Just as water flowing downstream follows the path of least resistance, sometimes we expect the companies we own to do the same.
Among small-cap metal miners, few gems have shone as brightly as Taseko Mines (AMEX: TGB ) . Once a commensurate underdog with a feverishly loyal following, Taseko's stock has come into its own lately as the Prosperity gold and copper project moves closer to the start of construction.
Taseko reported 2009 earnings results last week, with net income of more than $10 million. The flagship Gibraltar mine yielded about 68 million pounds of copper at an average total cash cost of $1.54 per pound. Healthy margins between that cost and an average realized price of $2.31 per pound produced strong operating profit of around $46 million. Unfortunately, unrealized derivatives losses accounted for a wide discrepancy between operating profit and the decidedly less prosperous net income per share. After scoring a phenomenal set of hedges on Gibraltar copper production for the second half of 2010, however, those derivative exposures are poised to decline.
More important than the earnings results, the company gave its most definitive indication of the intention to monetize about 20% to 25% of Prosperity's future gold production to raise about $340 million of the $800 million required to construct this mine. Although my initial reaction to this strategy was disappointment, a closer look has eased my Foolish mind.
My initial misgivings were based on concerns that derivative-based forward sales might be employed, and gold investors well know the impact that such arrangements had on shares of Barrick Gold (NYSE: ABX ) . To an investor who has carefully avoided hedged gold producers like AngloGold Ashanti (NYSE: AU ) and Randgold Resources (Nasdaq: GOLD ) , the specter of encumbered gold production struck an unsavory chord. Upon further investigation, I was relieved to discover that Taseko is targeting the far more palatable avenue of a gold royalty arrangement. Because the relevant playing field is extremely limited in scope, Royal Gold (Nasdaq: RGLD ) and Franco Nevada are the most likely candidates for facilitating such a deal.
To understand why monetizing a portion of future gold production represents the best available option for Taseko, Fools must first concede that a corporation looking to raise about 90% of its market capitalization -- the full amount needed to get Prosperity up and running -- in this credit environment faces a difficult challenge. Because I once hypothesized that the only road to prosperity might involve a takeover by a copper-loving gold producer like Yamana Gold (NYSE: AUY ) , the very existence of a self-directed path is a welcome achievement. Second, the stock remains far too undervalued for investors to welcome a share offering.
If Taseko can obtain $340 million for less than a quarter of its Prosperity gold, and copper remains an equally significant revenue component of the project, then what does that say about an $857 million market capitalization, when we have clear evidence of a $680 million market value for the existing Gibraltar mine?
I'll let you value hounds continue to crunch the numbers, but even considering the sacrifice of a chunk of forward gold production, Taseko remains one of the clearest stores of unlocked value that this Fool has encountered in the sector. Under the circumstances, I believe that a royalty arrangement for a portion of gold production represents the path of least resistance for achieving timely golden prosperity.