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I find that the joy of pinpointing a stock that I simply must own is compounded when I can share the company's story with others and present my investment thesis. With that in mind, I aim to explain why I believe Primero Mining (NYSE: PPP ) is the premier investment opportunity among the myriad miners of gold. This discussion becomes particularly timely in the midst of the dramatic pullback in gold prices last week, and I believe the associated sell-off in Primero shares opens up one of the lowest-risk means available to gain valuable investment exposure to gold.
Because I had a chance to speak with Primero CEO Joe Conway last week, Fools will find excerpts from our conversation woven into the following two-part discussion. Here in Part 1, we'll get to know Primero's primary asset and its superb management team, and then in Part 2 we'll highlight some of the contributing factors behind the stock's punishing decline and assess the stock's bargain valuation.
Understanding the asset
I recently selected Primero Mining as my top stock recommendation for gold because of my deep conviction that the market has failed to comprehend the true nature of the San Dimas asset. The site first began yielding gold and silver more than 250 years ago, and for more than a century now the mine has continuously churned out high-grade gold and silver from its uncommonly expansive network of epithermal veins. Beginning in 2005, the operation contributed to Goldcorp's (NYSE: GG ) celebrated growth trajectory. Primero expects to produce at least 100,000 gold-equivalent ounces from San Dimas during 2011, and promptly double that output organically to 200,000 gold-equivalent ounces by 2013.
Even when Goldcorp moved to monetize the asset last year to permit Primero's founding transaction -- valuing San Dimas at $500 million when gold traded for $1,220 -- Goldcorp's esteem for the project's remaining productive potential was crystal clear. Typically, a seller will have incentive to understate the significance of a disposed asset to win favor with shareholders; however, Goldcorp went out of its way to explain that existing reserves at San Dimas offered a wholly inadequate understanding of the asset's true value. As Goldcorp explained, "The long history of continuous mining at San Dimas and the known occurrence of the mineral veins have overridden the need to prove up reserves for many years ahead. Consequently, the true potential of the deposits are neither fully realized nor reflected in the stated reserves and resources."
But actions speak louder than words, so I find even greater significance in Goldcorp's retained 36% equity stake in Primero Mining. I was astounded, furthermore, by the savvy deal maker's commitment to guarantee total output of at least 215 million ounces of cumulative silver from San Dimas through 2031 (I estimate approximately 168 million ounces will remain outstanding after 2011). As I pointed out when the Primero deal was struck, Goldcorp's backstop within the modified silver stream agreement with Silver Wheaton (NYSE: SLW ) conveys a confident expectation of remaining silver production that far exceeds currently stated reserves of 60.9 million ounces!
We'll revisit the intriguing disconnect between stated reserves and perceived potential when we examine the stock's valuation in Part 2, but for now let's turn to my conversation with Primero CEO Joe Conway for his perspective on the mine's true potential:
Christopher Barker: As your VP for exploration recently quipped, "San Dimas has had a short mine life based on reserves for over one hundred years." Can you help my readers to understand why the asset's true productive potential may remain so underappreciated, and speak to your own expectations or targets for organic reserve growth at San Dimas?
Joe Conway: Underground mines in general are harder for the investor to fully understand, as compared to open pit operations. Underground mines typically have short mine lives based on reserves alone. What we have at San Dimas is a very long and impressive operating history. We know that over the last 30 years, for example, there has been a 90% resource-to-reserve conversion ratio. Add this to the fact that there are over a hundred known veins at San Dimas with only a very small proportion currently being mined, gives us the confidence that we have a much longer mine-life than our current reserves might imply. In fact, we see this mine as having the potential of over a 20-year mine life.
Knowing the management team and its strategic vision
For a junior gold producer that has now seen its market capitalization knocked down to truly obscene depths, this company boasts the sort of executive dream team you might expect to find in a substantial mid-tier miner. I think that has something to do with where this team expects to take this company over the coming years. Conway has done it before, sealing the deals as CEO of IAMGOLD (NYSE: IAG ) which generated one of the great growth stories of the mid-tier gold miners. Primero's executive chairman, Wade Nesmith, is also a founding director of Silver Wheaton. Executive Vice President Eduardo Luna served as Silver Wheaton's interim CEO 2004-2006, and also remains a member of that company's esteemed board of directors. Luna brings to Primero unrivaled expertise on the San Dimas mine specifically. As President of Luismin S.A. from 1991 to 2007 (Luismin became a Goldcorp subsidiary in 2005), Luna had direct oversight of the San Dimas operation.
Just last month, Conway nearly succeeded in putting together a seriously transformative transaction with Northgate Minerals (AMEX: NXG ) . The deal would have given Primero a second platform for growth with the nearly constructed Young-Davidson project in Ontario. Furthering its own highly impressive growth story, however, AuRico Gold (NYSE: AUQ ) managed to block the deal with a substantially higher bid for Northgate. Primero nonetheless pocketed a $25 million break-up fee and emerged from the ordeal with enhanced visibility bolstered by the launch of a U.S. listing on the NYSE. Suspecting as I do that Primero will not delay in pursuing an alternate avenue for growth, I put the question to Mr. Conway:
Barker: Given the appearance of an acquisition-oriented corporate culture at Primero, are investors correct to anticipate an aggressive long-term growth strategy? And specifically, what sorts of assets are you looking toward currently since the Northgate deal fell through?
Conway: I do have experience growing gold companies through acquisitions. We have always considered Primero an ideal growth platform; it generates more than enough cash flow with which to execute on our goal of becoming a leading mid-tier gold producer by the end of 2013. We are focused in the Americas and seeking advanced-stage projects that will provide additional production within a three-year time frame.
Given the rather odd fact that three of my most highly recommended gold stocks have danced together over the past few months, perhaps I'll try my luck at this stage by suggesting that Brigus Gold (AMEX: BRD ) could make an excellent alternative dance partner for Conway's Primero. Like Northgate, I believe Brigus Gold to be one of the industry's most powerful turnaround stories in the making. And like San Dimas, I believe Brigus' Black Fox Mine presents an uncommon platform for continued organic growth and reliable forward cash flow. On the other hand, bargains abound among the junior gold producers, and I'm more likely to be surprised by Primero's next target than I am to be correct.
For a more complete understanding of the investment thesis behind my new No. 1 pick for gold, please join us for Part 2 of this discussion, and track my ongoing analysis of the mining industry by bookmarking my article feed here.