Research
Report: ECU Silver Mining Inc. - written by
Mike Kachanovsky
Tuesday, April 26,
2005.
I recently traveled to the city of Torreon, Mexico to
visit the office and operations of ECU Silver Inc. The company controls excellent properties in a prolific
mining district and operates a recovery mill, but a series of issues have
limited the investment performance during the last few years. I believe the management has done and exceptional job to
resolve these issues, and that the company is now on the verge of delivering
growth and earnings that will result in much higher share values for investors
in the years ahead. Although the
company funded my travel expenses to review the mine workings and recovery
plant, I have not accepted any compensation for my work to produce my report. I
do own shares and warrants of ECU that I subscribed for in the last private
placement offering, and may purchase more shares in the market in the future.
– Mike Kachanovsky
Office Address:
559 Boul. Temiscamingue, Rouyn-Noranda, Quebec, J9X 7C8
Telephone:
(819) 797-1210
Fax:
(819) 797-1214
Corporate Office:
J.I. Jimenez #663, Colonia Los Angeles, Torreon, Coahuila, Mexico
Telephone:
011-52-871-717-8633
Website:
www.ecu.ca
Exchange listing
symbol (TSX-V): ECU
Share structure:
Issued:
152,745,250
Fully
diluted:
192,745,250
Market
capitalization:
$39.7 Million
ECU Silver Mining is
a Canadian company engaged in the production of precious and base metals in
Mexico, that appears to be on the verge of turning the corner from a checkered
past towards achieving a bright future. Its
history reads like a work of fiction, filled with setbacks and disappointments,
lawsuits, triumph and tragedy. However the company was able to surmount all of the various
hurdles in its path and has now reached the respectable stage of stable
production and positive earnings from operations. Mining is a difficult business under the best of
circumstances. Only a tiny minority
of junior mining companies ever advance to level that ECU has achieved, and the
future prospects look very good. The
company has managed to carve out a niche for itself, working a prolific vein
system of the Velardena mining district in the state of Durango. While the ore from these veins is very high grade, it is
deposited in such narrow intervals that the larger producing mining companies in
Mexico would have no interest in it, based on marginal economics.
However, ECU Silver has managed to not only prove they can mine the
system efficiently, they have thrived and are now advancing exploration to the
point that a much larger system with robust economics may be awaiting
development on their property.
When attempting to
accomplish any complex and challenging endeavour, it is determination and
perseverance that are probably the most important characteristics that define
those that are successful. The
current management team at ECU, President Michel Roy (accepted the position in
1999) and Executive Vice-president Richard Hamelin (since 2004), have certainly
endured their share of challenges since they assumed leadership of the company.
They have negotiated a mutually agreeable settlement in a lawsuit
regarding ownership of their flagship property, raised the necessary capital
through equity offerings to keep the company solvent, and then patiently
implemented a development strategy to generate a revenue base necessary to allow
for growth. Michel Roy has been
active in the mining industry for thirty years, serving at the senior management
level with several mining companies, and as an independent consultant.
Richard Hamelin achieved distinction in the brokerage industry before his
tenure with ECU. While these
gentlemen have progressed competently and quietly in their careers prior to
joining the company, both men are to be congratulated for their success in
turning around the fortunes for ECU Silver, and based on their accomplishments
to date, they can be considered brilliant project managers.
They recently hired Pierre Gagnon to serve as their project engineer, and
his knowledge acquired through decades of experience in operating mines will
assist the company to advance the underground development necessary to continue
growing production.
The principal asset
owned by the company is a 4.65 square kilometer property hosting a cluster of 7
mines in the Velardena district of Mexico.
Two of these mines are currently in production:
the Santa Juana and the San Mateo, working epithermal systems bearing
gold, silver, lead, zinc, and copper. While
the property itself has been in production at various intervals for over 450
years, the geologists working with ECU have recently compiled a database of the
entire structural trend across the region to better understand the nature of the
mineralization of the vein systems. The
geological model for the property suggests that the ore bodies are within an
extension of the same geology as the Santa Maria Mine operated by Grupo Mexico
about 5 kilometers away across a valley, where it is estimated that over 5
million tons of ore was extracted before that mine was closed.
The Santa Juana Mine is positioned at a slightly higher elevation, and
while past production occurred in mostly narrow, higher grade veins, they are
now beginning to develop deeper levels. The
18th level recently opened at Santa Juana has encountered carbonate
replacement mineralization that compares very closely to the ore of the Santa
Maria Mine at the same depths. If
indeed the same geological process led to the formation of both deposits, then
the potential exists that several million tons of ore remain to be extracted
from the ECU property.
The ore from Santa
Juana Mine presents some difficulties arising from high arsenic levels that are
in the areas bearing the richest grades of gold, silver and base metals.
This has the effect of lowering the value of the gold pyrite concentrate
that is produced. The arsenic
levels are lower in ore that is produced at the deeper levels however and will
have a reduced impact in future operations.
The system remains open laterally and at depth, and more exploration work
is necessary to confirm additional resources.
Fifteen other veins in this system have been identified, some traced to
surface, and it is hoped they will contain similar mineral grades in the range
of 300 g/t silver and 6-10 g/t gold that has been achieved to date.
Further to the south
lies the San Mateo Mine where limited development has been completed.
The ore from this mine contains no arsenic so it will become an important
source of future production. Higher
grade silver values have been encountered up to 2,000 g/t from the workings of
this mine, illustrating the attractiveness of this future exploration target.
Some work has also
been completed at the nearby Terneras Mine, and the San Juanes Mine.
Exploration activity has been limited however in an effort to preserve
working capital, since they have enough ore available from the current workings
to supply several years of production.
It should be noted
that 8,900 meters of surface drilling has been completed at the Santa Juana
Mine, and only 2,000 meters for all of the other mines combined.
The geologists in charge of the development program are very confident
that significant new resources remain to be discovered at these mines.
There have also been other surface showings identified on the property
through sampling and mapping that have not seen any exploration activity, and
some shallow historic workings that have been discovered are also prime targets
for future exploration.
The company also
controls the San Diego property, located approximately 10 kilometers to the
northeast. This property has an
estimated historic resource of 1.4 million tons of near-surface silver-lead-zinc
mineralization, with lower grade gold values, but it too has seen almost no
exploration activity from ECU to date.
Of the mines that are
currently in production, several miles of underground drifting has been
completed. The host rock formation
is consistent and stable, with limited potential for rock falls and requiring
only a minimum of bracing. Flooding
from water seepage at the lower levels is not an issue and in fact the lack of
ground water represents a challenge at the processing plant, where access to
water is critical to keep the concentrators operating.
The property is well serviced with road and rail infrastructure in place,
and is connected to the hydro grid with abundant access to reasonably priced
power.
A low tech approach
has served as the most efficient method for operations.
Well trained local mining crews with years of experience working in the
district advance the various levels of mine, with three shifts operating around
the clock. The mostly older
equipment at the mine is maintained in excellent working condition.
The company rents a
fleet of trucks that transports the ore approximately five kilometers down the
valley to the mill and recovery plant. The
ore is then dumped into a hopper and directed into a jaw crusher, before
processing in a ball mill for fine grinding. This is then mixed with water and chemical reagents to form
slurry that is processed through one of four operating flotation cell banks (2
for lead and 2 for zinc). Oxygen is
pumped into the cells and the concentrate is floated off and recovered.
All of the equipment at the plant was operable and in excellent
condition. Allowing for periodic
maintenance and downtime, it is estimated that the plant will run 27 days per
month.
Another low tech
process utilized by the company is the use of a pit to dry the concentrate
material, instead of a power drying unit. The
concentrate is dumped in the pit and then manually spread to a thickness of
eight inches, allowing the sunlight and dry air to do the work.
While this approach is cost effective, in the winter months when the
sunlight is less intense, it reduces the output of the plant.
There are plans in place to install a modern drying unit as the
production capacity increases, to streamline the operation and ensure consistent
residual moisture levels in the concentrate.
This upgrade will be financed through internally generated cash flow.
The concentrate is
then shipped to a smelter operated by Industries Penoles.
The revenues paid for the concentrate vary with the grades and purity
that is shipped. In recent months
ECU has realized increasing revenues for their product due to improved
efficiency of the flotation process.
Working narrow width
veins that are periodically offset by faulting is a challenging set of
circumstances for an underground mining operation. The company relies on experienced engineers and geologists to
interpret the path of the vein system and direct the drifting to intercept the
ore zones. Specialized equipment is
employed to ensure minimum dilution from the excavation of waste rock, allowing
for stopes only one meter in width.
There are only three
ways for a mining company to improve their bottom line.
They can increase production, they can lower their cost base, or they can
benefit from receiving higher prices for their product.
Management identified targets in each of these areas that had to be
addressed and then set about to achieve their objectives.
The engineers and
geologists working at the mines tour the workings several times a week to ensure
that development is directed to intercept the ore zones efficiently.
New levels have been developed at the mine to allow multiple access
points across several veins. This will provide the ability to sustain increased
production as the capacity at the milling operations improves.
It is estimated that the operation is able to extract ore for the
exceptionally low cost average of $17 per ton.
Management has
directly contributed to lower administration costs by moving their offices to a
lower cost building in a residential district of the city of Torreon, and by
opting to engage in daily business activity without the services of a support
staff. This willingness to take on
the additional workload has resulted in a lower cash burn rate while the company
made the transition to profitable operations.
At the recovery plant
facilities, efforts have been directed towards increasing capacity.
A thorough overhaul of critical machinery was completed, including
refurbishing the flotation cells and replacing the liners in the 200 tpd ball
mill. A new electric transformer
has been installed to support new machinery, and this power supply has allowed
for the operation of a fifth bank of flotation cells, and the smaller 70 tpd
ball mill. The immediate effect of
these improvements is that the capacity of the facility has now increased to
over 250 tpd. Additional flotation
tank capacity allows a longer retention time for the slurry from the mill, thus
increasing the percentage of metal recovered in the process.
The company plans to further increase capacity to over 300 tpd with the
installation of another ball mill, and there is room on the property to continue
to grow the capacity as additional equipment is sourced.
Progress has been
made to fine-tune the operations to recover higher percentages of the mineral
content. By adjusting the crushing
equipment to produce a feedstock with the texture of fine soil they have
improved the efficiency of the flotation process. They are currently working to optimize the recovery process
further by blending various amounts of lower and higher-grade ore in the
feedstock. A lab based in the state
of Durango provides most of the assay information for the grades of the feed
material and the tailings, in order to generate the data for to establish the
recovery percentages.
Improvements at the
operating level are also coming as a result of the higher ore grade in the lower
levels of the mine, that has been found to have a lower arsenic content, and the
smelter pays a higher price as a result for the concentrate produced.
They currently process an even mix of the low-grade development ore, and
the higher-grade production ore. As
the recovery plant efficiency improves, the percentage of higher-grade ore in
the mix will increase, thereby increasing the quantity and the value of the
concentrate.
In the months ahead,
ECU is positioned for strong earnings growth due to the effects of all the
improvements that have been implemented. These
accomplishments include increasing the production capacity at the mine,
increasing the capacity and efficiency of their recovery plant, reducing costs
at all levels of operations, and shipping higher quantities of concentrate
produced with a higher market value per ton.
One wildcard that
will factor into forward earnings estimates is the utilization of the Nichromet
Extraction process, a technology that promises to radically improve the recovery
levels to over 90% of the gold, silver, lead, zinc and copper contained in the
ore. Current operations only
recover a fraction of the gold content, and it is estimated that over 50,000
tons of tailings leftover from past production grading 4-5 g/t gold will serve
as feedstock for this process. Now
that operations have become cash flow positive, the company plans to use
operating profits to fund the installation of a Nichromet circuit.
This will result in a dramatic increase in production revenues that will
go straight to the bottom line.
The company would
also like to acquire an additional milling facility with the capability to
process oxide ore. The mines are
capable of supplying up to 1,000 tonnes per day of feedstock. Also, a significant tonnage of oxide ores bearing high-grade
gold values has been encountered along the fault zones of the mines, which
cannot be processed with the existing circuit.
This ore is being stockpiled at surface until such time as a cyanide
leaching circuit is found to process it. Once
the company has achieved a level of maximum production at the current milling
facility, it is anticipated that the operation will be spinning out sufficient
cash flow to begin aggressively searching for an additional mill.
It should be noted
that the capability of the Santa Juana Mine to produce ore well beyond the
maximum capacity of the recovery plant is a good problem to have.
The vast majority of small mining ventures in production in Mexico are
unable to supply enough ore to keep their recovery operations running near
capacity, and the profitability for these operations is impaired.
It is estimated that ECU only requires production of 170 tons per day to
break even on all operating and administrative costs.
To have a mine that can easily supply double that throughput at the mill,
putting the company well into a profitable range, is an advantage that cannot be
overstated. The potential to double
or triple production in the years ahead with the installation of additional
processing capacity is a bonus that shareholders should not take lightly.
One other significant
wildcard going forward is the potential for the company to begin producing
copper. There is lower grade copper
present in the ore from the Santa Juana mine that adds marginal value to the
revenues the company currently receives for their concentrate.
However, significant copper resources grading up to 3% have been
encountered in the ore mined at the San Juanes vein system, which could amount
to a very large boost in revenues if a recovery circuit is installed targeting
copper. So far only limited scale
mining and near surface drifting has been completed at this part of the mine,
but it represents an intriguing possibility as copper continues to hover near
multi-decade highs in the commodity markets.
Some discussion is
appropriate this point on the fundamentals for pricing of the various metals
produced. ECU Silver is fortunate
to mine ore containing economic quantities of so many metals.
The combination of base and precious metals production serves as a
natural hedge offsetting the uncertainty of future metals prices.
During the last few years, strong demand from China and India has served
to push prices for lead, zinc, and copper to the upper end of their long-term
price ranges. While there are no
significant new sources of supply expected to balance this demand for several
years, if the economies of these areas slow down, then it should be expected
that the base metals would decline in price.
However, silver and gold account for a large part of the gross production
revenue for the company and would serve to counterbalance any weakness in the
base metals going forward.
ECU Silver is
currently valued in the market with a multiple more befitting an explorer, well
below the valuation that could be justified as the operator of a producing mine.
There are a number of reasons for this.
The company has endured a troubled past, including having trading
temporarily halted on three separate occasions in the last two years while
regulatory and reporting issues were resolved, and an ongoing legal challenge to
their ownership of the Velardena property that was recently settled.
The balance sheet is weak, as the company struggled to remain solvent
while funding operations and maintaining payments on a long-term debt amounting
to $6 Million USD. To meet their
working capital needs the company issued several equity offerings completed in
non-brokered private placements that were priced at the lower end of the trading
range due to inopportune market conditions, and resulted in rapid dilution of
the share capital. Also, the
company enjoys no analyst coverage at this time, and does not have a budget for
a full time investor relations department.
The company also suffered while their corporate website was offline.
All of these factors have combined to discourage investment in the
company, limiting the market value.
As a measure to
protect shareholders and ensure consistent reporting standards among listed
companies, Canadian securities regulators have imposed a set of requirements for
reporting companies documented under National Instrument 43-101.
This set of regulations prohibits communication of data for estimates of
reserves, resources and forward-looking performance discussion, when the
information has not be verified by qualified geologists and engineers at arms
length to the issuer. A process has
been ongoing for a number of months to bring the company into compliance, and
the engineering consultants that have been contracted to complete the task could
issue the final report shortly. In
the absence of a thorough, documented report on the asset value and operational
outlook for the company, investors have responded with indifference to
purchasing shares of ECU.
In the immediate
future it is likely that ECU Silver will be reporting recurring earnings from
operations and demonstrating strong growth on a quarter over quarter basis.
Most of the issues that have been discounted into the share price have
now been resolved and it appears that the company has turned the corner,
achieving traction in corporate revenues and a stronger balance sheet.
Additional financial resources will allow for further capital investment
to generate conditions for even more robust growth in future quarters.
The corporate website was recently restored online, and new material is
being added to update it on a regular basis.
While the junior
mining sector appears to be out of favour, and the company appears to be priced
at a maximum discount in the market, it now appears that ECU Silver is at the
beginning of a prolonged episode of growth and profitable operations.
This set of circumstances would appear to be the ideal time to establish
a position in the company.
When operating near
the current maximum capacity for the milling and recovery operations, the
company is capable of generating profits of over $225,000 USD per month.
Assuming the company is able to maintain this production rate and that
metals prices continue in the same range, a forward price to earnings multiple
of 20 would generate a market capitalization for ECU of $65 Million CDN, or a
target price of 42 cents per share, representing a gain of 61% above current
prices.
Management have
stated that they plan to aggressively direct surplus revenues toward capital
improvements at the mine and recovery plant that will yield immediate growth in
production and revenues. If they
are able to achieve this objective, ECU could report earnings of $5-10 Million
USD in 2006, with a resulting expectation of improved market performance
amounting to several hundred percent from the current levels.
It should also be
emphasized that there are only a very small group of junior mining firms that
have been able to report recurring earnings, and thus ECU Silver should be
considered among the top performing corporations. Management deserves commendations for their accomplishments.
Given their success in building value for shareholders with such limited
resources in the past, the potential is strong that they will be able to
continue this success now that the company has become cash flow positive.
The ability to generate cash flow from operations also suggests that the
company will no longer be dependant on raising working capital through equity
placements in the market.
No discussion on
investment performance in the junior mining sector can be considered complete
however without adding the disclaimer that this sector is subject to extreme
volatility and market risk, and should only be considered appropriate for risk
tolerant investors. There is no
guarantee that commodity prices for metals will remain firm or that future
circumstances will continue to support profitable operating conditions for the
company. A degree of risk and
uncertainty also affects the assumptions that can be made on the grade and
tonnage of mineral resources contained on the properties controlled by the
company.
In full consideration of these risks however, on balance with the potential for upside appreciation, ECU Silver represents an attractive opportunity at the current value for investors seeking exposure in the junior mining sector. Management has successfully implemented a complex strategy under difficult circumstances, and ECU is now positioned to benefit from these accomplishments. They have clearly demonstrated that the system of narrow veins near the surface of the property can be mined profitably. There are abundant exploration targets to continue to expand the development, and the promise that a much larger ore body is within reach to the deeper levels of the mines. The problems that have adversely affected the company during the last few years are likely to be resolved within a matter of weeks, and as the expected development continues at their properties, ECU offers the potential to outperform the sector for many years. If in fact the sector is in the early stages of a long term bull market, then ECU Silver looks like one company that investors will not be able to get enough of in the years ahead.
Disclaimer: I have made my research and opinions available to the public as a resource to provide investors and the public with basic information. My comments and opinions should not be interpreted as a recommendation or investment advice, which I am not qualified to provide. While I have made every effort to maintain accuracy in the information I provide, it is possible that there are some errors or omissions in my coverage and the accuracy cannot be guaranteed. It remains the responsibility of each individual investor to confirm if the subject of my analysis is appropriate for their investment objectives, and to conduct their own research and due diligence, and retain the services of a qualified advisor on to provide this service on their behalf. I accept no responsibility for the performance of the companies that I feature in my coverage. Junior mining and exploration companies are a risky market sector and investment in these companies can result in loss of capital. Past performance is no guarantee of future success. From time to time I may purchase stocks in the companies I feature in my reports, and I may sell some or all of my holdings. I will disclose personal ownership in those companies that I refer to at the time of my first coverage, or after follow up reports. I do not accept compensation from companies as payment to provide positive coverage or opinions.