TGB - Taseko Mines Ticks A Box But Balance Sheet Is Stressed

2023-09-19 08:45:00 ET

Summary

• Taseko Mines Limited's share price rallied 16% after receiving the Underground Injection Control Permit for the Florence Copper project.
• The Florence copper mine has the potential to transform Taseko's fortunes, with lower costs and increased cash flows.
• However, there are technical risks and uncertainties surrounding in-situ copper mining, and Taseko's balance sheet is stretched with significant debt coming due.

The share price for Taseko Mines Limited ( TGB ) rallied 16% when the news about the U.S. Environmental Protection Agency (or EPA) issuing the Underground Injection Control Permit for the Florence Copper project broke on September 14, 2023. This permit paves the way towards construction and operation of the Florence copper mine, an asset that has the potential to prove transformational for Taseko, if implemented successfully.

The Florence copper mine has been envisaged as an in-situ leaching operation, where acidic liquid is pumped through a porous ore body via injection and recovery wells.

Why Transformational?

Taseko owns an 87.5% stake in the operating Gibraltar open pit mine in the Cariboo district of BC, Canada. With annual production averaging 130M lbs of copper over the remaining 22 years of mine life the Gibraltar mine is one of the largest copper mines in North America. This is a low-grade bulk mining operation, with a reserve grade of 0.25% copper, and metallurgical recoveries averaging around 80%. It's a high-cost operation that generates free cash flow when the copper price is high; and creates headaches when the copper price is low. As a result, Taseko's share price is highly cyclical as the company's fortunes are tied to the copper price. In fact, the company only just survived the 2016 and 2017 downturn when Osisko Gold Royalties ( OR ) came to the rescue and purchased a silver by-product stream from metals produced at Gibraltar. Interestingly, the foundations for the positive news mentioned in the introduction were also laid during this downturn, as Taseko acquired the Florence project during this time, amid a myriad of headwinds as discussed here .

The Florence mine will shift the balance for Taseko as cash costs and all-in sustaining costs per pound of copper produced will be substantially lower at Florence, underpinning the company's viability during down-cycles, and adding substantial cash flows during up-cycles. And with a price tag of just $232M to complete the mine according to the latest technical report there should be little doubt about Taseko's ability to finance construction and ramp-up of the Florence project -- if it wasn't for a balance sheet worthy of discussion later in this piece.

Environmental activism has provided plenty of headwinds over the years and receiving the final permit was by no means guaranteed as Taseko went through the motions of getting the final nod from the EPA. With this in mind, the positive market reaction to the latest permitting milestone was to be expected.

The Risks

In fact, if there was any surprise about the market reaction, it was the limited extent of the rally, and the lack of follow-up in sub-sequent trading. The chart below provides the context of a full year of trading, along with a peer comparison ( COPX ). Taseko dropped below peers in early summer, coinciding with a slight drop in the copper price and has traded range-bound since then.

The move following the permit announcement has taken the share price to the upper limit of this trading range, but unfortunately for Taseko investors, momentum was insufficient to break resistance to the upside of said trading range. Market concerns about the technical risks involved with in-situ copper mining was most certainly one contributing factor for this lack of follow-through.

In-situ mining is a tested and proven mining method, and plenty success stories of in-situ uranium mines exist. However, when it comes to in-situ copper mining these success stories are very few and far between. Technical data and practical experience are scarce, and in addition, the cautionary tale of the nearby Gunnison project is certainly weighing on Taseko investors. A junior miner by the name of Excelsior Mining ( EXMGF ) has been developing the in-situ Gunnison copper project a couple of hours by car to the Southeast of the Florence project. This Gunnison project was supposed to go into commercial production over two years ago, but numerous technical challenges have delayed the well field development and ramp-up -- with plenty of uncertainties about the viability of in-situ mining at Gunnison still remaining.

It is worth noting that Taseko has been operating a test well field successfully as part of the permitting and development process for the Florence project. At this point, it seems that several problems that have hampered the Gunnison project have not been reported at Florence. However, the market is well aware of the difficulties at Gunnison and it's reasonable to expect continued skepticism from investors until Taseko can prove the pudding by scaling up copper production from the present test facility to commercial production.

Balance Sheet

Taseko's balance sheet appeared stressed at the end of Q2, providing additional reasons for concern. It sported $80M in working capital at the end of June 2023, but also $38.7M in current debt and financial liabilities, plus a staggering $578.342M in long-term debt.

Senior secured notes with a book value of $530M maturing in February 2026 constitute the lion share of the long-term debt. These notes bear 7% interest and come with covenants that strictly limit Taseko's ability to take on additional debt (hence our comment regarding project financing for the Florence project earlier in this piece).

The Gibraltar mine generated $119M in free cash flow in 2021; but then it generated only $7M in 2022; and $8M during the first half of 2023. At this rate, the free cash flow from the Gibraltar mine barely covers interest payments for the 2026 notes, and it's nigh-impossible to see how this mine can generate the funds needed to repay any significant portion of the 2026 notes when they come due in a year and a half. In fact, the free cash flow numbers above were calculated strictly on a mine-site basis, and ignored capital expenditures at Florence, which amounted to $160M since the start of 2021.

Quite clearly, Taseko will have to refinance its 2026 notes. And quite clearly, this task will represent an uphill battle as interest rates in general have increased significantly since the last refinancing in February 2021. And increasing the debt load in order to fund mine construction at Florence will only complicate this task further. Alas, management seemed less concerned when prompted on the debt and the ability to fund the Florence construction during the Q2 earnings call :

But certainly as we get into the second half next year, we’ll be keeping a close eye on markets and looking for an opportunity to refinance that. I think we have a good story to tell obviously with Florence coming online, it’s going to be a very meaningful growth story for the equity and for bond holders as well in terms of its cash flow generation and its impact on our credit.

Valuation

At the time of writing, Taseko shares were trading for $1.42, translating into a $404M market capitalization and an enterprise value of $940M.

The company carried the Gibraltar mine with $725.4M on its books, which seems like an overly optimistic point of view given the mine's recent performance in a relatively robust copper price environment. A recent transaction provides a better yardstick. Taseko purchased a 12.5% stake of the Gibraltar mine from a JV partner back in March this year, and the price tag for this stake implied an asset value of somewhere between $356M and $694M -- depending on the agreed contingency payments. Our estimate for the value of the Gibraltar mine sits right in the middle of this range, at $535M.

Deducting the asset value for the Gibraltar mine from Taseko's enterprise value leaves $405M for the Florence mine at the current market valuation.

The latest technical report assigns an NPV (8%) of $930M to the Florence copper project.

Consequently, we believe, that the market is currently valuing the Florence project at ~0.45xNAV. And that seems like a fair valuation of a challenging feasibility stage project with uncertain funding prospects.

Summary & Investment Thesis

Receiving the final permit for the construction of the Florence copper mine represented an important milestone for Taseko. Nevertheless, this is a technically challenging project with plenty of remaining uncertainties.

Taseko's balance sheet is stretched, with significant amounts of debt coming due within 18 months. The operating Gibraltar mine is not generating the cash flows necessary to repay this debt. Refinancing this debt will be a top priority in 2024, and it seems that management is speculating on increasing the debt load yet again in order to fund mine construction at Florence. Taseko's debt load is already exceeding its market capitalization, and this ratio will get worse for shareholders should the postulated refinancing materialize.

Among other factors, the success of Taseko's plan will hinge on the copper price performance in the coming quarters as Gibraltar quickly turns into a liability if copper prices fall significantly below recent levels.

The current market valuation appears fair, if not somewhat optimistic, given the plentiful financial and technical risks in the company's story. Taseko is an investment for risk-tolerant investors who wish to speculate on continuing high copper prices, management's ability to manage a precarious balance sheet, and the company's ability to avoid the pitfalls of in-situ copper leaching.

Given the current market valuation, we see insufficient potential rewards for the myriad of risks associated with an investment in Taseko. We are happy to stay away, and would probably sell when the share price re-visits the upper end of the current trading range again.

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