Fresnillo ranks in lowest quartile of cost-curve for silver, gold

Since Mexico’s mining group Penoles spun off its silver and gold assets creating Fresnillo (FRES-L), the 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 its ranking 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. Fresnillo currently trades at about 3.89 (US$7.16) per share.

Named after its largest mine in the Zacatecas region of central Mexico, Fresnillo raked in pre-tax profits in 2007 of US$161 million on sales of US$647.9 million. (It produced about 34.4 million oz. silver and about 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 mineto 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 15 years mine life, reaching 5,000 tonnes per day by 2017, witih production ramping up to 30 million silver-equivalent oz. per year.

Capital expenditures for Fresnillo II have been roughly estimated at about US$400 million, and a pre-feasibility 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 1,800 hectares 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 Penoles since 1961. At Fresnillo I, the San Carlos vein, the mine’s main source of current silver production, 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 oz. contained silver) and grading 0.61 gram per tonne gold (0.5 million oz. contained 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 holds the remaining 44% stake.)

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

In terms of additional development, it holds 1.3 million hectares of mining concessions and its Fresnillo’s 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 the Herradura mine. The company expects annual production to fall in the range of 3.5 million tonnes to 5 million tonnes, producing a peak rate of about 100,000 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 mineralisation 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.

Anticipated annual production at Soledad and Dipolos is expected to be in the range of 3.5 million tonnes to 5 million tonnes of ore by 2010, for about 100,000 attributable oz. gold each year.

Citigroup likes the company’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 & 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 start up of Fresnillo II should deliver substantial volume gains from 2010 onwards.

They expect these will increase silver equivalent production by 60% between 2007 and 2012.

Citigroup also asserts that the company 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 from US$311.62 million to US$424.21 million, a 36.1% rise. Attributable profits jumped 56.4% during the same period, from US$90.11 million in the first half of 2007 to US$140.97 million in the first half of 2008.