El Chanate write-down surprises AuRico shareholders

Despite a $127 million write-down of the El Chanate mine in Sonora, Mexico, Canaccord Genuity analyst Rahul Paul says he isn’t changing his investment thesis on AuRico Gold (AUQ-T, AUQ-N) and is maintaining his US$11 price target on the stock. At presstime in New York, AuRico was trading at US$6.30 per share.

In a Mar. 27 research note, the Toronto-based analyst said that while the impairment charge “took investors by surprise,” and “a write-down of an acquired asset is always a cause for concern,” Paul pointed out that the company attributed the charge “to a more conservative modeling approach that excluded any non-resource ounces from valuation (particularly in light of the fact that reserves mined in the last year were not replaced).”

While this could mean that “the previous valuation methodology may have been too aggressive,” he continues, “the reasons for the impairment do not appear to have any impact on our outlook going forward. ”

Paul describes El Chanate, which AuRico acquired in April 2011, as having “attractive exploration potential in light of recent new discoveries that will likely take some time to prove up.”

Last year AuRico identified two new discoveries directly on trend of the El Chanate open pit, as well as the extension of the previously identified North West zone, about 50 metres northwest of the open pit. The newly discovered Rona zone is about 600 metres northwest of the pit and the Loma Prieta zone is about 1.2 km southeast of the ultimate pit boundary.

At the Northwest Zone, five drill holes over a 300-metre strike length intersected intervals of 6-27 metres down hole with grades comparable to material currently being mined in the main open pit (which has a reserve grade of 0.65 gram gold per tonne and a resource grade of 0.42 gram gold). The boundary of this zone is within 50 metres of the ultimate El Chanate open pit outline.

In the Rona zone, which is open along strike and in both directions, one hole intersected 52.5 metres of 0.34 gram gold including 24 metres of 0.49 gram gold and 12 metres of 0.37 gram gold. A second hole intersected 0.27 gram gold over 58.5 metres. And in the Loma Prieta zone, six holes intersected mineralization at less than 70 metres depth. Unlike the other zones, however, there was a higher grade portion, on occasion in excess of 10 grams gold, rather than a broad zone of disseminated mineralization.

The El Chanate mine, 37 km northeast of Caborca, consists of an open pit, crusher, heap leach pads and a process plant on 3,665 hectares within 19 mineral concessions.

News of the write-down on El Chanate on Mar. 25 was accompanied by the results of a feasibility study on AuRico’s Kemess underground project, 5.5 km north of the past producing Kemess South mine in northern British Columbia. (The Kemess South mine produced nearly 3 million oz. gold and more than 300 million pounds of copper during its lifetime.)

The feasibility study outlines an underground block cave operation with average annual production of 105,000 oz. gold and 44 million lbs. copper at cash costs of $213 per oz. of gold, net of by-product credits, over a mine life of about 12 years. The operation would leverage existing infrastructure from the mill facilities at the Kemess South mine including an area previously permitted for tailings storage in the Kemess South pit.

At base case prices of US$1,300 per oz. gold, US$3.00 per lb. copper and US$23 per oz. silver, the feasibility study envisioned total production of 1.3 million oz. gold and 563 million lbs. copper. Pre-commercial capital costs were estimated at $452 million with sustaining capital costs of $181 million during the life of the mine, including $35 million in closure costs.

The Kemess Underground project would yield an after-tax net present value of $134 million at a 5% discount rate and an after-tax internal rate of return of about 10% with a 3.5-year payback on the initial capital cost from the start of commercial production. At US$1,650 per oz. gold and US$3.67 per lb. copper, the project would generate an after-tax IRR of 18%.

Last year the company posted revenue of $163.6 million and net earnings of $29.2 million or $0.10 per share prior to the $127 million non-cash goodwill charged related to El Chanate. The company produced 127,283 oz. gold at cash costs of $516 per oz. Operating cash flow before changes in working capital reached $39.1 million, or $0.14 per share.

This year the company intends to pay an annual dividend of $0.16 per common share.