Donner Metals: De-Risked Projectable Cash Flow

by James West on October 18, 2011

http://www.midasletter.com/index.php/donner-metals-de-risked-projectable-cash-flow/

Exploration is a risky game and exploration companies are discounted heavily to reflect that risk.

Gold-in-the-ground, for instance, is valued at about $20 per oz (inferred), $30 per oz (measured and indicated), and $160 per oz (proven and probable).

After a mine is built and commercial production starts, metal companies are valued more like conventional manufacturers: cash costs, units sold, price per unit, debt, projectable revenues etc.

It’s as though the market won’t believe in the product until it rolls off the assembly line.

Occasionally there is a window of opportunity for investors when a company is about to become a producer – but is still being valued as an explorer.

Donner Metals (TSX.V:DON) appears to be one such company.

Donner is a Canadian company partnered with Xstrata (XTA.L) in the Matagami Mining Camp district in Quebec. Since 1963, the area has produced 8.6 billion pounds of zinc and 853 million pounds of copper.

The company is currently trading at .21 – close to the 52-week low – with a market cap of $26 million.
The Bracemac-McLeod combined open-pit mine is destined to replace Xstrata’s Perseverance zinc mine, which is closing in 2012.

The new mine will feed Xstrata’s 2,600-tonne-per-day Matagami mill complex, which has already been built at a cost of hundreds of millions of dollars.

Bracemac-McLeod is a Volcanogenic Massive Sulfide (VMS) deposit forged in the earth millions of years ago by a rare hydrothermal event. It contains rich veins of copper (39,000 tonnes) silver (46,000 kgs) and gold (445 kgs), adding about another $300 million in value.

VMS deposits offer investors a mine-specific metal diversification strategy, which sees amplified gains on a small shift in metal prices.

Based on the 2010 feasibility study completed by Xstrata the supply of ore is projected to last 4 years. With 43-101 compliant proven & probable reserves of 606 million pounds zinc, 83 million pounds copper, 1,497,000 ounces silver and 13,090 ounces gold.

This extends mine life 2-3 years confidently.

Donner continues a drill program and results from the drill program are consistent with grades comprising the resources and reserve calculations in the feasibility study.

Valuation
The feasibility study on Bracemac Macleod estimates $41 million in pre production capital required by Donner. Through a metal purchase agreement with Sandstorm and the exercising of warrants and stock options Donner has been able to raise $31 of the $41 Million required for capital expenditures.

Donner needs to complete its additional fundraising by March/April 2012, based on our understanding of Donner’s fundamentals and the cyclical nature of the junior mining stocks we feel it is likely they will complete their financing at .35 cents, which gives Donner a pre production fully diluted share structure of just under 200 million shares.

Donner’s financing can occur at a premium to the market as they are able to raise funds as flow through shares with Quebec based institutions who are current shareholders of the company.

The September 2010 feasibility study completed by Xstrata estimates production at 2500 tonnes per day. Using conservative zinc prices of .80 cents per pound and projected operating costs of $73 per tonne. We estimate Donner will receive approximately $32 Million in cash flow per year from their share of Bracemac Mcleod.

Employing a conservative estimate of $6 million for G&A, this puts cash flow attributable to Donner at approximately $26 million per year or $.13 per fully diluted share.

Zinc and Base metal producers generally trade at a conservative 5x Cash flow per share multiple for a 4-5 year life of mine. This points to a significant discrepancy to the current valuation of Donner.

Summary
The market is still valuing Donner as an explorer, but the big obstacles to production have already been removed.
This disconnect creates an interesting investment opportunity.

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Midas Letter is the Journal of Investment Strategy of the Midas Letter Opportunity Fund, a Luxembourg-based Special Investment Fund that specializes in Canadian-listed emerging companies in the resource sector with a focus on precious metals explorers and miners. James West is the Portfolio and Investment Advisor to the fund.

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