Primero’s star rises in the west

 The industry expected big things from Toronto-based Primero Mining (P-T, PPP-N) when it acquired the San Dimas gold-silver mine in Mexico for US$500 million from Goldcorp (G-T, GG-N) just over two years ago. But things did not always go as planned — at least not right out of the gate.

Following problems with grade variability at the underground operation, which straddles the Durango-Sinaloa border in the country’s northwest, Primero president and CEO Joseph Conway announced ramp-up would be delayed so that the company could complete  a geological review to better understand the asset’s complex, vein-style mineralization.

Given Conway’s past success as a mine builder with intermediate gold producer Iamgold (IMG-T, ING-N), the  markets severely punished Primero on the delay news. Shares dropped 47%, or $2.17 en route to all-time lows of $2.28 in the second quarter of 2012, after having made its market debut  at highs of $5.85 in late 2010.

“People were definitely concerned about the review at the time. It was a very significant drop from the old numbers,” Conway concedes in a phone interview. “One of the things I see in the market is that companies are rewarded for doing what they say they are going to do. When your understanding of your mine is less than optimal, your ability to meet those expectations gets tough. At this point we have a good handle on where we are, and we can tell people with confidence what we’re going to produce.”

Conway’s comments follow a second quarter during which Primero set records across the board.

It started with record production, with the company producing 23,280 oz. gold and 1.36 million oz. silver at cash costs of US$525 per oz. gold equivalent. That led to record cash flow of US$36 million and a cash position of US$126 million.
Primero also raised its production guidance by 10% to 110,000 to 120,000 oz. gold equivalent for 2012.

The improved performance can be traced directly to a better geological understanding of the gold-silver systems and a rise in average grades.Compared to the fourth quarter, Primero managed a 9% jump in gold grades during  the first quarter of 2012, and followed it up with another 5% boost during the second. Average head grades are now back to a healthy level of 4.25 grams gold per tonne and 256 grams silver per tonne.

“We took a review of our reserves and resources at year-end and came up with a different approach, and a lot of that was driven off of trying to reconcile our reserves with our production,” Conway explains. “What we’re seeing in the last six months is a greater understanding of the geological controls at the site, and that has translated to our performance meeting or exceeding our guidance in general.”

Primero needed to mull over San Dimas’ history in order to move forward. According to Conway, the company identified a high-grade central mineralized corridor and began to look at the gaps where previous operators had either failed to identify strong deposits, or not paid adequate attention.

Due to the nature of epithermal vein systems, exploration is touch-and-go with drill holes often coming up with nothing despite the fact that a high-grade gold vein might be sitting nearby. Primero’s new strategy hinged on its view that previous operators had given up on certain central areas too early, and missed potential high-grade deposits that could extend San Dimas’ life and improve project economics.

“Previously you might step out 100 or 200 metres and if you didn’t hit anything you wouldn’t come back to it,” Conway says. “But because of this reserve-resource model we’ve been following, we have a better understanding of the geology in general and we don’t get discouraged if one drill hole doesn’t hit mineralization.”

Primero discovered four new veins in the past 18 months on the basis of its new model, including the Elia and Aranza high-grade veins at the southern end of the central corridor in the Sinaloa Graben. The company followed up with the discovery of the Victoria vein 2 km north of Elia, and the Alexa vein in the West Block — a new area located on the Sinaloa Graben’s western flank.

Grades continue to look promising, with highlights from the drill program at Alexa including: 16 grams gold and 508 grams silver over a true width of 3 metres in hole 7-01; 13.4 grams gold and 543 grams silver over a true width of 3 metres in hole 7; and 7.4 grams gold and 188 grams silver over a true width of 4 metres in hole 5.

“Victoria and Alexa were classic examples,” Conway continues. “They were previously found by one isolated hole that carried a bit of mineralization, but not a lot, so there was no follow-up to it. As we’ve gone back in and actually done that follow-up we’ve seen some high-grade material. It could add an important amount of ounces in pretty short order.”

Success has driven Primero to increase its exploration budget to US$14 million for 2012. The company will be undertaking 40,000 metres of delineation drilling, 40,000 metres of exploration drilling and 2,000 metres of exploration drifting. These numbers do not include 6,500 metres of development drifting as operations approach the Sinaloa Graben from the east and south.

Primero expects to update its reserve and resource estimates in the third quarter, perhaps incorporating Alexa and Victoria into its resource estimates and mine plan by early 2013.

But Conway and his team aren’t close to being finished, and it sounds like the work at San Dimas is about to begin in earnest. The real focus for the company will be the continued optimization of its mine operations, and a decision on whether to proceed with a mill expansion to 2,500 tonnes per day, or boost that number to a daily 3,000 tonnes in light of increased reserves. A mill study is underway and expected to be completed by the end of September.

Primero has contracted a group of external consultants to look at mine operations, and Conway’s goal is to drop production costs, which already sit at a relatively low US$591 per gold equivalent oz. for the year. The company is also considering  shifting from conventional cut-and-fill mining to long-hole methods on a portion of the orebody. (Long-hole methods require greater continuity in mineralization, but can save producers cash costs if properly executed.)

“Quite frankly, we’re looking at a reduction on the cost per ounce side,” Conway comments. “That’s part of the big reason we brought in the external consultants. To look at things like how we are controlling our dilution, look at our work practices and are we effectively utilizing our equipment. So there are a number of things that should have a significant impact. Our target is to drive costs down — and hopefully materially.”

Aside from San Dimas, Primero is acutely aware of the potential for mergers and acquisitions in a market that has seen junior gold projects significantly discounted.

Conway compares the current market dynamics to conditions he experienced during the 2008 recession, when Iamgold was working diligently on acquisitions that would see the company rise to intermediate producer status. Primero has made clear its intention to pursue “comparable assets to San Dimas. That means gold operations in the Americas with production capacity in the range of 100,000 oz. gold equivalent per year.

Primero narrowly missed out on buying Northgate Minerals and its Young-Davidson gold project in northern Ontario in August 2011, when AuRico Gold (AUQ-T, AUQ-N) swooped in and blocked the transaction with a substantially higher bid.

“The way we see it, we’re a single asset company and I think it’s important to diversify and
grow the company through [mergers and acquisitions],” Conway explains. “From a management team and a board perspective, we feel that this is a good time for us to be looking to deploy our capital. There is no question there are more people willing to discuss the concept than there were six months ago.”

And markets have started to take notice of Primero’s meticulous approach and shrewd management. The company has soared 53% — or $1.33 since the end of June — as investors jump back on board in light of improved operations and a strong cash position. Primero closed at $3.82 at presstime and has a $337-million market capitalization.

Conway says the company still has a ways to go to get back to its “proper value,” but he expects more grade consistency and solid operating costs.

He says the exploration results remain a wild card that could see grades jump at the project, further driving value.

“We definitely have to continue to demonstrate good operating results. That will increase investor confidence, and with that confidence comes an increase in share price. I think we’re in the early stages of that with the expansion scenario and reserve growth leading to further appreciation. The other thing that’s important, in terms of an acquisition, is to diversify that single asset aspect of our company. That’s where we are trying to get to — go from a junior player to an intermediate player.”