ARD has a market capitalisation of $35 million (137m shares...

ARD has a market capitalisation of $35 million (137m shares outstanding - check latest Cleansing Notice post options exercise). The company has $10m in cash after recent options exercise. So ARD has an EV of $25m and a JORC resource of 31m oz of silver.

On 23rd November 2010, ARD released a notice to ASX "Current prices boost economics of Kempfield Silver Project". The bottom line of this announcement was that at the prices that prevailed at that time (silver US$27/oz, gold US$1400/oz), the mine could support a 1mtpa processing operation for 16 years and produce $230m in discounted cash flow before capex. Capex was estimated previously at $40m (but let's assume this needs to be $80m for higher processing capacity). Therefore pretax NPV of roughly $150m or $1.1 per share. At 25c per share stock is trading at 25% of pretax NPV.

But, now let's update the Nov 2010 announcement for current prices (silver $40, gold $1600). Mine expected to produce:
21m oz silver * $40/oz = $840m
34,000 gold = $54m
Lead and zine (assume same) at $52m and $162m respectively

So now total expected revenue (non-discounted) is $1,108m. If costs are same as Nov 2010 announcement ($585m) then total pretax profit is now $523m. Apply a discount factor to this and $80m in capex and discounted pretax cashflow is roughly $330m or $2.40 per share. Post tax we can call it $1.70 per share.

The question you need to ask is what is the right discount to apply to this? 10%, 20%, 50%? Probably not current discount which is 85%!

There are few factors to consider in applying discount:
1). can management bring project to production?
2). what will costs be (might be higher than discussed so far)
3). is $40 the right long term price for silver

Another way to view the stock is as a call option on silver prices. Currently call options on silver are very expensive - eg. a $50 strike Jan 2013 silver call (on Silver ETF in US) trades for about $4 - due to the high volatility of silver prices. This volatility has a price and it is not being reflected in the "premium" that should be paid on this pure play silver company.

Put another way, if silver goes to $75 you would make about 5x your money buying the call discussed above. But if silver goes to $75, then the post tax NPV of ARD goes to about $650m or nearly $5 per share. Yes, $5 per share. Buying at 25c today would net you 20x (compared with only 5x on the options).

So bottom line, if you like the upside on silver and want to get cheap call option exposure on silver, ARD makes sense.

One final note - over the last year (while silver prices have been surging) ARD has risen 2x. Meanwhile First Majestic Silver (AG in the US) is up 7x and AYN is up 5x. Those stocks are pricing in the incredible leverage to commodity prices.

If my maths is wrong, please feel free to correct (or ask the company to update the numbers, including latest cost models) so it is clear for all