Arizona Mining: A Deep Discount to NPV

Arizona Mining (AZ.TO) has been one of the highest quality growth stories in the junior mining sector and is up over 500% since our initial investment last year. The company has made significant progress on its flagship Hermosa-Taylor project, quickly developing it into one of the largest zinc equivalent deposits in the world. Despite this, in recent months AZ's stock has been the subject of heavy selling pressure, falling from its peak of $3.49 in December to settle in the $2.20-$2.30 range. Last week, on April 4th, 2017, the company released its long-awaited PEA. Many investors believed the PEA would be closely followed by a sharp movement in the price of AZ stock, but there has been little to no reaction from the market in the days following its release, despite the positive results. In my opinion, the market's lack of response to the PEA has created a significant value opportunity for investors. In addition, I believe there is an overemphasis on project risks and a resulting undervaluation.

Preliminary Economic Assessment (PEA)

A Preliminary Economic Assessment or "PEA" is an economic analysis of a potential mineral project to determine the viability of its mineral resources. The PEA is usually one of the first steps a mining will go through in transitioning from an explorer to a mid-tier junior miner. In terms of confidence level and predictability of resources, the PEA is subordinate to a "Feasibility Study" but it is still a primary catalyst for movement in a mining company’s share price. 

The Hermosa-Taylor PEA contained the following highlights ($USD):

- Substantial NPV8% of $1.26 billion 

- Robust after-tax IRR of 42%

- Initial capex of $457 million

- Short 1.7 year payback

- Total operating costs of $48/ton

- 19 year mine life based on conservative 60.8 million tons of ore production

If this your first time reading PEA results, I can assure you that these are excellent numbers. A substantial NPV value, robust IRR, short payback period, and relatively low capital costs are all considered to be attractive project features in the eyes of mining developers and financiers. 

Net Present Value (NPV)

Net Present Value or "NPV" is the most commonly used metric to evaluate potential mining projects. It measures the expected change in company value as a result of undertaking the project at hand. In layman's terms, if you took all the minerals in deposit, all the costs and incomes, and processed the entire thing right now, the resulting value would be the NPV. In the case of Hermosa-Taylor, this value is USD$1.26 billion or CAD$1.69 billion of additional value for the firm and its shareholders; on a per share basis, this is roughly ~$6.75 CAD. At the time of this article, the stock price of Arizona Mining is $2.22 per share, representing a 66% discount to their NPV. It is not uncommon to find junior mining companies trading at a significant discount to their NPV. This discount reflects the various risks and potential pitfalls that can arise over the life of a project. The discount may also reflect the possibility of any future shareholder dilution, as most mining companies will need to raise additional funds in the form of equity in order to advance to the production stage. As a project gets closer to production, the various risks become less relevant and the discount to NPV is gradually reduced.

Internal Rate of Return (IRR)

The Internal Rate of Return or IRR is another metric used to measure the profitability of a potential project. The IRR is a bit more difficult to understand than the NPV. As in investor, what you need to know is that a higher IRR is desired. Also the minimally acceptable levels for IRR that mining developers like to see are also important. Projects with an IRR of less than 10% are not usually advanced to the production stage. The IRR for the Hermosa-Taylor deposit is well over this threshold, at 42%.  

Capital Expenditures (CAPEX)

Capital Expenditures or 'CAPEX' consists of all the costs that will need to be incurred in order to develop the deposit and extract its resources. This number is especially important for developers and financiers of a project, as they will not usually proceed if the NPV is less than or equal to CAPEX, as these projects are considered to be much riskier. The CAPEX for the Hermosa-Taylor deposit is $457 million. As with NPV, the CAPEX of a project is also an important measure but is less useful when viewed in isolation. Comparing the ratio of NPV to CAPEX provides a more useful tool for evaluation.


This ratio compares the additional value created over the project’s life to costs that will need to be incurred. This ratio is extremely important to developers and financiers of a mining project as they will not usually invest in projects with an NPV/CAPEX of less than 1. The Hermosa-Taylor deposit features an NPV/CAPEX ratio of around 2.75. In other words, the additional value that the Hermosa-Taylor will create is nearly triple to that of its costs, a very attractive feature in the eyes of mining developers.

Key Issues

At the moment, there are a few key issues that investors have in mind: manganese content, possible equity dilution, and the biggest issue, permitting.

Regarding the manganese content within the resource, management has already proven that there is an ongoing interest for its future concentrates from smelters and other offtake groups. A $13 per Metric Tonne penalty was also applied to the NPV calculation to account for the costs of separating the manganese from the ore.

As for equity dilution, Jim Gowans, President and CEO recently announced the company’s intent, “to fund the project with little to no equity.” He also added: “In light of the project's strong cash flow, we should be able to attract significant conventional debt ($250-$300 million), off-take financing ($75-$150 million) and a silver stream ($200-$350 million). We will minimize equity dilution wherever we can to benefit all shareholders.” 

As for permitting, James Gowans, President and CEO, announced plans to, “initiate state permitting for operations on our patented land and break ground on the tailings facility by the end of 2017.” He also added that, “Our permitting efforts are underpinned by strong existing local and state support built on early and extensive engagement."

Ultimately, approval for permitting will be at the discretion of the US Government but i am confident that AZ's management team will be able to work things out with the EPA, as this is a major product and would help to boost economic growth in Arizona.

Insider Buying

Immediately following the release of the PEA, Robert Wares, one of the directors at AZ, purchased 100’000 shares on the open market at an average price of $2.23. While insider buying can often serve as a catalyst for an upcoming switch in the market's direction,  investors must be very careful about reading positive messages into every insider buy that they see. While one big insider buy or sell order might offer investors a hint of things to come, it hardly translates into a sure-fire pointer for outperforming the market. It is important to look deeper at the order size, timing, and specific insider who made the purchase.

In this case, the purchase was from an independent director and professional geologist, Mr. Robert Wares. Wares has over 35 years of experience in the mining and exploration industry and his guiding hand on exploration has led to the ultimate discovery of over 13 million ounces of gold. This is one of the industry’s most well-known veterans making a large, strategically timed open market purchase.

A Life Cycle Analysis

The chart below show the performance of AZ's stock price since last January. 

A brief comparison of the Arizona Mining stock chart to the 'Life Cycle of a Mine' chart below should help you to gain a better understanding of the recent activity in the stock price.