Luna Gold Corp. (fka LGCUF)

[investor15]

2 Brazilian Gold Miners With Enormous Upside

Jul 15 2013
Steve Nicastro

Disclosure: I am long SAND, COLUF.PK, LGCUF.PK. (More...)

Previously, I had written an article titled "How Safe is Sandstorm Gold" (SAND) in which I made the case that the company is one of the less risky gold stocks on the market due to their solid business model, expert management and the strength of their partners. Here I'd like to make the case that two of Sandstorm's partners - Luna Gold and Colossus Minerals - perhaps present an even more compelling investment opportunity.

If you own Sandstorm or are looking to build a position, I want to stress again how important it is to follow not just the company, but their partners as well. Even though Sandstorm gets their gold (GLD) at $500 and lower creating healthy profit margins, if their partners are not financially healthy themselves, it doesn't matter as they could shut down operations for an extended period of time or altogether. This is why management has focused on doing business with what they consider excellent management teams and low-cost mines.

In the past 2-3 months, insiders at two of Sandstorm's main partners have been buying up their company's shares at depressed levels, which could mean that they believe their stocks are cheap and that we've reached a near-term bottom.

Both companies are also at a critical stage of development, as Luna works on an expansion plan to potentially double production and Colossus nears initial production.

Here I will further analyze these companies:

Luna Gold Corp. (LGCUF.PK)Credit: Luna Gold

This is by far Sandstorm's largest stream as it currently makes for about 35 percent of Sandstorm's production profile. Sandstorm has the right to purchase 17 percent of life of mine gold at the Aurizona project in Brazil at $400 per ounce, and the mine is expected to produce about 100,000 ounces in 2013 and 125,000 ounces in 2014 as Luna undergoes their expansion plans.

The current share price of Luna Gold is $1.09 with a market cap of $115 million. They have a P/E ratio of just 6.91 based on EPS of .16.

The company has cash of about $15 million with debt of $30 million. The all-in cash costs for Aurizona are low, at $1,250, but as I mentioned in my previous article, these costs are expected to drop to $1,100 an ounce this year, meaning that the mine is profitable even at current gold prices.

Aurizona hosts 4,667,000 ounces of Measured, Indicated and Inferred resources. With their $115 million market cap, this places a value of just $24.64 on each ounce of gold. This is fairly low for a producer. Yamana Gold (AUY) has a value of about $123/oz, Goldcorp (GG) $132/oz, and AuRico Gold (AUQ) $100/oz, according to GoldMinerPulse.com.

The insider ownership of Luna is high at 14.4 percent and this doesn't take into account the recent insider buying as highlighted below:

(click to enlarge)

Credit: Canadian Insider.com

- On July 10, Luis J. Baertl bought 30,000 shares (six different transactions) at $1.10 per share. Baertl is a director.

- On July 2, Keith Robert Hulley bought 5,500 shares at $1.06. Hulley is Chairman and Director.

- On July 2, Geoffrey Chater bought 10,000 shares at $1.08. Chater is a Director.

- On July 2, Mark Halpin bought 5,000 shares at $1.07. Halpin is VP of Corporate Development.

- On July 2, Titus Haggan, VP of Exploration, bought 8,100 shares at $1.09.

- On July 2, Baertl again bought 50,000 shares at $1.08 and $1.09.

Additional buying took place in June:

- On June 28, Baertl bought 40,000 shares at $1.20. He also bought another 40,000 shares on June 25/26 at $1.50.

For the full list of transactions, click here.

What is the Risk with Luna?

If the price of gold were to remain at the $1,250 level or drop lower for an extended period of time, this could definitely affect Luna's Aurizona expansion plans.

According to their most recent presentation, the company requires $43.2 million of capital for the expansion. $15.7 million of this has been spent through March 31, 2013, leaving $27.5 remaining. The company reported earnings of $5.6 million in the first quarter and as I mentioned earlier, they have $14.9 million cash (as of March 31).

Worst case, the company could take on more debt to finish the expansion or issue shares. They don't have too many shares outstanding so an equity raise wouldn't be the worst thing in the world. Their current debt poses no short-term issues, in my opinion. Here is info. on the current long-term debt they have:

"The Corporate Facility matures on June 30, 2016 and carries an interest rate of LIBOR plus 4.25%. The principal amount of the Corporate Facility will be reduced by $3.0 million every quarter beginning on September 30, 2014 until the Maturity Date, when the remaining outstanding amount will be due in full." (from the 1Q report).

Finally, here's a one-year chart of Luna Gold:

(click to enlarge)Credit: Yahoo!Finance

What will it take for Luna's share price to get back to $3 and higher? If gold prices have indeed bottomed and we see gold just get back to $1400 an ounce, Luna could reward shareholders with a 100 percent share price increase from current levels.

But that is just the tip of the iceberg. If the production expansion goes as planned, the company could be producing as much as 200,000+ ounces a year (at all-in cash costs under $1200):"A Phase II PFS considers the Aurizona Gold Mine increasing annual gold production to between 200,000 and 300,000 ounces." (June 19 News Release).

Here is a chart showing the company's production potential:

(click to enlarge)Credit: LunaGold.com

A 200,000 ounce producer at $1400 gold at $1200 all-in cash costs means the company could potentially bring in $40 million cash flow a year. With a higher gold price, adjust accordingly. With higher production, potentially as much as 400,000+ ounces... I think you get the idea.

*With a well-executed expansion and a recovery in the price of gold, I see at least 300+ percent upside in shares of Luna Gold over the next 1-3 years.

Colossus Minerals (COLUF.PK)

Credit: Colossus Minerals

As I stated in my previous article, I believe Colossus is by far the most important developmental asset that Sandstorm has a stream on. They own and are developing the super-high grade Serra Pelada project. Serra Pelada is a joint venture between Colossus (75 percent) and Cooperativa de Mineração dos Garimpeiros de Serra Pelada ("COOMIGASP") located in the State of Pará, Brazil.

Sandstorm has the right to buy 1.5 percent of the gold and 35 percent of the platinum produced from Serra Pelada at a per ounce cost of $400 for gold and $200 for platinum. Sandstorm paid $60 to acquire the stream in September of 2012.

Colossus's share price has jumped since I wrote that article, from $1.20 to $1.62 due mainly to the price of gold rising but also due to positive drilling results from the company's Cutia project.

Colossus has a market cap of about $170 million. They have $32 million cash (as of April) plus they recently completed a $28.75 bought deal financing, giving them enough capital to get to commercial production. The company has a gold-linked note for $86.25 million that matures on Dec. 2016.

Right now is crunch time for Colossus Minerals and they work on getting their Serra Pelada mine into production. Here are their upcoming milestones:

(click to enlarge)Credit: Colossus Minerals.com

As you can see above, the company will first produce gold until their PGM flotation plant is completed in the third quarter of 2014.

Here is a chart of recent insider buying:

(click to enlarge)Credit: Canadian Insider.com

The following chart below is courtesy SA author Markus Aarnio, in his article"2 Basic Material Stocks With Recent Intensive Insider Buying."

Month Insider buying / shares Insider selling / shares
June 2013 7,533,000 0
May 2013 0 0
April 2013 2,138,200 50,000
March 2013 347,900 0
February 2013 12,000 40,600
January 2013 0 0
- On June 14, J. Alberto Arias purchased 7,500,000 shares in the public market at a price of $1.60. Arias is a Director. "Arias has over 20 years of experience in international mining finance including being the Managing Director of Goldman Sachs - Metals & Mining Research from 1998 to 2006, covering the sector globally" (ColossusMinerals.com).

Arias now controls 16.6 percent of the company or just over 20 million shares in total.

- The CFO, another director and the VP of Investor Relations also bought a significant amount of shares in this time period.

For a full list of insider buys at Colossus, visit this link.

What are the Risks With Colossus? What is the Upside?

- The risks associated with Colossus are the risks that every single mining company faces - falling gold prices, failure to produce, for whatever reason. Mine delays, construction failures, etc.

- The other main risk is the fact that they are not yet in production and that they will be a single mine operator until their next developmental project has undergone extensive work.

- Again, Colossus's Serra Pelada project has no defined resource (yet).

However, despite these risks I see huge potential in Colossus for a number of reasons:

- First, the drilling results from Serra Pelada are absolutely tremendous and the deposit is world-class (The deposit is one of the highest grade gold and platinum group deposits in the world based on drilling). *This should result in the company being one of the lowest cost producers in the entire world.

"Serra Pelada hosted the largest ever gold rush in Latin America with up to 80,000 artisanal miners producing 2 million ounces of gold, plus platinum and palladium, from a hand dug open pit." Credit: SandstormGold.com

Take a look at these drill results, some of the highest grade on record:

Credit: ColossusMinerals.com

Here is a news release in 2011 with some of the most impressive drill results I've ever seen. The drilling intersected 74.40 metres at 31.17 g/t gold, 3.02 g/t platinum and 6.78 g/t palladium in the Central Mineralized Zone ("CMZ").

Another release in December highlighted the following results: 74.35 metres grading 15.45 g/t gold, 4.54 g/t platinum and 7.04 g/t palladium.

These are unbelievable drill results, to say the least.

Is Colossus's Management Trustworthy?

I believe the management is first class.

Here is a bio on their CEO and Director, Claudio Mancuso: "Mr. Mancuso has over 10 years experience in the mining industry and capital markets. Prior to joining Colossus, he served as Vice President, Treasurer of Agnico-Eagle Mines Limited (AEM), a position he held since January 2009.

Prior to that appointment, he served Agnico-Eagle in various financial management positions. Prior to joining Agnico-Eagle in 2002, he held positions at the Ontario Securities Commission and BDO Dunwoody LLP, a public accounting firm. Mr. Mancuso was appointed to the Colossus Minerals Board of Directors, effective as of October 15, 2012. Mr. Mancuso is a graduate of the University of Waterloo and is a Chartered Accountant."

Note that Mancuso has experience at a major gold mining company - Agnico-Eagle Mines.

Their Chief Operating Officer and President, David Anthony, has experience at Barrick Gold (ABX):

"Mr. Anthony is a mining engineer with more than 30 years experience in the mining industry and brings strong engineering and mineral processing expertise. In 2010 and 2011, Mr. Anthony was the Vice President & Senior Project Director, Cliffs Natural Resources Inc. and from 2001 to 2010 Mr. Anthony held senior positions at Barrick Gold in Tanzania responsible for the development of the Bulyanhulu, Buzwagi and Tulawaka mines which are three of the four world-class gold and copper operations which form African Barrick Gold ("ABG")."

- Luis Albano Tondo, VP of Operations and Country Manager in Brazil, worked in a variety of capacities for Kinross Gold (KGC), another major mining company.

- Jason Brooks, their VP of Finance: "most recently served as Assistant Controller of NewGold Inc., an intermediate gold producer. Previously, he spent six years with Barrick Gold Corporation in various financial management positions."

These are just a few examples and there are more. This is a first-rate management team that I'm sure Sandstorm is thrilled to do business with.

In conclusion, with initial production expected next quarter, a 1,000 TPD ramp-up the next quarter, and platinum and palladium production coming in 2014, Serra Pelada should be one of the lowest cost precious metals producers in the world and is certainly a company to keep an eye on.

Here is an idea of how much production is possible from Serra Pelada. The chart is courtesy SA author Hyperinflation, from his story "Colossus: The Small Cap Miner Will Soon Be a Cash Cow."



Here are some estimates:

Gold Production: 175,000 + (ounces)

Platinum Production: 37,000

Palladium Production: 60,000

This would result in the company potentially bringing in over $90 million in annual cash flow in 2015. (Please keep in mind these are just rough, educated estimates).

Colossus also has an option to buy back 50 percent of the stream by April 1, 2015, for $48.75 million. I see this as likely if metal prices are significantly higher than current levels at that time and the mine is bringing in substantial cash flow.

If the management can deliver, I see at least 300 percent upside from current levels. Just getting back to 2011 prices would indicate a potential return of over 700 percent!

(click to enlarge)Credit: Yahoo!Finance

What About Brazil? Is it a Mining Friendly Country?

- Brazil was ranked as the 13th best mining jurisdiction in the world in 2011 and in 2013 it was ranked number 9.

- Major producers in Brazil include Kinross Gold, Yamana Gold and AngloGold Ashanti (AU).

- In short, I strongly believe that Brazil poses little to no political risk. If this changes in time, I will certainly update this article and re-access my investment thesis in both companies mentioned.

Where Does Gold Go From Here?

All this talk of Colossus and Luna would be useless if we did not analyze where the price of gold will be in the coming years.

Personally, I believe in the argument that the bottom for gold is the all-in cost of producing an ounce.

In the article "Gold Is Approaching a Bottom" author Prudent Finances lists the calculated all-in production cost for the top 20 gold producers for Q4 2012 to be $1,306 per ounce.

As I pointed out in my previous article, high cost mines have already begun to shut down as they are unprofitable at current prices.

In the short term, I don't think this has a big impact on the price of gold, but in the long term, I absolutely believe that this provides a floor for the price of gold.

I am absolutely in the camp of those who believe that the Federal Reserve will not taper QE at the end of the year. If anything, I believe that they will actually have to increase the size!

One thing it seems nobody is talking about right now is the US National Debt, which is closing in on $17 trillion. If you count unfunded liabilities like Social Security and Medicare, the total is FAR greater.

The USA is also expected to hit the debt limit once again this fall. My point is that the growth in US debt is far outpacing the growth in GDP.

(click to enlarge)Credit: USDebtClock.org

Because of this reason, I believe that the Fed CAN'T let interest rates keep rising and will have to up the size of QE. The US already pays $223 billion just on interest of debt (Credit: USDebtClock.org). So any further increase in interest rates would have an effect on the cost of debt, which means an increase in the budget deficit.

I guess what I'm trying to say is that the primary case to own gold and the miners has not changed. If anything, the case has gotten much stronger. Don't let the Fed's phony talk of tapering scare you out of gold.

This is just a brief analysis of why I feel the Federal Reserve simply can't taper anytime soon. I hope to write another article soon, which goes into more detail.

To Buy Sandstorm or to Buy Their Partners? That is the Question

While I believe Sandstorm makes for a safer investment than their partners, I do feel that Luna and Colossus have a bit more upside in the long term.

Investors willing to take on more risk for more potential reward should keep an eye on these two companies going forward. If you are interested in investing in either company, my advice is to buy in blocks of shares, rather than try to pick a bottom.

If you want exposure to these companies but don't want to take on the added risk, then you can simply buy shares of Sandstorm Gold. Remember that Sandstorm has no more capital requirements to make on either project, meaning that they get all the upside exploration potential and are protected against a potential increase in production costs (making them the ultimate inflation hedge, in my opinion).

Best of luck!

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