Analyst keen on Red Dog

The Red Dog mine in northwestern Alaska is by far the world’s largest zinc deposit, a fact not lost on mining analyst Greg Barnes of Canaccord Capital.

Following a recent tour of the site, Barnes issued a buy recommendation for mine-owner Cominco (CLT-T), noting that Red Dog “almost has an embarrassment of riches,” with its 24 million tonnes of contained zinc dwarfing its closest competitor, McArthur River in Australia, by 7 million tonnes.

“But this is not all — exploration in the vicinity of the mine continues to uncover yet more resources,” Barnes writes in a research report. “With the expansion now under way [which will take zinc contained in concentrate production up to approximately 615,000 tonnes per year], the mine has a life approaching 34 years.”

Cominco plans to spend about US$100 million to improve the efficiency with which Red Dog produces its concentrates, as well as the quality of the product. This will mainly come by way of increasing flotation capacity. As a result, annual production should rise to 1.1 million from 900,000 tonnes.

“Given its volume of production, Red Dog already contributes the base load of concentrate to a large number of the world’s zinc refineries,” notes Barnes. “By increasing its quality even higher, the Red Dog concentrate will become even more indispensable.”

Red Dog’s product is already clean enough to overcome any penalties at the refining stage. The new expenditures should see the silica content reduced to less than 3% and help Cominco improve its negotiating leverage.

Barnes is equally impressed with Cominco’s commitment to exploration, noting that the company spends about US$5 million annually in the surrounding region. So far, this strategy has been rewarded with the discovery of the Anarraaq and Su/Lik deposits. The former lies 10 km from the mine but has grades and thicknesses similar to those being mined.

However, Anarraaq faces several hurdles, some of which are related to its deep-seated position (600 metres below surface) and the possible presence of natural gas in the rocks that host mineralization.

“In fact,” notes Barnes, “management indicated that, based on Cominco’s economic hurdle of a 10% return at a US45-per-lb. zinc price, Anarraaq probably could not be developed as a stand-alone operation. There is potential that the deposit could be developed using the Red Dog metallurgical facilities; however, this would involve complications under the agreement with the Northwest Alaska Native Association, which governs the operation.”

That agreement calls for Cominco to pay a 4.5% net smelter return (NSR) royalty until project capital is repaid, which is expected in about six years. Another three years are expected to pass before advanced royalties to the association are recouped, after which time the NSR converts to a 25% net profits interest that grows by 5% every five years to a maximum of 50%.

On the plus side, the presence of natural gas presents a potentially cheaper source of energy than the mine’s current source — diesel-electric generators. To assess this possibility, Cominco plans to enlarge one of four gas holes already drilled to determine if the rocks are sufficiently permeable to produce gas. The possibility of generating power from high-grade thermal coal deposits in the area is also being assessed.

In addition to Red Dog, Cominco owns various interests in several base metal mines — Polaris, in Nunavut; Sullivan, in British Columbia; Highland Valley, in B.C.; and Quebrada Blanca, in Chile — as well as the Trail and Cajamarquilla metal refineries, in B.C. and Peru, respectively. Recently, the major announced it will reopen the past-producing Pend Oreille zinc-lead mine in Washington state.

Cominco has 85.4 million shares outstanding, of which Teck (TEK-T) owns just under half, and currently trades at about $22 in a 52-week range of $33 and $17.95. Barnes has set a target price for Cominco of $31.50, or eight times his estimate for Cominco’s cash flow per share in 2001.