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Addicted to Cardero Resource



December 14, 2011 – Comments (0) | RELATED TICKERS: CDYCF

Location: TMFSinchiruna's CAPS Blog

Author: TMFSinchiruna

I have a problem that I have no intention of fixing. I believe it's a benign addiction, but no matter how many shares of Cardero Resource I amass, my desire to acquire more is never sated. It has rapidly grown into my third-largest equity position, and I'm not sure I have the will power to stop myself from continuing to build my stake so long as the stock remains at these unseemly valuations. Even when I set out to raise my cash allocation within my portfolio as I did recently, I find myself returning to the trough for more shares. The fact that this is primarily a met coal play rather than a precious metals play may pique the interest of my readers, though it is very much in keeping with my ceaseless reminders to members of this community not to underestimate the bullish long-term potential of the met coal market. One of my junior met coal plays has already paid of quite nicely, with a quick 40% return on my Grande Cache stake after the company was taken out last month. But I believe that is child's play compared to the potential upside from Cardero Resource.

The last time I suffered from an addiction of this sort, I was acquiring shares of Great Panther at $0.60, $0.70, and $0.80 per share until it was by far my largest holding, and as you can well imagine that prior addiction had a dramatic positive impact upon my investment portfolio, as I know it did for the portfolios of many of my readers as well. Although of course I can not guarantee that every particularly bullish recommendation I issue will enjoy similar results, I will say that this one has me as excited as I've been about a stock in quite some time. Within this blog post, I will endeavor to convey my perspective on Cardero's story, and my investment rationale. Please recall that no single blog post can ever replace the due diligence process that each investor must construct on their own before determining whether a stock pick is right for them, but at the same time I view this community as a tremendous shared resource by which we can trudge through much of that process together.

With that said, let me get started explaining why I think Cardero Resource has some powerful multi-bagger potential that keeps me busy adding shares at every opportunity.

A Brief Overview:

Cardero Resource has served as the parent company for a wide range of resource-focused endeavors over the past 12 years, and prior to the recent restructuring to focus its efforts squarely in the direction of metallurgical coal, the founding management had already proven its capacity to add value and monetize assets through the $100 million sale of the company's Pampa de Pongo iron ore deposit in Peru (completed in early 2010). Cardero had purchased the asset 6 years earlier for less than $1 million!

Cardero made its next transformational move in June of 2010 with the acquisition of a 49.5% stake in Coalhunter Mining Corporation, which in turn held a 75% interest in the Carbon Creek met coal deposit within British Columbia's coveted Peace River Coal Field. The Carbon Creek deposit had been known to the industry for quite some time, with exploration on the property dating back to at least 1909, and substiantial work carried out by a company called Utah Mines prior to 1981. More recently, the deposit was subject to a protracted legal dispute over ownership that Coalhunter founder Michael Hunter worked to resolve by early 2010. Through those negotiations, Coalhunter acquired its 75% stake in the asset. Cardero pounced on the opportunity shortly after that resolution, and then issued shares to acquire the remainder of Coalhunter earlier this year:

Michael Hunter initially came on as President of Cardero, and more recently took-on the role of CEO. To Cardero shareholders like myself, Cardero's brisk transformation from a diffuse agglomeration of unrelated resource plays into a very honed strategic focus upon metallurgical coal signaled the inevitable coming of a multi-bagger growth spurt like a thousand trumpets. But the market remained mute, seeming unable to make sense of the company's story even as that story became impossible to misconstrue. As an investor, I am thankful for such glaring failures of the market as a pricing mechanism, since it rewards the careful observer with truly outstanding opportunities to enjoy portfolio-transforming gains. I am thankful, furthermore, that I have this opportunity to bring the stock to the attention of my community of investors before the onset of what I believe is an inevitable breakout to the upside.

At the heart of the market's ongoing confusion, I believe, is Cardero's retained portfolio of non-core projects and equity investments that do not fit neatly into analysts' preconceived notions of what a focused met coal play looks like. In addition to Cardero's core Carbon Creek and (recently added) Trefi met coal deposits in British Columbia's Peace River Coal Field, the company also dabbles in: iron ore assets in Ghana (the Sheini Hill iron ore project) through a trio of proposed joint ventures, an iron sands project in Peru (Pampa el Toro) that will soon be 100% owned, and a pair of promising iron / titanium deposits in Minnesota called Longnose (option to acquire 85%) and Titac (100%-owned). Drill results from those deposits have been very solid, and an initial resource is imminent to follow-up on BHP Minerals' historical characterization of Longnose as "the largest known ilmenite resource in North America".

Cardero recently optioned its Organullo gold project in Argentina to Artha Resources, but Cardero retains a right to retain a 45% interest in the project.

Cardero had previously optioned its Pirquitas silver project (partially surrounding Silver Standard's mine of the same name) in 2008 to a company called Davcha Resources, whereby Davcha could earn a 55% interest. Those options later transferred to Artha Resources.

Cardero optioned a trio of silver/lead/zinc properties in Mexico to Ethos Capital in 2008, whereby Ethos earned a 70% interest. Of those 3, Santa Teresa has become one of Ethos' primary targets in Mexico.

And this entire motley assortment of projects and optioned properties is completely apart from an array of recource equity holdings that themselves demand their own chapter of due diligence. We'll dig into those a bit deeper when discussing Cardero's valuation later, but for now here is the list:

International Tower Hill Mines (THM)

Trevali Mining (TREVF)

Wealth Minerals (WMLLF)

Dorato Resources (DRIFF)

Indico Resources (IDIFF)

Balmoral Resources (BALMF)

Corvus Gold (CORVF)

Abzu Gold (ABZUF)

Ethos Capital (ETHOF)

The largest holdings according to market value are, by far, International Tower Hill Mines (nearly 4m shares worth $17.2m) and Trevali Mining (11.2m shares worth nearly $9.3m). As of today, the combined equity portfolio alone carries a market value of $31.8m, or a full 31.8% of Cardero's puny $100m market cap.

Because of all these "extras", I suspect Cardero's met coal story is getting lost in the noise, but I do not expect that condition to last. These extras are non-core assets that either have been or likely will be partially or completely monetized in due course to fund fast-tracked development at Carbon Creek and Trefi. Cardero's assets in the Peace River Coal Field are as sweet as they come, and just yesterday as I began drafting this post, the company released a preliminary economic assessment for the Carbon Creek deposit that crystallizes the significance of the deposit and clears the way for fast-tracked development.

Carbon Creek: A Gem of the Peace River Coal Field

Any Fools who paid attention to my article linked beneath the first paragraph above will by now possess an understanding of the rash of consolidation taking place throughout this prolific strip of high-quality met coal strewn along British Columbia's northern extension of the Rocky Mountains.


Larger image:

Just within the past year or so, we've seen Walter Energy snatch up Western Coal's assets in the area within its $3.24 billion acquisition. Xstrata paid $153 million for First Coal, which in turn was a company previously founded by the man behind the present opportunity: Cardero President & CEO Michael Hunter. AngloAmerican's coal subsidiary recently bought out its partners to control 100% of the operating Trend Mine and nearby development projects at Roman Mountain and Horizon. Anglo also holds a 50% stake in a partnership with Walter Energy that controls a significant stretch of properties extending down to the Alberta border.

In October, Xstrata purchased the Lossan deposit from Cline Mining (my 2nd favorite met coal vehicle) for $40m to extend the scope of its holdings acquired from First Coal. Teck Resources is muling a possible re-opening of its Quintette mine south of Rio Tinto's holdings in the area. Grande Cache's properties, recently the target of a $1 billion all-cash deal, are across the border in Alberta in the Smoky River Coalfield. But broadly speaking the deposit occurs along the same backbone of the Canadian Rockies, and so it too forms part of the larger story regarding global recognition of the strategic significance of Western Canada's met coal resources.

It is within that context that I encourage you to consider the value of Cardero's Carbon Creek and Trefi deposits.

Yesterday, while I was busy drafting this very post, Cardero released a preliminary economic assessment of the Carbon Creek deposit. The project as proposed now carries a net present value of $752 million (after-tax) with a discount rate of 8%! The 29.9% IRR documents the robust profitability of the proposed operation using conservative price assumptions, while prices closer to recent market reality would an IRR of more than 46% (with a corresponding NPV of $1.75 BILLION!)

Just as importantly, the resource expansion achieved through this assessment was truly enormous. Measured and Indicated resources just ballooned by 46% from 114Mt to a very meaningful 166.7Mt.

Note: the proportion of MINEABLE coal resources to the larger in-situ figures that typically confound coal investors is very high here at Carbon Creek. Of the 166.7Mt in M&I in-siru resource, 137Mt is classified as mineable under this PEA (82% minebale / in-situ) In contrast, Xstrata's recently purchased Lossan property contained in-situ resources of some 240Mt M&I, but per Cline's feasibility study the mineable reserves were only 14Mt. The $40 price tag looked well out of place when staring at a 240Mt figure, while in relation to the 14Mt mineable the transaction implies a reasonable sales price of $2.86 per ton.

If one were to apply that implied market value, then, to Cardero's 137 Mt mineable M&I resource at Carbon Creek, we arrive at a price tag approaching $400 million (100% basis) without breaking a sweat. Complex distinctions in coal quality and characteristics make such comparisons on a per-ton basis problematic, but between Carbon Creek's far more meaningful scale of mineable resources and my understanding of the deposits favorable characteristics, I would expect Carbon Creek's coal to demand a per-ton premium over the example of Lossan. Did I mention that Cardero's entire market capitalization stands at $100m (including all those "extras" outlined above)?

Here is Cardero's PEA for Carbon Creek released yesterday. The market's anemic response was such a joke! But there again, I'm glad the shares didn't double overnight, because I want my readers to have an opportunity to assess the company and consider climbing aboard for the ride.

I have enjoyed speaking with Michael Hunter during a pair of conference calls over the past several months, and the latest call occured just after Cardero announced the letter of intent to acquire the Trefi deposit. Trefi is about 60km from Carbon Creek, and roughly equidistant to the relevant infrastructure lkike the proposed rail loadout on the existing rail line, highways, electricity lines, etc. This is an attractive strategic bolt-on that further raises the caliber of Cardero's holdings in the Peace River Coal Field. Additional work is required to determine the extent of mineable resources at Trefi, but already the property boasts an in-situ resource of 39.1Mt M&I and 51Mt inferred.

Without wishing to back Mr. Hunter into a corner so soon after the Trefi acquisition, I will speak in general terms and suggest merely that Trefi offers the potential to meaningfully expand Cardero's annual output from the 2.9Mta envisioned for Carbon Creek by the recent PEA. Once Trefi is added to the picture, I can foresee Cardero reaching combined annual output easily surpassing Western Coal's entire Canadian output for fiscal 2011:

I have so much more I'd like to say about Cardero, but due to time constraints I will have to hold-off for now. I intend to spell out the valuation equation in a separate post, but I suspect you will all see the glaring disconnect for yourselves with even a cursory examination of the company's assets. I can tell you I have considerable confidence in Mr. Hunter following the pair of conference calls in which I've participated. This is a guy who knows these deposits inside and out, and I find his strategy for bringing them into production on a fast-track basis well formulated and strategically sound. Carbon Creek had extensive pre-permitting legwork completed during the 1970s by prior owner Utah Mines, so a substantial set of baseline data exists to facilitate the present permitting process. Take a look at International Tower Hill Mines and Trevali Mining, and conduct some DD to determine whether you believe Cardero's major equity holdings in those 2 companies are apt to bear fruit. I have some further homework to do myself with respect to previously optioned properties like those discussed above, but that too can be considered "extra" homework since the investment case for Cardero can be made exclusively based upon the met coal assets.

I intend to continue building my position in Cardero, since I can not fathom a scenario whereby the stock fails over the long haul to more reasonably reflect the value of its assets (both met coal and otherwise). Likewise, the company's capacity (and provern ability) to strategically monetize the non-core assets over time leaves me utterly confident in the company's ability to generate and raise the funds necessary to construct the mine at Carbon Creek. A worst-case scenario, in my view, would be a premature and undervalued hostile takeover by one of the major consolidators active in the Peace River Coal Field, though I would consider the assortment of non-core assets a potential defense against such unwanted advances. But even in such a worst-case scenario, investors climbing in at these levels would net a cozy gain.

I recommend shares of Cardero Resource, without reservation, and characterize the current share price as a phenomenal investment opportunity. I have no problem envisioning the stock at several multiples of the current price as Carbon Creek progresses through feasibility, permitting, and construction over the next couple of years. Analysts are beginning to discover the story as well, so I do not expect the stock to remain overlooked for very long.

Please enjoy completing due diligence on the investment opportunity I have outlined above, and please be sure to share the findings of that process with your fellow investors in this and future blog posts about Cardero. Good luck, Merry Christmas, and best wishes for another multi-bagger bonanza like the ones we've enjoyed together in the past. While of course I can't guarantee that outcome, I can tell you that I for one am 100% convinced of its uncommonly strong potential.

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