TGR: One of your recent research flashes reported on the Mexican government's consideration of imposing a royalty on Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) on companies that mine commodities in Mexico. Tell us about that.
DM: Whenever that topic comes up, it puts pressure on Mexican producers and developers. We are seeing the potential of a royalty getting priced in to those companies, and priced in as a worst case scenario.
Initial discussions centered on a 5% EBITDA royalty, which could affect company valuations significantly. However, Mexican mining companies are working with the government to find a more reasonable solution. If the proposal gets ratcheted down to a 2.5% EBITDA royalty or perhaps a 2% net smelter return, then company valuations could recover.
In Mexico, you want to look for companies that have low all-in cash costs. They will be somewhat insulated from the royalty because their margins won't be as compressed as higher cost operations.
For example, we like Timmins Gold Corp. (TMM:TSX; TGD:NYSE.MKT), which sold off on the royalty news. We think the selloff was unjustified, because the company has generally low all-in cash costs and higher margins than many of its peers.
TGR: Timmins is expected to announce that the mine life at San Francisco could be extended 10 years. Would that attract a buyer?
DM: It could, but I don't think Timmins is in the sweet spot for acquisition. The company is too small for a big company to acquire and too big for some of the midtier companies.
Once Timmins' resource report comes out, the stock should move up as investor confidence improves. There has always been concern about Timmins' long-term grade profile and the mine life at San Francisco. The pending resource update will answer those questions.
TGR: Your share target on Timmins is $3.20, correct?
DM: Yes, and we have a buy rating on Timmins. Considering its cash cost profile, Timmins is trading below three times 2014 EBITDA. If you look at the company's low cash cost peers in Mexico, similar open-pit, heap-leach operations trade at six to eight times EBITDA. I think the resource update will improve investor confidence and we could see an upward rerating.
http://www.theaureport.com/pub/na/three-essentials-to-look-for-in-junior-mining-equities-derek-macpherson
