The Toronto Venture Exchange (TSX-V) is the center of the Canadian junior resource sector. Most of the listed companies are early-stage exploration and development stocks that in the majority of cases do not generate cash flow and may not even have any significant assets. Without income, they rise and fall in concert with market sentiment toward their potential. From time to time, the expectations are backed by a genuine discovery, but many times they are a product of management's promotional efforts.
There is a reason they are called "the most volatile stocks on earth." And today, these stocks are showing the downside of that volatility. In this update, we examine some of the details of this junior market and by extension, what to look for in a junior explorer.
Got cash?
Cash is a junior's most important asset – arguably even more so than a 43-101 compliant mineral resource. Cash is the lifeblood of their business; those companies that can raise it on good terms have a chance to discover and develop a deposit into a profitable mine. Those that don't have much in the till must find ways to raise more without instigating shareholder revolts, or they won't remain in business for long.
To look at how cash-healthy the companies comprising TSX Venture Composite Index are, we traced their cash positions from the first quarter of 2007 to present, as you can see in the following chart.
This chart shows how much cash a TSX-V-listed company has on average. Since we had several outliers in the data set, we measured the median amount of cash per company instead of the mean. Please note that the current index may not include all companies that entered and left the TSX Venture Exchange since Q107. Also, although the TSX-V is dominated by resource-sector stocks, some companies are in other industries.
The chart is quite telling: the trough from late 2008 through the first half of 2009 is distinct, as is the giant increase in late 2010. Following the mid-2011 peak, the Venture Exchange entered a cool-down period that has continued until now. Today, an average TSX-V-listed stock has one-third less cash than it did in the second quarter of 2011, having US$2.8 million in the till compared to US$4.3 million at the peak.
Although the 2011 drop seems concerning, some may be reassured by the level being much higher than it was in 2007, before the 2008 crash. However, on a per-share basis it's worse. As the total share count of the constituents in the composite index soared from 13.2 billion in the first quarter of 2008 to 54 billion the last quarter, the amount of cash per share dwindled, coinciding with the bearish shift in investor sentiment, as you can see in the chart below.
On average (and we used medians here, too), a TSX-V-listed company seen its cash backing per share decrease by a factor of at least two: from 6.2 cents in the second quarter of 2011 to 2.8 cents in the most recent quarter. The current situation resembles the 2008 downturn, although it is not yet quite as dramatic: at the bottom of the crisis, in the first quarter of 2009, the average TSX-V listed company had a mere 1.6 cents of cash per share.
On the other hand, we believe there's a greater difference between the "haves" and "have-nots" today. The median doesn't look too dire, but instead of a sudden crash, we've had a long decline, during which many companies put off raising funds, hoping to do so when market conditions improved. Those happier days have failed to materialize for so long, there must be a lot more companies running on fumes today than there were in 2008.
Bills to pay
Let's now see how much in liabilities TSX-V-listed companies have against their cash. The next chart shows that TSX-V-listed companies now have more liabilities per share than they did in 2008.
As of the most recent quarter, the median amount of total liabilities per share equals just 2.6 cents, slightly below the median company's cash backing per share.
This tells us in simple terms that the average exploration-stage company, after deducting their liabilities, has very little cash to continue funding their operations. After they pay off all their liabilities, they have only 0.2 cents per share to spend on drilling, for example. By these numbers, a company with, say, 50 million shares outstanding would have only US$100,000 left after its total liabilities are deducted from cash.
The fallout of this deficit is that we will almost certainly see less drilling and development until the market turns around or the exploration-stage companies raise more cash, which at this point would be on bad terms. In the big picture, this is bullish for gold: fewer drills turning will lead to fewer discoveries, limiting supply. Further, this will impact major mining companies that need to replace depleting reserves and find the pickings getting slimmer. Given that an average TSX-V stock is basically insolvent, where will the new discoveries come from? A lot of the majors are cutting back on non-mining-related activities – which include exploration – so we may see them drilling less, too. Shareholders are increasingly demanding cost-cutting measures – rightfully so in many cases – but it's possible that the austerity the industry demands will backfire on these same companies when they fail to replace depleting reserves.
This is all very bullish for the well-run, cashed-up juniors that are making significant, economic discoveries.
Assets – Liabilities =?
If current market conditions persist, we may observe a major cleansing of the TSX-V. Resource companies that haven't been able to discover a potentially economic, low-risk deposit will go.
This doesn't necessarily mean that they will delist from the Toronto Venture Exchange or go bankrupt, though this will be true for many of them. Some may end up on the NEX – a subdivision of the Toronto Venture Exchange, where stocks that fail to meet TSX-V standards are moved. According to the next chart, for the first time in the past six years, the number of companies that had their shares withdrawn from TSX-V to the NEX exceeded the number of IPOs at the Venture Exchange.
It may take a while until the weaker companies start delisting or go bankrupt in large numbers, but it's clear that more stocks have fallen below TSX-V standards in recent quarters.
Conclusion
Where does all this leave us? Looking for "bottom feeding" opportunities, but with extreme caution. We will continue paying special attention to companies' treasuries, as well as their liabilities and burn rates. Those that don't have sufficient cash will face a choice: move to the NEX, go private, go into hibernation as shells, or cease to exist. The TSX-V isn't going away – but it may well be on the verge of becoming much smaller for a time.
As always, we will continue focusing only on the most crisis-proof companies for inclusion in the International Speculator portfolio. We will continue buying the best of the best companies, which would see their share prices diverge substantially from the underlying value (and even cash in the bank) during a true market panic and capitulation. It is this type of irrationally bearish market that can bring life-changing profits to those who spot and act on unrecognized value.
For example, in the latest issue of the International Speculator we initiated coverage on an exploration-stage company whose projects, according to drill data, host numerous high-grade zones of mineralization along the same geological trend as one of the Canada's biggest gold-mining operations. The company has an excellent management team and a healthy treasury. At the current price, the company is a steal.
Whatever cleansing the TSX-V undergoes will be a good thing, separating the wheat from the chaff. Hunting for opportunities in such a beaten-down market is rewarding, provided you get the fundamentals right. We look forward to it.