A few positive comments from the MF Global report.

Investment attractions:

» Production within two years from Cerro Del Gallo. Capital payback in less than two years, operating for over 15 year mine life. Feasibility study
complete, we expect a decision to mine to be taken by early 2012.

» Resource announcements during Q311. At Namiquipa, given the potential for a large silver deposit to materialise, and containing existing workings, we foresee development of this project over the next 4-5 years using cash generated from Cerro Del Gallo. At Mt Philp, there is potential for a high grade hematite deposit with export infrastructure solutions.
There is great interest from the industry in such deposits, as we have seen with competing takeover bids for Territory Resources (TTY AU).

» Valuation upside. We have valued the Cerro Del Gallo Project using a DCF model. Base case of 21c per share assuming project expansion to 2027. At spot prices DCF rises to 41c per share. On resource valuation Cerro trades at a significant discount to both producing gold peer group: 179% on EV/Reserve and 99% on EV/Resource and pre-producing gold peer group:56% on EV/Reserve and 77% on EV/Resource. When we consider Cerro‟s silver reserves and resources only (no gold), we find it trades at a significant discount to the silver producer peer group: 166% on EV/Reserve and 164% on EV/Resource. Note both Naimiquipa and Mt Philp provide further additional valuation upside.

Operating Cost Estimates – average for peer group at $470/oz Au eq (stage 1) and $560/oz Au eq (stage 2)
Gold grades are low, but Cerro has many positive characteristics which reduce its overall cash costs:
(1) Very low strip ratio below 0.8, keeping mine cost to $1.60 life of mine (LOM)
(2) High silver content. Silver will account for 90% of the recovered output. When converting into gold equivalent ounces, assuming a gold/silver ratio of 60, this results in an effective uplift in gold output by around 20%.
(3) Recovery rates are industry average but could potentially be much higher from undertaking more advanced metallurgical test work. For example, indications are that more finely crushing the ore through high pressure grinding roll (HPGR) methods may increase recoveries by more than 5%. CIL processing produces higher gold recoveries despite the lower grade of the sulphide ore being processed. However, silver recoveries reduce with CIL.

Cashflow and Returns – very strong even at long term prices due to low operating and capital costs
(1) High EBITDA margins averaging close to 60% even at long term prices due to the low operating cost. EBITDA averages between $40-50m per annum and NPAT $30-35m per annum in both cases
(2) Quick payback on capital expenditure, just 2 years
(3) Capital efficient, with net cashflow (nominal) paying back capital costs 2.4x (Stage 1) and 3x (Expanded Case)
(4) Relatively stable underlying operational cashflows, given the stable production profile, grade and recoveries. The average and median net cashflows (after capex) for both Stage 1 and the expanded cases are between $30-35m per annum.

Capital Cost Estimates – low at equivalent ratio of $195/oz Au eq output (Stage 1) and $146/oz Au eq output (expanded case)
Sedgman has provided the capital cost estimate for the first stage heap leach processing facilities and is continuing with engineering design work. The Mines Group in Reno, USA has completed pad and pond design, hydrological assessment and pit slope analyses for the first stage.

Funding Growth

Cerro has $20m in cash (no debt) on the balance sheet as of May 2011. Aside from exploration expenditure at Namiquipa (c.$8m) and Mount Philp (c.$2m) in 2012, cash and funds will be directed towards the Cerro Del Gallo Project. If Goldcorp elect to not contribute to capex then Cerro will increase its equity share to 90% (from 65.7%), which is our assumption. Thus the total funding requirement to first sales is close to $70m ($90m capital costs less $20m in cash). There are various options available:
■ Mixture of straight equity and debt
■ Potential for forward selling of some future production in exchange for capital now
■ Sell down or sale of the 100% owned Mount Philp project (see project details in Mount Philp section). A sell down or sale could be possible. An initial resource statement for the Northern section is due late in Q3 with further work continuing into 2012. There is very high demand from the trade for iron ore assets that have potential infrastructure solutions, particularly outside of the Pilbara. A good example being Territory Resources (TTY AU).
Territory sells 2.2mtpa of hematite (60% grade) per annum from its Frances Creek mine located 200km south of Darwin, shipping through the Port of Darwin. Two takeover offers are currently outstanding for Territory Resources at $120 and $130m, one by Exxaro and the other by Noble Group (a cornerstone shareholder).
■ We view a potential sell down or sale of the 100% owned Namiquipa Project as less likely for Cerro Del Gallo funding purposes, given that the project is located in Mexico and involving silver (both specialties of management). If anything Namiquipa would potentially be a good USE of the cash generated from Cerro Del Gallo in future years. We expect the Group to await further details on the scale and grade of the resource to assess the optionality around potential production.

Peer Analysis

» We expect Cerro‟s cash costs to be USD468/oz gold eq. in line with its peer group.
» Cerro trades at a significant discount to producing peer group: 179% on EV/Reserve and 99% on EV/Resource
» Cerro trades at a significant discount to pre-producing peer group: 56% on EV/Reserve and 77% on EV/Resource
» We note the substantial exploration upside that we expect to be announced at Namiquipa and Cerro Del Gallo
» Given the rarity factor, silver only or mostly silver exposed companies trade at a premium » When we consider Cerro‟s silver reserves and resources ONLY (no gold), we still find it trades at a significant discount to the silver producer peer group: 166% on EV/Reserve and 164% on EV/Resource
» We note the substantial exploration upside that we expect to be announced at Namiquipa and Cerro Del Gallo

Share price performance

» On a long term chart, we can see that Cerro is trading well below its pre-financial crisis highs despite stronger precious metal prices, greater resource identification, having added the Namiquipa project to its asset base, and having completed a feasibility study on Cerro Del Gallo and being closer to production.