Scarsdale Equities LLC Member FINRA, SIPC
Alexco Resource Corp. is amending their agreement with Silver Wheaton Corp. to become a low-cost producer of silver. An expanded mining operation at Keno Hill may rival the length of activity of earlier operators which lasted for decades. We are initiating coverage with a Buy rating. Investment Conclusion Alexco Resource Corp.’s environmental remediation abilities qualified it to acquire Yukon’s Keno Hill silver district. A silver stream agreement with Silver Wheaton Corp. allowed them to rapidly commence silver production ahead of the competition. Operations were suspended due to low metal prices and a high operating cost profile which is being corrected. Summary
•Keno Hill Operations Significantly De-risked: Alexco optimized operations at the Keno Hill mill, outpacing throughput from Bellekeno, its sole operating mine. Following suspension in mid-2013, Alexco acquired an additional ball mill, permitted the Lucky Queen and Onek mines, expanded a resource at Flame & Moth, completed a PEA increasing mine throughput from three mines, and prepared to amend the agreement with Silver Wheaton. •Significant Near-term and Blue Sky Exploration Potential: Alexco is defining extensions of deposits at Bellekeno, Lucky Queen and Flame & Moth. Additional resources may be added at the Onek and Silver King deposits, with blue sky exploration including Bermingham, and extending along a seven kilometer corridor from Flame & Moth to Sadie Ladue. •Accomplished Management Team: Alexco’s management team built and operated a mine at Keno Hill, and benefits from mine building, operating, and mine closure and remediation experience in Yukon. The team has integrated its wholly owned Alexco Environmental Group (AEG) into permitting and remediation at Keno Hill and elsewhere in the Americas. •Catalysts for Company Stock Price Appreciation: Catalysts for appreciation include restarting production at Keno Hill and emerging as a low-cost operation under the amended silver stream agreement with Silver Wheaton. Cash flow from three mines feeding Keno Hill operations, plus Alexco Environmental Group, projects a positive financial profile. The company is positively leveraged for higher metal prices and improving investor sentiment for resource stocks. We are initiating coverage of Alexco with a Buy rating and price target of US$2.00 per share based on a sum-of-the-parts analysis.
Mike Niehuser Analyst 1 (503) 922-3191
[email protected]
Alexco Resource Corp. September 8, 2014
NYSE MKT: AXU TSX: AXR
Rating: Price Target:
BUY US$2.00
Price (9/8/14): 52-Week Range: Cash (M)*: Debt (M)*: Market Cap (M)*: Enterprise Value (M)*: Shares Out. (M)(1) Shares Diluted (M) Q2 2014 Rev: FY13 Rev:
US$0.90 US0.91-2.27 C$6.3M C$ 0.0M C$62.3M C$56.0M 62.6M 66.5M C$ 3.2M C$59.4M
Stock Performance
Source: Bloomberg
Company Description Alexco Resource Corp. is headquartered in Vancouver with offices in Toronto, Whitehorse and Denver. Their flagship asset is the Keno Hill silver district in Yukon. The company’s wholly owned Alexco Environmental Group provides mine permitting, closure and remediation services in the Americas.
See Page 24 for analyst certification and important disclosures. Scarsdale Equities does and seeks to do business with companies covered in research reports. Investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report.
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining
Investment Thesis Alexco Resource Corp. (NYSE MKT: AXU, TSX: AXR) has taken the necessary steps to resume production at its 100% owned Keno Hill silver district and emerge as an entirely new project. Since mine suspension in the second half of 2013, Alexco has significantly de-risked the project and improved its ability to operate profitably at current metal prices. The company has expanded silver resources each year since acquiring the district in 2006, net of producing 5.6 million ounces of silver since 2011. Alexco has benefited from modern mining and exploration techniques, as well as from having scanned over 100 GB of maps and 2 GB of historic data, making possible the district’s first comprehensive modern geological assessment. The combination of a lower-cost structure, drawing ore from three separate mines, and processing through an optimized mill operation, has the potential to rival the long-lived operations of the United Keno Hill Mines (UKHM), which produced 217 million ounces of silver between 1921 and 1988. Keno Hill Silver District, Yukon, Canada
Source: Alexco Resource Corp.
The most recent and important improvements to reducing operating costs at Keno Hill include agreeing to amend the silver stream agreement with Silver Wheaton Corp. (NYSE, TSX: SLW). The amendment revises the original agreement, converting payments for silver from a flat cost per ounce to a sliding scale, based upon current spot prices. Alexco has agreed to pay US$20 million for the amendment, due by the end of 2014, for a period of ten years, starting at the recommencement of delivery of silver concentrate to the smelter. The amendment is immediately accretive to Alexco, net of the cost of the payment to Silver Wheaton, at current spot metal prices. Silver Wheaton benefits from the potential resumption of silver production at Keno Hill and the up-front payment. Prior to the concluding negotiations to amend the agreement with Silver Wheaton, SRK Consulting (Canada) Inc. produced an updated Preliminary Economic Assessment (PEA) for Alexco. The PEA focused on recommencing mining at Bellekeno with the addition of mining at Lucky Queen and Flame & Moth. (It was determined to place Onek, a permitted high-grade zinc mine, on hold subject to higher zinc prices.) The PEA also took into account the installation of a second ball mill that Alexco acquired in 2013. The PEA forecast increased mill capacity to 430 tpd, sufficient to meet
2
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining the 400 tpd completion test with Silver Wheaton. As amended, this test must be met two years from recommencing production. The PEA assumes a restart date at Keno Hill in the second quarter of 2015. Acquired Ball Mill at Keno Hill Mill Ready for Installation
Source: Analyst.
Prior to the concluding negotiations to amend the agreement with Silver Wheaton, SRK Consulting (Canada) Inc. produced an updated Preliminary Economic Assessment (PEA) for Alexco. The PEA focused on recommencing mining at Bellekeno with the addition of mining at Lucky Queen and Flame & Moth. (It was determined to place Onek, a permitted high-grade zinc mine, on hold subject to higher zinc prices.) The PEA also took into account the installation of a second ball mill that Alexco acquired in 2013. The PEA forecast increased mill capacity to 430 tpd, sufficient to meet the 400 tpd completion test with Silver Wheaton. As amended, this test must be met two years from recommencing production. The PEA assumes a restart date at Keno Hill in the second quarter of 2015. The PEA relied on a portion of existing resource estimates in late 2013 from the Bellekeno, Lucky Queen and Flame & Moth deposits. Alexco has approximately C$2.5 million in cash remaining from flow-through financings which is restricted to exploration to complete its C$5.0 million 2014 drill program at Keno Hill. Alexco recently increased its exploration target for 2014 to 14,000 meters of drilling from 10,500 meters, within the original budget, focusing at several targets in the vicinity of Flame & Moth. While the PEA outlines a 5.5 year mine plan based on previously identified resources prior to 2014, not all of the resources are included in the mine plan, and all three deposits remain open to expansion. Alexco has a record of increasing resources, net of production, and has additional exploration planned for 2014. This has the potential to extend the term of operations well beyond that assumed in the PEA. Alexco is institutionalizing other cost-saving measures. This includes acquiring heavy equipment from contract miners, renegotiating third party contracts, and moving away from a “fly-in fly-out” mine operation toward self mining with local personnel. Alexco is also assuming leadership in Yukon in the formation of the Centre for Northern Innovation in Mining to expand the pool of skilled labor in a wide range of essential support services. While these initiatives are anticipated
3
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining to offset increases in variable costs, the cost of production is expected to be reduced due to the increase and consistent flow of ore to the mill. Alexco forecasts a reduction in cost per ounce of silver closer to $16 per ounce, its own estimated future AISC incorporating project and administrative costs, which it believes, should be competitive with lowcost silver producers. Alexco continues to benefit from an increasing contribution from its wholly owned Alexco Environmental Group (AEG). It was the mine operating, closure and remediation capabilities of Alexco’s management team that qualified it as the company of choice to acquire the Keno Hill silver district from the government out of bankruptcy. Alexco has the opportunity as the sole-source provider to complete environmental remediation in the district, while completing exploration and mining, with no exposure to liability from previous mining activities. We believe the combination of exploration, mining and reclamation capabilities positions Alexco for success at Keno Hill well into the future. Shares of Alexco are currently selling below book value, which may be attributed to the current suspension of operations, and the required financing to complete the amended agreement and resume production. The agreement with Silver Wheaton is to be completed in 2014 with a payment of US$20 million, of which Silver Wheaton has agreed to participate up to US$5 million in any equity offering. The PEA estimated an initial capital requirement of C$13 million to complete development and commence production. In addition, Alexco estimates that it will need an additional C$12 million for working capital. We may assume that the financings will be staged, capitalizing on catalysts of concluding the amended agreement with Silver Wheaton, and taking positive steps toward resuming production, including favorable exploration results in the vicinity of Flame & Moth through the second half of 2014. Assuming stable or improving metal and capital markets, we see the potential, even with dilution, of doubling the current stock price over the next year. Alexco’s Current Situation at Keno Hill Summary of the Original and Amended Silver Stream Agreement with Silver Wheaton The original silver stream agreement between Alexco and Silver Wheaton was completed in 2008. Silver Wheaton paid Alexco US$50 million, providing the necessary capital to construct the Keno Hill mill and commence mining at Bellekeno. The agreement was limited to 25% of the payable silver produced at the Keno Hill silver district, whereby Alexco would sell the silver to Silver Wheaton for US$3.90 per ounce. In addition, Alexco was required to meet a completion test for production throughput at the mill at 400 tpd over a 30-day period ending June 30, 2015. Alexco retained the rights to the remaining silver production and 100% of other metals. The agreement allowed Alexco to rapidly move into production, bypassing bank required technical reports, along with customary dilution and hedging. Alexco’s decision to complete the silver stream agreement accelerated development of the Bellekeno mine and Keno Hill mill during a period of increasing metal prices and capital costs. The arrangement also allowed Alexco to rapidly move ahead with permitting and secure limited available power capacity in Yukon. As the agreement on Keno Hill was Silver Wheaton’s first transaction on a development stage project, this was an aggressive decision, displaying, in our opinion, a great deal of confidence in Alexco’s management team and the long-run potential for silver production at Keno Hill. (In addition, it is noteworthy that the resource at Bellekeno consisted of only an inferred resource of 38.4 million silver equivalent ounces).
4
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining
The Amended Silver Purchase Agreement The amended silver purchase agreement establishes a new “variable production payment curve” based on the spot price of silver. The revised payment varies between a maximum of US$18.00/oz and a floor of US$3.90/oz (and continues to be limited to 25% of the payable silver produced at Keno Hill). Under the amended agreement, Alexco is required to make a US$20 million payment to Silver Wheaton by the end of 2014 (of which Silver Wheaton has agreed to participate up to US$5 million of an equity raise). The amended agreement will be for a period of ten years with the option for Alexco to extend the term for an additional five to ten years, for an additional payment of US$10 to US$20 million, respectively. Alexco also agreed to expand the area of interest an additional kilometer outside of Alexco’s holdings at Keno Hill at the time of the original agreement. This takes in potentially valuable extensions of the developing Flame & Moth resource. Silver Wheaton also agreed to defer the 400 tpd completion tests until two years following the resumption of operations at Keno Hill. The variable production payment curve provides Alexco relief at current price levels, with additional protection at even lower silver price levels. At a spot price of US$19.45/oz silver, Alexco receives the maximum payment from Silver Wheaton of US$18.00/oz (which is significantly higher than the fixed US$3.90/oz payment agreed to in the original agreement). For each US$1.00/oz change in the spot price of silver, the payment amount either increases or decreases by US$0.91/oz. If the spot price decreases below a spot price of US$19.45/oz silver, the payment declines US$0.91/oz for each US$1.00/oz change in the spot price, down to a minimum of US$3.90/oz (continuing to provide at least some price protection to Alexco without penalizing Silver Wheaton). Should the spot price increase above US$19.45/oz, the payment will also decline US$0.91/oz for each US$1.00/oz change in the spot price, down to a minimum of US$3.90/oz at a maximum spot silver price of US$35.00/oz (allowing Silver Wheaton to share in the benefit of higher silver prices up to a level included in the original agreement). In summary, the US$20 million payment allows for the resumption of silver production at Keno Hill at current metal prices and provides Alexco some protection against lower silver prices. In addition, the amended agreement is favorable at higher prices up to a spot silver price of US$35.00, at which the amended silver purchase agreement matches the payments under the original silver purchase agreement. From another perspective, the amended silver agreement at a spot price of US$19.45/oz equates to only about 2.5% of the silver production at Keno Hill. Should silver prices increase to a spot silver price of US$35/oz, the payment amount from Silver Wheaton to Alexco declines for each ounce of silver purchased to US$3.90/oz, and the silver purchased increases the silver stream to reflect the value of the original 25% of payable silver produced at Keno Hill purchased for US$3.90/oz. Impact of the Amended Silver Agreement on the November 2013 Preliminary Economic Assessment The PEA was completed prior to the amendment of the silver purchase agreement and accordingly assumed the terms included in the original agreement with Silver Wheaton. The PEA assumed a nine-month development period for the Flame & Moth mine and 5.5 years of production from Bellekeno, Flame & Moth, and Lucky Queen. Annual production was forecast to be 3.1 million ounces of payable silver, 6.8 million pounds of lead, 6.6 million pounds of zinc and 1,050 ounces of gold. It is interesting that this forecast is close to the district’s average silver production by UKHM between 1921 and 1988. Alexco has internally estimated initial capital development of C$13 million plus an additional C$12 million for working capital. The PEA concluded that the operation would produce an pre-tax IRR of 45%, and a pre-tax
5
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining NPV of US$39.9 million (at a 5% discount rate), with metal price assumptions of US$24.00/oz silver, US$0.95/lb lead, US$0.85/lb zinc and US$1,300/oz gold. The PEA also assumed throughput of 406 tpd with increased mill capacity of 430 tpd made possible due to the addition of a ball mill to reduce a bottleneck in grinding ore. Alexco’s management appears confident that they will meet the test under the Silver Wheaton agreement based on previous operating experience of the existing mill running up to 20 tonnes per hour, improvements including an additional ball mill, and a higher level of throughput provided from three mines. Recoveries were estimated at 93.6% silver, 83.9% lead, 60.4% zinc and 71.3% gold that reflect earlier operating experience at Keno Hill. Costs of production (mining, milling and general & administrative) are estimated at US$253 per tonne. Alexco estimates that adjusting for the impact of the amended silver agreement with Silver Wheaton, the project would produce a Net Smelter Return (NSR) of US$419 per tonne. The PEA is helpful to envision the improved economics at Keno Hill mill balanced with the consistent throughput sourced from three operating mines. The economics detailed in the PEA are further enhanced by incorporating the amended silver purchase agreement and subsequent exploration. Alexco figures that under the original silver purchase agreement with Silver Wheaton, at a silver price of US$19/oz, the operation had a negative pre-tax NPV of C$14.0 million and negative C$11.5 million cumulative net cash. Upon the completion of the amended silver purchase agreement, given the same assumptions, the Pre-tax NPV increases to a positive C$13 million, or a positive C$26 million cumulative net cash. This is after the US$20 million payment from Alexco to Silver Wheaton to complete the agreement and so is immediately accretive to Alexco. (In addition, Alexco notes that at a silver price of US$19.00/oz, the original silver purchase agreement equates to a royalty of 20%, while under an amended silver purchase agreement this would be reduced to 2%.) The combination of the amended agreement, an expanded PEA including three mines, and subsequent exploration portrays a substantially different operation at Keno Hill. Summary of Alexco’s Keno Hill Mill and Bellekeno Mine Operating History Alexco had a brief but interesting period of production at Keno Hill. Production actually commenced in December of 2010 during a dark cold Yukon winter (with Alexco management declaring commercial production on January1, 2011), and at a time that it would experience the highest metal prices in its ten plus quarter operating history (US$39.88/oz. silver, US$1.20/lb. lead and US$1.07/lb. zinc). Production at the mill was augmented by ore stockpiled during development. Even though the mill had throughput of only 201 tpd (less than half the mill’s rated capacity) in the first quarter of 2011, with high grades of silver and lead of 829 g/t and 10.0%, respectively, and recoveries of 93% and 90% for silver and lead, respectively, Alexco produced 447,524 ounces of silver and 3.6 million pounds of lead (plus 1.1 million pounds of zinc). Strong early results at Keno Hill resulted in the first quarter of 2010 being one of its most productive quarters. Cash cost per ounce of silver production (not including the impact of the Silver Wheaton agreement) were $8.88/oz. The early high rate of success led Alexco management to provide guidance for silver production in 2011 of 2.8 million ounces. Annual guidance was subsequently revised downward to 2.2 to 2.5 million ounces of silver in August of 2011 following fires in Yukon which disrupted operations and power availability. Even though operations at the Keno Hill mill and Bellekeno mine improved consistently through 2011 (with higher levels of mill throughput, operating rates, recoveries and grades of silver, lead and zinc), the company failed to meet guidance, producing only 2.0 million ounces of silver (plus 16.5 million pounds of lead and 7.2 million pounds of zinc) with average mill throughput of only 222 tpd. It is also
6
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining unfortunate to note that metal prices for silver, lead and zinc significantly declined during 2011, with Alexco realizing US$29.27/oz. silver, US$0.93/lb. lead, and US$0.88/lb. zinc in the fourth quarter of 2011. Keno Hill Mill Quarterly Production Results 3Q13 64 days Ore tonnes mined Ore tonnes processed Tonnes processed per day
2Q13 1Q13 ending June ending Mar.
2012 Total
4Q12 3Q12 2Q12 1Q12 ending Dec. ending Sept. ending June ending Mar.
2011 Total
4Q11 3Q11 2Q11 1Q11 ending Dec. ending Sept. ending June ending Mar.
19,551 20,520 321
25,234 25,708 283
20,241 20,069 223
87,290 94,810 260
22,385 26,777 291
24,237 24,573 270
19,273 22,209 244
21,395 21,251 234
71,922 81,064 222
20,832 22,554 245
12,533 21,532 234
22,166 18,928 208
16,461 18,050 201
Grade of ore processed: Silver (g/t) Lead Zinc
717 8.6% 4.1%
751 7.1% 4.0%
636 7.5% 3.4%
760 9.6% 4.8%
760 9.6% 4.4%
691 8.9% 4.5%
704 8.8% 4.9%
899 11.3% 5.7%
834 10.0% 6.0%
889 11.1% 6.7%
792 9.2% 5.8%
822 10.5% 6.5%
829 10.0% 5.0%
Recoveries Silver Lead in lead concentrate Zinc in zinc concentrate
96% 95% 60%
93% 91% 57%
93% 90% 69%
93% 90% 56%
91% 90% 61%
94% 93% 51%
91% 85% 55%
94% 93% 57%
92% 90% 65%
90% 86% 67%
91% 90% 68%
93% 93% 65%
93% 90% 56%
Production Silver (ounces) Lead (pounds) Zinc (pounds)
452,392 3,665,305 1,112,594
576,155 3,658,668 1,297,116
379,616 3,001,005 1,034,145
2,150,959 18,183,755 5,676,284
595,823 5,120,451 1,592,672
514,879 4,471,580 1,227,269
458,472 3,661,412 1,340,557
581,808 4,929,079 1,515,960
2,020,644 16,454,334 7,220,514
608,093 4,878,780 2,473,561
500,703 3,908,517 1,865,739
464,324 4,074,122 1,770,159
447,524 3,592,915 1,111,055
Sales volume by payable metal Silver (ounces) Lead (pounds) Zinc (pounds)
596,167 4,369,672 989,535
466,071 3,020,897 1,100,007
391,593 3,340,520 1,005,298
2,033,821 17,207,146 4,771,416
522,894 4,379,174 1,082,591
437,890 3,628,904 1,016,365
532,095 4,544,254 1,232,019
540,942 4,654,814 1,440,442
1,769,849 14,991,596 5,697,639
454,446 3,816,127 1,788,784
459,297 3,875,684 1,437,836
470,023 4,119,866 1,761,119
386,083 3,179,919 709,900
Cash cost per ounce of silver
$12.93
$13.10
$16.67
$11.13
$10.48
$15.53
$11.01
$13.66
$10.83
$6.30
$8.88
Recognized Metal Prices Silver (USD per ounce) Lead (USD per pound) Zinc (USD per pound)
$22.06 $0.96 $0.86
$20.55 $0.95 $0.83
$28.70 $1.03 $0.93
$30.71 $1.01 $0.91
$34.18 $0.96 $0.88
$27.84 $0.87 $0.85
$32.81 $0.95 $0.92
$29.27 $0.93 $0.88
$33.47 $1.07 $0.97
$35.01 $1.13 $1.00
$39.88 $1.20 $1.07
$11.89
$10.17
Source: Alexco Resource Corp.
Alexco marginally improved production in 2012 over its initial year of production in 2011. Mill throughput increased steadily through the year, increasing processing to 291 tpd in the fourth quarter from 234 tpd in the first quarter. Production was challenged by mining lower grades for all metals and substandard mill performance, leading to changes in on-site personnel. In addition, recoveries of zinc were recognized as an ongoing issue. (Fortunately, the mill operation at Keno Hill has a lead circuit and a zinc circuit, with most of the silver recovered in the lead concentrate.) Alexco was able to meet guidance for silver production of 2.2 million ounces of silver and enjoyed slightly higher metal prices in 2012 compared to the fourth quarter of 2011. It was also becoming apparent at this point that the Keno Hill mill was operating ahead of the Bellekeno mine, increasing anticipation for permitting and developing the Lucky Queen and Onek mines. Alexco management commenced the 2013 year hoping to begin processing ore from three mines; Bellekeno, Lucky Queen and Onek. Guidance for the year was subsequently reduced to 1.9 to 2.1 million ounces of silver. The 2013 year got off to a difficult start, processing fewer tonnes of lower grade ore, producing only 391,616 ounces of silver in the first quarter, resulting in the highest cost per ounce of silver production since commencing operations in 2011. With increasing resource exploration activity in Yukon and the length of time to permit mines, permitting was becoming increasingly problematic. Despite this headwind, Alexco management persisted in maintaining its long-term district guidance for silver production of seven to ten million ounces of silver annually over the next decade. Metal prices continued to decline through 2013, and with ongoing uncertainty regarding the awarding of permits, early in the third quarter Alexco management decided to suspend mining operations. Ironically, this was during a period of steadily improving mill operations. Eventually, the mill would reach a record processing rate averaging 321 tpd in the first 63 days of the third quarter. With the Keno Hill mill outpacing the Bellekeno mine, this clearly demonstrated the 7
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining importance of bringing additional mines into production in order to increase the consistency of higher levels of ore to the mill. Activities Undertaken During Suspension of Mining Activities at Keno Hill Alexco management successfully completed an orderly suspension of mining activities at Keno Hill heading into the winter months in 2013 (Alexco continues to carry $4.3 million in underground unprocessed long-hole stope inventory at Bellekeno). This included acquiring select equipment from the on-site contract miner. In November of 2013, the company acquired a second ball mill for finer grinding to increase capacity and recoveries. In December of 2013, Alexco announced the completing of a PEA based on mining the Bellekeno, Lucky Queen and the Flame & Moth deposits. The company eventually received quartz mining licenses, completing the permitting for mining of the high-grade silver Lucky Queen and zinc-rich Onek mine. In June of 2014, Alexco concluded negotiations with Silver Wheaton to complete helpful amendments to the silver purchase agreement, important to resume production at current metal prices. Flame & Moth Deposit near Keno Hill Mill (Note proximity of proposed portal near Keno Hill Mill, also dry stack tailings center bottom)
Source: Alexco Resource Corp.
Alexco continued environmental activities, in spite of the suspension of mining at Keno Hill, through its wholly owned subsidiary Alexco Environmental Group (AEG). Since the suspension, AEG continues to treat mine water from five historic mines in the Keno Hill silver district. AEG also remains active in Yukon, as well as elsewhere in the Americas, and is involved in the handling of about half of the two dozen YESSA (Yukon Environmental and Socio-economic Assessment Act) applications currently being processed in Whitehorse. The growing importance of this unique business to Alexco with positive cash flow is becoming increasingly apparent. Discussion of Alexco Environmental Group Alexco’s specialty in the environmental area has its roots in CEO Clynt Nauman’s successful mitigation of challenges presented in his work at the Greens Creek mine near Juneau, Alaska. This business has grown to include permitting and
8
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining regulatory management, reclamation and closure services, with novel environmental and reclamation technologies. Alexco Environmental Group has grown to include the combined efforts of about fifty scientists and engineers. Notable successes include recognition for award-winning reclamation and closure performance at the Brewery Creek mine in Yukon, which received the Department of Indian Affairs and Northern Development Robert E. Leckie Award for Outstanding Reclamation Practices in both 1999 and 2002. The company’s environmental expertise was instrumental in becoming the successful bidder in the acquisition of the Keno Hill silver district out of bankruptcy from the government of Canada. Alexco management continues to report on AEG’s improving revenues and a maturing project pipeline, providing an important financial contribution, plus unique industry perspective and visibility. We have visited several projects which AEG was either managing or benefiting from their patented processes or services capable of addressing a wide variety of environmental contamination. One of AEG’s themes is to advance projects from traditional expensive “active” management processes, which perpetually treats symptoms of a project, to more effective options, completing “passive” solutions. This is made possible through its patents for in-situ encapsulation that work with nature to permanently neutralize the problem at its source. Barite Hill gold mine Superfund site, McCormick, South Carolina
Source: Analyst.
Our visits included the reclamation of the open-pit acid-lake at the Barite Hill superfund site in South Carolina. We also toured Platoro, a private project near Canyonville, Colorado, which treated water from an underground mine. In addition, we closely observed the management of mine water released from Galkeno 300 at Keno Hill (a great benefit to the residents of Keno City). Other Scarsdale employees have viewed AEG’s progress of the Globeville smelter superfund site in Denver, Colorado. At some point we are optimistic and envision the potential for AEG to have an opportunity to provide a “passive” long-term solution to the Berkley Pit, managed by Atlantic Richfield Corporation, a subsidiary of British Petroleum, near Butte, Montana in the Columbia River watershed.
9
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining An additional theme for AEG’s business plan is to retain upside in projects which have commercial potential following clean up. This is preferable to a consultant business model limited only to billable hours. This is the case in both acquiring the Keno Hill silver district and developing and operating mines, as well as work completed at the Globeville smelter site in Denver, Colorado, with the potential for commercial real estate development. AEG is the sole-source environmental contractor at Keno Hill, and they estimate the cleanup (in addition to processing silver from the Elsa Tailings from earlier operations by UKHM) to be about C$40 million, of which they would expect to earn gross margins of over 15%. A course of action for the eventual clean-up of the district is a time consuming process, but all parties have agreed on the available options. Once a course is agreed upon, a plan of action will commence and AEG will pursue necessary permits. Including Keno Hill, AEG reports a $70 million backlog. In the recent quarter, AEG contributed C$3.1 million in revenues, and with a gross margin of 27%, or a gross profit of C$812,000. Alexco management is becoming increasingly confident in the financial contribution of AEG as a “stand-alone” business. A Brief History of Keno Hill Silver District and Untapped Potential The Keno Hill silver district is upstream from Dawson City, known for the Klondike gold rush in the later part of the 19th century. Silver was discovered in the district following the Klondike gold rush and was mined nearly continuously by numerous small operations until being fully consolidated by United Keno Hill Mines Limited (UKHM). The history of the silver district is best described in the book Hills of Silver: The Yukon’s Mighty Keno Hill Mine, by Dr. Aaro E. Aho (partially funded by Alexco). The district was host to at least 35 known historic mines, which between 1921 and 1988 produced more than 217 million ounces of silver (5.37 million tons) with average grades of 40.52 ounces per ton silver, 5.62% lead, 3.14% zinc. In 1989, the mines closed when UKHM was forced to cease operations due to low metal prices and rising costs associated with increasing environmental standards. At the time, the Bellekeno mine was still in operation, and having been the latest operating mine at Keno Hill, was the most advanced opportunity for resuming operation in 2011. UKHM had established a well documented history, providing important information for exploration of the district. Alexco notes that Keno Hill is Canada’s only primary silver district and estimates that only 5% of the potentially productive terrain in the district has been tested. The Keno Hill silver district is located in Yukon, situated about 330 kilometers north of Whitehorse, available by plane to the town of Mayo, and then by road to Elsa or Keno City. The district comprises about 23,350 hectares (233.5 square kilometers) of mining leases, quartz claims and Crown grants. From east to west the district extends about 20 miles. Most of the mining in the Keno Hill silver district has been limited to only 200 to 300 meters from the surface. In some instances, mining at the Silver King and Hector-Calumet has followed silver mineralization for up to 1,000 vertical meters. Mineralization at Keno Hill is structurally controlled and has been made complex by significant faulting in Yukon. We believe the exploration upside at Keno Hill is comparatively untouched, but potentially comparable to the Silver Valley in Idaho, where Hecla Mining Company (NYSE: HL) has taken the Lucky Friday mine to a depth of 6,000 feet. The Silver Valley has produced approximately 1.2 billion ounces of silver since 1884. While exploration is by its nature speculative, we believe exceptional potential for discovery seems to exist, as evidenced by Alexco inadvertently (but fortuitously) locating the Keno Hill mill close to near-surface extensions of the Flame & Moth deposit.
10
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining
Summary of Current Keno Hill Silver District Resources Historic Production and Drilling at Bellekeno Bellekeno is on the north facing slope of Sourdough Hill, across the Lightening Creek valley from the Keno mine. Bellekeno was initially staked in 1919 and mined from 1921 to 1928, producing 495 tonnes of hand-sorted vein material grading 281 oz/ton silver. UKHM completed intermittent exploration, development and rehabilitation programs. Production from Bellekeno through completion of the PEA in 2013 totaled 7.9 million ounces of silver, from 284,940 tonnes of ore, grading 862 g/t silver, and 2.7% lead. Of this amount, Alexco alone produced about 5.6 million ounces of silver from 241,250 tonnes, grading 725 g/t silver, and 9.2% lead. Between 1975 and 1996, UKHM completed four surface and two underground percussion programs (totaling 4,944 meters in 60 drill holes). Total combined drilling by Alexco consisted of 41,843 meters of drill core from 405 holes. This includes five surface drill campaigns totaling 19,861 meters at Bellekeno. In addition, Alexco completed underground drilling of 21,981 meters, in 336 holes, for exploration and resource infill drilling. The current Bellekeno resource includes 21,418 samples, of which 3,549 were used for the resource estimation. Historic Production and Drilling at Lucky Queen The Lucky Queen deposit was mined from 1927 to 1932, until the identified deposit was terminated by faulting and mined out. During this brief period, 112,100 tonnes of ore were mined, grading 3,062 g/t silver, yielding 11.0 million ounces. In addition, the Lucky Queen produced 17.2 million pounds of lead, grading 7.0%, and 6.7 million pounds of zinc, grading 2.7%. Between 1985 and 1987, UKHM developed a 1,800 meter exploration drift in an attempt to locate the extension of the original vein, but the effort ceased due to poor ground conditions and failure to locate the vein. Altogether, Alexco drilled four holes in 2006 totaling 875 meters, three holes in 2007 totaling 557 meters, 12 holes in 2008 totaling 2,999 meters, 14 holes in 2009 totaling 3,048 meters and 14 holes in 2010 totaling 3,625 meters. The most impressive hole was K-07-0114 intercepting a 1.12 meter interval grading 17,380 g/t silver (507.0 oz/ton), including a 0.52 meter interval of native silver grading 35,618 g/t silver (1,039.0 oz/ton), plus lead and zinc. More important than this high-grade silver intercept, Alexco succeeded in locating the lost mineralized vein which had been offset by faulting. The current Lucky Queen resource includes 3,144 core samples used for the resource estimation. Historic Production and Drilling at Flame & Moth The Flame & Moth was initially staked in 1920, which was followed up by a number of shallow workings. In 1954, UKHM completed bulldozer trenching and soil sampling, identifying a 240 meter strike. At this time, small scale mining produced 1,440 tonnes grading 627 g/t silver, 1.1% lead and 0.9% zinc. Work was discontinued due to the depth of overburden until UKHM drilled 28 vertical overburden holes in 1965. A resource of 3,360 tonnes was estimated grading 573 g/t silver, 1.4% lead and 5.6% zinc. UKHM completed an additional four holes totaling 989 meters in 1974 and continued to evaluate the target through the closing of the district. Following site selection of the Keno Hill mill, Alexco completed a total of about 21,724 meters, including 3,986 meters of core drilling in 14 holes in 2010 (including the Flame Vein discovery hole K-10-0264 intercepting 693 g/t silver over 4.64 meters), followed by 7,149 meters in 32 holes in 2011, 8,753 meters in 39 holes in 2012, and 1,836 meters in eight holes
11
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining up to the completion of the 2013 PEA. The current Flame & Moth resource includes 4,857 samples, of which 367 were used for the resource estimation.
Keno Hill Silver District Category
Property
Tonnes
Indicated
Bellekeno Deposit Lucky Queen Deposit Flame & Moth Deposit Eastern Keno Hill Silver District Onek Bermingham Total Indicated - Sub-Surface Depos Elsa Tailings Total Indicated - All Deposits
262,000 124,000 1,378,000 1,764,000 585,000 257,000 2,606,000 2,490,000 6,096,000
585 1,227 516 676 194 460 479 119 303
n/a 0.2 0.1 n/a 0.7 0.1 n/a 0.1 n/a
3.5% 2.6% 1.7% 2.0% 1.2% 2.0% 1.8% 1.0% 1.4%
5.3% 1.7% 5.7% 6.4% 13.7% 2.1% 6.8% 0.7% 3.8%
4,933,000 4,891,000 22,859,000 32,693,000 3,648,000 3,800,000 40,131,000 9,526,000 49,867,000
Inferred
Bellekeno Deposit Lucky Queen Deposit Flame & Moth Deposit Eastern Keno Hill Silver District Onek Bermingham Total Indicated
243,000 150,000 107,000 500,000 236,000 102,000 838,000
428 571 313 448 203 372 369
n/a 0.2 0.3 n/a 0.4 0.1 n/a
4.1% 1.4% 0.9% 2.6% 1.1% 1.1% 2.0%
5.1% 0.9% 4.2% 3.7% 11.5% 1.8% 5.6%
3,338,000 2,753,000 1,081,000 7,172,000 1,540,000 1,220,000 9,832,000
Silver King Proven, probable and indicated Inferred
88,888 22,681
1,364 1,458
n/a n/a
1.6% 0.1%
0.1% n/a
4,310,000 1,067,000
Historical Resources
Ag (g/t) Au (g/t) Pb (%)
Zn (%) Contained Ag (oz)
Source: Alexco Corporate Presentation, June 2014
Source: Alexco Resource Corp.
Onek Mine Resource Discussion Onek is a permitted zinc-rich silver deposit in the vicinity of the Keno Hill mill which was not included in the 2013 PEA. The Onek Mining Company Ltd. was formed in 1922 to explore Onek in a number of open-cuts and shallow underground workings. UKHM reopened the shafts in 1950, mining ore through the early 1960s. Total production at Onek consisted of 95,290 tonnes, yielding 1.3 million ounces of silver grading 13.6 oz/t silver, plus 10.5 million pounds of lead, grading 5.5%, and 6.5 million pounds of zinc, grading 3.4%. In the 1970s, UKHM completed about 13,000 meters in 319 holes. Alexco drilled a total of 11,981 meters at Onek, consisting of thirteen holes in 2007 of 2,803 meters, 29 holes of in 2008 of 5,127 meters, 25 holes in 2010 of 2,913 meters, and 12 holes in 2011 of 1,138 meters. The current Onek resource includes 4,384 samples, of which 589 were used for the resource estimation. Though Onek clearly sets itself aside as a zinc-rich silver deposit, silver grades are respectable but appear relatively underwhelming compared to other deposits in the PEA mine plan. Alexco management is confident that the current resource estimate may underestimate Onek’s silver potential, and that this deposit may become more important with exposure to higher zinc prices.
12
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining
Exploration Drilling in 2014 Subsequent to the 2013 PEA Focus on Flame & Moth From the acquisition of the Keno Hill silver district, Alexco has expended $65 million on exploration, with an overall discovery cost of $0.92 per ounce silver. Over the last five years, this has improved to $0.60 per ounce silver, with its greatest exploration results at Flame & Moth, with discovery costs of $0.42 per ounce silver. Of the $5 million budgeted for 2014, 8,000 meters of the exploration program of 10,500 meters was planned for Flame & Moth drill targets in the Christal Lake Corridor in 2014. Flame & Moth Area 2014 Drill Targets
Source: Alexco Resource Corp.
Alexco recently increased its surface drill program to 14,000 meters, from the original 10,500 meters, due to efficiencies gained in the budgeted 2014 drill program. Through the end of July, Alexco has drilled about 9,700 meters, 70% of which was in the Flame & Moth corridor stepping out more than one half kilometer from the Flame & Moth resource. About 40% of the drilling has been on the Flame & Moth resource itself to further define and expand the deposit. The balance of the surface drilling has primarily been at Birmingham. Drilling at Keno Hill is expected to continue through October, with drill results reported through the end of 2014. The addition of the Flame & Moth provides a significant opportunity for Alexco. The mineable portion of the strike length is about 600 meters, with drilling in 2013 showing possible extension to 900 meters, remaining open along strike and depth. The high grades and thicknesses of the mineralized areas provide Alexco the potential to increase throughput to the mill at a lower cost. The discovery of a relatively large silver resource at Flame & Moth has increased attention to other exploration in the immediate area. Alexco management has consistently commented that the exploration success at Flame & Moth is reminiscent of UKHM’s experience with the Hector-Calumet mine at Keno Hill,
13
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining producing 96 million ounces of silver over 20 years from 2.7 million tons, grading 35.4 opt silver, 7.5% lead and 6.1% zinc. Management Discussion We have had ample opportunity to observe Alexco’s management team since the company was founded and have visited Keno Hill multiple times. Through the years they have consistently appeared to be working in the same direction toward the same goal. This is often an important precursor of success, especially given the challenges presented in the mining industry, but also the teamwork required for administration of an environmental business run parallel to the main effort at Keno Hill. Having multiple business lines, with multiple goals, requires leadership and teamwork to effectively focus the essential team strengths at the immediate priority while working toward strategic goals. Their character has been noted from acquiring Keno Hill, through development, construction, operation, suspension of production, to the current amendment with Silver Wheaton. They have also led mining in Yukon with collaborative leadership toward improving the permitting environment, as well as sponsorship of the Centre for Northern Innovation in Mining in Whitehorse. The ability to hold a competent and loyal team through the process and uncertainties as a unified organization is an asset to both Yukon and the company’s shareholders. Clynton R. Nauman, Alexco’s President and Chief Executive Officer has over 35 years of diversified experience in the mineral industry, ranging from exploration and business development to operations and business management in the precious metals, base metals and coal sectors. Mr. Nauman is also currently the CEO of Asset Liability Management Group, and was General Manager of Kennecott Minerals from 1993 to 1998, and the President and CEO of Viceroy Resource Corporation from 1998 to 2002. Mr. Nauman holds a B.Sc. (Hons) in geology Otago University, New Zealand. Brad A. Thrall is Executive Vice President of Alexco, and Chief Operating Officer and President of Alexco Environmental Group, and has over 25 years of experience and accomplishments in operations management, environmental management, technical services and mine-closure planning and execution. Mr. Thrall is also currently the President of Asset Liability Management Group, and was Manager of Technical Services for Viceroy Resource Corporation from 1998 to 2002, as well as the General Manager of Viceroy's Brewery Creek Mine, with operations management positions with Barrick Gold and Goldcorp. Mr. Thrall holds a B.Sc. in Metallurgical Engineering from South Dakota School of Mines and Technology and an MBA from the University of Colorado. David E. Whittle is Alexco’s Chief Financial Officer and Company Ethics Officer. Mr. Whittle is a Canadian qualified Chartered Accountant with 25 years of experience in auditing, financing and accounting for public and private companies, having worked in the mining industry for over 20 years. Mr. Whittle has completed numerous corporate financings for mining projects, encompassing a variety of structures including prospectus offerings and private placements in Canada and the United States. Mr. Whittle was the Chief Financial Officer of Hillsborough Resources Limited, a TSX-listed coal mining and development company. Mr. Whittle currently serves as an independent director of Mountain Province Diamonds Inc. and Kennady Diamonds Inc.
14
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining
Discussion of Mining Environment Resource exploration and production are sophisticated activities which are compounded by the complex and changing environments in which they operate. Current prices and expectations of underlying project metals, impacted by the larger influences of available capital (financial, material and human) within the resource industry (global oil, gas and metals), are outside the company’s control or influence. Alexco management has achieved a level of success in negotiating amendments to the original agreement with Silver Wheaton for the opportunity to emerge as a long-lived, low-cost producer. Alexco management has also been a consistent advocate for meaningful change of the permitting environment in Yukon. The direction of both metal prices and permitting environment in Yukon and Canada have significant influence on the near to long-term potential at Keno Hill. Mining Environment in Yukon We spoke at Yukon Gold Mining Association Mining Summit in November of 2012, presenting on the competitiveness of Yukon relative to other Canadian jurisdictions and the world in general. At that time, a record of over $300 million had been invested in Yukon resource exploration and mining in 2011, a trend that was noticeably being reversed by the time of our presentation. Coincidentally, nearly a billion dollars of annual transfer payments were made from the federal government to Yukon, benefiting a population of around 35,000. We noted an atmosphere of complacency combined with a general lack of understanding, at odds with the competitive nature of global capital markets that seek to optimize returns and reduce risk. We were troubled by government responses to these trends, which appeared somewhat nonchalant, in spite of the evidence of tightening capital markets, leaving companies adrift to navigate competitive challenges alone. Conversely, we did come away with an enlightened and improved perspective of Yukon First Nations, recognizing them as real long-term stakeholders having a vested interest to further positive economic development. We have since maintained a hopeful but critical view of developments in Yukon while maintaining an admittedly skeptical bias. We were recently included on a tour in early August of 2014 of companies and projects in Yukon organized by the Yukon Mining Alliance and sponsored by companies and the Government of Yukon. This was an excellent follow up to the YGMA Mining Summit in 2012 and a Scarsdale Equities project tour of Yukon in 2013. This provided a first-hand update on most of the companies and an opportunity for taking a first-hand barometric reading on the political environment of permitting and mining in Yukon. The tour commenced with a function including Yukon dignitaries, government employees and company executives. We heard presentations by the Darrell Pasloski, Premier, Government of Yukon, and Currie Dixon, the Minister of Economic Development, Government of Yukon. We were pleased that Minister Dixon recited the recommendations listed in the 2013 Yukon Mining Advisory Board’s Annual Report, including timelines, transparency, and to a lesser extent accountability. Going a step further, Minister Dixon listed a number of surprising initiatives by the Government of Yukon. These included a number of studies including a financial commitment for road development, replacement of diesel generators in Whitehorse to LNG from diesel, commencing studies for a major hydroelectric project, as well as studying an extension of the electric grid to Skagway and improving port capacity. In addition, the Minister noted steps already taken to improve permitting and improving available local skilled labor through the founding of the Centre for Northern Innovation in Mining. This was a complete set of materially-significant improvements relative to our earlier
15
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining impression at the YGMA, and a reorientation by Yukon that may be counted as a positive signal to investors. We remained guarded and alert to subtle guideposts to materially gauge both future direction and progress. Following the tour we had an opportunity to have a several-hour phone conversation with Minister Scott Kent, Yukon’s Minister of Energy, Mines, and Resources, Yukon Energy Corporation, and Yukon Development Corporation, as well as Minister Dixon. Minister Kent went into great detail on recent activities to improve application of the current Yukon Environmental and Socio-economic Assessment Act (YESAA) plus their influence upcoming changes in the federal legislation within 2014. The modifications proposed appear to have the potential to position Yukon procedurally as the most favorable political jurisdiction for mining in Canada. The modifications on the federal level will need to be adopted locally, and along with improvements to the Yukon Water Board, investors may track meaningful progress of the Government of Yukon. We also covered initiatives to improve infrastructure by the Government of Yukon in depth with Minister Dixon, including power, infrastructure and human capital. The Government of Yukon has a progressive view toward LNG, replacing diesel generators with LNG in Whitehorse. They view this initial step as a short-term solution for meeting increasing demands for power and in the mid-term as a precursor for wider adoption of LNG in Yukon. We were even more surprised by a government commitment to studying a new “major hydroelectric project” which would likely have support of First Nations and Yukon. In addition, connections are being studied to link a potential hydro project in Skagway, USA. As this has the potential to offload power to Yukon in winter months, this initiative takes Yukon one step closer to being on a grid connected to British Columbia. These welcome initiatives were not apparent during our visit in late 2012, and if executed, may present a significantly improved investment profile for Yukon. Comments on Silver and Base Metal Price Outlook Completion of the amendment of the silver purchase agreement with Silver Wheaton has the potential to improve the cost profile of production at Keno Hill at current metal prices. The quality of silver bearing lead and zinc concentrates produced earlier at Keno Hill are reported to be of high quality, attractive to smelters. The prices of metals produced at Keno Hill are useful for physical investment and a hedge against inflation or for use in industrial purposes. Silver prices are generally correlated with gold prices and are considered to be more volatile. Silver is also in demand for physical investment and industrial electronic applications. Lead and zinc prices are associated with inventory levels in connection with economic growth. Both lead and zinc prices have recently firmed and concern for closing large zinc mines may present an opportunity for zinc in particular. Higher prices of these metals may be helped by further economic expansion in China, even if growth slows, as growth rates are figured on the enlarged base of economic activity. Metal prices are difficult to forecast, and resuming operations at Keno Hill under the amended agreement presents a viable operation at even lower prices while positively leveraged at higher metal prices. Discussion of Issues Critical to Investment Financial Discussion Alexco reported C$16.0 million in current assets and C$6.3 million of cash and cash equivalents as of June 30, 2014, the end of its second quarter. As of the end of the quarter, current liabilities were C$4.3 million with positive net working capital of C$11.7 million. As of the time of our visit, Alexco had about C$2.5 million remaining of a C$5.0 million flow through financing dedicated to its 2014 drill program. 16
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining
The company reported completing a financing on August 21, 2014 with gross proceeds of C$7.0 million by issuing 6.1 million shares at C$1.15 per share and one half of one common share purchase warrant. Alexco had 62.6 million shares outstanding and 66.5 million shares diluted as of the end of the second quarter of 2014. Shareholder’s equity was about C$99.00 million at the end of the second quarter, and based on the addition of C$7.0 million and 6.1 million shares, we would estimate book value per share to be C$1.54 per share (significantly above the current share price of about C$1.00). With the 2014 drill program covered, management anticipates sufficient cash flow from AEG and the recent financing to cover company overhead. As Silver Wheaton has agreed to take C$5.0 million in a financing to raise the C$20.0 million necessary to complete the amendment, Alexco will need to raise an additional C$15.0 net other available cash by the end of 2014. In addition, the company expects to raise an additional C$25.0 million for working capital and mine development to bring Keno Hill back into operation by mid-2015. This may be provided through equity financing or possibly a line of credit with smelters. Important Events in the Next 12 Months and Our Model We assume that the recent financing, along with cash flow from AEG, is sufficient to cover general and administrative expenses over the next twelve months. We anticipate that Alexco will successfully complete its 14,000 meter drill program in 2014 from the earlier flow-through financing, which should provide increased clarity on the economic potential of Flame & Moth beyond that identified in the 2013 PEA. Alexco is required to pay Silver Wheaton C$20 million by the end of 2014 and will need to raise an additional C$25.0 million to bring operations back on line by mid2015. Keno Hill Mill, New Ball Mill location and Flame & Moth Portal (Note: Existing Mill on left, adjacent site of New Ball Mill area cleared, Flame & Moth Portal upper right)
Source: Analyst.
17
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining The Bellekeno and Lucky Queen mines are fully permitted and may be brought into production relatively quickly. The plan includes starting with Bellekeno and stockpiling ore along with completing development work at Flame & Moth. The permitting schedule for Flame & Moth targets completing YESAB by the end of September, being awarded the Quartz Mining License Amendment by the end of October, and the Water License Amendment by the end of April of 2015. Alexco has cleared the location of the Flame & Moth portal (within 50 meters of the Keno Hill mill) in anticipation of completing a 1,200 meter decline to the ore body to commence production by mid-2015. We believe that Alexco is among the foremost organizations with a proven ability to permit mines in Yukon and that there are no observable issues that would keep Flame & Moth from being permitted. The 2013 PEA provided the underlying economics for mining Bellekeno, Lucky Queen and Flame & Moth within the current identified resource. The combination of the production from the three mines forecast production of about three million of ounces of silver annually, commensurate with the operating history of UKHM, for a period of five and a half years. While UKHM generally maintained only about two to three years of resources ahead of production, Alexco’s record of resource discovery has outpaced this level, and it is reasonable to conclude that Alexco has the potential of replacing production and expanding capacity to previous long-term guidance for annual production of seven to ten million ounces of silver. The 2013 PEA provides adequate clarity, based on prior operating history by Alexco at Keno Hill, to forecast costs of production. The 2013 PEA includes higher than current market metal price assumptions and the original silver purchase agreement with Silver Wheaton. Taking the amended agreement into account, Alexco completed its recent offering and estimated cumulative cash flow over the five and a half year operating period of C$26 million, net of the C$22 million (US$20 million) payment to Silver Wheaton. This implies a forecast of C$48 million in cash flow from operations at a $19.00 silver price over five and a half years, or C$8.27 million per year. Assuming a silver price of $19.00, for the duration of the amended agreement with Silver Wheaton, we conclude that Alexco has the potential to generate an average of C$8.27 million for a period, to match or better the operations of UKHM. (This does not include capital costs of additional mines beyond Bellekeno, Lucky Queen, Flame & Moth and Onek or exploration expense, nor does it include the upside of higher metal prices.) Alexco will need to raise about C$40.0 to C$45.0 million to complete the amendment with Silver Wheaton and fund working capital and development. Silver Wheaton has agreed to provide C$5.0 million of the C$20.0 million required to complete the amendment to the silver stream agreement. The PEA budgeted C$25.0 million for development and working capital which Alexco believes may be reduced with further optimization. Of the remaining budget, Alexco has the option of using available cash, raising equity, monetizing assets, or as a last resort seek readily available flowthrough equity for mine development. Alexco may also seek a credit line for the necessary working capital with the smelter to avoid dilution. The company has a good track record for avoiding dilution of outstanding shares. Should the terms of the recent financing apply, at a price of C$1.15 per share with a half a warrant, based on the diluted share count and issuing 28 to 30 million shares, diluted shares may increase to about 105 to 110 million shares. Assuming cash flow from operations, and 105 to 110 million shares outstanding, at a $19.00 silver price, annual cash flow per share could be roughly C$0.08 per share. AEG has a run rate of C$12 million in revenues and about C$3.25 million of gross profit. Based on a price to sales multiple of two times revenues, this implies a C$24 million value or C$0.22 to C$0.23 per share. Currently Alexco trades at C$1.00 per share, net C$0.22 for AEG, which implies a market value for Keno Hill of C$0.78 per share, or about ten times project operating cash flow. This calculation is for explanatory purposes only as share prices are greatly 18
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining influenced by many factors, including positive operating leverage with higher metal prices or potentially more favorable financing terms including a higher stock price, the exclusion of a warrant, or a lesser financed amount. While metal prices are difficult to predict, higher metal prices and successful permitting on Flame & Moth may positively influence both potential cash flow and market sentiment, which could significantly reduce dilution. For this reason we anticipate a staged financing and that the current price of Alexco represents the base operating potential at current metal prices with significant upside at higher metal prices. It is possible Alexco may also locate a single investor bullish on silver of completing a large portion of the financing at current metal prices. Considerations for Investment There are a number of factors that we consider to be positive considerations for investment in shares of Alexco. These may be unique to the company or considered positive relative to other alternate investments in the resource exploration and production sector. •The Keno Hill silver district is 100% owned in a stable political jurisdiction. •The Keno Hill mill is an existing mining operation that has been optimized and de-risked. •2013 PEA forecasts low cost operation from three mines at current metal prices. •Tailings are dry stacked at Keno Hill or converted to paste backfill and returned to the mine. •The proposed portal for the Flame & Moth mine is only 50 meters from the Keno Hill mill. •The permitted zinc-rich Onek mine provides an option on increased zinc prices. •AEG is a complimentary branded business with supporting cash flow. •The Keno Hill silver district has significant long-term exploration upside. •Management has a long history of success and breadth of experience in the mining industry. •The stock price is trading near a 52-week low and significantly below book value. Risks and Mitigations Investing in resource exploration and production companies include a significant amount of risk. This report attempts to qualify a number of the factors which may influence potential risks and opportunities. In addition to previously listed positive considerations for investment, investors should be aware that some risks may have not been outlined in this report. A limited number of potentially significant risks with accompanying mitigations are highlighted below. Risk:
Mitigation:
Risk:
Resource companies are exposed to market risk of volatile metal prices and capital markets impacted by market sentiment toward metals and the resource sector, much of which is outside the company’s influence. Alexco has mitigated the impact of metal prices by negotiating an amendment with Silver Wheaton to emerge as a low-cost producer. Investor sentiment may be increased with higher metal prices, successful permitting of Flame & Moth and conclusion to the 2014 exploration program, particularly with regard to Flame & Moth. The company’s shares are trading near their 52-week low, which may suggest that the market has already priced identified risks into the stock price. Permitting is a significant risk in the mining sector and it is essential that Alexco receive necessary permits to proceed with development and mining the Flame & Moth deposit.
19
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining Mitigation:
Alexco has a proven record of successfully permitting several mines at Keno Hill, in the Yukon and in the Americas. The portal for the decline to the Flame & Moth deposit is only 50 meters from the Keno Hill mill. The Keno Hill mill is a small scale operation with tailings dry-stacked or converted to paste backfill and returned to the mine. Flame & Moth should have high visibility in Yukon and is recognized as a bellwether for Yukon’s ability to permit mines.
Risk:
Developing a mine is a sophisticated engineering and physical activity. The geology of Keno Hill is complex as a result of faulting and changing rock types which may complicate progress. Alexco has successfully completed development including rehabilitating portions of the historic underground as well as driving drifts at the Bellekeno and Lucky Queen mines. Weather was not an issue with commencement of production in the winter of 2010 and declaring commercial production January 1, 2011
Mitigation:
Risk:
Mitigation:
Risk:
Mitigation:
Operating mines and mills are as much an art as a science. As the Keno Hill mill sources modest volumes of high-grade ore from its mines, careful ore control limiting dilution and consistently maintaining high recoveries at the mill becomes increasingly important. Alexco has successfully operated and optimized the underground mine at the Bellekeno mine over two and a half years. This includes pioneering long-hole stoping in Yukon at Bellekeno. The mine has consistently provided high grades of ore to the mill and achieved high levels of recoveries. The mill also consistently increased processing rates and eventually outpaced the availability of ore, prompting the opening of additional mines. During suspension of operations, Alexco acquired another mill to increase capacity and improve recoveries. Resource exploration is an expensive activity and speculative in nature. It is a difficult process to target mineralization, interpret results, and conceptually identify and build a deposit. Keno Hill is characterized by significant faulting and is structurally complex. Determining the geometry of a deposit is challenging. The style of high-grade mineralization at Keno Hill has been demonstrated by UKHM never having more than a few years of resource while remaining in operation from 1921 to 1988. UKHM, except on rare exceptions, only mined or explored from mineralized outcroppings at surface to depths of only a few hundred meters. Alexco is the first to consolidate available exploration and mining information to form a comprehensive understanding of the district. Despite the challenges of complex structures, Alexco has succeeded in adding ounces to resources and more than offsetting production at Bellekeno. Alexco has experienced its lowest costs for discovery at Flame & Moth, with significant resources and drill results yet to be incorporated into the 2013 PEA mine plan. Alexco management is confident that the annual silver production has the potential of reaching seven to ten million ounces.
Conclusion and Recommendation: Hills of Silver A primary requirement for investing in Alexco is to hold an opinion that silver prices will increase five to ten dollars over current levels in their investment time horizon and that this increase may result in an inflow of investment dollars into resource companies. This may possibly occur when the U.S. dollar begins to weaken or real interest rates turn more negative creating an investment horizon favoring tangible assets. Investors holding this opinion would benefit by locating deep value companies selling at a discount to assets with operating leverage, including the potential to increase
20
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining cash flow at a greater rate than the appreciation of the underlying metals. Well managed deep value companies with strong operating leverage have the potential to appreciate significantly and rapidly when investment funds rotate into the sector. We have made the case that Alexco has de-risked its operations that are situated in a safe and improving political jurisdiction. Also, that Alexco has enhanced the production capacity while reducing its cost profile to remain viable at current metal prices. In addition, that the company is well managed and has significant exploration upside, along with a complimentary environmental business with a growing business pipeline. The combination of a competent management team operating mines in an established silver district with excellent infrastructure, with immediate potential for moving into production, and exploration upside capable of rivaling past long-lived mines, provide multiple catalysts for appreciation of the company’s stock. Shares of Alexco’s stock may appear to be fully valued at current metal prices and suspension of operation. We believe the current stock price does not reflect the potential that production at Keno Hill may resume in the very near future as an expanded, longer-lived and lower-cost operation. Also, that the exploration profile of the district has the potential over the long-run to double or triple production. In addition, should metal prices increase and investor sentiment toward the sector improve, the company’s stock may experience momentum ahead of generated cash flow or operation expansion. We believe that these factors, when recognized by investors, may have the potential to allow Alexco to appreciate from deep value to, at minimum, to book value or twice the current level. We are initiating coverage of Alexco with a Buy rating and a price target of $2.00 per share. Analyst at Historic Hector-Calumet Mine Portal
Source: Analyst.
21
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining
Alexco Resource Corp. Balance Sheet June 30, 2014 (in Canadian dollars, in thousands) ASSETS Current Assets Cash and cash equivalents Accounts and other receivables Inventories Prepaid expenses and other current assets
$
Non-Current Assets Restriced cash and deposits Long-term investments Property, plant and equipment Mineral properties Intangible assets
6,345 3,972 5,288 402 16,007 9,753 685 24,209 78,827 316
Total Assets
$
129,797
$
3,190 21 41 300 754 4,306
LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Accounts payable and accrued liabilities Income taxes payable Environmental services contract loss provision Deferred revenue Flow-through share premium pending renunciation Non-Current Liabilities Environmental services contract loss provision Deferred revenue Silver streaming interest Decommissioning and rehabilitation provision Deferred income tax liabilities
184 1,280 18,118 3,899 2,968
Total Liabilities
30,755
Shareholders' Equity
99,042
Total Liabilities and Shareholders' Equity
$
Source: Alexco Resorce Corp.
22
129,797
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining
Alexco Resource Corp. Income Statement (in Canadian dollars, in millions) 2011 6/30 Revenues Mining operations Environmental services Total revenues
2011 (6mo.) 12/31
2012 12/31
2013 12/31
38,269 6,833 45,102 $
38,639 3,876 42,515 $
76,725 7,983 84,708 $
43,114 16,319 59,433
Cost of Sales Mining operations Environmental services Total cost of sales
23,352 6,897 30,249
28,770 3,597 32,367
61,691 5,097 66,788
Gross Profit Mining operations Environmental services Total gross profit
14,917 (64) 14,853
9,869 279 10,148
General and administrative expenses Mine site care and maintenance Foreign exchange losses (gains) Write-down of mineral properties Write-down of property, plant and equip Loss on impaired long-term note
11,221 445 123 -
$
Operating Income (loss) Other Income (Expenses) Investment income Finance costs Gain on sale of mineral property Derivative loss Income (Loss) Before Taxes Income Tax Provision (Recovery) Current Deferred Net Income (Loss)
1Q14 3/31
2Q14 6/30
256 3,071 3,327 $
105 3,064 3,169
43,143 7,470 50,613
2,090 2,090
2,252 2,252
15,034 2,886 17,920
(29) 8,849 8,820
256 981 1,237
105 812 917
5,625 114 -
16,657 324 -
12,471 1,210 (182) 51,840 3,501 2,160
2,284 740 105 -
2,300 752 (368) -
11,789
5,739
16,981
71,000
3,129
2,684
3,064
4,409
939
(62,180)
(1,892)
(1,767)
293 (48) -
122 (35) -
748 (46) 6,346 (8)
246 (47) (98)
7 (14) -
17 (12) (7) -
3,309
4,496
7,979
(62,079)
(1,899)
(1,769)
212
60 2,713
449 4,110
231 (11,860)
14 (494)
(108)
3,097
1,723
3,420
(50,450)
(1,419)
(1,661)
23 (32) -
(311) (2,062) 2,160
417 150 -
(383) 3 -
Other Comprehensive Income (Loss) Items that may be reclassified subsequently to net income (loss) Cummulative translation adjust (50) 25 Loss on long-term investments Recycle loss on imparired longTotal Comprehensive Income (Loss)
$
3,047 $
1,748 $
Earnings (Loss) Per Share Basic Diluted
$ $
0.05 $ 0.05 $
0.03 $ 0.03 $
3,411 $ (50,663) 0.06 $ 0.06 $
Source: Alexco Resorce Corp.
Disclosure Appendix AUTHOR CERTIFICATION 23
(0.81) (0.81)
$
$
(852) $ (2,041)
$ $
(0.02) $ (0.02) $
(0.03) (0.03)
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining
R. Michael Niehuser, the author primarily responsible for this report certifies, with respect to each security or issuer in this report, that: (1) all of the views expressed in this report accurately reflect his own personal views about the subject companies and their securities; (2) part of the author’s compensation may be, directly or indirectly, related to a portion of the commissions generated by Scarsdale Equities LLC [“SE”] in transactions in this or other securities designated for the author’s credit; (3) the author does not receive compensation based on investment banking or advisory services SE might provide to this or any other issuer.
IMPORTANT U.S. REGULATORY DISCLOSURES Fundamental Analysis. The research provided in this report is based on “fundamental analysis”. The investments discussed in this report in some cases will not be suitable for all investors. Investors should use this report as only one input in formulating an investment opinion. Additional inputs should include, but are not limited to, the review of other research generated by a review of regulatory filings, other available news items, and other analyses that may influence the merits of the securities of the issuers discussed.
RATING DISTRUBUTION Covered companies from which Scarsdale Equities LLC has received investment banking compensation within the previous twelve months or from which it expects to receive compensation within three months: Scarsdale Equities LLC Fundamental Analysis Coverage Universe (as of 9/8/14) Count Percent Investment Banking Relationships Buy
2
100%
Neutral Sell
0 0
0% 0%
Count
Percent
Buy
1
100%
Neutral Sell
0 0
0% 0%
Buy:Expected to outperform broad market averages by at least 15%. Neutral: Expected to perform in line with broad market averages. Sell:Expected to underperform broad market averages by at least 15%.
COMPANY SPECIFIC DISCLOSURES All applicable current disclosures on the items referred to in this report are obtainable by contacting Michael Niehuser at (503)307-3188. The following disclosures apply to the securities discussed in this research report: 1 Scarsdale Equities LLC, at the time of publication, does not make a market in any security. 2 The author has a financial interest in any security covered in this report. 3 Part of the author’s compensation may consist of a portion of the commissions generated by transactions in this issuer’s securities placed at Scarsdale Equities LLC for the credit of the author. 4 Scarsdale Equities LLC may seek or receive advisory or investment banking compensation from the issuer in the next ninety days.
PRICE TARGET METHODOLOGY AND RISKS Alexco has a market cap of $C62.3 million. The company will need to raise about C$40.0 to C$45.0 million to complete the amendment with Silver Wheaton and fund working capital and development. We anticipate they will need to issue 28 to 30 million shares increasing diluted shares to about 105 to 110 million shares. Assuming cash flow from operations, and 105 to 110 million shares outstanding, at a $19.00 silver price, annual cash flow per share could be roughly C$0.08 per share. AEG has a run rate of C$12 million in revenues and about C$3.25 million of gross profit. Based on a price to sales multiple of two times revenues, this implies a C$24 million value or C$0.22 to C$0.23 per share. Currently Alexco trades at C$1.00 per share, net C$0.22 for AEG, which implies a market value for Keno Hill of C$0.78 per share, or about ten times project operating cash flow assuming a silver price of $19.00 per ounce. Presently, Alexco has
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Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining a book value of C$1.56 per share which reflects the value or assets net liabilities recorded on the company’s balance sheet. We believe the current value of Alexco’s shares incorporate the risks of dilution and current metal prices. We believe that Alexco has the potential of experiencing exploration success, optimizing development costs. Should Alexco complete necessary financing and recommence production, should the price of silver increase, we believe the company’s stock may demonstrate momentum exceeding book value to $2.00 per share. Risks were discussed in the Risks and Mitigations section of the report. Important risks include volatility of metal prices and capital markets. Alexco will also need to receive numerous permits for developing the Flame & Moth deposit. Company risks include development, operation and exploration. The mining industry is a complex industry and many risks may not be identified in advance.
OTHER DISCLAIMERS This report is not directed to, nor intended for use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject SE or its subsidiaries or its affiliates to any registration or licensing requirement within such jurisdiction. None of the material, nor its content, nor any copying of it, may be altered in any way, transmitted to, copied or distributed to any other party, without the prior express written permission of SE. All trademarks, service marks and logos used in this report are trademarks or service marks or registered trademarks or service marks of SE. The information, tools and material presented in this report are provided for informational purposes only and are not to be used or considered as an offer or the solicitation of an offer to sell or to buy or subscribe for securities or other financial instruments. SE in some cases will not have taken any steps to ensure that the securities referred to in this report are suitable for any particular investor. SE will not treat recipients as its customers by virtue of their receiving the report. The investments or services contained or referred to in this report in some cases will not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about such investments or investment services. Nothing in this report constitutes investment, legal, accounting, or tax advice or a representation that any investment or strategy is suitable or appropriate to your individual circumstances or otherwise constitutes a personal recommendation to you. SE does not offer advice on the tax consequences of investment and you are advised to contact an independent tax advisor. Please note in particular that the bases and levels of taxation may change. Information and opinions presented in this report were obtained or derived from sources SE believes are reliable, but SE makes no representations as to their accuracy or completeness. Moreover, SE is under no obligation to inform you if or when data, information, or opinions in this report change. SE accepts no liability for loss arising from the use of the material presented in this report. This report is not to be relied upon in substitution for the exercise of independent judgment. SE in a report may suggest a trading call. Trading calls are short term trading opportunities based on market events and for technical ratings, the relationship of expected return to expected risk based on a set of technical measures. Past performance should not be taken as an indicator or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Information, opinions and estimates contained in this report reflect a judgment as its original date of publication by SE and are subject to change without notice. The price, value of, and income from any of the securities or financial instruments mentioned in this report can fall as well as rise. The value of securities and financial instruments is subject to exchange rate fluctuation that may have a positive or adverse effect on the price or income of such securities or financial instruments. Investors in securities such as ADRs, the values of which are influenced by currency volatility, effectively assume this risk. In jurisdictions where SE is not already registered or licensed to trade in securities, transactions will only be effected in accordance with applicable securities legislation, which will vary from jurisdiction to jurisdiction and in some cases will require that the trade be made in accordance with applicable exemptions from registration or licensing requirements. Non-U.S. customers wishing to effect a transaction should contact an SE entity, if any, in their local jurisdiction unless governing law permits otherwise. U.S. customers wishing to effect a transaction should do so only by contacting a representative at SE in the U.S. Any information provided in this communication has been prepared from sources believed to be reliable, but is not guaranteed by SE and is not a complete summary or statement of all available data necessary for making an investment decision. In addition, such information in some cases will be condensed or contain calculated data which should be verified by the recipient. Any information provided is for informational purposes only. To the extent that any financial projections are contained herein, such projections are dependent on the occurrence of future
25
Scarsdale Equities LLC
Buy
Alexco Resource Corp (NYSE MKT: AXU, TSX: AXR) – Precious Metals Mining events, which cannot be assumed; therefore, the actual results achieved during the projection period, if applicable, in some cases will vary from the projections. Additional information is available upon request. Write to Mike Niehuser at Scarsdale Equities LLC, 10 Rockefeller Plaza, Suite 720, New York, NY 10020 to obtain additional information or email him at
[email protected]
SCARSDALE EQUITIES LLC Mike Niehuser, Analyst Scarsdale Equities LLC 10 Rockefeller Plaza Suite 720 New York, NY 10020 Work: (503)-822-3191 Cell: (503)-307-3188 Fax: (212)-969-9015 Email:
[email protected] None of the information contained in this report constitutes a recommendation, solicitation or offer by Scarsdale Equities LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. The information contained in this report has been prepared without reference to any particular investor's investment requirements or financial situation. Certain transactions give rise to substantial risk and are not suitable for all investors. Information herein may not reflect actual prices or values that would be available in the market at the time an investor may want to purchase or sell a particular security or other instrument. Past performance should not be taken as an indicator or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. The information provided in this message is not provided to and may not be used by any person or entity in any jurisdiction where the provision or use thereof would be contrary to applicable laws, rules, or regulations of any governmental authority or regulatory or self-regulatory organization or clearing organization or where Scarsdale Equities LLC is not authorized to provide such information or services.
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