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Soho Resources (SOH.V) - emerging with renewed vigour

Update by Objective Capital , Jul 18, 2011 download full report
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Key Points:

  • Soho has a substantial mineral resource delineated at Tahuehueto
    Previous drilling by Soho allowed the company to delineate a significant mineral resource at Tahuehueto. The project currently hosts a measured and indicated, NI 43-101-compliant mineral resource of 7.38 million tonnes, averaging 2.1 grams of gold and 35 grams of silver per tonne, as well as 2.01% zinc, 1.06% lead and 0.28% copper. The deposit hosts a further inferred resource of 4.87 million tonnes, averaging 1.06 grams of gold and 31.8 grams of silver per tonne, as well as 2.26% zinc, 1.23% lead and 0.23% copper. Potential for further discovery remains excellent. Accordingly, we model an additional 7.0 million tonnes of hypothetical mineralisation into our model.

  • Soho has commenced prefeasibility data collection at Tahuehueto
    Soho has recently commenced data collection in preparation of a prefeasibility study of Tahuehueto that will be based on a model that includes both open pit and underground mining. We previously noted the potential for conducting open pit mining and are encouraged to see the company’s preliminary economic study (PEA), completed last year, incorporate an open pit design at El Creston. The prefeasibility study will pursue the potential for open pit mining further, including a possible second open pit at the Cinco de Mayo zone.

    The PEA indicated an internal rate of return of 31 percent and a 27-month payback, based on capital costs of US$89.1m. The PEA projected cash flow over the life of the project at US$184.2m, or US$109.6m when discounted at 5%. The study contemplated a processing rate of 2,750 tonnes per day, in excess of our 2,000-tonne-per-day estimate as a result of the open pit plan. These economics were achieved using conservative metal prices considerably lower than currently prevail, although they are in line with our own estimate.

    The potential for higher metals prices provides significant upside potential. The PEA generated particularly robust economics at current metals prices. According to Soho management, the IRR rises to 56 percent and the net present value, discounted at 5%, rises to US$300m, with capital cost payback within 1.5 years, using spot metal prices as of February 16, 2011.

  • Prefeasibility drilling has commenced at Tahuehueto
    Soho recently recommenced work at Tahuehueto. The company envisages a drill programme designed to provide infill drill data as well as geotechnical information for the prefeasibility study. The company will employ one drill but plans to add a second when funds permit.

    The drilling and data collection phase of the prefeasibility programme will take an estimated four months. The engineering and analysis of the data will require a further four months, leaving Soho potentially in a position to complete its prefeasibility study in early 2012.

  • New infrastructure could provide an added boost to a Tahuehueto mine
    The Mexican government is constructing a new paved, two-lane highway that connects northwestern Durango State with Tamazula and Culiacan, and to the Pacific coast via a more direct and easier route than previously existed. Soho’s previous plan involved transport of its concentrate over a 185-kilometre gravel road requiring extensive upgrading, thence another 400 kilometres to a Penoles smelter in Torreon. The new route will pare nearly 200 kilometres from the distance and require significantly less capital cost. Further, the new route, via Topio, has the added bonus of putting Tahuehueto within closer reach of Durango’s power grid, which is currently about 30 kilometres distant. Soho had initially contemplated acquiring power from Tepehuanes, nearly 200 kilometres distant.

  • Successful fundraising will be key to timely advancement of Tahuehueto
    Although the recession forced Soho well off its timetable, the company has been able to successfully raise exploration funds. Early this year the company sold 30.58 million shares at C$0.10, with insiders accounting for 4.76 million shares. The placement was well received within the financial community, with investment bankers purchasing another 3.2 million shares for their accounts.

    Soho requires more cash within the next several months, if it is to stick to its prefeasibility timetable. Management indicates that successful completion of a private equity placement sufficient to cover costs of the study is an immediate priority. The reception received by Soho’s previous placement provides some comfort the company will be able to raise the necessary funds. Further, the company’s cash requirements are modest in the short term.

  • Soho is proposing a C$0.4m budget for its Jocuixtita silver project
    In mid-2009, Soho acquired a second prospective precious metals property in Mexico, at Jocuixtita, in Sinaloa, Mexico, through the staged payment of US$1.0m in cash and stock over six years. Several due diligence channel samples collected on the property yielded assays of up to 867 grams of silver per tonne, with encouraging levels of gold, lead and zinc. The samples suggest silver accounts for 50% of the potential rock value at Jocuixtita, with zinc and lead also major contributors.

    Soho has commenced its first phase of exploration at Jocuixtita. The proposed programme includes geological mapping of exposed mineralisation and drilling, commenced in late May, at two main zones, La Salvadora and El Carmen. These features, the sites of Soho’s due diligence grab samples, lie 700 metres apart along a 3,000-metre structure. The budget for the proposed first phase of the 2011 exploration programme is C$0.4m.

  • Our valuation has increased despite major shifts in its individual components
    Clearly, the recession exerted a powerful negative influence on all resource companies and Soho placed its projects on care and maintenance. Nevertheless, the requirement to fund the company through and in the immediate wake of the recession resulted in significant shareholder dilution. Since mid-2009, the company’s shares outstanding rose nearly 50%, from 125.9 million to 187.5 million shares, with a further potential overhang of 31.2 million share purchase options and warrants. This dilution has a correspondingly direct negative impact on our valuation.

    The US dollar has weakened against its Canadian counterpart by approximately 15 per cent since our previous valuation of Soho in mid-2009. The company’s revenues and most of its expenses are valued in US dollars, whilst its stock trades in Canadian dollars, with a resulting negative impact on our valuation. This is partially mitigated by lower interest rates.

    On June 22, Soho arranged a non-brokered private placement of up to 15 million shares priced at C$0.10. One-half share purchase warrant will accompany each share, exercisable at C$0.13 during the first year and C$0.175 during the second year. The funds to be raised are to cover continuing prefeasibility data collection at Tahuehueto, to expand a drilling programme at Jocuixtita from 2,000 metres to 3,000 metres, and for general corporate expenses.

    All other major factors appear positive. Metals prices have risen substantially since mid-2009 and are at or near new all-time highs. Although we model all metals prices as reverting toward their long-term, inflation-adjusted means, our model now reflects significantly higher metals prices than earlier.

    In particular, the price of gold, which has averaged US$1,450 per ounce this year, is more than double the long-term inflation-adjusted mean of US$710 per ounce. Although we see nothing material to suggest a quantum shift in the gold market that would prevent the price reverting toward its long-term mean, the lengthy mean time to revert and comparatively low volatility rates suggest continuing inflation could keep the real price the long-term average (US$710) when expressed in current dollars. In fact, our modelling suggests the price will remain above US$1,100 per ounce when expressed in future dollars.

    Further, should metals prices hold near current levels or continue to rise, the value ascribed to Tahuehueto would increase significantly.

    We have decreased our capital cost estimate from US$150m to US$100m, based on the company’s PEA, which incorporates contract mining, negating the need to procure and maintain a substantial fleet of surface and underground vehicles and equipment. Further, the PEA treated all underground development as an operating expense, reducing capex further. Our estimate nevertheless reflects a greater degree of conservatism than the PEA assumed.

    Our operating cost estimate has declined from US$50 per tonne to US$40 per tonne to reflect the impact of open pit mining versus the previous model, which assumed mining would be entirely by underground methods.

  • Our valuation of Soho rises to C$0.47 per share
    Based on these developments, our base-case valuation of Soho Resources increases from C$0.35 to C$0.47 per share, a quite encouraging result given the substantial shareholder dilution incurred since mid-2009. In fact, our more optimistic assessment, which assumes higher probabilities of exploration success, increases to C$0.63 from C$0.44 per share.

    Further, the upside potential of Soho becomes apparent at future stages of development. Assuming success at all stages through feasibility and permitting, our base-case and optimistic assessments rise to C$1.10 and C$1.59 respectively, compared with our earlier estimates of C$0.85 and C$1.22 respectively.

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