Amerigo may be a Merry Go Round

But if copper prices firm up, it will pay off handsomely

Amerigo Resources (ARG.TO) extracts copper from mine tailings and produces about 61 million pounds of copper a year with a modest amount of by-product molybdenum. Extraction costs of ~US$2.15 a pound are competitive with most mines, but royalties (which have a sliding scale and get higher as the price of copper rises) average about 30%. Fixed costs including SG&A are low and capital costs to sustain the business are about $6 million a year. Surplus cash can be and is either paid out as dividends or used to repurchase stock for cancellation.

At copper prices of US$3.50 a pound or higher, this is a terrific investment. The stock trades in Toronto at about CAD$1.00 a share and currently pays a quarterly dividend at a CAD$0.12 per share annual rate, for a yield of ~12%. In the past year, the company has repurchased and canceled ~18 million shares, about 7 million through a Substantial Issuer Bid at CAD$1.30 a share which closed in November and another 11 million through a Normal Course Issuer bid at an average price CAD$1.62. There are now about 160 million shares outstanding.

Amerigo is virtually debt free. When a company trading at CAD$1 a share just completed share buybacks at over $1.60 a share you have to wonder what the directors were thinking. Maybe they were thinking the recent pull backs in copper prices are temporary and future prices will benefit from the demand pull of the enormous amount of copper needed for electric vehicles (EV’s). I think they may be right but a recession in the immediate future might pinch those plans a bit so some caution is warranted not only by investors but also by the board of directors of Amerigo.

I have modeled the company based on steadily firming copper prices over the next few years based on maintenance of the current dividend and no more buybacks using a multiple of 8 X free cash flow. With copper prices of US$3.30 today, the company looks overvalued and is consuming cash to maintain the dividend. That is the Merry-Go-Round issue of overpaying dividends and completing stock buybacks in a commodity based company and has been the downfall of many oil & gas companies.

But I do think copper prices will firm up once the central banks create enough economic malaise to temper inflation and if Amerigo can survive a downturn (which it can easily do by curtailing the dividend and hunkering down since it is cash flow positive even at low copper prices), the company could be a compelling small cap investment for the eventual recovery.

The major risk is management judgment but the financial risk is relatively low since the board can’t spend itself into trouble without compliance of lenders and both can readily understand the ongoing economics of running the company safely.

I expect the dividend to be cut in the near future but purchased an opening position of 10,000 shares now. The stock will likely sell off on any announcement of a dividend cut, and I will add at that time if I remain convinced copper’s outlook is robust.

A funny little company off the radar. I like the risk-reward balance.