The Good, the Undervalued, and the Geologically Promising: Minera Alamos Advances Mexican Projects

Executive Summary

Minera Alamos Incorporated (“Mineral Alamos”) (TSX:MAI) is a Canadian company advancing a number of mining projects in north-western Mexico. After several years slowly advancing a polymetallic project which struggled to gain market traction, the Company changed tack when Darren Koningen, ex-Vice President Development of Castle Gold was appointed as President of Minera Alamos in June 2015. A focus on gold-silver projects that could be advanced quickly was introduced.

In early 2016 the La Fortuna project was bought from Argonaut Gold Corporation (“Argonaut”). La Fortuna is a small, high-grade deposit, which has been advanced to preliminary economic assessment (“PEA”) level with well-defined resources. The project is uncomplicated and essentially needs permitting to advance towards construction. The approach by Darren Koningen and his team is not to spend large sums on studies for public consumption, and instead to focus on derisking elements of the project that the management team believe relevant. While proceeding without formal NI 43-101 studies carries risk, the mitigating factor at La Fortuna is grade. Good grades cover a multitude of sins, and in the case of La Fortuna the grade is sufficiently high, the engineering sufficiently simple, and team sufficiently experienced to make the project economically robust and capable of withstanding anticipated set-backs and challenges that will undoubtedly arise due to a lack of planning and verification. Crux Investor, for example, thinks that the capital expenditure estimates are a bit light, but even that does not derail the project.

While Fortuna was the first acquisition by the ‘new’ Alamos team, it has since been superseded by the Santana project which is now approaching production. Bought in January 2018, Santana is an even more extreme example of a project being brought to production without formal feasibility studies. The confidence management brings to this style in development is largely due to the fact that it has done it before. Santana is very similar to the El Castillo project which was developed by Darren Koenigen and team at Castle Gold. Like El Castillo, Santana is a lowgrade deposit that is apparently amenable to low-cost heap leaching. In terms of size, the mineral resource of Santana is similar to the resource at El Castillo when it first started producing, being approximately. 0.3 million ounces (“Moz”). The key difference with the Santana project is that the Nicho deposit where currently exploration is focused appears to have a much higher grade than the 0.36 g/t gold of El Castillo. It should be noted that not only is there no formal feasibility study, but the project is actually advancing without publicly announced resource estimates. This is only possible due to low costs and high gold prices, and it gives Crux Investor the greater challenge in making an independent assessment and valuation. For the purposes of this report, and using only publicly available information, we have estimated that the grade conservatively averages 0.5 g/t gold, based on reviewing all the reported drill results at Nico. The derived mineable “resources” assumes mining of the drilled 200 m (NW-SE) x 200 m (SW-NE) x 170 m (depth) outline with no attempt to selectively higher-grade portions in this outline. A bulk mining approach simplifies mining and grade control which means that mining costs are lower.

The Santana project is expected to come into production in early 2021 using contract mining and contract crushing. The use of contractor mining and crushing keeps the initial capital expenditure low and provides operational flexibility.

The company has a second-hand plant available with a capacity to crush plant feed in three stages to 3/8 inch at a rated capacity of 2.2 million tonnes per annum (“Mtpa”). However, we believe that a throughput rate of 3.1 Mtpa can be achieved if two-stage crushing is used. While Minera Alamos is miserly with its information, it has indicated that good leach recoveries have been achieved after only much coarser size crushing, which would enable a higher throughput rate. The red flag of limited disclosure flaps again, and we are left to back-calculate probable recovery rates of 70% from test work on a 50,000 tonne bulk sample. And another red flag flaps in that the bulk sample, with a grade of close to 1 g/t gold is unrepresentative of the overall grade of the deposit, which makes it difficult to say that the recovery rates of 0.5 g/t gold will be the same. Technical details like these are typically resolved in a good quality feasibility study, which is why they cost a lot of money and take a lot of time to produce.

Nevertheless, assuming a recovery of 70% this valuation arrives at a NPV7.5 value of US$109 million for Santana using a gold price of US$2,028/oz. Every additional year production would add US$16 million to the NPV. In addition to Sanatana, the Fortuna project is still going through permitting and we expect first production will be in 2022. Crux Investor arrives at an NPV7.5 value of US$136 million for La Fortuna, when using the capital expenditure numbers provided by Minera Alamos. The valuation shrinks when more conservative (larger) capital expenditure figures are used. The graph below shows the cash flow at corporate level, assuming repatriation of positive net free cash flow from the projects, which would be subject to a withholding tax of 10%. Included in the calculations are corporate overheads which amounted to a modest C$3.3 million in 2019, excluding share-based compensation, interest payments and non-cash items. It is refreshing (green flag) to see a management team running lean and being frugal with shareholders cash.

The company is forecast to generate sufficient cash flow to be able to fund La Fortuna project internally, especially when it keeps the funding generated by Santana in Mexico and avoid the 10% tax on expatriation of funds which is calculated at US$3.3 million in 2021.

The NPV7.5 of corporate cash flow amounts to US$216 million, almost exactly the same as the calculated diluted Enterprise Value of US$213 million as at 10 August. The market has obviously not given full credit to the effect of higher metal prices on net free cash flow and does not discount additional exploration success at Santana. Not only that, but market clearly has not yet absorbed the impact of the Cerro de Oro project. On 4 August management announced the addition of an El Castillo lookalike project promising low-grade, widespread mineralisation amenable to heap leaching. While it is early days for sure in the evaluation of Cerro de Oro (Hill of Gold for the non-Spanish speakers… it always a good sign when the local names are along these lines), it is great to see the Company adding potential valuable assets to the portfolio for very little capital outlay. It is exactly deals like this that contribute to our confidence in the team.. Herein lies the opportunity.

Minera Alamos is a well-managed company going places fast, with an eye on shareholder value and revelling in the tailwind that the gold price offers.

Introduction

Minera Alamos Incorporated (TSX:MAI) is a Canadian company which was incorporated in January 1934. In May 2014 it was renamed from Virgin Metals Incorporated to its current name. At the time it was focused on developing copper and molybdenum projects in northern Mexico.

In June 2015 Darren Koningen was appointed President of Minera Alamos. Mr. Koningen was a founding member and vice-president of Castle Gold and played a key role in the development and commissioning of the El Castillo heap-leach gold mine in Durango, Mexico, which Argonaut Gold incorporated (Argonaut) subsequently acquired in 2009 for $130 million. The approach of Mr. Koningen and his team at Castle Gold was to select a mining project that is a low capital-intensive opportunity and advance it on a shoestring budget.

Early in 2016 Minera Alamos bought the La Fortuna Cu-Au-Ag project from Argonaut. The project was viewed to be high-grade and open pittable, albeit with relatively limited resources. Management was of the opinion there are good prospects for finding additional resources at satellite prospects.

The purchase price was US$2.0 million paid in instalments with the final US$1.0 million due at the announcement of a construction decision. Argonaut is also entitled to a net smelter return (“NSR”) royalty of 2.5% capped at US$4.5 million.

Minera Alamos bought a second hand processing plant in June 2016 and in August 2016 the company secured directly from the Mexican government an additional 5,200 hectares of mineral rights around La Fortuna.

In October 2017 Minera Alamos acquired the Guadalupe de los Reyes Au-Ag project (“GDR project”) from Vista Gold Corporation (“Vista Gold”), This was soon followed in January 2018 with the purchase of Corex, a Mexican company, through a plan of arrangement. Corex’s main asset was the advanced Santana gold project in Sonora, Mexico. The plan of arrangement placed a value of US$20.1 million on Santana. At the time of the acquisition a bulk sample had been mined and was being processed to determine whether the mineralisation was amenable to treatment by heap leaching. Minera Alamos started a new drill campaign from May 2018 onwards.

In mid-2018, Minera Alamos announced the results of a PEA study on La Fortuna with an after-tax NPV7.5 value of almost US$70 million with pre-production capital of only US$26.9 million. In April 2019, they sold their rights in the GDR project to Prime Mining Corporation (“Prime”) for 19.8% of the outstanding shares of Prime and assuming all option payment obligations to Vista.

In mid-2019, the company started a Phase 2 drilling programme at Santana to find additional resources at the main deposit and to follow-up at several new discoveries. By the end of 2019, the company had secured all key permits to construct a mine at Santana with the operating permit including two open pit mines, waste dump areas, a crushing plant, a heap leach pad, leach solution ponds, gold recovery facilities and all related infrastructure. The receipt of the operating permit for Santana will allow Minera Alamos to initiate applications for other state/local permits such as water extraction and explosives permit, that will be required in advance of any commercial mine production.

In January 2020 the company acquired a 5,000-6,000 tonne per day crushing and agglomeration plant from Mako Mining’s La Trinidad operation where the plant operated for a short period until the mine’s closure in 2019. The plant comes with a number of portable conveyor sections feeding a radial stacker which deposits crushed material to the leach pad.

El Castillo’s was generating around 30,000 oz Au a year up to a peak of 95,000 oz Au after the group was stacked. El Castillo is now generating around 65,000 ounces annually.

On 5 August 2020 Minera Alamos announced the acquisition of the Cerro de Oro project for a total consideration of US$2.9 million and 4 million Minera Alamos shares, of which US$0.4 million and 2 million shares is payable upon closing and the balance in instalments over 4 years.

According to the company, the project has many similarities to El Castillo (and Santana) with much historical drilling information. The transaction is therefore totally consistent with management’s strategy.

Strategy

The Minera Alamos team, headed up by chief executive Darren Koningen and president Doug Ramshaw, is aiming to replicate the success of Castle Gold. Koningen was VP Operations for Castle Gold and the Company took the El Castillo mine in Durango state from generating around 30,000 ounces a year up to 75,000 ounces of gold, before the group was sold in 2010 for C$130 million. El Castillo is now generating around 100,000 ounces annually.

When Koningen was at Castle Gold he worked alongside Chester Miller, one of the industry gurus when it comes to mining and heap leaching. The hands-on engineering experience learned at Castle Gold drives the operating ethos of Minera Alamos. The philosophy is that the team has done it before, and knows what it is doing, so why pay for expensive consultants to come in, spend time getting to know the projects, and sign-off on what Minera Alamos is already doing? In addition, there is tremendous focus on value-engineering. Management is alive to the idea of getting into meaningful production as quickly as possible, while reducing upfront capital expenditure as much as possible. Crux Investor really likes this can-do attitude and the understanding of the strength of cash-flow in a strong gold market. Green Flags abound, and there is much to like about the real-engineering focus of the Company rather than going through studies as part of a box-ticking culture.

Crux Investor does, however, caution against being penny-wise and pound-foolish. It is also true that building mines without formal and full economic assessment carries risk. There is also the hoary chestnut that mine engineers can over-simplify metallurgy and geology, so the prudent approach is always to complete a good quality resource estimate and to carry out truly representative metallurgical testwork prior to construction. Still, where the engineering is simple, the metal prices are high, the input costs are low, and the margins are robust, there is plenty of wiggle-room.

Capital Structure

The graph shows the sharp run-up in share price in 2016 with the La Fortuna acquisition finding approval from the market. The acquisition of GDR also resulted in a price rise, but after September 2017 excitement waned over time with little obvious progress in developing La Fortuna and GDR. The market started to take a real liking after mid 2019 when the potential of Santana became evident and with the rapid development towards mine construction. This rise was interrupted by the COVID-19 pandemic crises, only to accelerate again since end of March 2020.

The price graph suggests that Santana is the company making asset with La Fortuna playing a minor role and a polymetallic legacy asset called Los Verdes considered to be of no importance.

Management holds 6.1% of shares, with 18.7% held by Osisko Gold Royalties, 9.6% by Donald Smith Value Fund, 4.9% by Aegis Financial, and 8.4% by other institutions. The pie chart below shows the important interest held by Osisko. Management has skin in the game, and a considerable slice at that when one considers the fact that the team has only been in control for the past five years. As to be expected with a company that has a history back to 1934 there is a long tail, with retail shareholders owning more than half the company. The low proportion of financial institutions may well be linked to the fact that the market capitalisation has until recently been very small, combined with the fact that there is an absence of key milestone technical reports filed on SEDAR.

Commodity

Minera Alamos is effectively a gold company, even though La Fortuna also contains silver and copper. As such the Company is benefitting from tailwind provided by the great bull run of 2020. The Los Verdes Cu-Mo-W-Ag project is non-core.

In case you had missed it, the economic uncertainty surrounding the coronavirus pandemic has resulted in the highest gold prices since the peak seen in 2011 with it breaking US$2,000/oz in early August. As the major global economies turn to the printing presses in a coronavirus panic, so the fundamental attributes of gold become more widely appreciated, and therefore more sought after. It seems as if the world is slowly waking up to the reality that gold has 24/7 price discoverability, it can be held in small fractions, it is fungible, it can easily be tested for purity and is understood worldwide, and unlike fiat currencies it is hard to debase. So much to like.

The price of gold is expected to continue increasing and prices that are above $2,000/oz are no longer considered to be the preserve of gold bugs, conspiracy theorists and financial tin-hatters.

Country

Minera Alamos’s properties are located in Mexico, with the Santana project in the state of Sonora and La Fortuna in Durango. Mexico is considered a safe mining jurisdiction and is the fourth most attractive jurisdiction for mining investment in Latin America, following Chile, Peru, and Brazil. Mexico is the world’s largest silver producing country and a top global producer of gold, copper, and zinc. Mining is a key contributor to the Mexican economy and so the industry benefits from a well-structured and supportive regulatory framework.

In the past, there have been concerns in Mexico regarding crime and violence, especially that posed by drug cartels, in much of the country. However, federal police and armed forces, along with some private citizen groups, have increased their enforcement activities and, while the problem is still there, it is not at the same level as it has been in the past.

Sonora has a long history of mining and the industry has been an important part of the state’s economy since the discovery of silver near Alamos over 300 years ago. Sonora is the leading producer of gold in Mexico and has the largest mining surface in the country as well as three of its largest mines. Durango also has a long history of mining and ranks fourth in the country for gold production and third for silver. As a result of this, mining still makes up a major component of the state’s economy.

Santana - The Project & Valuation

The Santana project is located in the Mexican state of Sonora, approx. 200 km east-southeast of Hermosillo and close to Highway 16, which connects Hermosillo with Chihuahua.

The mineral rights are held through its subsidiary Corex Gold Corporation and comprises nine mining claims covering 3,100 hectares (“ha”) plus two contiguous mining concession covering 350 hectares along the north of the block.

Minera Alamos does not provide a detailed tenement map and nor is there detail on which areas are subject to royalties. A bit of detective work in the documents archive unearthed Corex management discussion and analysis (“MDA”) which mentions that, of the 4 concessions it secured, two were covered by a 2% net smelter return (“NSR”) royalty of which 1% point can be acquired for US$1.0 million.

In December 2019 the company announced a combined equity and royalty financing package with Osisko Gold Royalties Ltd (“Osisko”) with a 3% NSR sold for C$5 million.

The company has secured approval for the use of 73 hectares for mining, which covers two deposits: Nicho and Nicho Norte. The scope of the operating permit includes the two initial open pit mines, waste dump areas, crushing, heap leach pad, leach solution ponds, gold recovery facilities and all related infrastructure.

Geology and Mineralisation

Minera Alamos does not provide a significant amount of geological information. The old map shown below identifies the main exploration targets with the two deposits that are subject to the mining permit, Nicho and Nicho Norte, shown in the west.

The gold-silver mineralisation at Nicho and Nicho Norte are controlled by both lithological and structural features with gold hosted by subvertical hydrothermal breccias present in intrusions.

A geological cross section through the Nicho Deposit (below) illustrates the close relationship between mineralisation (indicated in red along the drill traces) and degree of fracturing (grey shading).

Also missing from the publicly available materials are comprehensive drill collar location plans or set of sections through the deposit allowing to get a full picture of the size deposit and average grade.

Nevertheless, based on the deposit outline in Figure 7 and the cross section in Figure 6 a NW-SE length of 200 m and SW-NE length of 200 m can be inferred and depth of 170 m (accounting for dropping relief to the NW and SE), which at an average density of 2.6 would indicate 17.7 million tonnes of potential crushing feed.

Drill Results and Grade Estimation

To obtain an indication of the gold grade over wide intervals within the proposed deposit outline drill results from the 2009-2011 drilling campaigns by Corex and 2018-2020 by Minera Alamos were reviewed. These include results for satellite deposits which are not relevant at this stage.

Table 1 summarises the results for the Nicho deposit during 2009 to 2011 derived from the various press releases of Corex. It was also called Santa Lucia by Corex in the early stage of exploration.

Table 2 summarises the results for the Nicho deposit during 2018 to 2020 derived from the various press releases published by Minera Alamos.

The lower average grade for the more recent drilling programme is probably due to Minera Alamos testing the northwest periphery of the deposit and reporting preferentially larger intervals, averaging out low grade sections and internal waste intervals.

This Crux Investor report has assumed that the whole deposit will be mined without attempting to selective mine waste and economic intervals. Bulk mining will greatly simplify operations, enabling large-scale equipment to be used and removing the need for detailed intra-pit grade control drilling. This approach was used successfully at the El Castillo deposit with a cut-off grade of 0.15 g/t Au and that mine proved to be highly cash generative.

Production Strategy

As previously mentioned, Minera Alamos is looking to repeat the successful development plan previously used by the team at La Colorado and El Castillo. Here, at Santana, upfront costs have been kept as low as possible with a build decision made without a formal economic assessment, or even a resource estimate. Management rather relied on test heap leaching of bulk samples instead of column leach tests in a laboratory. The team is obviously confident enough about the economic viability of the project as the grade is clearly higher than El Castillo’s grade of approx. 0.36 g/t gold and the heap leach testing of bulk samples indicating cheap processing.

Minera Alamos has opportunistically bought a crushing plant at a low cost without having had final information about the process route. The second hand plant gives flexibility with three stages of crushing to 3/8 inch and including equipment for agglomeration available for use if required. The plant also includes a programmable logic controller (“PLC”) automation package, which will reduce labour requirements.

Despite having the plant, management announced on 30 January 2020 it would start initial operations using contractor portable crushing equipment “until optimal crushing strategies are better understood’.

According to Minera Alamos testwork has shown that crush sizes much larger than 3/8 inch have little influence on metallurgical recovery apart from a slower gold leaching rate. Agglomeration does not seem to be required and the reagent consumption is low at 0.2 kg/t for both cyanide and lime.

An Evaluation of the Santana Project

Economic Assumptions

An input price of US$2,028/oz Au was used as the base case gold price.

Production Schedule

Management guidance is for production to start in early 2021, with the first full year of production yielding 35,000 oz.

In a news article dated 3-16 February in the Northern Miner, management disclosed the metallurgical process would only be taken to gold loaded on carbon with carbon stripping and doré production carried out in the USA. Apart from saving on upfront capital expenditure, protection and transport of loaded carbon lower risk than transporting doré around Mexico.

The metallurgical recovery is difficult to establish as Minera Alamos only discloses the recovered amount per tonne treated: 0.65 g/t gold. It seems it did not perform regular belt cuts to determine the crushed grade. This Crux Investor report assumes a recovery rate of 70% which although high for industry-wide heap leaching operations, is in-line with recoveries achieved at Castillo. Back-calculating the grade of the bulk sample with a recovery of 70% and a recovered grade of 0.65 g/t gold implies an average bulk sample grade of 0.93 g/t gold.

Based on production guidance of 35,000 oz per annum at steady state, a feed grade of 0.50 g/t gold and metallurgical recovery of 70% an amount of 3.1 million tonnes per annum (“Mtpa”) needs to be crushed at steady state. With reference to Figure 6, a strip ratio of 1.0 has been estimated, including large blocks of internal waste, which is probably conservative.

Cost Estimates, Santana

Given that the press release in December notes that the equity and royalty finance package with Osisko takes Minera Alamos through to production, pre-production capital cost is estimated at C$10 million. With the operation planned as contractor operated, both mining and processing, Crux Investor believes that is a fair estimate.

For operating cost the El Castillo mine is a good reference for processing cost as it also had low reagent consumption: US$4.0/t crushed. Whereas El Castillo’s mining cost was US$1.50/t, this is already a few years out of date and a number of years ago and for an operation that could give the mining contractor a long-term contract at a particular production rate. For this reason, Crux Investor believes that it is more prudent to uses a higher rate of US$2.0/t mined. Site G&A was given an annual provision of US$3.0 million.

Taxation

This valuation has assumed the worst-case scenario of the mining areas being subject to the 2% NSR royalty of which 1% point is purchased for US$1.0 million. For simplicity this valuation assumes the C$1.0 million buy-out is covered by the financing arranged.

In addition Osisko has a 3% NSR and this valuation assumes that Minera Alamos does not need the optional additional C$3 million royalty financing for an additional 2%-point NSR.

The tax regulations applicable for mining in Mexico include:

• An “environmental protection fee” of 0.5% on gross revenue for precious metal producers.
• A “Special Mining Tax” at 7.5% of the Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA). This charge is deductible for income tax purposes.
• Amortisation of pre-production investment to a 10% rate on a straight-line basis, but allowing for accelerated depreciation when the life of mine is shorter, resulting in full depreciation upon mine closure. However, running ahead of the Fortuna project valuation, the PEA document states that the company can also choose for a one-off 72% accelerated amortisation, which has been used. The starting balance for amortisation is the US$20 million Corex acquisition plus US$10 million initial capital expenditure.
• The income taxes are currently 30%.
• Tax on expatriation of dividends a 10%.

Results

Table 3 shows the forecast financial performance over the life of mine.

Table 3 above indicates that the Santana operation makes a cash margin of almost 49%, which is good considering the initial capital investment. Despite the high government take of 38% of EBITDA with the low capital investments 60.4% of EBITDA is available for distribution to shareholders, equivalent to almost 30% of gross revenue.

Table 4, below, shows the sensitivity of the net present values (“NPV’s”) for various discount rates to the main input parameters.

Table 4, above, illustrates that a one percentage point change in the gold price (i.e. US$20.3/oz) increases the NPV7.5 by only US$1.8 million (1.6%). The change in NPV is not very sensitive to the discount rate used because of the short duration of life of mine (“LOM”) which is just over 6 years. An additional year of production adds approx. US$16 million to the NPV7.5, or almost 15%.

The project’s robustness is also evident from the low sensitivity to operating cost changes with a 1%-point rise resulting in a drop of only 0.7% in NPV7.5.

La Fortuna - The Project & Valuation

Most of the information on La Fortuna used in this analysis comes from a NI. 43-101 technical report by CSA Global Mining Industry Consultants (“CSA”) in support of a preliminary economic assessment, dated 13 July 2018.

The La Fortuna project is located in the far northwest of the Mexican state of Durango.

The Project can be reached by road from the coastal city of Culiacan approx. 70 km to the southwest in the State of Sinaloa. The road is paved to within 35 km of the town El Barco situated on the Humaya River which cuts through the southern part of the Project area, approximately 3.5 km south- southwest of the La Fortuna proposed mine area. Culiacan itself is situated 270 km northwest of Mazatlan, a major port city.

The La Fortuna Gold Project consists of eight contiguous mining concessions encompassing over 6,108 ha. Four mining concessions, including the historic La Fortuna Mine and totalling 994 ha, were originally acquired by Minera Alamos from Argonaut Gold Inc. (“Argonaut”) in May 2016 (the red outlines in Figure 9). Four additional concessions totalling 5,114 ha were acquired directly from the federal mining authorities in Mexico in August 2016 (blue outlines in Figure 9).

All four mining concessions purchased from Argonaut are subject to a 2.5% NSR royalty on all production to a cumulative maximum of US$4.5 million.

Osisko has the option to purchase up to a 4% NSR on the La Fortuna Project for cash proceeds of US$9 million upon a construction decision. Osisko has the right to participate in half of any buybacks of existing royalties pertaining to La Fortuna, as well as acquire a 2% NSR (to be purchased at a reasonable market valuation) on any property acquired within a 250 km radius of the La Fortuna project area.

Minera Alamos has secured surface access to a 235-ha area which encompasses the envisioned mine pit, processing facility and all other necessary infrastructure to begin mining. The surface rights agreement also provides access to a substantial surrounding land package.

Further exploration is planned to be undertaken with the objective of expanding the project’s current resource base.

Geology and Mineralisation

The regional geology in the area of La Fortuna is dominated by a large intrusive batholith from which a number of different intrusive stocks are thought to have emanated.

Mineralisation in the project area appears to be spatially associated with a series of parallel fault structures (approximately 1.5–2 km apart) and related to breccia bodies which are located along the periphery or flanks of a north-northwest striking, west dipping, tabular intrusive that appears to be approximately 60 m wide and forms a prominent topographic ridge prominent in the mine area. The Fortuna deposit is up to 60 m thick and dips 30o to the west.

Mineralisation consists mainly of pyrite (Fe2) and chalcopyrite (CuFeS2) stockwork veinlets, fracture fillings and disseminations in amounts consisting up to 10% of the host rock. Minor tetrahedrite ({Cu,Fe}12Sb4S13), sphalerite (ZnS) and galena (PbS) are present. Minor mineralisation occurs in the tabular intrusive.

Mineral Resources

The resource estimate is based on the results from 125 diamond drillholes. Minera Alamos personnel supplied sectional interpretations, wireframes, contours, and string outlines of the geology, surface topography and underground mine works for modelling the resources.

Figure 10 contains isometric views from various directions of the wireframes with A looking north, B looking west and C a plan view. The red is the mineralised breccia and yellow are barren dykes cutting through the deposit.

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The tableshows that La Fortuna is a well-defined deposit with little prospect for moreresources beyond established at Measured and Indicated confidence levels.

Figure 11 shows atypical cross section and a horizontal plan through the block.

Mining Method and Mineable Inventory

Conventional open pit mining by a contractor is planned for La Fortuna and assuming small bench heights of 5 m to provide good plant feed/ waste selectivity. Overall pit slopes of between 41o and 43o are planned, which is not aggressive considering the observation by CSA that the rock is reasonably competent and the short LOM duration.

For mining selectivity relatively small mining equipment is planned with 25 tonne haul trucks. According to CSA haul distances will be short for both waste and plant feed, being less than 500 m.

The inferred resources were treated as waste in the pit optimisation, which assumed a gold price of US$1,250/oz, mining cost of US$2.50/t, processing cost of US$30/t, 95% metallurgical recovery and 45-degree pit slopes. Given these input parameters a cut-off grade of 0.85 g/t Au would be applicable.

Mine dilution of 10% was assumed for blocks with grades above 1.6 g/t Au, which would be send directly for processing, and 25% for low-grade blocks with a grade above 0.8 g/t Au planned to be send to a stockpile for later processing by an ore sorter as from production Year 3 onwards.

The pit optimisation arrived at the mineable inventory shown in Table

Despite the assumed dilution the mineable inventory has much higher grade than the M&I Mineral Resources. More than 76% of the gold content in M&I resources are planned to be fed to the plant for processing at a grade that is 32% higher than the resources grade, which is confusing. Crux Investor knows has struggled to digest the publicly available information on resources and cut-off grade. This is a red flag that will, hopefully, in time be addressed.

Metallurgy and Processing

Metallurgical testwork was carried out in 1995 and 2008 and Alamos commissioning confirmatory testwork in 2016/17. Conclusions of all tests were:

• The host rock was found to be hard-to-very hard with a work index of around 18 kWh/t.
• Gold is associated with sulphide, primarily pyrite and chalcopyrite, which creates opportunities for ore sorting.
• Gravity concentration testwork indicates potential for +80% gold recovery at 70–80 microns, which provides opportunity to recovery majority of gold content by cyanide leach of gravity concentrate. Expected production plant recoveries would be 60–80% of this value depending on where the centrifugal concentrator(s) is placed in the process.
• Bulk flotation gold recoveries up to 98–99% are achievable at typical mass recoveries of 8–10%. A combination of gravity with flotation concentration would therefore achieve high gold (high 90’s), copper and silver recoveries.
• Copper recoveries of +90% are achievable into a concentrate with ~20% copper content when regrinding the bulk concentrate before removing copper sulphides. Removal of Cu prior to downstream cyanidation significantly reduces overall process cyanide consumption.
• Of the gold in the flotation concentrate more than 90% is leachable when the concentrate is reground to <75 microns. Gold in gravity concentrate is leachable rapidly in the high 90’s.

Based on the testwork results a process flow is planned with crushing and grinding to 80% passing (“P80”) 250-300 microns followed by bulk sulphide flotation. The concentrate is reground to P80 minus 80 microns [this is engineering-speak for 80% of all the material is finer than 80 microns] after which the copper minerals are floated to generate a copper concentrate. Centrifugal gravity gold recovery circuits are included in both the primary and concentrate reground circuits to extract free gold as a concentrate. Tailings from the flotation circuit are dewatered via filtration and dry-stacked in the tailings containment area adjacent to the processing plant.

Approximately half of the gold is extracted as a gravity concentrate, which will be cyanide leached at site and loaded onto activated carbon for shipping outside of Mexico for final doré production. The other half of the recovered gold ends up in the copper flotation concentrate (along with majority of the copper and silver), which is filtered and transported to the port facilities at Guaymas (approximately 500 km) for final sale.

The business plan provides for X-Ray Extenuation (“XRT”) ore sorting from production year 3 onwards to upgrade 0.8 g/t – 2.0 g/t gold material. According to CSA, testwork has shown that at the planned crusher size +80% of the contained gold can be recovered into a concentrate with gold contents similar to the high grade (3.5–4.0 g/t gold) direct milling material from the mine.

Minera Alamos has purchased a used 2,000 tpd grinding/flotation/ filtration process plant, which is double the planned process rate.

The production forecast assumes 45% of the gold recovered into gravity concentrates and 45% in the copper concentrate together with 85% of the silver and 90% of the copper in the plant feed. The copper concentrate has a low copper grade of 18%.

An Evaluation of La Fortuna

Economic Assumptions and Marketing Terms

The model uses a gold price of US$1,775/oz Au, a silver price of US$18.0/oz and a copper price of US$2.73/lb.

For the copper concentrate, payment terms were assumed with a minimum deduction of 1.25 percentage point copper content (giving an effective payability of 93.1%), 1 g/t for gold (effective payability of 95%) and 30 g/t for silver (effective payability of 95%).

For transport, treatment and refining of the loaded carbon product reference was made to Argonaut’s El Castillo operation which incurred US$20/oz gold treated. Treatment charge for the concentrate is US$80/t with refining charges of US$0.08 per payable pound Cu, US$6.0/oz Au payable and US$0.5/oz Ag payable.

For transport to the harbour, port handling fees, freight and insurance a total provision of US$165/dry metric tonne concentrate was used.

Production Schedule

The production schedule has a throughput rate of 380,000 tonnes per annum, in the first 2 production years, increasing by 30,000 tonnes for the years thereafter, supposedly because of the introduction of the ore sorters, which treat 410,000 tonnes per annum of low-grade material. The feed grades remain roughly the same over the LOM.

This production schedule provides for a LOM of only five years. The overall strip ratio is 6.9, but with a sharp increase toward later years. The production schedule clearly needs refining considering highly fluctuating handling requirement (i.e. year 4 has 60% more material mined, plus needs additional capacity for rehandling of stockpile).

This valuation assumes construction in 2021 and the first production year being 2022.

Capital Expenditure

Table 6 shows the initial and sustaining capital cost estimated by CSA for La Fortuna.

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Considering the scope of work required to improve the access roads, onsite haul roads, number of electrical power generators for a base load in excess of 2 MWh, and water supply, the provision of US$3.5 million for site development and infrastructure seems too low for comfort. Crux Investor has been prepared to take the Santana figures given by the management team at Minera Alamos, but in the case of La Fortuna it is likely the capital numbers will increase as further details emerge.

For example, the estimated CapEx of the plant, shown above as $15 million, is possible, but potentially light. Consultant engineers who see a lot of plants being built tend to have a “rule of thumb” to sense check any numbers. Outliers need to be investigated! In the case of processing plants, it is obvious that the installed capacity of Gold Plants affects the CapEx required to build the plant, and one rule of thumb is that the cost of a new plant on conventional processing is US$650- 700/t of installed monthly capacity. This means that a plant capable of processing 100,000 tonnes per month is likely to be in the US$65-70 million range. Another rule of thumb is that second hand plants end up costing about 65% of the cost of new builds, once every bug is ironed out. Considering this the CapEx of $15 million is possible. The calculation goes like this:

• 32,000 tonnes monthly capacity x $700 = US$22.4 million
• Factor for 2nd hand installation (65%) = US$14.6 million

Another query about the Company assumptions for La Fortuna is raised when looking at mine closure. Crux Investor doubts that a realisation of US$3.0 million upon mine closure is credible given that mining equipment belongs to the contractor and second hand plant has limited value. The low value of second hand plants is known to be low as Minera Alamos pays little for its second hand plants. In this Crux Investor analysis of the economic value of La Fortuna, no salvage value is ascribed to the plant.

Another sign that the numbers on La Fortuna might change is the fact that the contingency of US$5.4 million is 25% of the outlays before the contingency. For a scoping level study a 25% contingency is low and a more prudent approach would be 35%.

In conclusion, Crux Investor feels that the capital estimate for La Fortuna are too light, which is a red flag. It is hoped management will address the detail in these capital cost estimates in future.

Cash Operating Cost Structure

Table 7 summarises the estimated operating cost over the LOM at La Fortuna.

While much of the work that Minera Alamos is proposing seems to be well considered, Crux Investor is yet to be convinced by the merits of postponing installation of the ore sorter by two years. There may be factors that are not in the public domain, but on our analysis the benefits of introducing ore-sorters soon outweigh the drawbacks. The cost of rehandling different grade material to and from stockpiles is estimated to cost US$2.5 million over the life of mine. Postponing acquisition of ore-sorters at a cost of US$7.1 million would save very little in time value of money. Moreover, immediate installation would allow for a smaller plant and less complex operating protocols. We believe that if it is worth doing, it is worth doing from the outset, and in these markets the extra capital can be afforded without too much dilution.

Regarding operating costs, the mining cost of US$2.15/t mined is reasonable compared to the historical contractor cost rate at El Castillo of US$1.50/t. The G&A provision of US$2.2 million per annum seems too low, even considering the low-cost structure in Mexico and the company management style of keeping operations lean and mean.

While a ruthless approach to cost control is a key attribute in an operation, it is also important to balance internal targets with external expectation management. Benchmark costs are usually an excellent reference point, as they provide real-world examples of cost structures. And it may be the case that Minera Alamos can beat industry benchmarks when it comes to cost delivery, which would be a fantastic result. Crux Investor, however, suggests that when operating without the standard (comforting) levels of disclosure provided by formal studies, it is better to err on the side of Under-promising and Over-delivering. It is true that the cost of the formal studies can contribute to the expenses ledger, and it is true that third-party consultants have a tendency to arse-cover by over-engineering solutions. All of which provide management teams like Koningen and Ramshaw a golden opportunity to under-promise by using benchmark costs, and over-deliver by beating the publicly released information when it actually gets built.

Working Capital

Given the very short LOM, investments in working capital have been ignored as having a negligible effect after the flows involved are discounted.

Royalties and Taxation

The model includes the 2.5% royalty to Argonaut up to a maximum of US$4.5 million. This valuation has ignored the right of Osisko to exercise its option to purchase up to 4.0% NSR royalty for C$9 million.

The tax regulations at La Fortuna are identical to those at Santana (see p.17). The valuation has adopted CSA approach and used accelerated depreciation of 72% for one year.

Results

The table below shows the forecast financial performance over the LOM for two scenarios: using Stantec’s input parameters, but accounting for tax on repatriation of profits, and using a scenario with the currently prevailing metal prices.

The table above indicates that the operation will have a high cash margin of almost 66% for PEA metal prices and almost 79% for spot prices, which compares very well with peer projects. The low capital expenditure requirements mean that the amount of EBITDA available for distribution to shareholders is almost half, despite the high government take of US$142 million, equal to 38% of EBITDA.

The NPV7.5 of US$136 million is almost five times initial capital expenditure requirement, which again is extraordinarily high compared to peer projects.

Table 9 shows the sensitivity of the net present values (“NPV’s”) for various discount rates to the main input parameters. The table illustrates that a one percentage point change in the gold price (i.e. US$20.3/ oz) increases the NPV7.5 by only 0.8%, again highlighting the very high margin earned at Base Case metal prices. The sensitivity to one percentage point changes in working cost (i.e. US$4.79/t million) and capital expenditure (i.e. US$0.37 million) results in changes in NPV7.5 of respectively 0.3% and 0.2%.

The Cerro de Oro Project

Cerro de Oro is a very recent addition to the mineral properties stable of Mineral Alamos, located in the extreme north of the Zacatecas State of Mexico on the border with the Coahuila State (see Figure 5_1).

The project does not have declared mineral resources but has been substantially drilled (8,200 m, of which 4,200 m by Noranda in the 1990’s) and trenched (6,000 m) by previous operators. According to Minera Alamos its consultants are working towards completing a NI 43-101 compliant resource estimate, which is surprising as it is at least doubtful the Noranda drilling was subject to the required Quality Assurance Quality Control (“QAQC”) measures.

Without a technical report it is difficult to do detailed analysis on the project. Some information is provided, but except for a cross section, the location of holes cannot be established. There are also numerous holes over a large section of the borehole location map without grade information, presumably “less interesting” holes. One fence of holes defines mineralisation over a length of 300 m, but with little information on parallel fences, there is not much one can do to define volume/ tonnage.

Nevertheless, a first appraisal of Cerro de Oro suggests that it is a similar type of project as both Santana and El Castillo with outcropping low-grade mineralisation that is oxidised. The presumption is it will be amenable to heap leaching, but no metallurgical information is provided to confirm this was established through testwork. The grade is in the 0.35-0.70 g/t Au range which is again like El Castillo and Santana.

We look forward to management providing ongoing updates and technical reports as the project advances through the exploration and evaluation stages. With time, it may develop into a third-leg for the Company providing yet another source of low-cost production.

Management

The main feature of the Minera Alamos management team is the track record of engineering success and value creation. Experience is the key point, with many of the team having worked with Darren Koningen at Castle Gold, and capital markets and technical strength in depth.

Darren Koningen - CEO and Director

• +20 years of engineering/metallurgical experience and led the development of Castle Gold’s El Castillo project prior to its sale to Argonaut
• Designed, constructed, commissioned and operated two gold heap leach operations in Mexico under budget and on time
• Doug Ramshaw - President, Director
• +25 years of experience the mineral resource sector as a former mining analyst and senior executive of several exploration companies with focus on mineral project evaluation, M&A and business development strategies supporting corporate growth
• Director of Great Bear Resources

Kevin Small – Non-Executive Director

• +30 mining experience as an operations leader to numerous mine operation and start-ups projects.
• Currently President and CEO of Jerritt Canyon Gold (100% owned by Sprott Mining Inc.) previously Director of Mine Operations at the Beta Hunt mine in Western Australia.
• Ruben Padilla - Non-Executive Director
• +25 years of diverse mining and exploration experience focused on the Americas.
• He served as Exploration Country Manager in Peru and Colombia for AngloGold Ashanti and as Chief Geologist for the Americas exploration group
• Currently Chief Geologist of Talisker Exploration Services Inc.

Bruce Durham - Non-Executive Director

• +40 years of experience in the mining and exploration industry and was a member/leader of various exploration teams credited with the discovery of several mines in the Hemlo and Timmins areas
• President and CEO of Nevada Zinc Corporation

Chris Chadder - CFO

• +20 years of financial management experience and has served in senior roles with various mining companies in all stages of the mining cycle including involvement in the development and commissioning of 3 mines in the last 10 years

Federico Alvarez - VP Project Development

• +30 years of experience within academia, government and the mining industry, primarily in Mexico
• Past VP Operations for Argonaut Gold and Castle Gold and for 10 years was Director of Mining Affairs for the State of Guanajuato

Miguel Cardona - VP Exploration

• +20 years of experience as a geological engineer in mineral exploration and underground and open pit mining operations
• Led the 3x increase of El Castillo’s gold resource for Castle Gold from 400 koz to 1.2 Moz

Carolina Salas - VP Technical Services

• +15 years of experience in design/ construction, operation, metallurgy and maintenance at various projects sites throughout Mexico, 6 of which at Peñoles
• Oversaw all gold processing and recovery facilities at Lluvia de Oro gold heap leach project in Sonora

Victoria Vargas - VP Investor Relations

• +18 years of experience in the mining sector, she started her career at Kinross Gold Corporation and joined Alamos Gold Inc. in 2004 and led the effort to increase investor exposure and positively upgrade the company from the TSX Venture to the TSX

Timeline

Minera Alamos report that construction began on their 30,000 ounce per year Santana mine in January 2020 and completion is estimated in early 2021. This is a small, understandable slippage related to the coronavirus storm.

In parallel the Company is carrying out exploration drilling at Santana, with the Phase 3 drill program (20-25 holes), totalling 4,000m, at Nicho and the first drill holes at the Zata and Gold Ridge targets as well as the recently identified Bufita target. There are also further holes planned for the Divisadero target to gain a better understanding of the geometry, limits and the internal characteristics of this gold bearing intrusive centre. In total, this drill program amounts to approximately 6,000- 7,500 m of drilling to be conducted over the second half of 2020. By the second half of 2021, the company expects to be progressing with increasing production rates of the Santana project, and updating the market with new resource estimates to feed the increased mine output.

With the recent completion of a preliminary economic assessment for La Fortuna and final permitting drawing to a close, a 12-month build is expected for the 50,000 ounce per year open pit mine. Assuming construction can begin soon, this means the first production from La Fortuna is expected before the end of 2021.

Ongoing exploration and evaluation is anticipated at Cerro de Oro over the next eighteen months.

Finance

The historical financial performance from 1 January 2016, the year when it acquired La Fortuna, until 30 March 2020 is shown below.

The table shows that Minera Alamos has expensed exploration and evaluation costs, keeping investment low. These costs will be capitalised once the project on which these expenses were incurred proves to be technically feasible and commercially viable. As a result, despite the degree of development of Santana and La Fortuna, the cash absorbed by operations since 2016 is a very modest US$22.2 million.

Over the same period, funding was almost exclusively from equity placements, amounting to almost US$27 million. One of the reasons for the modest funding requirements is cash inflows from the sale of the Guadalupe de los Reyes project and royalties. The number of shares in issue has increased by 4.7 times in the past five years, but without the cash inflows from Guadalupe de los Reyes, the company would have experienced significantly higher dilution.

Minera Alamos currently has its highest cash balance for years despite constructing the Santana mine. Furthermore, it is forecast to generate sufficient cash flow to be able to fund the La Fortuna project internally, especially when it keeps the funding generated by Santana in Mexico and avoid the 10% tax on expatriation of funds which is calculated at US$3.3 million over 2020 and 2021.

Marketing

The most remarkable aspect of the way Minera Alamos communicates to the market is the relative paucity of technical information but the relative simplicity of the messaging. Information on the website, in the news releases and in the presentation is consistent in its tone and delivery. Which is to say that the plan is clear (bring Santana then La Fortuna into production) with an emphasis on track record (the team did something similar for Castle Gold), and a notable absence of formal studies signed off by independent competent persons (no resource, no feasibility study for Santana which is coming into production).

Nevertheless the company is well followed, and well backed. Minera Alamos notes on its website that it is covered by five Canadian financial houses, and with this Crux Investor report there is no shortage of written material on the Company. The fact that Alamos has issued stock regularly in the past few years is no doubt one of the reasons why the Canadian brokerages have been keen to cover the Company. It is important to note that Ruben Padilla, a board member, is a representative of Osisko Gold Royalties through his position in Talisker Exploration. Ruben is a vastly experienced geologist, and being a board member he is privy to more information than the general public – not least because Mineral Alamos has not invested in completing formal resource or economic studies recently. And it is no coincidence that Osisko Gold Royalties increased its position in the company from 12.3% to 18.7% in the financing that closed in January of this year.

As Crux Investor represents the independent investor we can raise a red flag to say that there are clearly two tiers of information dissemination. Those that are on the inside (such as management, Directors and Osisko Gold Royalties) and those that are on the outside (such as almost everyone else). While it commendable to husband shareholder capital frugally, it is generally considered good practice to publish technical and economic studies as an exercise in derisking projects technically, and also as an exercise in transparency.

Red Flags

Minera Alamos offers a slight conundrum to investors in that the Red Flags and the Green Lights associated with the company are by and large simply different sides of the same coin.

On the one hand, the Company has a go-getting approach that eschews expensive consultants and over-engineered solutions, preferring to trust in the team’s own technical experience and good old-fashioned experience and good enough engineering. On the other hand, that very approach means that investors and analysts end up scrabbling around trying to find information, and due to a lack of independent reports the projects carry with them inherent risk around resources, metallurgical results, and engineering plans.

The mitigating features amid this Mexican (literally) stand-off are the holy trinity of low costs, good grades, and high prices. The low costs are a feature of opportunistic plant purchases and prior experience of exactly these types of simple mining and processing operations. The management team has first hand experience of how these kinds of simple operations are built and run, and also a good handle on how much it costs to execute the plan. The good grades and high prices bolster confidence in operating margins, which in turn is passed into the public arena.

• Lack of feasibility studies for either project, Santana or La Fortuna
• Lack of adequate geological maps and information, especially Santana
• Absence of up to date resource estimates at Santana
• Lack of information on bulk sample metallurgical testwork at Santana
• Lack of clarity on La Fortuna mill feed grade
• Risk of undershooting the CapEx estimate for La Fortuna
• Lack of equality in dissemination of information among stakeholders
• Risk of being ‘penny-wise, pound-foolish’, with cost-cutting potentially impeding value creation (c.f. ore-sorters at La Fortuna would simplify the operation and increase the NPV)

Green Lights

• Strong, experienced management team with a highly relevant track record
• Better grade than otherwise identical profitable development used as a ‘test case
• Rising gold price and buoyant equity market
• Strong relationship with Osisko Gold Royalties provides financial muscle
• Simple, proven gold deposit types with low capital expenditure requirements and, on the information available, highly profitable
• Well-managed treasury, minimising dilution and maximising shareholder value creation
• Addition of new Cerro de Oro project not baked into share price
• Recent metal price rises not fully baked into share price

Valuation & Conclusion

As noted above the company is frugal with both money, and with information. With little technical information available for Santana, not even a resource statement, a proper and reliable valuation based on discounting forecast cash flow for a particular production schedule is not possible. This section of the report, therefore will approach the valuation of Santana by estimating annual cash flow based on some broad-brush assumption derived from publicly available information. Given the nature of information and approach the established value must be seen as very approximate.

The Enterprise Value of Minera Alamos at 66c

At a share price of C$0.66 the market capitalisation of Minera Alamos is C$271.2 million, or US$203.4 million.

At the end of March 2020 the company had 2.77 million warrants outstanding, the majority of which have an exercise price of C$0.10 and are therefore in the money. A further 0.2 million warrant expired in June 2020 at an exercise price of C$0.30 were also in the money.

As at the end of March 2020 the company had 26.0 million options outstanding, which are all well in the money. Of these 2.08 million expired on 22 June 2020 and can be considered exercised and included in the current issued share capital figures.

The net current assets on 31 March 2020 have been ignored as irrelevant as well as the C$5.0 million received from Osisko in April 2020 for the Santana royalty and the sale of Prime Mining Company shares and warrants for proceeds of C$1.67 million. These funds are all considered committed to bring Santana into production.

Based on the above the diluted Enterprise Value for Minera Alamos is C$284 million, equivalent to US$213 million as derived in Table 10.

Corporate Cash Flow

Figure 13 shows the forecast cash flow at corporate level derived from Santana and La Fortuna, but also accounting for corporate overheads, which were C$3.3 million in 2019, excluding share-based compensation, interest payments and non-cash items. This low amount illustrates the frugal nature of the management team and the fact that the Company is working for all shareholders.

The company is forecast to generate sufficient cash flow to be able to fund the La Fortuna project internally, especially when it keeps the funding generated by Santana in Mexico and avoid the 10% tax on expatriation of funds which is calculated at US$3.3 million in 2021.

The NPV7.5 of corporate cash flow amounts to US$216 million, almost exactly equal to the calculated diluted Enterprise Value of US$213 million. The market has obviously not given full credit to the effect of higher metal prices on net free cash flow and does not discount additional exploration success at Santana.

Not only that, but market clearly has not yet absorbed the impact of the Cerro de Oro project. On 4 August management announced the addition of an El Castillo lookalike project promising low-grade, widespread mineralisation amenable to heap leaching. While it is early days for sure in the evaluation of Cerro de Oro (Hill of Gold for the non-Spanish speakers… it always a good sign when the local names are along these lines), it is great to see the Company adding potential valuable assets to the portfolio for very little capital outlay. It is exactly deals like this that contribute to our confidence in the team.

Interestingly, there are many catalysts for further value creation. Exploration success at Santana to extend the minelife is the most immediate and the most tangible. The Company will also rerate as it comes into production. Production at La Fortuna will further consolidate Minera Alamos. And now Cerro de Oro offers further upside potential. So much to like.

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These CRUX Reports are written for expert investors AND for people new to natural resource investing. But whether you are an expert or a newbie, we all have the same driver. We invest to make money. Sometimes investors get emotional about the investment. They actually think they own a mine. They don’t. They own shares in a company. So focus on your investment strategy, work out the best plan for your needs, stick to the fundamentals and remember that the only way you make money is if your shares go up in value… assuming you don’t forget to cash them in!

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