Lara Exploration is an Excellent Speculation

Matt Geiger believes that prospect generator Lara Exploration (TSXV:LRA) is a solid buy for patient investors

Matt Geiger | February 11, 2020 | SmallCapPower: Lara Exploration Ltd. (TSXV:LRA) is a prospect generator active in Brazil and Peru. Lara became the newest addition to the MJG portfolio when we first purchased shares at C$0.44 in November 2019. Our average cost per share now sits at C$0.49 after factoring in subsequent purchases

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In all honesty, I shouldn’t be writing about LRA at this juncture as we haven’t finished building our full position. However, I’m fired up about the company’s long-term prospects and couldn’t resist including it as the featured investment in this letter.

Lara simply makes sense for those of us comfortable investing in prospect generators. The company has a low burn rate, management ownership of 10%, a tight share structure, a comfortable working capital position, a sticky shareholder base, and very little speculative premium baked into the current share price.

Not to mention that Lara has exposure to two serious partner-funded drill programs over the next 12 months, a soon-to-be cash flowing royalty, and no need to finance for years to come. I should note that I’m hardly the first investor to vouch for Lara.

Mentors of mine such as Adrian Day, Paul Stephens, and Rick Rule have been long-time backers of Lara and CEO Miles Thompson. But I could care less about being first. I’ve been looking for the right opportunity to invest in Lara for a few years now, and I think the time is now right.

In this Featured Investment piece, I begin by providing an overview of Lara’s company history – with a focus on management experience, insider ownership, working capital, share structure, and financing history. We then take at a look at Lara’s overall project portfolio before delving into the company’s four most significant assets – a 30% free-carry to production at Planalto, a 2% NSR at Corina, a 30% interest in the Liberdade Copper Project, and a 2% NSR plus 5% ownership stake in the soon to be producing Celesta Copper Project.

Next, we review Lara’s expected milestones over the next couple of years, so readers can keep tabs on the company’s progress alongside me. Most significant is first royalty cashflow from Celesta expected later this year. We conclude with a discussion on why Lara offers attractive speculative value at its enterprise value, while also touching on the potential risks of investing in the company.

Lara Exploration was founded in 1997 by Miles Thompson as a prospect generator focused on Brazil and Peru. More than two decades later, the company is still laser-focused on this same mission – with the exception of two phosphate assets in Chile, the company’s entire project portfolio is comprised of assets located in one of these two countries. Miles remains at the helm as CEO and owns roughly 8% of the company himself.

As with any prospect generator, the quality of the people involved is the most significant variable. Miles is a geologist by training and plied his trade at Gold Fields (now the 9th largest gold miner in the world) before founding Lara. Miles has decades of exploration experience in South America, but ironically his claim to fame would occur in Serbia – where he led prospect generator Reservoir Minerals from a $1m company in 2009 to a C$512m acquisition in 2016.

Reservoir of course made the world-class Timok discovery along with earn-in partner Freeport-McMoRan. Reservoir was ultimately acquired by Nevsun, which in turn was acquired by Zijin Mining in late 2018 for C$1.8 billion. I followed this saga closely as the MJG partnership owned shares of Nevsun from mid 2013 until the Zijin takeover closed in late 2018. Reservoir Minerals will forever be a case study of the upside potential inherent in a properly executed prospect generation business plan.

Given that Miles is now focused exclusively on Lara, investors have an opportunity to bet on him repeating the trick in South America – which as mentioned is a jurisdiction where he has deep connections and decades of experience. There are only three other members of the Lara management team. Chris MacIntrye serves as LRA’s Vice President of Corporate Development and has tight relationships with Lara’s major shareholders. Chris played a similar role at Reservoir where he was part of the founding team, and he has now worked alongside Miles for over a decade now.

Michael Bennell (Vice President Exploration) and Helio Ikeda (Senior Geologist Brazil) round out the team by providing boots on the ground experience. Between the two of them, they have over six decades of experience in South America and have worked for companies such as BHP, Anglo, Vale, and Barrick. Mr. Ikeda has been with Lara since inception, while Mr. Bennell joined the company in 2007.

Despite Lara’s relatively long existence, the company has never done a share rollback and maintains a tight share structure (38.6m shares issued and 43.7m full-diluted). Lara has only conducted six financings in the fifteen years since going public in 2005, which is a testament to the company’s embrace of the prospect generation model as well as its low corporate overhead. Miles runs Lara as an owner-operator should – with the company spending less than C$100k per month on G&A. Lara’s working capital position currently sits at a comfortable C$2m.

More significantly, the company is expecting C$2.2m in partner payments over the course of 2020. Given that Lara has an expected all-in budget of only C$2m for 2020, the company is in the enviable position of potentially ending the year with more cash than it started with.

Given the working capital cushion, expected partner payments, and a soon to be cash flowing NSR at Celesta, Lara has no need to raise capital for the foreseeable future. This is one of the company’s strongest selling points in a junior sector that remains starved for capital. Overview of Project Portfolio Lara Exploration has exposure to twenty-one projects located almost exclusively in Brazil and Peru. Ten of these projects are 100%-owned and are actively being marketed to potential earn-in partners or acquirers.

Three of these projects (Planalto, Liberdade, and Lara) are subject to joint ventures with larger parties. Lara holds royalty interests over the remaining eight projects, including Celesta, Corina, Cumaru, Vertical, Picha, Ancash, Tocantins, and Bahia Inglesia.

These twenty-one projects are in various stages of development but none are yet in production. That will change this year at Celesta when partner Tessarema commences commercial production in Q3. Lara holds a 2% NSR covering Celesta, owns 5% of the asset, and will be receiving monthly US$100k payments for the next nine months. First royalty cashflow later this year is of course a significant catalyst for the company.

While each of these twenty-one projects have their own merit, there are four that stand above the rest in terms of significance to the company. The first is the Planalto Copper Project in Brazil, which the company considers to be its flagship asset. The second is Hochschild Mining’s Corina Gold Project over which Lara holds a 2% NSR. The third is the company’s 49% stake in Liberdade, which is embroiled in a lawsuit between Codelco and Vale.

And finally, there is the aforementioned Celesta Project just months away from commercial production. I will now provide color on each of these. Planalto Copper Project Lara signed an option agreement to purchase Planalto for US$500k in 2013.

The asset is located in the heart of the Carajás region in Brazil. Planalto is surrounded by two producing copper mines (Vale’s Sossego and Oz Minerals’ Antas) as well as three mines in development (Vale’s Cristalino, Oz Minerals’ Pedra Branca, and Tessarema’s Celesta). At the time of acquisition, the Lara team was already responsible for two discoveries in the Carajás region (Celesta and Liberdade) – so from day one Planalto seemed like a natural fit in the company’s portfolio.

Planalto hosts IOCG-type mineralization that is similar to both Sossego and Antas. After a few years of grassroots exploration work on the property, Lara management took the risky step of drilling the project on a 100%-basis in 2018.

I’m almost always against prospect generators drilling on their own dime, but in this case Miles’s decision was justified when the company announced a 284m intercept grading 0.48% copper and 0.05 g/t gold, including 130 meters at 0.88% copper and 0.09 g/t gold. This was an excellent intercept, particularly in an existing copper district.

The company leveraged these drill results into a joint-venture with Capstone Mining in late 2018 – where Capstone agreed to earn up to a 70% in the Project by funding exploration, feasibility studies and electing to finance, build and manage a commercial mining operation, with Lara repaying its pro-rata share of the production financing out of cash flow. In other words, a 30% free-carry to production which is undeniably an excellent deal for Lara.

In spring 2019, Lara and Capstone completed eighteen diamond drill holes for roughly 3100 meters total at Planalto. (Fifteen of the holes focused on the Homestead Target where Lara drilled previously, and three were scout drill holes testing a soil anomaly south of Homestead.) The results of this drill program underwhelmed the market as Lara was unable to replicate the grades from the initial program.

The good news is that earn-in partner Capstone Mining remained undeterred and, on November 4th, Lara announced that a 2000 meter diamond core program would be completed by year end 2019 – focused primarily on extensions of the Homestead Target “where copper-gold mineralization is already recognized to underlie an area with dimensions of more than 350m north-south and 350m east-west and is open down dip to the west of the current drilling”.

An IP survey is also in the works, which indicates that Capstone is thinking beyond the current drill program and is evaluating new targets elsewhere on the property. I’m expecting the assay results from this 2000m program to be reported in the coming weeks, likely sometime in February.

This has the potential to be a major catalyst for the Lara share price, but we’ll need to see significant intercepts of greater than 0.50% copper equivalent to get the market exited. Time will tell, but the key takeaway here is that Capstone seems to have long-term ambitions for Planalto irrespective of the results of this upcoming program. Lara meanwhile gets to share in any upside without spending another dime. Corina Gold Project The Corina Gold Project comprises a block of licenses totaling 8,300 hectares in the Antabamba region of Southern Peru. The project has been in the hands of Hochschild Mining since mid 2014 when Lara sold the property to a Hochschild subsidiary for staged cash payments of US$4.15m and a 2% NSR with no buyback provision. Lara has yet to receive the vast majority of the cash payments as only US$300k has been paid to date. However, the next of installment of US$350k is due by July 2020.

Corina is a low-sulphidation epithermal gold target. The land package is located a stone’s throw away from Hochschild’s Selene Mill and operating Pallancata and Immaculada mines. Pallancata, which sends its production to the Selene Mill, is expected to run out of ore within the next four years. A soon-to-be hungry mill is of course good news for Lara shareholders, as it gives Hochschild an incentive to advance Corina aggressively in the coming few years.

On October 1st, 2019, Hochschild announced results from its first ever drill program at Corina. The results were promising, particularly hole COR19010 which cut 16 meters of 6 g/t Au and 28 g/t Ag starting at 186m in depth. At just under 100 gram-meters, this is quite possibly an economic intercept and bodes well for the future of the project. In total, the program consisted of fourteen holes – with assay results from the final four holes still pending release.

Hochschild has signaled that it will be busy at Corina over the next twelve months. The company is currently in the process of permitting no less than 33 drill pads at Corina and it is anticipated that Hochschild will commence a Phase 2 program in Q3 2020. The size of this program remains to be seen, but it looks like it will be substantial given the drill pad construction.

This upcoming drill program provides another exciting near-term catalyst for LRA shareholders. Liberdade Copper Project Like Planalto, the Liberdade Copper Project is an 8,491-hectare license located in the Carajás region of Brazil. Liberdade has the potential to become a company-maker for Lara but remains embroiled in a seemingly endless legal fight between Codelco and Vale.

While at this point the market has written off Liberdade entirely, a positive resolution to the legal dispute would be a game changer for Lara. Liberdade was originally staked by Lara in 2007. After conducting a program of reconnaissance level mapping and sampling, Lara announced in October 2010 that the Chilean copper giant Codelco had signed an earn-in agreement to acquire a 75% interest in the property for US$3m in expenditures and the requirement to define a minimum resource of at least 500,000 tons of copper equivalent.

Codelco was drilling the property within a year and shortly thereafter announced that hole LBCD-02 had intersected 197m of 0.72% copper equivalent from a depth of 49m at the Fortuna target. This appeared to be a bonafide discovery hole, and this was confirmed when hole LBCD-06 intersected a further 128m of 0.75% copper equivalent in a 650-meter step out on the same geophysical and geochemical anomaly. Codelco put its foot on the gas pedal and completed several additional drill programs.

By 2013, Codelco had spent the US$3m necessary to earn a 51% interest in the project. However, this is where the trouble begins. In July 2013, Codelco requested a standard three-year extension to the exploration license that it had acquired from Lara. At this point, Vale came out of the woodwork and complained to the Brazilian Department of Mines that it had a license covering the Liberdade Project dating back to 1986 that was still valid. A lawsuit ensued and the case has been held up in the Brazilian federal courts ever since.

Without opining too much on an ongoing court case, I can confidently say that Vale would not have brought this suit had there not been an economic discovery made at Liberdade. I will also note that it is curious that Vale allowed Codelco to drill for a couple of years at the project before making its claim. But regardless of the merits of the case, Lara, Codelco, and Vale remain at the mercy of the Brazilian federal court system as this war of attrition grinds on. If there is a silver lining for Lara, it is that the company does not have to bear the costs of the litigation.

Understandably, Lara management is mum both on the timing of a potential decision and the likelihood of Codelco (and hence Lara) winning the case. My expectation is that we will see the long-awaited resolution sometime within the next twenty-four months. Were the decision to go Codelco’s way, one could reasonably expect the LRA share price to double on the back of the positive news. Conversely, a win for Vale is unlikely to have a significantly negative impact on the Lara share price as the market has largely forgotten about Liberdade after seven long years of litigation.

Perhaps the company’s most important asset is a 2% NSR and 5% ownership stake in Tessarema’s soon to be producing Celesta Copper Project. Celesta (previously known as Maravaia) is a small, high-grade copper deposit in late-stage mine construction. Mining will initially focus on the Osmar target, which has an Indicated Resource estimate of 2.14 million tonnes and average grades of 4.2% copper and 0.66 parts per million gold.

Like Planalto and Liberdade, the project is located in the Carajás region of northern Brazil. Celesta was initially expected to go into commercial production in late 2018. However, Tessarema missed this deadline due to a combination of construction delays and a funding shortfall. This triggered a US$1m “late penalty fee” due to Lara, which was stipulated in the original option agreement. At this point, there was legitimate concern of whether Tessarema would be able to dig itself out of its financing hole or whether the project would be returned to Lara.

This outcome would be a losing proposition for both parties – Tessarema would lose its investment while Lara would be stuck with a construction stage project rather than a monthly royalty check. Thankfully, the well-respected metals trading house Ocean Partners stepped in to save the day by agreeing to lend Tessarema US$2.6m to fund upgrades to the plant, pre-stripping, and mine infrastructure in return for a life-of-mine offtake.

As its pound of flesh, Lara was able to obtain a 5% project ownership stake in addition to its 2% NSR. Furthermore, Lara started receiving its late fee in US$100k increments beginning in December 2019. The company will be paid the remaining US$900k over the coming nine months. On December 2nd, Lara provided a timely progress update on Celesta. The company announced that “development work in recent months has been focused on dewatering and a cutback of the Osmar pit and stripping to access the mineralized material.

This work is expected to be completed by year end in preparation for mining during the first quarter of 2020.” In other words, first production at Celesta can be expected as soon as this quarter – with commercial production to follow in Q3.

While Celesta is not a potential company-maker like Planalto, Corina, or Liberdade, Lara’s 2% NSR will soon become the company’s first cash flowing royalty. This makes it a very important asset for Lara for a couple of reasons.

First, the annual cashflow from Celesta is expected to be in the ballpark of US$750k per year. Remember that Lara’s corporate overhead is only ~C$1m per year, which means that the royalty checks from Celesta will cover 75% of the company’s corporate expenses.

The implication is that Miles and Chris can now go years without having to raise a single dollar, which again is exceptionally rare for a C$20m junior. The second reason is more speculative. Assuming Miles is up for it, Lara Exploration has the opportunity to become a legitimate royalty company over the coming 5-10 years. Commercial production at Celesta is the first step in this direction.

The process will by no means happen overnight, but I see a path where the 2% NSR at Corina begins cash flowing within the next 4-5 years and the 30% interest at Capstone is eventually traded for a 3-5% NSR. Add 1-2 NSR purchases to the organically generated ones, and Lara has itself a nice royalty portfolio. We’ll see whether the company ultimately heads this direction – for the time being, all eyes will be on EMX Royalty (NYSE: EMX) to see whether it is able to successfully make the transition from prospect generator to a proper royalty business valued on a P/CF basis.

Upcoming Milestones

I’ve provided below the Lara milestones that can be expected over the coming twenty-four months. The most significant near-term catalyst is drill results from the recently completed 2000 meter program at Planalto. These can be expected in February. Just as important is the announcement of commercial production at Celesta expected later this year, which will mark first cashflow for Lara from an organically generated royalty.

  • Drill results at Planalto (2000m) by end February 2020
  • First copper production at Celesta by end Q1 2020
  • Final US$100k payment received from Tessarema by end September 2020
  • Commercial production at Celesta by end Q3 2020
  • Drill results from Hochschild at Corina (33 drill pads) by end 2020
  • Resolution to Codelco/Vale lawsuit at Liberdade by end 2021

Conclusion

Unlike past MJG Featured Investments such as Golden Valley Mines, Lara should not be considered through a deep value lens. Instead, an investment in Lara at its current C$22m enterprise value is a rational speculation on the company’s maturing project portfolio. Lara’s 30% free-carry at Planalto, 2% NSR at Corina, and 49% interest at Liberdade each on their own have the potential to be worth multiples of Lara’s current market capitalization.

While we wait for each of these stories to play out, Lara shareholders can be rest assured that there will be no dilution for the foreseeable future – thanks to the company’s low burn rate, healthy working capital position, expected partner payments, and the soon-to-be cash-flowing royalty at Celesta.

Furthermore, let’s not forget that Lara also has ten 100%-owned projects that are actively being marketed to potential earn-in partners or acquirers. CEO Miles Thompson has a substantial rolodex after his multi-decade experience in South America and the recognition he’s garnered from the resounding success of Reservoir Minerals.

Lara shareholders can expect new parties to come to the table in the coming months and years. Prospect generation is a game of volume – the more shots on goal, the better the odds of scoring.

While I clearly have high hopes for Lara, the investment does not come without risk. Lara’s working capital position only covers 8% of the company’s fully-diluted market capitalization, which is much lower coverage than most of our holdings.

This suggests that were we to go into another nuclear winter for mineral exploration like we saw between 2011-2015, the Lara share price would be more exposed than would the share prices of the aforementioned Golden Valley Mines or EMX Royalty. It’s also worth noting that three of Lara’s four most significant assets are located in Brazil, which exposes LRA investors to political risk.

Jair Bolsonaro’s administration has been very friendly to mining since assuming power early last year, which bodes well for Lara’s activities in Brazil over the next few years. But long-term Lara shareholders have an obligation to keep tabs on the political situation in Brazil – with a close eye on the next general election scheduled for October 2022. Even with these risks in mind, Lara shares provide excellent speculative value at the company’s current valuation.

After all, Miles and Chris sold a prospect generator for C$512m less than four years ago. Here’s an opportunity to invest alongside them at a reasonable valuation as they try to repeat the trick with Lara. With two serious partner-funded drill programs over the next 12 months, a soon-to-be cash flowing royalty, and no need to finance for years to come, Lara is a solid buy here for patient investors.

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