Citigroup big on precious metals miner Fresnillo

A tunnelling machine digs in at Fresnillo's namesake silver-gold project, in Zacatecas, Mexico. Spun off from Industrias Penoles in May, Citigroup Global Markets predicts that over the next year, the company will trade at around 5.10 per share on the London Stock Exchange, up from its recent 3.20.A tunnelling machine digs in at Fresnillo's namesake silver-gold project, in Zacatecas, Mexico. Spun off from Industrias Penoles in May, Citigroup Global Markets predicts that over the next year, the company will trade at around 5.10 per share on the London Stock Exchange, up from its recent 3.20.

Since Mexico’s mining group Industrias Peoles (IPOAF-O, PENOLES-m) spun off its silver and gold assets creating Fresnillo (FNLPF-O, FRES-l), the new company has generated some buzz.

It was the first Mexican listing ever on the London Stock Exchange. And as the world’s largest

silver producer and Mexico’s second-largest gold producer, and in the lowest quartile of the cost curve for both silver and gold, the company has become the darling of equity research analysts at Citigroup Global Markets.

Citigroup holds a buy on the stock and anticipates that over the next year it will move up to about 5.10 (US$9.39) per share. At presstime, Fresnillo traded at about 3.20 (US$5.70) per share.

Named after its largest mine in the Zacatecas region of central Mexico, Fresnillo raked in pretax profits in 2007 of US$161 million on sales of US$647.9 million. (It produced about 34.4 million oz. silver and 280,000 oz. gold).

Management claims the company will double its silver-equivalent production over the next decade with the help of another underground mine adjacent to its existing Fresnillo mine — to be christened Fresnillo II.

Fresnillo II is about 9 km southwest of Fresnillo I and is expected to be about the same size as its counterpart. The company expects to develop the deposit here into a world-class producing mine by 2011, with a 15-year mine life. Production is expected to reach 5,000 tonnes per day by 2017, ramping up to 30 million silver-equivalent oz. per year.

Capital costs for Fresnillo II have been roughly estimated at about US$400 million, and a prefeasibility study is expected to be completed in the first quarter of next year.

Development underway includes land acquisition, environmental studies, permitting, engineering studies and underground access. In the last three years, the company has purchased 18 sq. km of land to build the new mine. Now Fresnillo is in the process of obtaining permits to build a high-tension power line to the site.

The Fresnillo district has been picked over since the 1550s and by Peoles since 1961. At Fresnillo I, the San Carlos vein, the mine’s main source of current silver pro- duction, was discovered in 1997.

Proven and probable reserves at Fresnillo I total 26.4 million tonnes grading 455.1 grams silver per tonne (386.7 million contained ouces silver) and grading 0.61 gram per tonne gold (500,000 contained ounces gold).

In addition to Fresnillo I and the planned mine at Fresnillo II, the Mexico City-headquartered company owns two producing gold mines. It has a 100% stake in the Cienega mine, 325 km from Durango in the northwestern corner of Durango state, and a 56% stake in Herradura, in northern Sonora. (Newmont Mining [NMC-T, NEM-n] holds the remaining 44% stake.)

Proven and probable reserves at Cienaga are 7.5 million tonnes grading 86 grams silver (20.8 million oz. silver) and 5.52 grams gold (1.3 million oz. gold). At Herradura, proven and probable reserves total 65.3 million tonnes grading 0.5 gram silver (1.1 million oz.) and 0.88 gram gold (3.7 million oz.).

In terms of additional development, Fresnillo holds 13,000 sq. km of mining concessions and its Soledad and Dipolos development project, 9 km northwest of the Herradura mine, looks promising. Mineralization there is located along the same strike of the Mojave- Sonora mega-shear zone as Herradura. The company expects annual production to fall in the range of 3.5 to 5 million tonnes, producing a peak rate of about 100,000 attributable oz. gold by 2010.

As with Herradura, Fresnillo has a 56% stake in Soledad and Dipolos and Newmont owns 44%. Development drilling is underway to outline the limits of the mineralization so that it can site the leach pads, dump site and plant facility. At the same time, metallurgical studies, engineering designs, baseline environmental studies and preliminary construction plans are also under development.

Citigroup likes Fresnillo’s high-quality, low-cost operations and its strong volume growth through brownfield acquisitions and development of its Fresnillo II operation.

“Exploration has been a key driver for group valuation, as it was responsible for the discovery of the Fresnillo II and Soledad and Dipolos projects, which should be major contributors to group production growth,” the Citigroup report states. “Exploration success is the key near-term driver.”

While Citigroup notes that Fresnillo has limited volume growth this year and next, brownfield expansions at Cienaga and Herradura and the startup of Fresnillo II should deliver substantial volume gains from 2010 onwards.

The investment bank expects these will increase silver-equivalent production by 60% between 2007 and 2012. “We expect silver production to increase from 34.4 million oz. in 2007 to about 56 million oz. by 2012,” it says.

Citigroup also asserts that Fresnillo should deliver significant earnings growth over the next three years, driven by a combination of volume and a “positive pricing environment for gold and silver.”

Total revenue in the first half of the year climbed to US$424.21 million from US$311.62 million, a 36.1% rise. Attributable profits jumped 56.4% during the same period, to US$140.97 million in the first half of 2008 from US$90.11 million in the first half of 2007.

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