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Despite a strong rise in gold prices this year, Bluestone Resources (OTCQB:BBSRF) is trading at the same levels as it was in February. The company is advancing the development-stage Cerro Blanco gold-silver project in Guatemala, and this high-risk jurisdiction is the likely reason for investors’ hesitation to back the stock.
Who does back the stock, however, is the legendary Lundin family who has been building and selling mines in difficult jurisdictions for decades. We view the family’s involvement as the key reason that the project will get financed and built, with initial production on the near horizon. As a high-grade, low cost operation with 1.4 million ounces of gold, we see the current valuation as compelling from a risk/reward perspective.
Over the past year, Bluestone is up 40% and is trading roughly in line with the junior gold miners index (GDXJ). The company lags its peer group of near-term developers and projects going into construction. With production on the horizon at Cerro Blanco, we dive into the details.
One-year share price performance
Cerro Blanco: High Grade, Near-Term Producer
Cerro Blanco is a gold development project in Guatemala, and was previously advanced by Goldcorp (NYSE:GG) who invested over $230 million into the project before exiting the country after closing its Marlin mine in 2017. Goldcorp sold the Cerro Blanco project to Bluestone that same year for $18 million in cash and a 10% stake in the company.
A 2019 feasibility study on Cerro Blanco returned healthy economics, with an NPV of $454 million, a 55% IRR and 1.4 year payback on a capital cost of $196 million, assuming $1,600/oz gold and a 5% discount rate. Over the 8 year mine life, the project is expected to produce 113,00 ounces per year at $579/oz all-in sustaining costs (which is net of silver by-product credits).
If the price of gold were to fall, the economics still look reasonable: at $1,250/oz gold, the NPV(5%) is $241 million, along with a 34% IRR and 2.1 years payback.
We think a higher discount rate (8-10%) should be applied given the jurisdiction, which would lower the NPV. Looking at the sensitivity table in the feasibility study, applying a higher discount rate of 8% reduces the NPV at $1,250 gold by 20%. Making a rough extrapolation on the NPV at $1,600 gold, the NPV (8%) should be around $363 million.
The deposit presents several challenges, due to its narrow and complex vein structures, as well as the presence of high-temperature water underground that the company is planning to mitigate by diverting the water and generating electricity with a tandem geothermal plant on site. Through the feasibility study by JDS, the company seems to have accounted for these challenges; however, it is an added risk compared to more straightforward deposits.
Overall, the economics of the project appear robust due to the deposit’s high grade of over 10 g/t gold, which provides a margin of error for a higher risk project. If the resource grade was around 5-6 g/t gold, this project likely wouldn’t be feasible even at higher gold prices.
M&I resource grades of comparable companies (g/t gold)
(Source: Company presentation)
Fair Valuation Will Get Better as Project Goes into Production
As of the latest resource estimate from last year, Cerro Blanco contains 1.4 million ounces of gold (4.27 Mt at 10.3 g/t gold) in the measured and indicated categories. Taking the current market cap of $196 million and subtracting the net cash position of $58 million, the company has an enterprise value of $138 million. Currently Cerro Blanco is being valued at $99 per ounce, which is reasonable for a permitted, near-term producing asset with high grades.
Looking at the project’s NPV as above, taking the metal price of $1,600/oz (15% lower than today’s spot price), the company is trading at an EV/NPV between 0.3x and 0.4x, depending on the discount rate used. This is a reasonable level for a near-term developer, with the expectation that when Cerro Blanco is in operation the company should be trading in the 0.7x-0.9x range as a junior producer.
(Source: Company presentation)
This transition from developer to producer is typically one of the best entry points for a mining investor, as the initial run-up in share prices driven by speculators during the discovery and exploration phase gives way to the boring engineering, permitting and financing phase that Bluestone is currently in. New drill results, no matter how high grade, won’t move the needle for the share price; but as Cerro Blanco enters the construction phase, patient investors should be rewarded. If management can deliver on what’s forecast in the feasibility study, Bluestone will look cheap in retrospect and should offer a re-rating opportunity as it reaches its first gold pour.
There are several recent examples of this, from Pure Gold (OTCPK:LRTNF) to West African Resources (OTC:WFRSF), where no one cared about the stock for a long time until suddenly everyone woke up and realized they really were going to be producing gold, along with healthy profits at current prices.
Construction phase share price comparables
(Source: Company presentation)
The Lundin Group: Mining Royalty Mitigate Jurisdictional Risk
Bluestone is backed by the billionaire mining Lundin family, who are the biggest shareholders with 26% of the company. Jack Lundin, the grandson of family patriarch Adolf Lundin, took over as CEO of Bluestone earlier this year.
The Lundins know how to operate in difficult jurisdictions and put projects into production before eventually selling them. They’ve been doing it for decades, and we don’t think the eventual result will be different at Bluestone.
Most recently, Jack Lundin and his family of backers put the world-class Fruta del Norte mine in Ecuador into production. While Cerro Blanco is not close in terms of quality to Fruta del Norte, Ecuador is a good comparable for Guatemala and the hurdles that management will have to get over as it advances the project towards production.
Guatemala is a challenging and high-risk jurisdiction, highlighted by the issues at Pan American’s (NASDAQ:PAAS) Escobal mine which continues to sit idle after previous operator Tahoe Resources (NYSE:TAHO) lost the operating licence amid local opposition just two months after Bluestone acquired Cerro Blanco from Goldcorp. While it was operating Marlin, the first commercial-scale gold mine in the country, Goldcorp was dogged by issues with the local community and allegations of poor environmental standards.
With all of that in mind, the negativity towards the country among mining investors is fully warranted. However, this presents a buying opportunity for investors who are willing to take the risk to find undervalued opportunities while gold prices are near all-time highs. Many jurisdictions are challenging, but it does not mean that it is impossible for a company to gain social licence and operate successfully. What is required is a strong management team that can win the acceptance of local stakeholders.
A key differentiator for Bluestone is that it already has an exploitation mining licence for Cerro Blanco. With permits in hand, development at Cerro Blanco is slated to start this year when the company finalizes the financing package for construction.
Next Steps for Bluestone
The news flow has been a bit light from the company recently. Since a $70 million bought deal financing in April, the company has only had two news releases of note, and both were just reporting mostly infill drill results within the existing resource areas.
As a pre-construction developer, the COVID-19 pandemic has affected its timeline and pushed milestones out. The company is now looking at finalizing the project financing package in Q4 this year, starting initial construction in Q1 2021 with the goal of first production in 2022.
It is not uncommon for junior development companies to get bought out by larger producers as they ramp up through the construction phase; however, we see that scenario as unlikely for Bluestone. While trading at a reasonable valuation, the resource and production profile aren’t big enough for a big producer to take on the jurisdiction risk, and so we wouldn’t expect many potential acquirers to look at the asset until it goes into production and management can prove that it is able to maintain its social licence.
The best fit might actually be for Lundin Gold (OTCPK:FTMNF) to acquire Bluestone, with the single-asset producer adding a growth project to its portfolio now that Fruta del Norte is in commercial production. However, the Lundins may prefer to keep the companies separate, and Lundin Gold itself may be taken over by Newcrest (OTCPK:NCMGF) sooner than later.
Bluestone is a high-risk, high-reward opportunity, with a high-grade, near-term gold development project run by one of the best groups in the business balanced by the jurisdictional risks of Guatemala that have kept most investors sitting on the sidelines.
The biggest factor for Bluestone is the backing and leadership of the Lundin family, who has a strong track record of building assets like Cerro Blanco in countries like Guatemala, and ultimately selling them at the right time to secure wins for shareholders.
As Cerro Blanco moves towards production, the share price should wake up from its doldrums as the company enters the construction phase. There are a limited number of new gold projects going into production, and based on a reasonable valuation we see Bluestone as a compelling story compared to most of its peers that have enjoyed much stronger share price gains in recent months.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.