Inca One’s Peruvian strategy poised to pay off

VANCOUVER — In early 2013, fledgling gold producer Inca One Gold (TSXV: IO; US-OTC: INCAF) shifted its business model away from exploration in a bid to benefit from a new mineral landscape in Peru. The decision was fuelled by President Ollanta Humala’s goal to formalize small-scale mining in Peru, and after two years of hard work Inca looks poised to deliver on a promise of free cash flow.

A big part of Humala’s campaign platform involved narrowing Peru’s pronounced wealth gap, which would naturally involve an influx of government spending on social programs. The initiative requires more government revenue, and 1 million oz. of un-taxed, small-scale gold production appeared to be a good place to start.

So policymakers created a process under which unregistered Peruvian miners who rightfully own mining concessions could formalize operations through documentation, baseline environmental studies, archaeological studies and community town-hall meetings. The government set a two-year deadline on the registration process, which expired in April 2014.

Enter Inca One and its toll-milling strategy. The company looked at the success of similarly positioned Dynacor Gold Mines (TSX: DNG; US-OTC: DNGDF), and figured there was room for another operator that could offer artisanal and small-scale gold outfits optionality in processing ore at a government-sanctioned mill facility.

“I would say the formalization initiative in Peru has been successful, though I guess there are people who would argue it’s been challenging, because only a small percent of mines actually completed the process,” CEO Edward Kelly said during an interview.

“But it’s ongoing, and the government has extended the deadline. Just because some small-scale miners weren’t able to formalize that doesn’t mean it hasn’t been a success. A lot of operations that couldn’t meet the criteria have simply been shut down, since the government has made it cost prohibitive to operate outside the system,” he adds.

Though the regulatory rejigging in Peru is ongoing, it has been a successful run for Inca. In July 2013 the company paid US$240,000 for a gold-milling facility in Chala, Peru. Inca invested US$2.8 million at Chala and made progress on various long-term licences and permits required for the plant to operate at 100 tonnes per day.

In December the Chala One plant began continuous daily test milling. The facility is approaching commercial production on a circuit that primarily relies on a 50-tonne-per-day ball mill. The company’s plan is to incrementally increase throughput while putting a second ball mill online. With ore supply arriving daily, Inca expects to hit its 100-tonne-per-day target by March.

Inca reported on Feb. 24 that Chala has processed 1,890 tonnes of material and recovered 1,709 oz. gold and 1,500 oz. silver, with gold grades averaging 28 grams gold per tonne. According to Kelly the mill is running at 60 tonnes per day, and the company is focused on signing agreements for more mill feed to hit a 1,500-tonne-per-month purchase target.

“We’re producing and kicking up cash at this point. I think it’s going to be a constant process, but our initial buildout at Chala is complete, and it’s all about fine-tuning and working out the bottlenecks,” Kelly elaborated. “Every day we have trucks coming into the plant, and ore is being processed continually. The grades have been almost double what we expected in our forecasts just over a year ago. We’d seen ore grades at that level, but we never imagined we’d be even close to that in our first year.”

And though plant optimization is a milestone, Inca’s more pressing task will involve reaching out to Peru’s mining community to source out long-term options for mill feed. Kelly said there is “definitely demand out there,” and added that Inca needs to distribute its risk across multiple mines to assure a steady stream of ore.

Over the past six months Inca has locked down four multi-delivery letters of agreement (LOA) to buy 1,350 tonnes of gold ore per month. The company’s target is to have 1,500 tonnes per month under LOA, or half of the total 3,000 tonnes per month needed to supply its expanded operating capacity. The balance of the mill feed is scheduled to come from ongoing spot purchases in the market.

“Right now it’s rainy season in Peru and we’ve already heard of certain potential ore suppliers getting caught up in the mountains, or something similar. So it really pays off to have a variety of ore sources,” Kelly adds.

Inca figures that general agreement terms will result in a minimum gross margin of US$265 per tonne processed at the mill when ore grades average 23 grams gold. The company estimates its 100-tonne-per-day operation at Chala would generate US$9.8 million in annual net cash flow, assuming a gold price of US$1,250 per oz.

By comparison, Dynacor operates a 250-tonne-per-day gold and silver processing mill at Huanca. The company cranked out 19,200 oz. gold during the third quarter of 2014 for a cash flow of US$2.5 million, or 7¢ per share.

“You quickly realize that producing gold is a whole different game than exploring for gold and asking for money to drill. You’re going to get returns, and there’s definitely money out there for production,” Kelly continued. “We’ve seen it recently with hundreds of millions of dollars in mergers and acquisitions, and promising mining opportunities continue to receive funding.”

And pending production has given Inca access to something most juniors can only dream about: debt markets. In late November the company closed the last US$1.4-million tranche of a US$5.5-million bond financing, and followed up in February with a US$500,000 debt financing to provide capital for buying more mill feed at Chala.

The next act for Inca will involve growing its production base. Kelly explained that the company no longer has “any interest in deploying capital for drill programs,” and intends to embrace its new business model. He noted that Chala could expand to 300 tonnes per day “relatively easily,” and that Inca’s mid-term objective is to hit a 1,000-tonne-per-day company-wide rate.

“We’re really actively looking for additional mill and expansion opportunities right now. Our committee is always looking at plants that meet our criteria, and we have our investors on stand-by, with the money ready when we find the right opportunity,” Kelly said. “I was just in Peru, and the government acknowledges this will be an ongoing process, which I think is good for us, since we’re in perpetually growth mode. We want our capital going towards buying additional plants.”

Inca has traded within a 52-week window of 13¢ to 24¢, and closed up 5% at 23¢ per share at press time. The company has 67 million shares outstanding for a $15-million market capitalization, and had US$2 million in working capital at the end of February.