The past three years have been tough for Avino Silver & Gold Mines (NYSE:ASM ) as the company had to shut down its mine in 2020 due to COVID-19 lockdowns and this was followed by a strike. The company restarted operations in early August 2021 just as silver and copper prices were soaring, but this was soon overshadowed by the purchase of the La Preciosa property which many analysts and investors consider to be a bad project.

In my view, the effective way Avino plans to extract value from this property has been overlooked, and the market also seems to be ignoring the good progress the company is making on the ramp-up of operations. In Q2 2022, Avino produced 649,569 ounces of silver equivalent and all-in sustaining costs (AISC) dived below $16 per ounce. Let's review.

Avino owns a polymetallic mine under the same name in the Mexican state of Durango which has more than 37 years of production history. The mine had measured an indicated resources of 117 million ounces of silver equivalent as of October 2020 and the nearby La Preciosa property has measured an indicated resources of another 113 million ounces of silver equivalent.

Avino Silver & Gold Mines

Avino Silver & Gold Mines

Avino Silver & Gold Mines

Avino Silver & Gold Mines

I think the exploration potential looks good as there are 20 named veins at the Avino property as well as another 50 unnamed veins. Avino has budgeted 15,000 meters of drilling in 2022, with a focus on the area at depth below the current Elena Tolosa production area. The recent drill results seem compelling, with the highlight being 41 meters at 206 g/t silver equivalent in June.

Avino Silver & Gold Mines

Avino Silver & Gold Mines

In 2022, the company expects to produce 2.2-2.4 million ounces of silver equivalent by processing 500,000 to 600,000 tonnes, and this should put it close to the levels achieved before the COVID-19 lockdowns.

Avino Silver & Gold Mines

Avino Silver & Gold Mines

In Q2 2022, silver equivalent production soared by 42% quarter-on-quarter to 649,569 ounces which pushed AISC down to $15.95 per ounce from $19.90 per ounce. The mill feed rate increased by 6%, but silver, copper, and gold grades surged by 30%, 23%, and 57% to 65 g/t, 0.69 g/t, and 0.46 g/t, respectively. These grades are above the average in the resource estimate, so I don't think they will be sustained for long. With the mill feed rate stabilizing and grades going down to levels close to the ones in the resource estimate, it's unlikely that AISC will stay below $16 per ounce of silver equivalent and I think they could increase to about $18 per ounce over the long term.

Despite the much higher output, revenues declined by 15% to $9.4 million as silver and copper prices decreased significantly in June due to global recession fears. Yet, EBITDA rose by 41% thanks to a $2.4 million gain on fair value adjustment on warrant liability due to lower share prices. Adjusted net earnings for Q2 2022 were $2.5 million.

Avino Silver & Gold Mines

Avino Silver & Gold Mines

Overall, I think that Avino is on track to achieve its production forecasts for 2022 and it seems the mine can remain profitable even if silver and copper prices remain low. CAPEX is expected to range from $7 million to $9 million in 2022 and the company had $12.8 million in cash as of June, so I don't expect liquidity issues to emerge.

Looking at the future, Avino's long-term growth plans include the development of La Preciosa. The company already paid $29.7 million in cash and shares for this property and the sum of the deal can increase to up to $93.4 million. Much of this amount has to do with contingent payments of $0.25 per silver equivalent ounce on any new mineral reserves discovered and declared outside of the current resource area and they are capped at $50 million. In view of this, I expect Avino to stay away from step-out drilling at this property.

Avino Silver & Gold Mines

Avino Silver & Gold Mines

So, why aren't analysts and investors optimistic about this project? Well, it's mainly due to the low internal rate of return (IRR). According to a feasibility study from 2014, La Preciosa has an estimated net present value (NPV) of $87.6 million at a 5% discount rate, with an estimated internal rate of return of just 9.5%. The numbers in the base case scenario were calculated using silver prices of $22 per ounce and the IRR is so low because the project has an estimated initial CAPEX of $327 million.

The initial CAPEX includes a 10,000 tpd processing plant for $262.4 million that will process both oxides and sulfides into dore bars as well as $53 million in mining costs that include pre-stripping as this was envisaged as an open pit mine. Avino plans to focus on underground mining, and it looks like it wants to process the ore at its existing facilities. This poses challenges as switching to a flotation flow sheet producing a concentrate will slash recoveries. Avino estimates that it can recover about 80% of the silver and 60% of the gold, but the bigger issue is that the complicated low-angle Martha vein accounts for about 60% of the resource. Underground mining there would be costly which means that Avino might have to focus on the remaining veins. In my view, underground mining at the Abundancia and Gloria veins could be economically feasible, and even if the company decides to mine only the highest grade ore at the project, there are around 66 million ounces of measured and indicated resources left.

Avino Silver & Gold Mines

Avino Silver & Gold Mines

Turning our attention to the risks for the bull case, I think the major one is that a global recession could lead to a further decrease in copper and silver prices. This would put significant pressure on Avino's free cash flow and the company could need to carry out a capital increase to fund the development of La Preciosa. In view of this, I would abandon my bullish stance if free cash flow becomes negative. Other risks include a return of COVID-19 lockdowns and strikes but those seem unlikely at the moment.

Avino is a high-cost silver and copper miner that has been ramping up production following a tough period, and I don't think the market is giving it enough credit for becoming profitable. The company booked a free cash flow of $1.2 million in Q2 2022 despite weak silver and copper prices, and its flagship project had measured an indicated resources of 117 million ounces of silver equivalent as of October 2020.

The market was also unimpressed by the purchase of La Preciosa as this is a project with a high initial CAPEX and a low IRR. However, I think this was a good purchase considering the property is at trucking distance from Avino's existing facilities which means the company doesn't have to build a new processing plant. In addition, Avino wants to use underground mining to get to the high-grade areas of the project which is more expensive but will avoid pre-stripping. Overall, I think that La Preciosa has the potential to be a transformative project for the company, but there is a lack of details for the time being. In light of this, I view Avino as a speculative buy at the moment.

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I have been investing in stocks for 13 years now, most of the time in my native Bulgaria. I have a bachelor's degree in Finance and a Master's degree in International Business and I like reading Pratchett and Michael Lewis. Regarding the opportunities that I cover, please take into account that I'm an admirer of legendary fund manager Peter Lynch so I tend to follow a lot of his investment philosophy.

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