Capstone Copper Corporation. (OTCPK:CSCCF) recently announced a potential increase in the life of the Mantos Blancos project and continues to successfully develop the Mantoverde mine. I researched the company’s most suitable mines and got a fair Capstone Copper Assessment. Considering political risk, accidents and changes in copper prices, I believe the company is very cheap at the current market price.
Capstone Copper produces copper and silver for mines in the United States and Mexico and for a project in Chile. Capstone’s main projects are highlighted on the company’s website with the following words:
Capstone Copper reported that the company’s four mines are currently producing a combination of copper concentrate, copper cathode, silver, zinc, gold and other minerals. The most valuable and most relevant products are copper concentrate and copper cathode. I wanted to keep things as simple as possible, so I assessed the company’s valuation by forecasting only future production of copper concentrate and copper cathode.
In July 2022, the price of copper concentrate is near $3.75 per pound. I wanted to make conservative assumptions, so I used a price below CAD 4.79 per pound in my financial models.
As of June 30, 2022, Capstone Copper reported $348 million in cash, $5.2 billion in total assets and $2 billion in total liabilities. In my view, the financial situation is quite beneficial.
Capstone Copper will require equity financing or more debt for its capex. Right now, the net debt is $242 million, which is not worrying in my view. In three or four years, I believe Capstone Copper will report free cash flow of over CAD 400 million, so the total amount of debt will be small. Bankers will provide additional debt financing to Capstone Copper if needed.
My base case scenario included a valuation of CAD 4.07 per share
Under normal circumstances, I thought the development of Mantos Blancos concentrate would help increase production at the mine. Note that the company expects recovery to pick up from Q3 2022 onwards.
The Mantos Blancos concentrator debottlenecking project is increasing design capacity to achieve targeted throughput rates and recoveries in Q3 2022. Source: Q2 Report to Shareholders
Management is discussing an increase in copper cathode production life. If the Mantos Blancos project produces more copper over time, investment analysts will raise the company’s target valuation. Share prices are likely to rise:
As part of the Mantos Blancos Phase II project we are also evaluating the potential to extend the lifetime of copper cathode production. A pre-feasibility study for the Mantos Blancos Phase II project was completed in Q2 2022, which will be integrated into an advanced basic engineering study in Q4 2022. Source: Q2 Report to Shareholders
Also, the Montoverde mine, far from completion, is progressing well. In my view, as the company continues to provide more information on the development of this mine, more investors will look at the mine. More production brings more revenue and more market capitalization:
The Montoverde development project remains on schedule and on budget. Major construction on primary crusher, concentrate thickener and water desalination plant tie-in is progressing well. Procurement, contracts and engineering are more than 99% complete, with manufacturing and fabrication approximately 95% complete. The overall project completion was 60% by the end of July 2022. Source: Q2 Report to Shareholders
To derive the company’s valuation, I assessed the total expected production of each mine separately. Using the total production of copper concentrate and cathode, I made several assumptions regarding the future price to arrive at the total return.
Capstone Copper is expected to produce copper from 2022 to 2039, according to a technical report at Arizona’s Pinto Valley mine. Concentrate production is expected to be close to 128 million pounds per year. My numbers are shown in blue in the table below. They include an assumption of CAD 3.45 per pound.
Under normal circumstances, from 2022 to 2031, Kozamine would produce close to 65-23 million pounds. Under my own assumptions in this case, I would say the revenue would be approximately CAD 176 million per year.
Mantos’ technical report covers copper production of close to 51 kt from 2022 to 2038. With roughly the same figures, I got an income of CAD 391-CAD 238 million per year.
Mantoverde’s production is expected to be close to 117 kt in 2024. From 2022 to 2024, the increase in production will grow significantly, which will have a beneficial effect on the company’s income. In my view, only investors who research production plans and technical reports very carefully will know about the incoming increase in production. My financial models include an increase from CAD 472 million in 2023 to around CAD 920 million in 2024.
By summing up my expected revenue figures from all mines, I got the revenue growth rate from 2024 onwards. My figures are slightly lower than other analysts because I do not include production of gold, zinc or other minerals. In this scenario, I did not imagine that the new exploration work would increase the mineral reserves of Capstone. With more mineral reserves and production of minerals other than copper, the revenue will be larger and the fair value of the company will be larger.
Assuming an EBITDA margin of around 48% and 35%, an effective tax rate of 20% and an operating margin of around 39% and 26%, I get a 2024 NOPAT of close to $602 million. Note that without new exploration, in 2042, Capstone Copper will produce all copper reserves.
Assuming conservative changes in working capital and related capital expenditures over the next five years, the FCF/Sales ratio will stand between 14% and 26%. We are talking about CAD 352 million FCF in 2025.
I assumed a discount of 7.7%, which is close to the rate used by experts in most technical reports I’ve seen. The NPV of future FCF is close to CAD 3 billion. By subtracting debt and adding cash of CAD 445 million, I got an implied equity valuation that shouldn’t be far from CAD 2.8 billion. Finally, with a weighted average number of shares outstanding of 693 million, the fair price is CAD 4.07 per share.
Best case scenario
Under optimistic conditions, I used a copper concentrate price of CAD 3.75 per pound. I increased production at the Pinto Valley and Montes Blancos mines to include the result of exploration work. Results include 2023 sales of CAD 1.55 billion and 2024 revenues of CAD 2.1 billion. These figures are slightly better than the previous case, but they are very realistic.
In this case, I used changes in working capital/sales closer to 2.5% and lower capex than in the previous case. EBITDA margin to reach 50% in 2023. The results include 2028 FCF close to CAD 553 million and an FCF/Sales ratio between 12.3% and 25%.
If we add it all up and use an optimistic discount of 5.55%, the net present value of the future free cash flows is around CAD 4.25 billion. The equity valuation will be CAD 4.01 billion and the fair price will remain at around CAD 5.
Capstone Copper may experience a significant number of disadvantages that affect the mining business model in general. Accidents, wildfires, labor disruptions, floods or accidental explosions can reduce future production and damage the free cash flow line.
Reputational damage may cause shareholders to leave the company or executives to cease company operations. Under these conditions, I believe the stock price will drop significantly.
Capstone’s operations are subject to all risks and hazards normally encountered in exploration, development, construction, care and maintenance activities and the production of copper and other metals, including, without limitation, workplace accidents, fires, wildfires, power outages, labor disruptions, port disruptions, floods, landslides, explosions , cave-ins, landslides, ground or stope failures, tailing dam failures and other geotechnical instabilities. Source: Q2 Report to Shareholders
A significant drop in the price of copper or other metals extracted from Capstone Copper could make Capstone’s mines profitable. If shareholders decide they cannot extract minerals to generate positive free cash flow, management may decide to reduce production or close some mines. As a result, if journalists notice a decline in production, the stock price may fall significantly.
Depending on the expected price for any minerals produced, Capstone Copper may determine that it is impractical to continue commercial production at the Mantos Blancos Mine, the Montoverde Mine, the Pinto Valley Mine or the Cojamin Mine or to develop the Santo Domingo Project. A reduction in the market price of copper, zinc, gold, silver, or iron may prevent capstone copper properties from being economically mined or result in the write-down of impaired assets as a result of lower metals prices. Source: Q2 Report to Shareholders
Let’s give an example of the price sensitivity of a company’s copper. Under the base case scenario conditions, if we assume a copper concentrate price of CAD 2 per pound, the amount of free cash flow would result in a stock price of CAD 1.72.
Capstone Copper operates in many countries where political instability may harm the Company’s operations. In the last quarterly report, management warned of eventual increases in taxes in Chile or violence and work stoppages in Mexico. Finally, management warned about the implications of President Biden’s Made in America tax plan:
There may be additional risks and uncertainties following Chile’s presidential, chamber and senate elections. Although the government’s legislative agenda is not yet fully known, it is known to include tax reform as a priority. Source: Q2 Report to Shareholders
Local economic conditions, including but not limited to increased incidences of criminal activity and violence in areas such as Mexico, may adversely affect the safety of our people, operations and availability of supplies. Source: Q2 Report to Shareholders
There are also uncertainties related to President Biden’s Made in America tax plan, which proposes corporate tax reforms that would increase Pinto Valley’s future tax obligations. Source: Q2 Report to Shareholders
Capstone Copper is discussing an increase in the life of the Mantos Blancos project. Management recently noted that development of the Montoverde mine is moving in the right direction. Using this information, I calculated the NPV of the company’s mines and obtained a combined valuation significantly higher than the stock market valuation. Yes, there are risks from copper price variation in the market, accidents in the mines and political instability. However, in my view, the current price is too low.