects and as prices become stronger valuation models need to become more conservative to take that into consideration. Paladin currently has a seriously inadequate production profile relative to market cap and even when their production growth plans are meet for 2010 the production profile is still highly marginal compared to their current market cap and is utterly crippled should prices decline.

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The Commodity Bubble?

If you've been watching commodities at all you probably saw some doom and gloom news, Metals Bubble Poised to Burst on commodities, and it certainly sent commodity prices tumbling despite a continuing trend to lower LME warehouse levels, as the charts below show.

Zinc warehouse supplies are at their lowest levels in over 5 years, so just what is this commodity bubble?

There is no question that some company's share price has gotten way, way ahead of itself, like Goldcorp, and its valuation could be described as a bubble valuation.

Another company that has gotten ahead of itself is Blue Pearl, now known as Thompson Creek Metals, TCM-TSX. They have a share price of $16.63 and made 45c/eps their last quarter. Their molybdenum production is 21 million pounds per year, increasing to 27 million pounds, so earning should go up, right?

Wrong, for this quarter where they report 45c eps commodity prices were so strong, in their opinion, so they reduced their inventory levels and they sold 10.5 million pounds for the quarter, twice their level of guidance. They do not have the inventory levels to repeat this feat, so productions sales for Q2 should be about half of Q1 and production will not increase until they've built another mine.

Add to that that with the US dollar declining their Canadian costs will go up, about 10% over last quarter just based on recent strengthening of the Canadian dollar. Molybdenum prices are up for this quarter so it will offset some of the increased costs due to currency losses, but trying to make up for doubling their sales for a quarter simply isn't going to be covered by the increase in molybdenum price.

The other thing is that they earned $47.7 million dollars, and that is over 105,395,000 shares diluted, or so they report to get 45c/share. Currently they have 111,749,000 shares, 24,644,000 warrants and 6,943,000 options for fully diluted share capital of 143,336,000 shares, or about 36% more shares then reported. Average the earnings over the full dilution and you get 33c/eps.

Blue Pearl, aka Thompson Creek metals, is highly unlikely to come close to its Q1 earnings, but with 2007 earning potential to be in the range of $140-150 million and a fully diluted market cap of $2.4 billion, it just isn't the kind of return investors in base metals are looking for.

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Hudbay vs Blue Note, experience vs new

Hudbay Minerals is Canada's third largest producer of copper and zinc and also produces some silver and gold. They are highly integrated in that they own a copper smelter, a zinc plant and they convert some of their zinc to zinc oxide. Their product is marketed by Considar Metal Marketing, of which they own 50%. Being fully integrated gives them autonomy over the entire process.

Fully diluted warrants and stock options they have 129,284,210 shares, and at today's closing price of $20.77, it gives them a fully diluted market cap of $2.69 billion. Hudbay has a history of successful mining production, and their financial reports fully breakdown their costs and production.

By contrast, Blue Note is a small soon to be producing mine acquired from Breakwater when zinc price was down. Breakwater had spent $100 million on infrastructure and shut down in 1998 due to zinc prices and recovery rates. Blue Note has refurbished with mining technology developed since then. Their mine is scheduled for start-up in June/July and their unproven production plan relative to their market cap is stellar, but as a start-up it is still unproven.

Blue Note has 312,930,175 shares and Breakwater has the option to convert a $15 million debenture into 41.7 million shares, or 20% of the Cariboo and Restigouche mines. Additionally a $30 million debt offering adds an additional 4.5 million shares. For comparison purposes, it works out to about 360 million shares fully diluted. At today's close of 46c, the fully diluted market cap is about $166 million.

The market currently values Hudbay at about 16 times that of Blue Note.

Mining Production to Concentrate

Hudbay has 4 producing mines and with one increase production this year. The totals are from the financial reports but the reports do not specifically break down production by mine, so the estimates are mine based on given recovery and production rates given. They give a general picture of production.

	Zinc (lbs)	Copper (lbs)	Silver (oz)	Gold (oz)	End of Mine *$ (millions)
Mine 777	120,000,000	84,000,000	725,000	75,000	2017 $527
Trout Lake	57,000,000	40,000,000	236,000	24,000	2009 $242
Chisel North	51,000,000				2011 $77
Balmat*	20,000,000				2014 $30+$75 +$82
Total	250,000,000	125,000,000	963,000	96,000
Market Value* (millions)	$375 + $75*	$425	$12	$65	Total $952

*Production to about 70 million pounds for 2007 and 125 million pounds for 2008.
*Prices I used are $1.50 zinc, $3.40 copper, $13.50 silver, $680 gold, and $0.85 lead.

Additionally, Hudbay buys other concentrates that they process through their smelter and zinc plants, further producing from concentrate about 70 million pounds of copper, 10 million pounds of zinc, 2,000 oz of gold and 380,000 oz of silver.

What they mine and what they produce from concentrate needs to be evaluated separately.

Blue Note has one mine set to start producing this year. Their first full year production plan is:

	Zinc (lbs)	Lead (lbs)	Copper (lbs)	Silver (oz)	End of Mine
Cariboo	104,000,000	57,000,000	1,300,000	1,300,000	2011
Market Value* (millions)	$156	$48	$4	$18	Total $226

Contrasting mining production only, Hudbay has 4.2 times the gross revenue potential from mining production.

In both companies the end of mine life is of concern for future income. Trout Lake has 3 years of operations left which is 20-25% of production. Whether there is opportunity to extend this LOM was unclear reading the reports. Their next mining project will not be a growth project but will be a replacement project.

Hudbay has significant exploration potential around their 777 mine. According to a 2004 technical report, "on average, mining reserves have increased 2.5 times over the initial resource and reserves estimate." Trout Lake has had 10-fold increase in estimates over its mine life, but whether there is more potential to extend the mine life at this point is not clear. Their Flin Flon/Snow Lake area also has exploration potential.

Blue Note's current plan is a 5 year LOM plan. Their mining plan goes to depth of 300 meters and they have some drill results to indicate that they will be able to continue their mine to 900 meters giving their mine a life of up to 14 years. This is a significant exploration potential.

Mining Production from Concentrate

Blue Note does not have facilities to smelt or refine their concentrate.

Hudbay has more refining and smelting capacity from concentrate then they get from their own mines. They purchase additional concentrate to utilize their capacity. This part of the business gives them some income stability from declining mine production in that when a mine stops producing they can continue this income stream by switching to purchasing more concentrate.

Financial reports have to be evaluation to determine how this part of the business adds to revenues.

Looking at Financial Reports

Blue Note does not have an earning history to look at and evaluate. It is a speculative stock based on its new mine production. The pre-tax earning potential according to their reports for 2007 is $25 million and that is with zinc priced at $1.44, lead at $0.52, silver at $12.50 and copper at $2.80, and that is based on 2007 projected production of 68 million pounds of zinc, 35 million pounds of lead, 0.8 million pounds of copper and 0.85 million ounces of silver. Current commodity prices suggest they will exceed this projection if they meet their production goals.

Hudbay had a record year for earnings and revenues. Revenues were $1.13 billion. What is highly confusing, and perhaps misleading, is how they came up with earnings of $5.32/share for 2006.

On page 28 of the Management and Analysis is the following table for 2006 (my totals):

	Q4	Q3	Q2	Q1	Total
Revenue	313,110	346,203	261,727	207,963	1,129,003
Earnings before taxes	134,636	151,582	94,590	61,643	442,451
Net Earnings	165,788	169,381	152,836	75,986	563,991
Basic EPS	1.32	1.37	1.71	.89	5.29
Diluted EPS	1.29	1.33	1.30	0.70	4.62

Problems

1. A minor problem is that their Key Financial results on page 5 of the report say $5.32 and $4.69 whereas when I add the quarters I get $5.29 and $4.62.


2. A big problem that I see is when you look at the difference between the basic and diluted EPS you see that for Q3 and Q4 the difference between the two values is about 2-3%. However, if you look at Q2 the difference between the two is 51c, and .51/1.30*100% is 39%, and for Q1 the difference is 27%. Without looking further, this tells me there was dilution and the true earning potential is overstated in the financial reports because of the dilution.
   
   They are doing this calculation using the net earnings divided by the number of shares at the time. If you redo this calculation using the today's diluted share count you get 564/129 for $4.37 eps based on today's fully diluted market cap. This is 93% of their diluted eps of $4.69 that they reported, and 82% of the undiluted $5.32 eps being promoted.


3. An even larger problem that I see is that is that earnings before taxes is less than earnings after taxes. Once you pay taxes earnings are supposed to go down, but somehow their earnings go up, very significantly. I saw this problem as so significant when reviewing the financial reports, I immediately checked insider activity.
   
   Upon a closer look at the financial reports I found that they had put $125 million of future tax into earnings and it says that as this is "drawn down, ... it will be reflected as a mining tax expense."
   
   When I take their earnings before taxes and divide it by the 129 million fully diluted shares I get $3.43 eps, which is 64% of the $5.32 eps, or more than 1/3rd less. It is an earning rate of 16.5% of the current share price, without paying taxes.
   
   I am not an expert, but I read the "reflected as a mining expense," as not a good thing. I read this as meaning that not only will future years bear their tax burden, but they will have this extra expense of writing off this future tax asset.
   
   I do not profess to understand how this future tax thing works, but from what I've seen in other financial reports in other industries is that it seems to result in highly overstated earnings in earlier years at the expense of plummeting earnings in later years.
   
   And my look at insiders going back to July of last year, they appear to have significantly reduced their positions. Anderson has taken a gain of about $185,000 from options, Axworthy about $252,000 from options (he still has about 6,000 shares), Deitrich sold 3,300 of 10,000 shares at $23.37, Gordon took a gain of about $2.2 million from options, Hair took a gain of about $950,000 from options, Jones took about $4-5 million from options, Palmiere sold options for a gain of about $525,000, Rood took a gain of about $300,000 from options, Swinoga took about $970,000 from options. Lawler is the only director that is holding significantly in the company, with 193,000 shares.

The average prices received for product for 2006 for Hudbay was $1.53/lb for zinc, $3.15/lb for copper, $603 for gold and $11.13 for silver. They are most price sensitive to zinc and copper.

I haven't studied how the money flows through smelting and refining companies. As commodity prices go up, what they pay for concentrate goes up, and the same is true for when commodity prices decline. This means that earnings from this part of Hudbay's business should remain relatively constant and is not subjected to the speculative risk of starting new mines, doing exploration for new deposits, etc.

A quick look at this part of the business is that it looks like it made up for about $250-300 million of the overall revenue. Operating expenses increased by about $120 million from 2005 to 2006, or 25%. If you examine the individual cost of operations you see far smaller price increases of 2-10% in the operating expenses. The biggest hit for the operating costs is in the smelting and refining part of the business because of buying the concentrate. A 2004 report breaking down the employment numbers shows that 558 were directly employed at mines and concentrators and 485 at smelter and zinc plant. So the mining part of the business is bringing in 75-80% of the revenue with about 54% of the workers directly employed in those operations.

The financial reports state what they averaged for final product, but they do not actually say what the average cost was for the concentrate they purchased.

The bottom line to me is that the 70 million pounds of copper, 10 million pounds of zinc, 2,000 oz of gold and 380,000 oz of silver produced from concentrate simply does not contribute to earnings the way that production from mining operations do.

My look at the two companies suggests to me that Blue Note has significant potential to outperform Hudbay. The risk with Blue Note is how successful they are in getting their new mine started. I see the handling of taxes and the loss of production from Trout Lake as the risks with Hudbay. I personally do not see how Hudbay can increase earnings this year over last year despite increased production because of Balmat and potentially higher commodity prices because of the $125 million added to earnings last year from future tax benefits. But I don't profess to be an expert, that's just my take on it.

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What's Up with Zinc?

I like Blue Note. It is a near term producer starting up in the next month or two.

The production plan for the Cariboo Mine is:

(x'000)	2007	2008	2009	2010	2011	Total
Zinc	68,105	104,467	107,748	107,039	88,816	476,175
Lead	34,946	57,471	46,571	44,708	39,804	223,501
Copper	805	1,263	1,905	1,945	1,699	7,616
Silver	847	1,317	1,055	1,014	886	5,119

Blue Note is ready to cash in on high zinc prices now, and it looks like their timing couldn't be better.

What's up with Zinc?

The charts below are the 24 hour spot price, the 5-year LME zinc price and the 5-year warehouse stores.


What caught my interest was the large Chinese imports of Zinc in 2005 when zinc was very cheap and then when zinc was peaking in price in Dec 06-Jan 07 the Chinese exports take off, and their large increase in exports brought the price of zinc down from its peak.







Meanwhile, there was a Shanghai exchange opened to trade zinc in March.

What's happening with the Shanghai Exchange?
On March 25th the Shanghai price for zinc was 28,510 yuan, which works out to $1.6765 US, but the LME price was just under $1.45, or almost 16% higher.

An April 5th article in the Chinadaily reports that zinc prices are around 28-30,000 yuan and that China's demand will rise about 10%.

An April 9th Bloomberg article states "Shanghai zinc for July delivery rose for a fourth day, advancing 990 yuan, or 3.2 percent, to settle at 31,950 yuan a ton. It rose by the maximum 4 percent from the morning session." That's about $1.88/lb, and about 19% more than today's LME price.

An April 10th story on Etrade said Shanghai zinc ended at 32,745, which at today's exchange of 7.7257 works out to $1.93 US/lb zinc, or about 21% more than the current 1.59/lb.

Zinc is looking good to me.

http://www.chinadaily.com.cn/bizchina/2007-04/05/content_843935.htm
http://www.bloomberg.com/apps/news?pid=20670001&refer=china&sid=ab.xX6jx.AJc
https://uk.etrade.com/e/t/uk/NewsContent_Component?ArticleId=2876744&ORIGIN=news.UKHeadlines&TITLE=
http://www.xe.com/ucc/convert.cgi
http://www.metalsinsider.com/WIR/zn260307.html

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Imperial Metals - The Right Hedge

Imperial Metals is a primarily copper mining company with other metal by-products. Like Quadra, in 2006 they hedged their copper, only Imperial hedged the right way, protecting earning and minimizing losses.

The company did have derivative losses from hedging, about $27 million for 2006, relative to production, that's about 1/5th the loss that Quadra had. In one hedge they protected themselves from copper going below $1.80, but participated in price increases to $2.60. Later they had a hedge that had protection from going below $2.90/lb, but price participation up to $3.68/lb, and another hedge had price protection for $2.50/lb and price participation to $3.06/lb. Sure the hedge cost them money, but this is the right way to hedge, keeping 75-80% of the gain. Quadra hedged at $1.60.

The change in their financial position from 2005 to 2006 is stellar, short term assets up $27 million, all assets up $78 million and none of those fiat intangible assets like "Goodwill" listed on their balance sheet. Additionally, their liabilities are down by $21 million for a total change in financial postion of $99 million. Not bad for a company with a fully diluted market cap of $433 million. Earnings per share for 2006 was $2.69, or 22% of today's earlier share price of $12.12.

Imperial currently has two sources of income, their Mount Polley mine which provided net revenue sales of $210 million for 2006 and their equity income from their share in the Huckleberry mine, which provided them with $34 million. Guidance for 2007 is 98 million lbs copper, 58,800 oz gold, 596,000 oz silver, and 210,000 lbs molybdenum. And again they have hedge for 2007, 3/4rd of their copper is hedged to between $2.97 and $3.47/lb.

The company recently purchased bcMetals for $68 million, from cash and a $40 million loan. According to Management Discussion and Analysis:

The Red Chris project has received Federal and Provincial environomental approvals for mine development. A bcMetals feasibility study on the Red Chris property indicates a 25 year mine life at 30,000 tons per day with reserves of 276 million tonnes grading 0.349% copper and 0.266 g/t gold.

Working through the numbers, 276 million tonnes of 0.349% copper is a contained resource of 2.1 billion pounds of copper, which they bought for a take-over price of about 1/3 of a penny per pound, making the gold free. That price is well under the 1c/lb of copper resource guideline of my previous post.

The production rate indicates 84 million pounds of copper/year and 94,000 oz of gold. With recovery rates taken into consideration it would be more in the range of 75 million pounds of copper and 50,000 oz gold (my rough estimate).

Other exploration holding include their Bear property which has molybdenum and copper. The best drill results were 296 meters of 0.059 molybdenum and 0.27% copper. Some pure moly plays for open pit have just 0.06 molybdenum.

Their Sterling property is gold and so far has defined a resource of 46,000 ounces of gold with 7.41 g/t. There are more exploration opportunities on this property.

Their Nak property has rich chalcopyrite veins which grab samples returned grades as high as 5.11% copper and has drill results with 0.1 to 1.1% copper.

Their Giant Copper property, located 220 km east of Vancouver, had a 1989 feasibility study that calculated a reserve of 3.7 million tonnes of 1.08% copper, 0.47 g/t gold, 19.18 g/t silver and 0.01 molybdenum. These results are before NI43-101, so they are not compliant.

Their Porcher Island property is also a gold property with before NI43-101 estimated mining reserve of 623,000 tonnes of 6.9 g/t gold.

By doing the hedge the right way Imperial Metals is in a very, very strong position for 2007 earnings. They will be able to pay off debt and be in a strong financial position to further develop and explore their properties.

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The Leverage of Earnings

"Around 2000 I left my job and cashed out my pension and put it into commodities," was what a colleague was saying. "I had $14,000 and it is now a quarter of a million."

The commodities bull run created an enormous leverage of earnings. Take Northern Orion, a junior start-up company around the beginning of the bull run and now it has $230 million in the bank. The big players have reported billions of dollars of earning.

Eastern Platinum has gone from a junior start-up to a company with a $1.5 billion dollar market cap. Its earnings are a little on the low side for the market right now, but with 700% expansion of mining production over 5 year planned, high grades of platinum resources and demand for platinum as both an industrial metal and a precious metal, they will have good growth in earning..

Roca is a new start-up that if moly prices remain where they are should make in the range of 25-30c/share in either Q3 or Q4 this year.

Blue Note is also building a new mine and should have earnings of 2-4c by Q3 or Q4 this year. Blue Note will perform nicely this year.

Aur Resources has gone from a $2 stock in 2000 to $23 today with 2006 earnings of $3.23 per share, and 60-70% growth in production planned over the next 2 or so years.

To have been there at the beginning of the bull run, at the period when earnings exploded.

There is one stock I've recently looked at that an unfortunate hedge decision reduced its earnings to about 20-25% of what they would have had without the hedge. The company's earnings were 87c/share for 2006, and with only 40 million shares, taking a $144 million dollar loss and still making money is amazing. $144 million is about $3.60/share of cash flow that they didn't have to put to earnings. There is a thing called taxes that they would have to pay on that, so it isn't quite that good, but it is very sweet overall.

The stock is Quadra and this stock is in a position to see a leverage of earnings much like the early bull run days, indeed, 2007 will be Quadra's bull run.

Quadra's hedge which limited them to an average of $1.72/lb of copper for 2006 hit them at both end, earnings and costs. There is a thing called "price participation" where as the price of a commodity increases, smelter companies get a cut of that increasing price. Quadra had hedged at $1.60 and copper went as high as $3.99/lb on the LME. So, not only did Quadra forfeit 60% of the potential income, they had to pay smelter costs as if they were getting $3.99/lb. So Quadra paid the full costs of the bull run, but had none of the benefits. The average LME price for copper for 2006 was $3.05/lb. Quadra didn't get an average of $1.32/lb of "free" money.

Quadra has even more leverage of earning to come. They ran into a few problems with production and produced 117 million pounds of copper. They believe they've worked out those issues, certainly towards the end of Q4 their recovery rates improved considerably, and they've given guidance of $125 million pounds, an small increase of 7%. But, they are in the process of building a second mine which is planned to start producing late 2008 and will add 75 million pounds of production per year, so a two year growth in production rate of 67%. There are a couple downsides, increased debt to pay for building the new mine, but that is highly preferable over dilution that would limit earning potential forever.

2007 is going to be Quadra's year for stellar performance.

QUA Toronto, QADMF.PK in the US.

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Blue Note (BN on Venture)

Blue Note is a little known near term producer. It is building a new mill to commence operations in June and will start mining the ore for the mill in April. The metals are zinc, lead, copper and silver.

Blue Note will be a commodity winner due to their choice to develop their mine and cash in on the commodity prices rather than to drill, and drill, and drill their property. An educated look at the property told them they have these metals at depth. An existing mine in the area has been mining for over 20 years and has mined to incredible depth. The geology of the area is similar.


A difference between Canadian and Australian philosophy in mining is that Canadian companies and investors have become more concerned with showing the resource is there rather than making money. Australian companies look at this policy of premature drilling when you have good reason to believed the resource is there as wasteful of capital. Spend $10 million today to establish a resource you won't use for another 20 years means you have spent $10 million that will gain no return for 20 years. Their mines work on a philosophy of having about 5 years of reserves always established. It maximizes the use of capital.

Blue Note has followed this type of philosophy in choosing to put the resource to work by building a mine and earning money sooner rather than later and also tying up capital to establish a reserve that won't be used for 20 years.

Their forecasted 2007 cash flow numbers look very good. At prices of $1.44 for zinc, $0.52 for lead, $2.80 for copper, and $12.50 for silver they expect $15.3 million cash flow. They also expect costs net of byproduct credits to be $0.76. Currently the price on lead means this cash flow estimate is low by about $10-$12 million. They are most price sensitive to zinc, then lead, then silver. Copper has little influence on their cash flow as it will only contribute perhaps 2% of the total.

The number get impressive for 2008. They have adjusted their prices way down, $1.17 for Zinc, $0.44 for lead, $2.29 for copper, and $11.65 for silver. The costs also decline, to $0.55 net of by product credit, and it gives them about $58 million in pre-tax cash flow. After taxes I calculate 2008 eps of about $0.14, exceptionally impressive for stock currently trading at $0.47-$0.48, and those earnings strongly take into consideration the price of commodities coming down. The IRR on the mine is 126.3%.

As a near term producer, Blue Note is one that will win big time for its investors.

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