Labour problems dog Gammon Gold at El Cubo

One year after a six-week strike shut down Gammon Gold‘s (GAM-T, GRS-N) El Cubo mine in Mexico, a second wave of labour unrest has forced management to put the mine on care and maintenance.

Gammon Gold’s head of investor relations, Anne Day, could not be reached for comment , but in a prepared statement president and chief executive Rene Marion said the company was “frustrated” that it had to close down the mine because of the “unwillingness of the union to work collaboratively with management.”

“The ongoing challenges caused by the relentless distractions of union labour disruptions and sub-optimal performance have rendered the El Cubo mine uneconomic and any further investments, including management’s time and effort, are not justified,” Marion said.

The modest sized gold mining operation has the potential to be “reasonably economic” but its “economic viability has been wholly undermined by a legacy of unacceptably low union productivity,” the company stated.

Last year’s strike ended on June 15 when the union agreed to a seven-day continuous work schedule in exchange for an 8% increase in basic wages and a 3% increase in benefits. The current labour problems, which began on June 3, involve a dispute over profit-sharing substitution arrangements and unionized workers have blocked contract workers and union members from entering the mine site.

A number of analysts who cover Gammon believe the company’s strategy is the only sensible option and argue the markets may have overreacted to the news. (In Toronto shares of the Halifax-based gold and silver producer closed down 24¢ or 3.4% at $6.80 per share.)

While Gammon likely will have to revise its guidance lower because of the problems at El Cubo, it isn’t a long-term negative for Gammon, argues Trevor Turnbull, a mining analyst at Scotia Capital.

“What Gammon has done is smart and it will pay off in the long-run,” he maintains. “Gammon needs to get more productivity out of the union and it needs the union to work with it to make El Cubo profitable because if they can’t improve productivity it’s not worth operating the mine.”

“They can continue to do exploration there but investing more money and mining the ore body at such high costs doesn’t make sense.”

Turnbull also noted that with the current price of gold as high as it is, placing the mine on care and maintenance and deferring some of the mining into the future wouldn’t necessarily put Gammon at a disadvantage.

He calculates that El Cubo represents about 13% of the company’s net asset valuation and has a twelve-month target price on the stock of $7.76 per share.

John McClintock of Mackie Research in Toronto argues Gammon Gold “has taken a strong line as it should” because the union’s actions are illegal.

“The timeline on this is very difficult to judge. The last one went for about six weeks so that might be an indication of how long this one might go, although this has the potential to go longer too. The thing is, though, the mine needs these changes and we stand by Gammon with its decision.”

In addition, while El Cubo is significant to Gammon if it can be profitable, it pales in importance to Gammon’s flagship OCampo mine in Mexico’s Chihuahua state, which achieved commercial production in January 2007, McClintock argues.

“The big juice for Gammon is the turnaround in steady operations at OCampo,” he explains. “El Cubo has always been the smaller brother and yes, it’s a distraction, but the stock has overreacted a little bit and at these levels it does represent a good buying opportunity.”

Mackie Research has a buy on the stock with a 52-week target price of $9.45 per share.

Over the last year the stock has traded in a range of $6.61-$13.19 per share and the company has 138.4 million shares outstanding.

In other news, Gammon announced it has entered into an agreement with Valdez Gold for a strategic option in that company’s Los Jarros properties. Los Jarros lies next to the Ocampo property to the north and east and surrounds the Pinos Altos properties of Agnico-Eagle Mines (AEM-T, AEM-N).