Primero up 36% on positive tax ruling

Primero Mining (P-T, PPP-N) shares soared 36% after the producer received a favourable tax ruling from Mexican authorities on an “advance pricing agreement” (APA) relating to its San Dimas gold-silver mine located on the border of Sinaloa and Durango, 125 km northeast of Mazatlan.

The ruling confirms that the Toronto-based firm’s method of recording revenues and taxes from sales under a silver-purchase agreement with

Silver Wheaton (SLW-T, SLW-N) at realized prices, instead of spot prices, is acceptable.

Primero has already announced earnings from the sales using realized prices, which was permitted while the case was being reviewed, David Haughton, an analyst at BMO, writes in a note.

However, he points out that the company had a contingent liability of US$56 million on its balance sheet if the ruling didn’t go in its favour. If that happened, Primero’s earnings per share would have taken a hit.

“The positive ruling now yields a significant lift, with cash flow up by US$60 million per year and valuation up roughly 87% [using 10% at spot],” Haughton says. This led Haughton to increase his price target to $8.50 per share from $6. He maintains an “outperform rating” on the stock.

Under Mexican tax law the APA ruling is applicable for up to five years, which for Primero means fiscal years 2010 to 2014, as it entered the agreement with Silver Wheaton on Aug. 6, 2010.

“Assuming the company sells its silver from San Dimas on the same terms and there are no changes in the application of Mexican tax laws, relative to the APA ruling, the company expects to pay taxes on realized prices for the life of the San Dimas mine,” Primero states in a release. Under the contract, Primero will provide Silver Wheaton the first 3.5 million oz. silver produced each year from the mine, and half of any additional silver ounces at US$4.08 per oz., increasing by 1% per year until Aug. 6, 2014. Thereafter, Primero will deliver the first 6 million oz. silver from San Dimas each year and half of any excess silver produced at US$4.20 per oz., also increasing by 1% a year.

Having approved a US$14.4-million budget, the company says it will take a staged approach to increase production at San Dimas and mill 912,500 tonnes per year, or 2,500 tonnes per day. Expansion should start immediately, with completion expected by 2014.

The development would boost average annual production to 160,000 equivalent oz. gold over the next five years, and reduce cash costs by US$110 per oz., to US$510 per equivalent oz. gold.

Primero says the expansion has good economics, with a 150% after-tax internal rate of return, and a payback period of less than two years.

The company might also increase the mill throughput to 3,000 tonnes per day, with detailed engineering studies slated by the end of 2013.

Primero touched a new 52-week high of $7.72 on the positive Oct. 5 tax ruling to close up 36% at $7.20, before dipping in the following week. The stock gained nearly 4% on the expansion plans, closing Oct. 15 at $7.27.