ARREF - Amerigo Resources: Full Exposure To Copper But Through Cheaper Shares

2023-06-30 02:26:07 ET

Summary

• The long-term outlook for copper is incredibly promising, as the base metal is an important element in the transition to renewable energy and the adoption of clean technologies.
• Given its high sensitivity to changes in the copper price, Amerigo stock represents a viable way in a bid to leverage this very solid long-term growth prospect for copper.
• The future should offer investors an opportunity to initiate or increase a position in Amerigo Resources' stocks at more attractive share prices.

This Analysis Assigns a Hold Rating to Amerigo Resources Ltd.

Amerigo Resources Ltd. ( OTCQX:ARREF ) ( ARG:CA ), a Canadian tailings copper processor in Chile, represents a viable solution for investors looking to gain full exposure to copper prices.

As illustrated in the Trading Economics chart, the price of copper does not evolve regularly over time, but rather through fluctuations depending on economic conditions affecting the metal's supply and demand, with a strong underlying uptrend.

Each of these characteristics of the copper price can be conveniently turned into a growth opportunity by the investor in Amerigo as shares of this stock are very sensitive to changes in the metal price. This stock will allow investors to capitalize on the bright future of copper, a key metal in the transition to renewable energy and the adoption of clean energy technologies.

However, this analysis does not suggest a higher recommendation rating than a "Hold" rating for the time being, as the copper price could soon come under negative pressure if a recession hits as expected, which would bode badly for copper.

A downward trend in the copper price would result in negative sales revenue adjustments and higher production costs due to lower by-product credits. Because of these dynamics, the company's profitability could deteriorate somewhat, and the board could decide to allocate less income to pay dividends to shareholders and less free cash flow to the repurchase of its outstanding common stock. Due to a stable financial situation, there is currently a very low risk of a reduction in the distribution program to shareholders. However, a potential decline in earnings and free cash flow from a falling copper price amid recession headwinds could weigh negatively on the stock price over the next few weeks as the market tries to anticipate a potentially weaker framework for Amerigo's growth prospects.

About Amerigo Resources in the Copper Industry

Amerigo Resources Ltd., based in Vancouver, Canada, is a copper producer in Chile.

Specifically, the company produces copper concentrates as a by-product from the processing of fresh and historical tailings from mining activities at Codelco's El Teniente Mine, known in the industry as the largest underground copper mine in the world.

Codelco is short for 'Corporación Nacional del Cobre de Chile', a Chilean state-owned copper mining company that owns and operates the El Teniente mine. The mineral deposit consists of extracting copper through underground mining techniques occurring near the uninhabited Chilean mining town of Sewell. This town is not regularly inhabited, since it was built specifically to house the miners and their families and is located on the slopes of the Andes, in the municipality of Machalí, in the province of Cachapoal, between 2,000 and 2,250 meters in altitude.

Amerigo Resources Ltd. produces not only copper but also molybdenum as a by-product of processing the tailings from the Chilean mine. Copper is currently Amerigo's primary source of revenue, accounting for about 80-85% of the company's total sales.

Amerigo operates through its subsidiary Minera Valle Central S.A. on the mine site. Its operations are made possible by a longstanding relationship with Codelco.

How Amerigo Performed in Q1 2023

Amerigo Resources closed the first quarter of 2023 with GAAP earnings per share of $0.05 , beating analysts' average forecast by $0.01. The income was lower year over year as the company reported GAAP earnings of $0.09 per share in Q1 2023.

The EBITDA also went down by 30% on a year-over-year basis to $18.5 million while the free cash flow to equity declined by 52% year over year to $8.6 million.

These earnings and cash flow deteriorations are primarily due to a decrease in revenue, which was $52.6 million in the first quarter of 2023 compared to $53.8 million in the first quarter of 2022, and higher production costs.

Revenue was impacted by a falling copper price as Amerigo's reported that the average price for the first quarter of 2023 was $4.02 per pound, compared to an average price of $4.64 per pound for the first quarter of 2022.

Amerigo's financial performance is very sensitive to changes in copper prices. The company calculates that a 10% drop in the copper price translates into negative revenue adjustments of more than $6.5 million, which is about 10% of $66.8 million, the gross value of copper produced in Q1-2023.

The negative development in copper prices observed so far this year will probably not lead to such a negative adjustment in sales in the second quarter of 2023. The average London Metal Exchange prices for April, May, and June, which are taken as final prices for January, February, and March sales, are well below the provisional copper price for Q1 2023 of $4.01 a pound, but not 10% lower.

The average market price for copper was about $4.00/lb in April, about $3.75/lb in May, and about $3.78/lb in June. This analysis forecasts a negative revenue adjustment of $3 million to $3.5 million for the second quarter of 2023 due to declining copper prices. The negative trend in copper prices reflects a lower outlook for copper demand after monetary tightening implemented by central banks to curb runaway inflation began to impact household spending and business investment.

As for rate hikes, ECB President Christine Lagarde and Fed President Jerome Powell agreed at the last panel of the Sintra Forum in Portugal to tighten further at least until the end of 2023.

Given the time it takes for the restrictive monetary policy to have an impact on consumption and investment, the copper price is expected to fall well beyond the second quarter of 2023.

This means that the headwind from the negative sales adjustment is expected to strengthen in the upcoming months, and the effect should start to be felt on the stock market as well but should not totally impact the shareholder compensation program as this can benefit from a fairly strong financial position.

The Financial Condition

Without prejudice to operating funds, the available cash on hand of $0.27 per common share is sufficient to pay the quarterly dividend of CA$0.03 per common share (the last dividend was paid on June 20), for the next 9 quarters. By then, the headwind to copper prices caused by monetary tightening should be over.

A strong balance sheet is also reflected by an interest coverage ratio of 8.84x (equivalent to a 12-month operating income of $16.8 million divided by a 12-month interest expense of $1.9 million) and an Altman Z score of 2.19 (scroll this page down to the "Risk" section), indicating a low probability of failure for the coming years. Amerigo Resources bears the interest expense because the company also funded the purchase of its assets through debt, which totaled $26.4 million at the end of the first quarter of 2023.

But the company may decide to further scale back its share buyback program based on what happened in the first quarter of 2023. Amerigo reduced the spending on its common stock repurchase by $1.5 million as copper prices fell 13.4% year over year. The company repurchased 1.6 million shares of common stock for $1.9 million in the first quarter of 2023, compared to $3.4 million used to retire 2.3 million shares of common stock in the first quarter of 2022.

The Stock Valuation

Not only Amerigo's financial performance but also its stock price is very sensitive to changes in the copper price.

As the Seeking Alpha chart below shows, the metal price and Amerigo Resources stock price have a very strong positive correlation. The curve that describes the development of the correlation coefficient over the past year is in the upper part of the diagram (above the zero line) with the exception of a few, very short periods of time. This implies that an expected lower copper price (here Copper Futures - July 2023 (HGN3) is the benchmark for the price of copper) will most likely drag shares of Amerigo down from current levels on the US over-the-counter market for the stock traded under the symbol of ARREF, and on the Toronto Stock Exchange for trading under the symbol of ARG.TO.

The stock should provide a more convenient entry point to build or strengthen the position going forward and the stock price to grab should be well below the long-term trend of the 200-day simple moving average.

Shares of ARREF traded at $1.15 apiece as of this writing, giving it a market cap of $186.55 million. Shares were above the 200-day simple moving average of $1.029, slightly below the 100-day simple moving average of $1.16, but on par with the 50-day simple moving average of $1.15. The 52-week range is $0.64 to $1.38. ARREF offers a Forward Dividend Yield of 7.83%, as of this writing.

Instead, shares of ARG.TO traded at CA$1.51 apiece as of this writing, giving it a market cap of CA$247.24 million. Shares were above the 200-day simple moving average of CA$1.40, but slightly below the 100-day simple moving average of CA$1.56, and slightly below the 50-day simple moving average of CA$1.54. The 52-week range is CA$0.85 to CA$1.85. ARG.TO offers a Forward Dividend Yield of 8%, as of this writing.

After analyzing the 14-day relative strength indicator [RSI], it appears that ARREF and ARG.TO stocks have ample downside room to reach significantly lower levels than the current ones.

The chart below illustrates the RSI of ARREF:

The chart below illustrates the RSI of ARG.TO:

Based on the motives outlined in this analysis, there is a strong possibility that the market will increase the attractiveness of Amerigo shares and provide more convenient entry points to gain full exposure to changes in copper prices.

The long-term prospects for copper are very bright.

S&P Global Market Intelligence expects copper demand to double over the next 12 years, from 25 million tons in 2021 to around 50 million tons in 2035, according to this article published by globalxetfs.com.au

Copper demand will benefit from the growing demand for renewable energy, electric vehicles, and the introduction of zero-emission technologies across industries.

Global copper supply is unlikely to keep pace with future demand. Global copper supply was already 3 million tonnes below global demand in 2021 and is expected to lose further ground in 2023 due to two factors: low copper stocks while the world's largest copper producer Chile will supply less metal in 2023, according to Trading Economics .

There will therefore be factors that will put significant favorable pressure on copper appreciation in the coming years.

In the short term, however, supply should be able to meet a demand that is expected to weaken in the coming months due to inflation and rising money costs both affecting the willingness of consumers and businesses to spend.

Conclusion

The long-term outlook for copper today appears very positive as the base metal is an important element in the transition to renewable energy and the adoption of clean technologies.

Given its high sensitivity to changes in the copper price, Amerigo Resources stock represents an interesting solution in a bid to take full advantage of this very solid long-term growth prospect for the base metal.

The upcoming future should provide the investors with an opportunity to initiate or increase a position in Amerigo Resources' stock as the share prices are going to become much more attractive than they are currently.

For further details see: