Tinka Resources (TSXV: TK)

An updated PEA completed last October indicated that TK could be worth at least C$0.75/share, or almost 5 times the current share price. Furthermore, it’s a good bet that TK eventually will be purchased by Buenaventura. However, we are no longer going to follow the stock at TSI. This is due to the lack of market-moving news and the slow on-the-ground progress. In effect, we have lost patience. We are prepared to ‘tuck away’ exploration-stage microcap stocks in our own account for years while waiting for the market to recognise the underlying value, but for TSI positions we prefer companies/stocks that are more active.

Based on the TSI entry price back in June-2018 and last Friday’s closing price, TK will go into the record books as a 60% loss.

At its current rate of spending TK is fully funded to advance the Ayawilca zinc project over the course of 2022. It is a good long-term play on zinc that we think eventually will be taken over by Buenaventura, its major shareholder, but these small exploration-stage mining stocks sometimes require extreme patience.

1. Initial capex of US$264M to build a bulk underground mine with average annual zinc-in-concentrate production of 155K tonnes over 14 years. This would make Ayawilca the largest zinc mine in South America.

2. After-tax NPV(8%) of US$433M and IRR of 31.9% at a zinc price of US$1.20/pound. At a zinc price of US$1.50/pound the after-tax NPV(8%) increases to US$785M. This means that a 25% increase in the zinc price boosts the value of the project by about 80%, which implies that TK offers substantial leverage to the zinc price.

3. The project is located in a major mining region close to a paved highway under construction and about 200km from an operating zinc refinery and port.

4. The mine plan minimises environmental impact by using 40% of tailings as underground backfill and using filtered dry-stack technology for on-surface tailings treatment and storage.

The current zinc price is around US$1.60/pound. However, to build in a margin of safety we think it’s prudent to assume a price of US$1.20/pound for company valuation purposes. In addition, NPV figures in PEAs generally should be discounted by at least 50%.

Applying a 50% risk discount to the US$433M NPV figure mentioned above and assuming a CAD/USD exchange rate of 0.85, we come up with a rough valuation of C$255M for TK. With 341M shares outstanding, this equates to about C$0.75/share.

With valuation-related upside potential of more than 200%, TK is a buy near its current price of C$0.23. Be aware, though, that considerable patience may be required. As noted in previous commentaries, junior resource stocks tend to do nothing for a long time and then do a lot in a short time.

Only geologists care about rock samples. Drilling is required to determine if there’s anything of economic value.

This is very good news.

The revised resource estimate is the basis of a revised PEA, the results of which will be announced within the next few weeks.

At its current rate of spending TK is fully funded to advance the Ayawilca zinc project over the coming 12 months. It is a good long-term play on zinc that we think eventually will be taken over by Buenaventura, its major shareholder.

We view the news as neutral.

We estimate that full value for TK would be around C$0.80/share at the current zinc price (US$1.35/pound). This suggests huge upside potential given that the current stock price is only C$0.22.

Peruvian politics is one reason for TK’s low valuation. Specifically, Pedro Castillo, a socialist, is favoured to win Peru’s presidential election run-off on 6th June and a Castillo victory would be negative for investment in general and mining-industry investment in particular.

The political risk appears to be factored into TK’s current price, but it will make sense to steer clear of Peru-based investments until the ramifications of the 6th June election can be assessed.

More information regarding the project’s economics is expected to arrive in the form of an updated PEA in July of this year.

The company now plans to update the project’s resource estimate and PEA by around the middle of this year.

In other news it was announced that Nexa Resources, one of the world’s largest zinc producers, has purchased an 8.8% stake in TK. This means that two large mining companies now have significant stakes in TK (Buenaventura owns 19% of the company). We had assumed that Buenaventura would be the eventual buyer of TK, but perhaps it will be Nexa.

At the current zinc price of US$1.26/pound we peg fair value for TK at around C$0.70/share. At a zinc price of US$1.40/share our estimate of fair value would rise to around C$1.00/share. This assumes that TK is worth 50% of the Ayawilca NPV(8%) calculated in the PEA completed in mid-2019 (we multiply the NPV by 50% to account for various risks).

Our valuation will be updated following the release of the updated PEA mentioned above.

TK is fully funded to advance the Ayawilca zinc project over the coming 12 months. It is a good long-term play on zinc that we think eventually will be taken over by Buenaventura, its major shareholder.

The company is awaiting the assay results from eleven completed holes and has a few more holes to drill in the current program, so TK should have decent news flow over the coming two months. Also, the company plans to complete an updated PEA in mid-2021.

Near its current price TK is a reasonable way for patient speculators to gain exposure to zinc.

The drilling program will continue into the early part of next year and will test the large area between West and South Ayawilca that has seen limited exploration to date. This should mean that TK will have good news-flow over the next couple of months.

TK is well positioned to advance the Ayawilca zinc project over the coming 12 months. It is a good long-term play on zinc that we think eventually will be taken over by Buenaventura, its major shareholder.

TK is well positioned to advance its exploration-stage Ayawilca zinc project (Peru) over the coming 12 months, assuming that the government of Peru relaxes its COVID-19 restrictions in the not-too-distant future.

According to a PEA completed in mid-2019, at a cost of US$262M the Ayawilca project could be developed into an underground mine with average annual production of 220M pounds of zinc and 0.9M ounces of silver over a 21-year life. At a zinc price of US$1.20/pound the after-tax NPV(8%) and IRR are estimated to be US$363M and 27%, respectively, but changes in the assumed zinc price result in relatively large changes in the economics. In rough terms, a 10% change in the zinc price changes the after-tax NPV(8%) by about US$130M. For example, the NPV would be about US$230M at a zinc price of US$1.08/pound.

Zinc currently is languishing at a 3-year low in the low-US$0.90s, largely due to speculative selling precipitated by the belief that the coronavirus will lead to greatly reduced demand for the metal. We are intermediate-term and long-term bullish on zinc, so we view the virus-related sell-off as a buying opportunity. That being said, at the current low zinc price the Ayawilca project would not be viable. Therefore, right now TK should be viewed as a very long-dated call option on zinc.

We think that TK’s current option value is about C$0.24/share, or what the ‘smart money’ recently paid for significant stakes in the company. Applying a 50% risk-related discount to the figures in the PEA, we arrive at a very rough valuation for TK of C$0.70/share at a zinc price of US$1.20/pound. That is, in rough terms we think that a 30% increase in the zinc price would almost triple the value of a TK share. Consequently, due to our positive outlook for the zinc market we view TK as a good intermediate-term speculation near its current price.

The importance of the above-mentioned private placement cannot be overstated, because it indicates that Buenaventura is interested in eventually acquiring the Ayawilca project.

The aforementioned financing means that TK has become fully funded for at least the next 12 months at a very attractive price in the context of the current lousy market for base-metal explorers. Even more importantly, it signals that Buenaventura is interested in eventually acquiring TK’s Ayawilca zinc project.

This is not just a vote of confidence in the Ayawilca project from the smart money, it’s a vote of confidence from the smartest money and confirms that TK suits our modified approach to dealing with speculative resource stocks. Given that we no longer can rely on the periodic aggressive buying of the public to create excellent profit-taking opportunities in junior resource stocks and that ETFs are diverting investment away from the juniors and toward the stocks of larger companies, we want to focus our attention on the mining juniors that own mineral deposits of sufficient size and quality to be of interest to the mining majors.

TK offers incredible long-term value near its current market price, but due to the effects of tax-loss selling we suspect that it and many other beaten-down junior resource stocks will remain depressed until late-December. By the same token, TK and many similar stocks could rebound strongly coming out of the tax-related-selling season.

We think that TK is extremely under-valued near its current price of C$0.16/share, but at the moment the stock market is not interested in exploration-stage mining companies that are advancing large base-metal deposits. This will change.

This news is a small plus. The reported high-grade intercepts won’t expand the overall resource because they are within the boundaries of the existing resource. However, the discovery of additional high-grade zones within the existing resource could increase the mined grade and thus improve the projected economics.

With gold, silver and platinum having achieved major upside breakouts over the past three months, the stage is set for copper and zinc to begin trending upward in the not-too-distant future.

TK’s current working capital should be enough to fund the exploration and engineering of its 100%-owned Ayawilca zinc project in Peru until at least the end of this year.

We expect that the base metals sector will do very well over the next 12 months. As the holder of a large and potentially valuable zinc deposit in a reasonable location, TK should benefit. More patience is required with TK, but we expect that the patience will be handsomely rewarded.

According to the PEA, at a cost of US$262M the project could be developed into an underground mine with average annual production of 220M pounds of zinc and 0.9M ounces of silver over a 21-year life. At a zinc price of US$1.20/pound the after-tax NPV(8%) and IRR are estimated to be US$363M and 27%, respectively, but changes in the assumed zinc price result in relatively large changes in the economics. In rough terms, a 10% change in the zinc price changes the after-tax NPV(8%) by about US$130M. For example, according to the PEA the NPV would be about US$490M at a zinc price of US$1.32/pound and about US$230M at a zinc price of US$1.08/pound. The current zinc price is US$1.10/pound and over the past two years the price has ranged from US$1.05/pound to US$1.65/pound. We are intermediate-term and long-term bullish on zinc, so we view the Ayawilca project’s leverage to the zinc price as a plus.

Another plus is TK’s market cap relative to the project’s estimated NPV. TK has about 265M shares outstanding, so the market cap at Friday’s closing price of C$0.24 is C$64M (US$48M). This means that at the “base case” zinc price of US$1.20/pound, the market cap plus the initial capex (US$262M) is well below the NPV. This is what we like to see, as it implies that the company offers good value from the perspective of a potential acquirer.

On the negative side of the ledger, 78% of the resource included in the PEA is defined as “Inferred”. Inferred resources can be included in a PEA (a PEA is called “Preliminary” for a reason) but can’t be included in the more advanced engineering studies (PFS and FS). Therefore, TK will have to fund a lot of drilling over the coming 12 months to get to the point where the bulk of the resource is in the M&I category. That being said, the company had C$10.5M of working capital at 31st March and probably has about C$8M of working capital right now, so there should be no short-term need for an equity financing.

Taking into account the current zinc market environment and applying a 50% risk-related discount to the figures in the PEA, we arrive at a very rough valuation for TK of C$0.57/share. At a zinc price of US$1.32/pound our TK valuation increases to C$1.20/share. That is, in rough terms we think that a 20% increase in the zinc price would double the value of a TK share. Consequently, due to our bullish outlook for the zinc market we view TK as a good intermediate-term speculation near its current price.

The results of metallurgical testing usually don’t move the stock market unless they reveal a problem (mining projects that appear to have economic deposits can be rendered uneconomic by metallurgical issues). There were no significant negative issues apparent in the test results reported by TK last week.

The TK news we are waiting for with bated breath is the PEA for Ayawilca. The PEA is due this month.

TK’s current working capital should be enough to fund the exploration and engineering of its 100%-owned Ayawilca zinc project in Peru for at least another two quarters.

The next milestone is expected to be completion of the Ayawilca PEA. This is scheduled to happen within the coming month and will give us the first look at the project’s economic viability. Also, the company is in the midst of a 10,000m drilling program that is testing for the presence of high-grade zinc mineralisation in a limestone unit underneath the current resource and along-strike extensions of the existing resource.

TK’s current working capital should be enough to fund the exploration and engineering of its 100%-owned Ayawilca zinc project in Peru for another 3 quarters.

The next milestone is expected to be completion of the Ayawilca PEA. This is scheduled to happen by the middle of this year and will give us the first look at the project’s economic viability.

The first look at Ayawilca’s economics should arrive via a PEA in the second quarter of this year.

At its current price of C$0.31/share, TK’s market cap is about C$80M. It potentially will be valued at a multiple of this within the coming two years.