Sprott Resource Corp vs AABSprott Resource Corp. TSprott Resource Corp. Trading at Substantial Discount to NAV
---0.94 Nav SCP Current SP 1.50 50M Shares out
vs
--0.94 Nav AAB Current SP 0.46 100M Shares out
And they are substanially discounted ??? right.
By David J. DesLauriers
29 Jan 2008 at 06:30 PM GMT-05:00
TORONTO(ResourceInvestor.com) -- For those that like the merchant bank modelthere is new player on the scene to take a look at Sprott ResourceCorp. [TSX:SCP].
Sprott Resource Corp. (SRC) is a collaborationof all-star resource investors and the key players at Sprott AssetManagement. This summer the company sold 40 million units at C$1.50 inan extremely oversubscribed placement to raise C$60 million dollars.
Thecompany’s CEO is Kevin Bambrough, Sprott Asset Management’s marketstrategist, who made a name for himself with prescient calls in thecoal and uranium markets among others.
With the recent marketdownturn the Resource Corp. has traded down from a high of almost C$4to the recent price of around C$1.50. At these levels we think thecompany represents a tremendous opportunity. Not only do investors geta world-class board and management team, but a back of the envelopecalculation of Resource Corp.’s Net Asset Value (NAV) illustrates thatSCP is trading at a substantial discount.
To start, let’s reviewthe basics of the NAV. There is currently C$36 million in cash in thetill. As well SRC holds C$11M in marketable securities. Withapproximately 50 million shares outstanding, the value of cash andsecurities is worth about 94 cents per share.
Coal Investment
SRChas also purchased a 22.5% interest in PBS Coal, a private Pennsylvaniacoal producer for $31 million. (Note: the purchase was made when theCAD dollar was worth about C$1.07, so the investment cost less thanC$31 million). The SRC equity injection will help bring production from2 million tonnes of met coal per year to 3 million tonnes and with therecent rise in metallurgical coal prices this investment looks to be ahome run. Best guess estimates on the value of PBS coal suggest to usthat it will in all likelihood contribute C$2+ per share to NAV.
Underpinningthe PBS coal investment are surging met coal prices. Recent spot pricesfor met coal have surged to $140 - $160 a tonne at port. We know thataverage costs per tonne for Appalachian coal producers are in the $50per tonne range.
If we are conservative and multiply a $60 pertonne gross margin by 2.5 million tonnes we get $150 million in grossmargin profit for PBS coal with $33.75 million (150 million x 22.5%)attributable to SRC. Assuming a 30% tax rate this leaves $23.62 millionprofit on SRC’s C$22.5 million investment.
U.S. public coalcompanies are trading at a price to cash flow multiple of around 15. Ifwe put only a 5 times multiple on this potential cash stream we get avalue of $118 million which is well north of C$2 per share. Not bad areturn for 3 months.
Phosphate Investment
Let’s continue.On November 16 last year, SRC announced it acquired an option toacquire an interest in the Mantaro Phosphate project.
Here’s what it says on SRC’s website about the project:
“In2001 a scoping study was completed by Bateman Phosphate Technologies ona portion of the property that outlined an ‘inferred resource’ estimateof 61 million tonnes. Beneficiation test work conducted by Batemanconcluded it was possible to produce a concentrate grading in excess of32% P2O5 and that the concentrate was amenable to production ofphosphate fertilizer.”
Located in Peru there is not much in thepublic domain about this property, but we do know that the companyacquired their property right before phosphate rock spot prices rosefrom $40 to $200 per tonne. There are not many publicly tradedcompanies developing phosphate assets. However, the few that are suchas Phoscan [TSX:FOS] have healthy market caps. To put a value on thevalue on Mantaro is premature, but the SRC has only paid a $50,000finders fee to secure the project, so the potential for a big upsidereturn certainly exists.
Net Asset Value
Adding up theseholdings on a pro forma basis we get 94 cents per share for cash andsecurities. Easily C$2.00 for the PBS coal investment and a wildcardupside on the Mantaro option for a total NAV of at least C$3.00 pershare. If things go well at PBS coal and Mantaro it could be muchhigher.
Before we go any farther it should be noted that thereare 40 million warrants at a strike of $2.50 that were issued as partof the $60 million dollar financing. As well the company operates onthe 2 and 20 hedge fund fee model. So 2% of assets and 20% of mark tomarket profits above the benchmark 30 year Canadian Treasury bond arecollected each year.
That being said this model may be more fairto the investor than the typical 10% rolling option plan used by mostjunior resource companies. In contrast to options which can becancelled and issued at lower and lower prices, SRC can only get asuperior return by generating performance.
Conclusion
AsKevin Bambrough, CEO of SRC has made clear, the company will continuebe aggressive in finding opportunities in the resource sector forserious value creation. Already the company has what looks to be twohome runs in its investments in PBS coal and Mantaro phosphate.
Whatis most important to keep in mind and what is really the key here whichshould guarantee consistently superior performance is this: SRC is theonly private equity company within the Sprott franchise so they willcontinue to see excellent deal flow because everybody wants the name intheir deal.
For the value oriented investor the recent marketcorrection has created an attractive entry point in SRC and it lookslike a no-brainer to us as the fund can enter deals that normalinvestors don’t have access to - and at the early stages.