Primero’s star rises over western Mexico

VANCOUVER — The industry expected big things from Toronto-based Primero Mining (P-T, PPP-N) when it acquired the San Dimas gold-silver mine from major player Goldcorp (G-T, GG-N) just over two years ago to the tune of US$500 million, but things do not always go as planned — at least not right out of the gate.

Following problems with grade variability at San Dimas, which straddles the Durango-Sinaloa border in northwestern Mexico, president and CEO Joseph Conway announced a ramp-up delay at the underground operation to complete a geological review aimed at better understanding the complex, vein-style mineralization in the region.

Given Conway’s success as a mine builder with intermediate producer Iamgold (IMG-T, ING-N) it may have seemed prudent to trust his judgement, but markets punished Primero as shares dropped 47% or $2.17 en route to all-time lows of $2.28 in second-quarter 2012 — the company had hit the market at highs of $5.85 in late 2010.

“I think people were definitely concerned about the review at the time. It was a very significant drop from the old numbers,” Conway comments in a phone interview. “One of the things I see in the market is that companies are rewarded for doing what they say they are going to do. When your understanding of your mine is less than optimal your ability to meet those expectations gets tough. At this point we have a good handle on where we are, and we can tell people with confidence what we’re going to produce.”

Conway’s comments follow a second quarter where Primero set records across the board.

It started with record production when the company produced 23,280 oz. of gold and 1.36 million oz. of silver at cash costs of US$525 per gold equivalent oz. That led to record cash flows of US$36 million and a cash position totalling US$126 million. Primero also bumped its production guidance by 10%, with estimates now in the 110,000 to 120,000 gold equivalent oz. range for the year.

The improved performance can be directly traced to a better geological understanding of the gold-silver systems and a subsequent rise in average grades. Primero managed a 9% jump in gold grades at San Dimas over the first quarter of 2012, and followed it up with another 5% boost during the second quarter — average grades are now back to a healthy 4.25 grams gold per tonne level.

“We took a review of our reserves and resources at year end and came up with a different approach, and a lot of that was driven off of trying to reconcile our reserves with our production,” Conway explains. “What we’re seeing in the last six months is a greater understanding of the geological controls at the site, and that has translated to our performance meeting or exceeding our guidance in general.”

Primero needed to look back at San Dimas’ history in order to move forward.

According to Conway the company identified a high-grade central mineralized corridor and began to look at the gaps where previous operators had either failed to identify strong deposits or not paid adequate attention. Due to the nature of epithermal vein systems exploration is touch-and-go with drill holes often coming up with nothing despite the fact a high-grade gold vein may be sitting nearby. Primero’s new strategy hinged on the fact previous operators had given up on certain central areas too early, and missed potential high-grade deposits that could extend San Dimas’ life and improve project economics.

“Previously you might step out one hundred or two hundred metres and if you didn’t hit anything you wouldn’t come back to it,” Conway says. “But because of this reserve-resource model we’ve been following we have a better understanding of the geology in general and we don’t get discouraged if one drill hole doesn’t hit mineralization.”

Primero discovered four new veins in the past 18 months on the back of its new model, including the Elia and Aranza high-grade veins at the southern end of the central corridor in the Sinaloa Graben. The company followed up with the discovery of the Victoria vein 2 km north of Elia, and the Alexa vein in the West Block — a new area located on the Sinaloa Graben’s western flank.

Grades continue to look promising, with highlights from the drill program at Alexa including: 16 grams gold and 508 grams silver over a true width of 2.9 metres in hole 07-01; 13.4 grams gold and 543 grams silver over a true width of 2.9 metres in hole AL-07; and 7.4 grams gold and 188 grams silver over a true width of 4.1 metres in hole ST-05.

“Victoria and Alexa were classic examples,” Conway continues. “They were previously found by one isolated hole that carried a bit of mineralization, but not a lot, so there was no follow-up to it. As we’ve gone back in and actually done that follow-up we’ve seen some high-grade material. It could add an important amount of ounces in pretty short order.”

Success drove Primero to increase its exploration budget to US$14 million over 2012. The company will be undertaking 40,000 metres of delineation drilling, 40,000 metres of exploration drilling, and 2,000 metres of exploration drift. Those numbers do not include 6,500 metres of development drifting as operations approach the Sinaloa Graben from the east and the south.

Primero expects to have an updated reserve and resource report out in the third quarter, and could see Alexa and Victoria incorporated into its resource estimates and mine plan by early 2013.

Conway isn’t close to finished, however; and it sounds like the work at San Dimas is about to begin in earnest. The real focus for the company will be the continued optimization of its mine operations, and a decision on whether to proceed with a 2,500-tonnes-per-day mill expansion or boost that number to 3,000-tonnes-per-day in light of increased reserves — a mill study is underway and expected to be completed by the end of September.

Primero has contracted a group of external consultants to look at mine operations, and Conway’s real goal is to drop production costs, which already sit at a relatively low US$591 per gold equivalent oz. for the year. The company is also internally reviewing a potential shift from conventional cut-and-fill mining to a long-hole methodology on a portion of its ore body — long-hole methods require a greater continuity in mineralization, but can save producers cash costs if properly executed,

“Quite frankly, we’re looking at a reduction on the cost per ounce side,” Conway comments. “That’s part of the big reason we brought in the external consultants. To look at things like how we are controlling our dilution, look at our work practices and are we effectively utilizing our equipment. So there are a number of things that should have a significant impact — our target is to drive costs down, and hopefully materially.”

Aside from San Dimas, Primero is acutely aware of the potential for mergers and acquisitions in a market that has seen junior gold projects significantly discounted.

Conway compares the current market dynamics to conditions he experienced during the 2008 recession when Iamgold was working diligently on acquisitions that would see the company rise to intermediate producer status. Primero has made clear its intention to pursue “comparable assets to San Dimas”, specifically gold operations in the Americas with production capacity around the 100,000 oz. gold equivalent per year range.

Primero narrowly missed out on the acquisition of Northgate Minerals and its Young-Davidson gold project in n
orthern Ontario in August 2011 when AuRico Gold (AUQ-T, AUQ-N) swooped in to block the transaction with a substantially higher bid.

“The way we see it, we’re a single asset company and I think it’s important to diversify and grow the company through [mergers and acquisitions],” Conway explains. “I think from a management team and a board perspective we feel that this is a good time for us to be looking to deploy our capital. There is no question there are more people willing to discuss the concept than they were six months ago.”

And markets have started to take notice of Primero’s meticulous approach and shrewd management. The company has jumped 53% or $1.33 since the end of June as investors jump back on board in light of improved operations and a strong cash position. Primero closed at $3.82 at presstime and carries a $337 million market capitalization.

Conway says the company still has a ways to go to get back to its proper value, but expects grade consistency and solid operating costs to continue to demonstrate a strong foundation. He says the exploration results remain a “wild card” that could see grades jump at the project, driving further value,

“We definitely have to continue to demonstrate good operating results. That will increase investor confidence, and with that confidence comes an increase in share price. I think we’re in the early stages of that with the expansion scenario and reserve growth leading to further appreciation. I think the other thing that is important, in terms of an acquisition, is to diversify that single asset aspect of our company. That’s where we are trying to get to — go from a junior player to an intermediate player.”