Stockhouse Ticker Trax is published to subscribers every Monday (
annual cost only $99). We focus on
best-in-class high growth small companies trading on the TSX and TSX.V between 5 cents and $3 with a market cap below $300 million.
Equity Analyst Danny Deadlock has 30 years of experience speculating on Canadian penny stocks and targets capital gain opportunities and diversification in metals and minerals exploration, energy, and technology.
For the experienced investor, Ticker Trax provides an extra set of eyes and ears (idea generation) and for those learning to invest in micro cap stocks, we provide stock picks and market education.
Subscribers receive; (1) new research (stock picks) weeks in advance of being featured on this weekend column (2)
exclusive access to our list of junior gold exploration companies (critical for peer valuation), (3)
exclusive access to our list of Cash Rich micro cap companies (our Virtual Vulture Fund) which contains 80 companies with almost $3 Billion.
Both tables are updated monthly.
Junior exploration can no longer depend on big brother
Small (micro cap) metals exploration and development companies are critically dependent upon financings OR acquisitions / mergers by mid or large tier producers.
Large company CEO’s being replaced (or worried about being replaced) across the industry means that they will not jump into new acquisitions just to build ounces – this is a Dramatic change from what we have seen in the past decade.
Economics must be VERY attractive and lead to a quick return (high grade, access to infrastructure, and low CapEx).
With respect to junior gold stocks in particular, I personally believe we will see little improvement in valuations unless:
1) the price of gold stabilizes in the $1400 to $1500 range “without” wild price swings
2) we start to see large foreign investors (the Chinese in particular) buying junior exploration stocks
Industry Shake-Up Means the Old Way of Looking at Junior Exploration Stocks No Longer Applies
I have been extremely careful in 2012 and 2013 with gold stocks but going forward this sector requires a very different approach than what has been used in the past (at least until price and volatility improve significantly).
If a different approach is not taken, the risk is that these become dead (idle) money. We have already seen this with companies like
Victoria Gold Corp. (
TSX: V.VIT,
Stock Forum) and
Clifton Star Resources Inc. (
TSX: V.CFO,
Stock Forum), who are Canadian based with big (dirt cheap) gold ounces.
THE PRIMARY PROBLEM....
In the past juniors could look forward to two things – financing and Acquisition or Merger with a Major. Now financing is very difficult to get because of gold's price volatility and high capital costs to develop a mine.
More Important - Large mining companies have HUGE problems of their own. This is highlighted in an interview recently with
Evy Hambro who manages the $8 Billion Blackrock World Mining Fund.
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EXCERPT
"It's very clear to us that there will be further write-downs as we go into the full year, or the results season at the beginning of next year. I would be very surprised if we didn't see more change in CEOs across the gold industry."
Producers from Toronto to Melbourne are
pledging to curb spending and halt expansions after taking $26 billion in write-downs since July in the wake of the price decline and an acquisitions boom.
"
Companies have been chasing ounces instead of profitability and return, and now those decisions in the past are coming back to haunt them," There are lots of ounces still being produced that aren't profitable. The gold price fell six months ago, what's going on?"
https://www.bloomberg.com/news/2013-09-27/blackrock-s-hambro-sees-ceo-exits-as-gold-miners-book-writedowns.html
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The majors (who in the past would buy juniors to build ounces) must now focus on controlling costs and generating a return for their investors.
In addition, the industry has seen a dramatic shake-up at the CEO level. At least seven CEO’s of major North American mining companies have lost their job in the past 18 months.
An incoming CEO is not going to risk his job by acquiring a junior - simply to build ounces.
We are seeing this across the gold sector but it is affecting many other mining industries.
The rate of return needs to be high with relatively quick payback.
Months ago I did a report on the problems facing the junior exploration companies (emphasizing the risks of high capital expenditure costs) but
this shake-up at the top levels of management is something profoundly important to small exploration companies and how we value them and their growth potential.
As an equity analyst that has specialized in small companies for 30 years, this is not a subject I like to write about. Unfortunately, it is a harsh reality we have to face because
this entire business of speculating on junior exploration companies has changed dramatically the past couple years.
Going forward this new insight will help determine what exploration companies we consider for future inclusion in Ticker Trax. It also means we will miss some opportunities but I would rather miss something than assume excessive risk (or sit on dead money longer than we should have).
Below is the section from my summer 2013 Report - It fits well with the topic above:
1) The Rio Colorado potash mine in Argentina owned by
Vale SA (
NYSE: VALE,
Stock Forum) is a $6 billion project experiencing significant cost over-runs. Vale keeps cutting back on construction plans and the Argentina government keeps threatening that investors from the Arab Emirates or China could assume control along with the government. High inflation and a weak local currency make the economics questionable.
2) The giant Mongolia copper gold project (Oyu Tolgoi) controlled by
Rio Tinto PLC (
NYSE: RIO,
Stock Forum) is now turning into a financial mess. Not only is the Mongolian government causing them grief (not a big surprise), but the project could be facing billions in cost over-runs. Russia and China have a very heavy hand in Mongolia and they would love nothing more than to get their hands on the world’s largest copper mine. You can bet this is far from being resolved or going into production.
3)
Barrick Gold Corp.’s (
TSX: T.ABX,
Stock Forum) Pascua-Lama gold/silver project in Argentina is also facing major financial problems. Barrick has already spent $2.8 billion but cost estimates run as high as $8 billion. This would be one of the largest, lowest cost gold mines on the planet but it is not helping the bottom line of Barrick. Chile was planning to build a $5 billion power plant that would supply power to this project but now that has been shelved.
And the flagship of the junior disasters –
Northland Resources SA (
TSX: T.NAU,
Stock Forum).
The top three are blue chip examples – Northland is the Poster Child of junior mine development disaster. The mismanagement of Northland is putting a dagger in the heart of exploration and development financing for small companies - in case it wasn’t struggling enough.
Northland is an emerging iron ore producer in Sweden. Since December 2010, they have raised over $1 billion (over $400 million in 2012 alone when you would have thought they had a grip on cost controls).
On January 24, 2013, the company announced that they are in serious financial trouble and because of cost over-runs, will need “at least” $400 million more!!
On February 8, they filed for creditor protection in a Swedish Court.
In addition to the financial disaster, Northland managed to drag 15 large institutional shareholders into this mess and they have research coverage from 16 different (very embarrassed) analysts.
Imagine what this is doing to the industry as a whole for small companies hoping to finance mine development or exploration. It has far reaching implications.
Simply take a look at
Champion Iron Mines Ltd. (
TSX: T.CHM,
Stock Forum) (50 cents). This week they released an attractive Pre-Feasibility study on their Canadian iron ore project. The problem is, capital costs are close to $1.5 billion. The market sold off on the news. Not because the economics were poor, but because they will likely have a terrible time trying to finance this.
This is a harsh reality facing many (if not most) smaller companies that have spent millions (and often years), reaching the point of Feasibility Study. Not only will your operating costs need to look very attractive, but your capital costs of construction will be the deal breaker.
Previously investors would take a “long term” approach to financing. That is not the case anymore and when it comes to mining in particular, bankers and large private investors are scrutinizing these deals like never before. If they don’t, they risk losing their job. And few are prepared to risk their career for a small cap or micro cap company. That is also why it is so hard to find proper coverage of small companies.
And it’s not just the obvious building, equipment, and labour costs of developing a mine. Companies are facing more hurdles with respect to the environmental and escalating costs of power, roads, water, etc. And because mining is often associated with less developed countries, government risk has increased along with labour disputes and disruptions.
When the smoke settles – it is a very different world we are living in since the financial crisis of 2008.
And the impact this is having on the junior exploration game cannot be under-stated. No longer can a small company just walk into a brokerage office and plan to raise millions in high-risk capital.
Financings will be smaller, lower priced and require the added bonus of warrants (which fuels excess dilution and share price volatility).
And for those fortunate enough to have cash from two or three years ago, they better manage it well because now it is worth its weight in gold. It may allow the cash rich ones to pick and choose higher quality projects.
Where does this leave the lower quality projects and public companies? Likely adrift in a sea with very few rescue boats.
There is literally hundreds of low quality or mediocre exploration projects publicly traded right now. And hundreds more looking for something. All of these companies hope to raise capital from a shrinking pool of financiers or investment banks willing to take on the risk, and we also have fewer retail investors willing to speculate (because many have lost a huge percentage of their portfolio on these stocks over the past 18 months).
In the junior mining space I personally won’t look at anything that doesn’t have a strong balance sheet, a very high impact exploration project, or grossly discounted proven reserves. And if the company’s share structure is a mess, then that is another serious concern.
Taking this approach means a person will miss out on gains from well promoted stories. But those are few and far between right now. And at some point the valuation has to be justified or the stock will come crashing back down once insiders decide the promotional party is over – or reality sets in that the sector was overhyped.
Whether we bounce back short term or not, the issues I discussed above will weigh on these small companies for (at least) the next year or two.
The old way of thinking (and speculating) needs to be thrown out the window as this is an entirely new investing environment.
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Disclosure: N/A
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