Value Microcaps Motherboard

[Bobwins]

Breakwater Resources bwlrf.ob

This is my dydd writeup for Breakwater Resources. I consider this a table pounder due to the undervaluation that the increase in the price of zinc has created.

Price of stock is still not reacting to the fundamentals of the underlying commodity. Zinc has made a big move recently and I don't think many investors realize the impact.

DYDD Member: Bobwins
Date of Recommendation: February 17,2005
Company Name: Breakwater Resources Ltd
Ticker: bwlrf.ob
Last Closing Price: $ .575
My Cost Basis Disclosure: $ .502
Market Cap: $ 208 million
ST Target (3 to 6 months): $ 1.00
LT Target Price (1 to 2 years): $ 1.50
Risk (High, Medium or Low): medium


Company Background:

Breakwater Resources, Ltd. Is a Canadian mining company with 5 mine properties that produce both base and precious metals. The mines produce zinc, copper, gold, silver and lead but zinc is the primary product. The mines are located around the world in Quebec, Tunisia, Honduras, Chile and British Columbia. In addition to the operating mines, Breakwater has inactive mines in Quebec and New Brunswick and exploration properties in Quebec, Honduras, Chile and Tunisia.

Breakwater bought the Myra Falls mine on July 23,2004 and is in the process of completing the merger of the operations. The new mine was included in the consolidated financials for the qtr ending 9/30/04. Q4 will be the first qtr with a full qtr of operations that include the Myra Falls mine.


Due Diligence:

The mining industry is recovering from a period of extremely low prices for base metals in the nineties. Due to the low prices, many mines were shut down as uneconomic. This period of low pricing caused financial difficulties for many mining companies and resulted in limited exploration. Against this backdrop of limited production increases, China has burst on the scene consuming massive amounts of base metals as they become the manufacturing center of the world. This has reversed years of inventory buildups in many base metals. Kitcometals.com maintains price and inventory supplies of the base metals over the past 5 years. The charts can be viewed at :

http://www.kitcometals.com/charts/zinc_historical.html

As you can see from the charts, there has been a big drop in inventories over the past two years and a corresponding increase in price. The increase in pricing has enabled Breakwater to record 3 consecutive qtrs of profits. The last posted qtr ending 9/30/04, Breakwater earned 2.4 million dollars Canadian or .01eps diluted.

Here is a breakdown by metal of the US$ revenues generated:

Metal 9month ytd q3

Zinc 103.4 36.6
Lead 8.8 4.5
Copper 5.8 2.3
Gold 8.4 3.2
Silver 8.1 5.0

Hedge Settlements/
Adjustments .2 -1.0
_____ ____
Totals $134.7 $50.1

Zinc is the main revenue source for Breakwater Resources Ltd. 2004 was a year of rapid increases in base metals pricing. Several experts think that zinc will be the metal with the highest chance of price appreciation in 2005. Zinc is used to galvanize steel as rust protection. Galvanized steel is in high demand in China as that country builds up its infrastructure as well as uses base metals for manufacturing goods for the rest of the world.

Breakwater produced 105 million pounds of zinc in q3. There was a note in the 9/04 earnings report that Myra Falls contributed to the increase but that most of the zinc concentrate was not sold. Therefore I expect q4 to show increased revenues from zinc due to the stockpiled concentrate from q3 as well as the price increase during the qtr.

Breakwater sold its zinc at .448/lb in q3. Based on the price charts, I am guesstimating that they will average .50/lb in q4. This will increase gross revenues by US$5.2 million and should flow to the bottom line. Since they made 2.4million in q3, I estimate net profits of 7 million for q4 or .02eps.

Based on recent prices of $.615, I estimate that q1 2005 will average .56/lb. That will increase gross revenues by another 6 million dollars. Assuming most of that becomes net profits, I am forecasting .03eps for q1 2005.


This is the Management Comments from the 9/04 SEDAR filing

http://www.sedar.com/csfsprod/data50/filings/00708770/00000001/C%3A%5CSEDAR%5CFILINGS%5Cintfin%5C200....

This is the url for the 9/04 Financials

http://www.sedar.com/csfsprod/data50/filings/00708765/00000001/C%3A%5CSEDAR%5CFILINGS%5Cintfin%5C200....


There are several factors that could disrupt my earnings forecast. Shipping the ore to refineries has become more expensive and refineries are raising their charges. Breakwater could have a disruption in production at one of their mines. While these are all possible, I do not think they will affect my estimates. I purposely left off any price adjustments for lead, copper and silver to provide for the shipping and refining increases. Also Breakwater just signed new labor contracts so there should be no labor issues outstanding. Last but most important, the price of zinc could fall. However given the time it takes to open closed mines OR actually find and develop a new mine, I think that is a low possibility. China could dramatically slow but the tremendous growth in their basic infrastructure would seem to point to a continuation of the high use of zinc. There is actually a fairly high level of zinc inventory but experts are predicting a sizeable deficit between usage and production that will squeeze pricing.

The share price has been lethargic compared to the price of zinc. I attribute that to the CEO of Breakwater resigning in December and has not been replaced yet. It also appears that Wellington Capital has been selling 4 million shares recently that held the price down. They still are a major holder of bwlrf.ob shares.


Based on my estimates of .02 for q4 and .03 for q1 2005 versus today’s closing price of .575, I think BWLRF.ob is very undervalued. .03X4=.12eps or fwd p/e of 5. I believe that the stock will hit .70-.75 after q4 is released and that the stock will hit 1.20 or a p/e of 10 after the market realizes that Breakwater can earn .03 per qtr and that zinc continues in short supply.

Bobwins