While investors have bid up shares of junior gold and silver mining companies some 40 percent thus far in 2014, Sabina Gold and Silver (OTCMKTS:SGSVF) has lagged, having risen just 20 percent. I think this underperformance is justified to a certain extent. On one hand, Sabina has two large and valuable assets — its Back River gold mine and its royalty on Glencore Xstrata’s (OTCMKTS:GLCNF) Hackett River silver and zinc mine. These assets are, from a quantitative standpoint, significantly more valuable than the company’s $157 million valuation. On the other hand, Sabina is going to have difficulty realizing this value in a timely manner. Let us look at the two assets to see why.
The Back River Gold Project in Canada’s Nunavut Territory is Sabina’s flagship property. It will operate both as an open pit and as an underground mine, but most of the resources are underground. The latest estimates show the project having 4.6 million ounces of measure and indicated resources at 6 grams per tonne and 1.9 million ounces of inferred resources at 8 grams per tonne.
Unfortunately, there are a couple of issues. First, the mine is, for all intents and purposes, located in the middle of nowhere. Sabina is going to have to develop this infrastructure itself. This leads to the second issue, which is that the project will cost roughly $600 million to bring into production, which is scheduled to begin in 2016. Once production commences, the mine should generate about 300,000 ounces of gold annually for about twelve years at cash costs of $680 per ounce.
The company estimates that the project has a post-tax NPV of $177 million at $1,250 per ounce gold using a 5 percent discount rate with an internal rate of return of 12 percent. Thus, while the Back River mine will produce a lot of cash flow, Sabina needs to raise a lot of capital to generate it. The company will likely have to issue stock, sell part of the project, or sell another royalty (Royal Gold already owns two different royalties on two different parts of the property), and each of these options will eat into its value.
Another option is for Sabina to sell its Hackett River royalty, which I will discuss now. The Hackett River silver and zinc project is located near the Back River project. It was discovered by Sabina and then sold to Glencore Xstrata. As part of the arrangement, Sabina was awarded a 22.5 percent royalty on the first 190 million ounces of silver mined and a 12.5 percent royalty on the silver mined afterwards. Given that the mine is only expected to generate 2.7 million ounces of silver per year, the 190-million-ounce threshold is unlikely to come into play. Thus, Sabina will be entitled to 600,000 ounces of silver per year for the life of the mine, which is expected to by 16 years.
This is going to generate a lot of cash-flow — more than Sabina’s $157 million market capitalization with silver trading at just over $21 per ounce. Unfortunately, the mine isn’t expected to go into production for several years. Right now we can guess that it won’t go into production until 2018 at the earliest, and Glencore Xstrata might take more time than this to bring it into production. This is the case for a couple of reasons.
First, like Back River, Hackett River is located in the middle of nowhere. All of the infrastructure needs to be developed, and this will be very costly. As I side note, I should mention that the two mines can share roads, water infrastructure, and electrical infrastructure, but this would push back the production timeline for Back River by at least two years. Second, Glencore Xstrata is a major mining company with lots of projects, and Hackett River is not a priority, even if it is a priority from Sabina’s perspective.
Thus, given the value of Sabina’s two primary assets (it also has two minor exploration properties with minimal value) and its $70 million in cash, it would seem that the shares are a screaming buy at just 82 cents per share. But I think there are a lot of issues here that can jeopardize this apparent value. A compromise might be for investors to take small positions on large pullbacks.