The Golden Side of Guanajuato Silver (GSVRF): Cash Flow

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Guanajuato Silver (OTCMKTS: GSVRF, TSXV: GSVR) is a junior silver mining company with operations in Guanajuato, Mexico.  It just completed a CA$9.52 million non-brokered private placement at CA$0.55 with above-the-market priced warrants at CA$0.75. This is likely to be their last tranche of money raised at low valuation levels.  The funding is being used to ramp up operations at the company’s mining and processing site at El Cubo, which is close to Guanajuato.  The company is focused on obtaining positive cash flow which is a feat that very few if any junior miners can obtain. They took a discarded asset from Endeavour Silver Corp. (NYSE: EXK) and are making it profitable very quickly, a win for Guanajuato Silver shareholders including their largest shareholder, Endeavor Silver.  When considering this as an investment there are the reserves and the operating cash flow from the mine.  When considering both, the company is extremely undervalued with its $87 million market cap.

Junior Miners Catch 22

Many junior miners start with claims and then they need to raise money to prove out those claims and define the ore body. Once they have a drilling program in place they need to move to the prefeasibility studies to justify putting a mine on the property. This is where the joint partner comes into play and creates another layer of dilution for shareholders but if they don’t find a partner then they are dead in the water unless they raise money through dilution of their own stock to get enough money to move forward with a bank feasibility study, These studies detail the engineering required to maximize production and minimize the cost of mineral extraction.  After the bank feasibility study, junior miners are traditionally gobbled by the majors that can execute on the mine plan. This plan worked out wonderfully for a junior miner like Great Bear Resources (OTCMKTS: GTBAF) which was recently bought for well over a billion dollars by Kinross Gold Corp (NYSE: KGC). The catch 22 is that investors know that these junior miners are going to have to dilute and only invest on favorable terms to the new investors which is all too often a bad deal for existing investors.  If only the junior miner could become operational first and produce revenue, then they would have leverage to raise funds on a less dilutive basis and at a better valuation—but they can’t start mining unless they have money for the project.

The Backstory Behind El Cubo

Very few junior miners find themselves in a position of making money.  Guanajuato, however, got their mine from Endeavor on the cheap.  The purchase was funded with equity capital.  About 10 months ago a medium-sized funding allowed the company to raise enough money to get the El Cubo mine back into production.  Before the handoff, Endeavor was mining with huge drum cutters that are capable of mining a vein.  The only issue was that the vein was of high grade but eventually became narrow so when running the larger equipment it actually lowered the grade of the overall ore to the point where it wasn’t profitable.  Guanajuato Silver came in with narrower drum cutters that stayed within the constraints of the high-grade part of the vein, enabling the recovery of high-grade ore. What is so unique about this opportunity is that much of the machines and equipment needed to concentrate the metal were onsite and included as part of the purchase.  This infrastructure got them in a position to sell the gold concentrate very quickly—within a year of securing the assets.  The current vein that they are mining isn’t large enough to keep the processing plant at capacity.  In order to optimize the mine, they need additional ore from the surrounding area, and as of now, that ore is going to be supplied from the company’s other mine.  They are working on finding more ore in the surrounding region to process. This will allow them to optimize their production while taking on ore from other nearby companies.  The story really has some legs but the icing on the cake lies in their workforce.  The nearest town is Guanajuato City and it has a rich mining heritage with decades of generational experience.  Guanajuato Silver epitomizes the idea of “one man’s trash is another man’s treasure.”

The Equity Raise

The recent raise was expanded from the initial CA$8.19 million to over CA$9 million and was completed with the support of long time shareholders including its large shareholders Endeavour Silver Corp. (NYSE: EXK), Myrmikan Capital LLC., and VBS Exchange PTY Ltd. Endeavor is a $750 million mining company that increased its stake in Guanajuato Silver from about 10.5% to about 12.5% in this latest transaction. Guanajuato originally purchased El Cubo from Endeavor for $15 million and then put about $5 million in the site to bring it up to working condition. Endeavor helped in the financing of their purchase by lending. This expansion of holdings by Endeavor validates the stock as Endeavor would not want even more equity unless they believed there was upside to the stock. The site was originally purchased by Endeavor for $250 million ($200 million upfront). The fact that Guanajuato got this facility up and running for approximately $20 million should be the first clue to investors that the company, with a market capitalization of $87 million USD, is undervalued. El Cubo, for Endeavor, however, became a capacity-constrained project for a company of Endeavor’s size and was best fit for a smaller company to manage.  In the coming year, they plan to add ventilation and electrical capacity. They are also only working with one ball mill, second going online soon and third to follow.  They also plan more development work for accessing higher grades of the mine.

Revenue-Producing Junior Miner

Guanajuato is one of few junior miners that has a low risk profile while maintaining significant upside, but not running on hopes and dreams of “striking gold” via drilling holes for exploration. Guanajuato actually produces products, as of a few weeks ago. Decades ago, the junior mining businesses used to be small companies with active mines. Now, due to larger companies needing to replenish their reserves and the capital expenditures and large-scale operations required to run a mine profitably, many junior miners are just drilling holes in an attempt to prove resources and then sell their mine to the highest bidder. So a business like this is hard to come by nowadays. The company has competent management and its employees, besides the few at the Vancouver headquarters office, are Mexican nationals with extensive mining know-how. The Mexican miner therefore benefits from local support which translates to jurisdictional/political support for the company as it isn’t viewed as a foreign-run company. Furthermore, as opposed to many natural resources companies’ sites, Guanajuato’s mine is about a 30 minute commute from the beautiful city of Guanajuato, which is a common vacation spot. This way, the company can attract the best Mexican talent in mining as the workers can easily manage a day job and have time with their families at home, a stark contrast from something like an oil rig at sea. The amount of experience management and its employees immediately bring to the table has enabled the company to start up production—mining and processing—of gold and silver on time and within budget. This is incredibly uncommon to see. Anyone familiar with public venture companies like other junior miners, biotech companies, or companies starting up a new production facility, knows that these projects hardly ever stay on schedule. All-in-all, this means that instead of a Hail Mary attempt at hoping to prove some massive amount of resources and then selling to the highest bidder before it is found out that the company doesn’t know how to operate a mine efficiently by itself, Guanajuato is simply proving itself as an old-school, revenue producing junior miner. In this way, it can almost be compared to the largest silver and gold miners like Industrias Penoles SAB de CV (OTCMKTS: IPOAF), Polymetal International PLC (OTCMKTS: AUCOY), Fresnillo PLC (OTCMKTS: FNLPF), Pan American Silver Corp. (NASDAQ: PAAS), Wheaton Precious Metals Corp. (NYSE: WPM), Coeur Mining Inc. (NYSE: CDE), Buenaventura Mining Co. Inc. (NYSE: BVN), Hecla Mining Co. (NYSE: HL), First Majestic Silver Corp. (NYSE: AG), and Fortuna Silver Mines Inc. (NYSE: FSM), as opposed to any of the many junior miners, though it will be significantly smaller than these businesses.

The El Cubo Site

Guanajuato Silver is named after the state and city in central Mexico. The beautiful city has a population of just 200,000 and a long history of silver and gold mining dating back 480 years, just 60 years after Columbus came to the Americas and the Spanish found high-grade gold. By the 1700’s Guanajuato was the source of about 40% of the world’s gold. And just over 10km from the city is El Cubo. Mining Magazine: El Cubo The El Cubo mine and processing facility that Guanajuato bought from Endeavor was actually closed by Endeavor; the company indicated that it had exhausted its resources. But that is actually a bit of a misnomer. Endeavor wanted to mine for volume and fully supply its processing equipment (50,000tons/day), and in doing so they modeled their gold vein for volume. But the high-grade gold came in at a much thinner width so they stopped mining. But Guanajuato is running a somewhat smaller operation and is only mining the higher grade gold, which enables the mine to be profitable again. They are mining for profitability, not volume. And this is “worth it” for a smaller company like Guanajuato. Guanajuato City So, in 2019, Guanajuato Silver got the opportunity to purchase the mining complex from Endeavor, and Endeavor moved on from their little mine to a larger complex. Guanajuato Silver raised $17 million to pay for the asset. Guanajuato Silver also has another mine called El Pingüico which is close to El Cubo. This complex doesn’t have the equipment to process bulk material so the idea is to transport it to El Cubo and use the excess capacity to process the material. El Pingüico and El Cubo both have a low amount of proven resources (~20Moz AgEq), but fairly decent exploration potential based on known geology and drill intercepts done in the past: El Pingüico Resource Expansion So the company can likely do ongoing exploration to aid in the production continuation of silver and gold from its mine beyond the inferred resources of ~20Moz AgEq.

On Time and On Budget

Guanajuato Silver has run an impressive operation getting their facilities fixed up and operating. In such a short time, they have refurbished the equipment and facilities (May 2020), started mining (September 2021), and started processing (October 2021), culminating in their first sales of metal concentrate (October 2020). Now it’s all about ramping up operations and revenues, and a few additional but noncritical refurbishments. In an industry that typically measures success in years or even decades, Guanajuato has executed within months.

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 Comparing Valuations

Since Guanajuato runs a tight operation and prudently spends capital, spending $20 million to get a projected annual 1.8Moz AgEq operation running, it is more than fair to estimate the stock price as if Guanajuato is a smaller version of a mature silver mining company—using comparables.        

Ticker TTM P/S Ratio TTM EV/S TTM EV/EBITDA Market Capitalization (USD million)
IPOAF 0.76 1.18 3.71 $4,610
AUCOY 2.66 3.27 5.68 $8,030
FNLPF 3.03 3.10 5.74 $8,602
PAAS 3.09 2.97 7.77 $5,110
WPM 15.27 14.99 20.80 $18,490
CDE 1.42 1.94 6.23 $1,270
BVN 2.00 3.19 18.94 $1,810
HL 3.30 3.73 11.00 $2,690
AG 5.17 5.60 20.93 $2,770
FSM 1.58 2.13 4.67 $942
Average 3.83 4.21 10.55 $5,432
  P/S Pro Forma EV/S Pro Forma EV/EBITDA Pro Forma Anticipated Market Capitalization
GSVRF 3.83 4.21 10.55 $156

  Some of the companies listed, such as WPM, aren’t the best comparators for GSVRF since they are metals streaming companies that contract to buy metals at a predetermined price from miners and then make money by selling that metal back into the market. Nonetheless, the average of these companies represents a reasonable estimate for future revenue and earnings comparison. At 1.8Moz AgEq/year and $22.65/oz Ag, GSVRF would be making $40.7 million USD in revenue. Using a P/S ratio of 3.83, GSVRF should, when it reaches this capacity soon, have a market cap of $155 million USD, or since GSVRF has 224 million shares outstanding, a share price of $0.70, ~77% above current levels. Using an estimated annual EBITDA of $10.5 million USD, one arrives at $0.50, or 25% above current levels. These fairly conservative numbers don’t take into account potential upside from further M&A in the Guanajuato region, as well as proving out more resources or improving earnings with cost-cutting measures. After all, the company has already proven it can effectively deploy capital.

Metals Traders Buying

Speaking of metals streaming companies, one of the key investors in Guanajuato is a metals trading/supplier company in the UK called Ocean Partners. Typically these companies don’t participate at all in investor-related activities like equity raises or lending, but the company was so impressed with Guanajuato and their business plan that they gained about CA$2 million in exposure to the company: 1 million stock units at CA$0.55 and a CA$1.5 million loan. Not only are metals trading companies as well as larger precious metals mining companies investing in Guanajuato; so are also veteran, notable, successful precious metals mining investors invested with Guanajuato.

Investment Summary

When buying a junior miner stock, it just makes sense to buy the best in the breed.  The existing cash flow lowers the likelihood of future dilution.  New exploration areas are very promising and fit the profile of their existing grade of ore being processed, which means no tooling to accept the new ore will be required.  The key highlights boil down to 1) mining corporations, metals traders, and key mining investors have long exposure to the company, 2) revenues are ramping, and 3) the company is undervalued relative to its peers based on the revenues its stock is set to reach profitability and justify valuations around 50% higher than current prices.

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