The Mangazeisky Silver Project
Silver Bear Resources (Ticker: SBR - Toronto) is a Canadian based company focused on the acquisition, exploration, evaluation and development of silver properties in Russia. The name fits the company well.
The company’s only project is the Mangazeisky Silver Project, located approximately 250 miles (400km) north of Yakutsk in the Russian Republic of Sakha (Siberia). Yakutsk has a population of about 300,000 and is the coldest city in the world.
In September 2013, Silver Bear was granted a 20-year mining license for the Vertikalny Deposit, which is the core resource of the broader Mangazeisky Project. A couple of months ago the company received a license extension from the Russian State Subsoil Agency (“Rosnedra”) to continue exploring the broader Mangazeisky Project region for another 7 years.
Silver Bear has committed to a 7-year mine plan to develop the Vertikalny Deposit. The company is well into the construction phase and the mine is set to be commissioned this quarter with full production starting during the 1st quarter of 2017. For the first 4 years, the company will conduct an open pit operation, followed by an underground operation over the last 3 years.
Before we dig into the resource details, allow me to provide some information for the benefit of readers who are less familiar with mining. Mines have Resource estimates. Resources are simply the estimated amounts of metal in a specific piece of ground. More importantly, we want to focus on Reserve estimates. Reserves—categorized as Proven & Probable with Proven having a higher confidence level—are the economically recoverable portion of the Resource at given costs and metals prices. In the case of the Vertikanly Deposit, the Reserves assume a silver price of $19 per oz and overall recoveries of 88%. Significantly lower silver prices can reduce Reserves. Investors have to pay attention to this when examining developers.
The Vertikalny Deposit will be the highest grade silver mine in the world. The open pit portion holds probable silver reserves of 14.1 million ounces grading at 1,209 grams per ton (g/t). There are precious few silver mines in the world with grades half this rich. The underground portion of the mine holds 8.4 million ounces grading at 569 g/t. Overall, we have a 22.5 million ounce deposit grading 852 g/t. The broader Mangazeisky Project contains an indicated resource of 33.8 million ounces of silver grading 1,046 g/t and an inferred resource of 21.8 million ounces grading 477 g/t.
To get a better idea of how rich this deposit is, consider that a 2017 Ford Super Duty pickup truck can haul 3.8 tons of material. This means that an average open pit scoop of Vertikalny soil loaded into a Super Duty would contain 162 ounces of silver worth almost $3,000 at current prices. If you use a Caterpillar 785C, then each 150 ton payload holds about $115,000 worth of silver.
The 7-year plan to mine Vertikalny includes the removal of only 822,000 tons of ground. This is only 326 tons per day (assuming a 360 day work week). That is 100 trips per day in the Ford or only 2 trips per day in the CAT.
What we have here is simply a super high grade mine with the primary obstacles being logistics and weather. Most importantly, the economics are very favorable which provides a cushion against any unexpected setbacks. At $20 silver the project boasts an after-tax internal rate of return of 82% (assuming Far East Tax incentives) with cash costs of $7.5 per oz. and capital costs of $3.5 per oz. (total costs = $11 per oz.).
If we did not have the obstacles of logistics and weather, then Vertikalny would have been extracted by now. Investors need to understand that the Russian Far East is sort of a final frontier of high grade gold & silver mining. The Soviets mined some projects here and there and companies like Kinross Gold, Polymetal, and Polyus Gold have been operating successfully in the region for years, but, in general, it is just beginning to open up to a greater focus on resource development. Especially considering its massive expanse, the Russian Far East is one of the few places left to find very high grade deposits.
The Russian government is very supportive of development in the Far East and has introduced significant tax incentives. For example, the income tax rate will be 0% for the first 5 years of the project and the mineral extraction tax (MET) will be 0% for the first 2 years, 1.2% for the 3rd and 4th years, 2.4% for the 5th & 6th years, and 3.6% for the 7th year.
Longer Term Potential
What I especially like about Silver Bear is that if it can truly establish a beachhead in the Mangzeisky region, there is plenty of rich exploration potential for ongoing development and expansion. The map above shows numerous silver deposits in the surrounding region. Over time, the accumulated operational experience and infrastructure development will further enhance the ability of the company to manuever successfully.
A good question to ask is, “Have any other companies operated successfully in this region?” Yes. Kinross’s Dvoinoye and Kupol gold mines are not too far from Mangzeisky. Kupol is the leading gold mine in Russia and has the lowest operating cost of any mine in the Kinross portfolio. Its 2015 cost of sales were only $474 per ounce. Kupol is now a processing hub for both Dvoinoye and Kupol and will soon accommodate additional production in the vicinity when the nearby Moroshka project begins producing in 2018.
Kinross’s success establishing a gold production hub in the region is sort of a blueprint for the potential Silver Bear could have with mining silver in Russia. It is noteworthy that the Vertikalny mine has a very high internal rate of return. This will provide the company with strong cash flow to invest in continued expansion of the Mangzeisky project.
When mining companies have feasibility studies completed and make economic assessments they typically do so with static variables based upon recent market prices. This is fine and to be expected, however, as a full-time investment manager with a broader focus, I like to combine multiple forecasts to squeeze out some additional insight on costs and margins. This is especially important with Silver Bear. Here we have a company whose costs are in Russian rubles, whose stock trades in Canadian dollars, and whose revenue is based upon the price of silver sold in U.S. dollars. The future price of oil is an important variable, because it will impact the ruble. One Canadian dollar is currently worth 46.5 Russian rubles. The following chart shows the theoretical impact of a higher ruble on the operating costs per ounce of the Vertikalny mine over its 7-year production life.
This is the general trend I am expecting, which is based on my assumption of rising oil prices over the life of the mine. If there is not a commensurate rise in the price of silver, then Silver Bear’s margins will take a hit. We should keep this in mind, but for now, it does not impact my near term valuation assessment of the company. Let us take a look at that now.
Barring some unforeseen setback, Vertikalny is going to start full production during the 1st quarter of 2017, which will be here before we know it. The plan calls for 110,000 tons of material to be mined each year. For the first 4 years—the open pit phase—the expected grade is 875 g/t with 84.4% recovery. This works out to 2,865,432 ounces of silver production.
Overlaying my silver price forecast, which calls for an average silver price of $17.5 in 2017, we get roughly CA$70 million in revenue (CA$ = Canadian dollar). This assumes a USD/CAD exchange rate of 1.4, which incorporates my expectations for ongoing U.S. dollar strength.
The mine plan estimates ruble costs at 528 per ounce of production, which translated at an exchange rate of 45 CAD/RUB comes out to CA$33.6 or $8.4 per ounce. I expect the ruble to strengthen a tad against the Canadian dollar on slightly higher oil prices. After incorporating my currency views, my cash cost projections are higher than those of Silver Bear’s preliminary economic plan. Also, I estimate depreciation expense of about $6.8 million for 2017.
Silver Bear took on about CA$70 million in long-term debt for this first phase of Mangazeisky development. The good news is they are borrowing from the 2 largest shareholders and most of the interest payments do not begin to hit until 2018. I estimate 2017 interest rate expense at roughly CA$2.63 million. This will jump to about CA$10 million in 2018, however, with the robust cash flow of the operation, the company should be able to quickly retire debt.
Assuming a 10% effective tax rate, which is probably too high given the Far East tax incentives, net income comes out to CA$24.4. If we add back the depreciation, subtract CA$1.5 million for sustaining capital expenditures (CAPEX), and subtract CA$3 million for expansionary CAPEX, we have CA$26.7 in free cash flow (FCF) at a FCF margin of 38.1%. This works out to be total costs of $10.8 per ounce and FCF per ounce of $6.7, given an average silver price of $17.5. So for every $17.5 ounce of silver the company digs up, shareholders theoretically net $6.7 of it on a cash basis.
These results would leave Silver Bear with a debt to EBITDA ratio of 1.9 which is solid. My guess would be that the first mission for the CA$26.7 million of FCF would be to pay down some debt. Longer term, I expect a good dividend. The Russian equity culture is synonymous with high dividends.
Silver Bear currently has 171.2 million shares outstanding. The company has the financial resources to get Vertikalny producing so there should not be a need to raise additional capital. My projections call for Silver Bear to bring in CA$.16 of FCF per share in 2017. The stock is currently trading for CA$.38 per share—only 2.4 times my projected FCF for next year. [Please see author updating comment below posted on November 1, 2016.]
The market is clearly discounting this stock because the company operates in Russia. As with any junior miner, and more so in Siberia, there are many potential operational risks with the Mangazeisky project. Aside from these though, I see two key positives for the Silver Bear case.
First, the tax advantages of operating in the Russian Far East are significant. Many junior silver miners operate in Mexico where the tax rate is 30%+ and trending higher. Money talks and these tax incentives demonstrate that resource development in the Russian Far East has the backing of the government.
Second, the two major shareholders, Aterra Capital and Inflection Management, both have representatives on the board, are providing the company with stable financial backing, and are seasoned, Russian-focused mining investment companies. They have every reason to see Silver Bear succeed.
I am bullish on both silver and Russia over the long term. I think Silver Bear is a unique opportunity, given the exceptional economics of the Vertikalny mine plan, the rock bottom valuation, and the longer term opportunity in the Russian Far East. It will be interesting to see how this stock performs over the next six months as the company becomes a producer.
Joshua S. Hall, ChFC
I do not personally own shares of Silver Bear Resources, however, it is currently a holding in some client portfolios that I manage through which most of my salary is derived.
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