McEwen Mining gets the go-ahead for El Gallo 2

Regulatory authorities in Mexico have given the green light to ­McEwen Mining (TSX: MUX; NYSE: MUX) to build and operate El Gallo 2 — part of the company’s larger El Gallo silver–gold mining complex in the foothills of the Sierra Madres in Sinaloa.

The state’s Secretariat of Environment and Natural Resources signed off on the final environmental permit within five months. Founder and chairman Rob McEwen says this “shows what is possible when the public and private sectors work together to achieve a common goal.”

McEwen Mining president Ian Ball said in an email that “it was five months for the government to review the permit and the permit took one year to prepare, since we were required to complete a baseline environmental study for the ‘wet’ and ‘dry’ seasons. Five months is very fast.”

Ball added that the company did not receive any comments from government agencies, noting that it took “a lot of precautions to ensure the least impact to the environment” when the project was designed, engaging the government “from the start,” and having no local opposition to the mine.

The El Gallo complex includes the El Gallo 1 mine, the Palmarito silver deposit and the Magistral gold deposit, all within 13 km. Commercial production at El Gallo 1 began on Jan. 1, 2013, and in its first full year the mine produced 31,129 equivalent oz. gold (30,733 oz. gold and 20,635 oz. silver). This year it is forecast to produce 37,500 equivalent oz. gold (37,000 oz. gold and 23,000 oz. silver) and 75,000 equivalent oz. gold by 2015.

El Gallo 2 hasn’t been built yet because the company is working on cost-saving studies and reviewing financing alternatives. Any decision to proceed, the company says, will be based on securing financing on more attractive terms. “We are not willing to build it at rates of 8–10% interest or at the current share price, as it would be too dilutive,” Ball explains.

On Dec. 31, 2013, McEwen Mining was debt free and had cash and gold–silver bullion totalling US$26 million.

McEwen’s management team says it can cut US$20 million in capital costs by reducing the number of leach tanks, building a smaller Merrill–Crowe processing refinery, using modular crushers and reducing the number of transformers. With those projected savings and taking into account the US$10 million spent on construction so far, management estimates it would need US$150 million to complete the mine.

“The original capex estimate was $180 million,” Ball says. “This was crushing, milling, tank leaching, Merrill–Crowe. Nothing has changed in terms of the process. We have been able to reduce the leach tanks using modular crushers and a smaller Merrill–Crowe plant. Cement and steel costs have come down since the estimate. We also changed many smaller items like civil works.”

If El Gallo 2 goes ahead, it is expected to produce 95,000 equivalent oz. gold per year (5.2 million oz. silver and 6,100 oz. gold) at cash costs of US$750 per equivalent oz. gold, including all pre-strip and Mexican royalties.

All-in sustaining costs are projected to reach US$800 per equivalent oz. gold (including US$5 million per year on exploration). Gold-equivalent ounces are calculated by converting silver into gold using a 60-to-1 exchange ratio. Two more permits for El Gallo 2 will be submitted before April, but won’t interfere with construction moving ahead once a decision is made. One of the permits is to allow for the mining of Palmarito, a satellite deposit, in 2016. The second permit is a right-of-way for electrical power to connect to the process plant. Mine construction could begin with power provided by generators, with the option of connecting to the electrical grid.

News of the permit lifted McEwen shares trading in Toronto by 17¢, or 5%, to $2.87; and by 12¢, or 5%, to US$2.61 per share in New York.

Adam Graf and Misha Leventhal of McCowan and Co. have reduced their target price from US$3.61 per share to US$3.32 per share.

“An all-leach option for phase two would reduce or eliminate the need for external financing,” the mining analysts commented in a research note. “However, the reduced recoveries would lower the gross asset value. In addition, several of the satellite orebodies and exploration discoveries would likely not be amenable to heap leaching. Therefore, longer-term value generation in the Magistral district will require a mill.”

At current metal prices, the analysts continue, McEwen Mining “will generate US$20 million to US$50 million per year in post-tax free cash flow from its operating assets — sufficient to build either an all-leach El Gallo 2 or Gold Bar (or potentially both), but insufficient for the US$150-million El Gallo 2 mill plan,” the mining analysts argue in a Jan. 21 research note to clients.

Heap leaching is an alternative, Ball comments in response, but he says there are many reasons why the company would prefer to build the mill, including “a longer mine life [and mining the various satellite deposits around El Gallo, which cannot be heap leached]; potentially reprocessing El Gallo 1 heap-leach material; increased leverage to the metals price, with annual production one-third higher; and less technical risk,” he says, because there are not many silver heap-leach mines.

The company’s other assets include the San Jose silver–gold mine in Santa Cruz, Argentina, with a 49% interest; the Los Azules copper project in San Juan, Argentina; and a portfolio of exploration properties in Argentina, Mexico and Nevada. In Nevada its Gold Bar development project is in the permitting phase, and management expects to start construction there this year, with gold production in 2015.