All commodities are booming whether is be gold, silver, copper, molybdenum, uranium, oil, wheat, corn, etc. The spot price in all of them have skyrocketed over the past few years and the trend seems poised to continue given the huge demand and lack of supply. However there has been a divergence lately and I will show you what that is and how we can exploit it. The divergence is in the junior/mid-tier metal producing stocks which have lagged and even moved against the uptrend of metal prices. The market perception in the junior miners' industry is poor because of the credit crises as most investors prefer the flight to quality in names such as Rio Tinto (RTP), BHP Billiton (BHP), Vale (RIO), Barrick Gold (ABX), Goldcorp (GG), Silver Wheaton (SLW), Teck Cominco (TCK), Freeport-McMoran (FCX), and the list goes on. Other speculators prefer to park their money, without having to deal with mining exposures, in ETFs such as GLD, SLV, DBA, etc. Junior miners (the play on words get me every time) need a lot of funding to start operations and the perception is that banks will not loan them money and the company shares will have to be diluted in stock offerings. Cost overruns are frequent in this group and delays are never a surprise.
So why do I like the juniors when most write them off? Well, to be frank, I do not like the junior miners, as a whole, too. To clarify, I do not like the risks involved with the junior 'explorers and developers,' but I do love the junior 'producers.' There is a huge difference, in my opinion, on how one values a company and most people put the junior miners in the 'explorers and developers,' category; thus, overlooking the corporations that are already in the production. Many investors have not investigated enough on the internals of the juniors and leave some gems buried. The production stage allows a company to become what I call a "cash cow" since they become self financed from operational cash flow (OCF) and can function as a bank once they generate copious amounts of net income. These companies then move into the mid-tier category like Yamana (AUY) by either ramping up production internally or through mergers and acquisitions (M&A). The major corporations' source of growth comes from gobbling up the smaller fish so the junior producers are primed as likely takeout canditates. The lack of M&A in the juniors does not show poor economics as most would like to believe, but rather the juniors are asking for more than what the big fish are bidding (pennies on the dollar). The junior producers want to become part of the elite and will not take offers unless the bid increases substantially. M&A picks up when business is unfavorable and slows down when business is booming (remember buy low and sell high?). The market is pricing the junior 'producers' as 'exploration and development' entities. The current metals boom is allowing the juniors to further grow their business and the low valuation in their stock offers us huge opportunity.
Although most of the junior producers are Canadian stocks with little exposure to US retailers, it does not mean one cannot make an offering on the AMEX or NYSE. I believe that exposure to more exchanges provides a short term pop, but the long run fundamentals will dictate the company's worth as in most cases and initial public offering (IPO) examples. As you will see in the Excel spreadsheet, a lot of them are trading at OIBDA [Operating Income Before Depreciation and Amortization (may exclude Tax and Interest)] multiples <5. I used OIBDA in my calculations because it measures the core operations of a business. Of course these are rough estimates and the actual earnings will differ when the other measures are factored in. I do know if and/or how to upload the spreadsheet here so please email a request and I will get it to you ASAP and for FREE!
Wednesday, April 9, 2008
The Stages of a Metal Mining Company
I spent the last month getting familiar with the mining industry and now I feel like a better investor. While there are thousands of corporations in this field ranging from basic to exoctic metals, very few actually generate revenue because plenty can go wrong from exploration to production in what is a 6+ year project. Below is a basic outline of how it all works.
An exploration company begins its business by staking land and receiving various permits to explore the region. The next challenge for a mining corporation is to scatter across their property and to find several concentrations of whatever metal they want. Higher graded resources are preferred since the extraction yield is better so the costs are lower. However with the current commodity boom and lack of supply to meet demand from BRIC (Brazil, Russia, India, and China), the cut-off grade continues to lower so even low grades are currently profitable. Many companies go belly-up by not measuring and indicating significant yields of resources and years of funding and patience from investors go down the drain.
For the ones that measure and indicate enough material for potential profitability, the next process is to conduct several feasability studies which breakdown the economics of the mine(s). Also, a company would need to apply for mining permits and comply with several regulations such as environmental standards which takes a long time. Some mines are vastly cheaper than others to develop as they depend on geography. Although most of the more economically viable mines are in foreign countries, they also carry their own geopolitical risks. For example in my province of BC (British Columbia), environmental regulation is very strict as opposed to other regions in the world and labour wages are higher, but the cost of energy and infrastructure is cheaper than in Ghana. North American mines operate with little intervention from government whereas a mine in Mongolia can be suspended by the Mongolian regime.
Should a corporation receive approval and funds for development, the construction of the mine begins. This stage is critical because poor planning can lead to future production problems in the future. A company typically experiences delays and cost overruns because a lot of emphasis is put on weather, labour, equipment, energy, safety, etc. Most companies further dilute their shares in order to finance their projects and the expenses can tally up immensively depending on the planning. The effect of poor economics can hurt a company like Novagold (NG) as represented by its chart. Novagold had to suspend their Galore Creek operations in Northern BC after cost estimates ballooned from $2.2 to $5 billion despite them having one of the largest deposits in the world. On a side note, several previously foreclosed mines have been coming into favor again because the CAPEX (capital expenditures) are low. Be aware on the same hand that old mines contain lower grades since the higher grades have been previously mined. If the spot price of metals fall, the cut-off will grades rise along with falling operational margins.
After the construction phase of the mine is complete, the process of commercial production can begin. The last step before the first pour is commissioning and that takes several months. Once final approval is granted, a corporation can begin commercial production and start generating income to finance more projects, acquire companies, pay back debt, or issue dividends, etc. A company can further ramp up production at any given time in order to take advantage of favorable metal prices and further increase their reserves by proving and making probable of the measured and indicated resources. The income from production fluctuates a lot depending on the production yield, grade being tapped, market spot price, cash costs from operations, etc.
Now you have a basic understanding of how metal mining corporations operate and a starting point with how to valuate them.
An exploration company begins its business by staking land and receiving various permits to explore the region. The next challenge for a mining corporation is to scatter across their property and to find several concentrations of whatever metal they want. Higher graded resources are preferred since the extraction yield is better so the costs are lower. However with the current commodity boom and lack of supply to meet demand from BRIC (Brazil, Russia, India, and China), the cut-off grade continues to lower so even low grades are currently profitable. Many companies go belly-up by not measuring and indicating significant yields of resources and years of funding and patience from investors go down the drain.
For the ones that measure and indicate enough material for potential profitability, the next process is to conduct several feasability studies which breakdown the economics of the mine(s). Also, a company would need to apply for mining permits and comply with several regulations such as environmental standards which takes a long time. Some mines are vastly cheaper than others to develop as they depend on geography. Although most of the more economically viable mines are in foreign countries, they also carry their own geopolitical risks. For example in my province of BC (British Columbia), environmental regulation is very strict as opposed to other regions in the world and labour wages are higher, but the cost of energy and infrastructure is cheaper than in Ghana. North American mines operate with little intervention from government whereas a mine in Mongolia can be suspended by the Mongolian regime.
Should a corporation receive approval and funds for development, the construction of the mine begins. This stage is critical because poor planning can lead to future production problems in the future. A company typically experiences delays and cost overruns because a lot of emphasis is put on weather, labour, equipment, energy, safety, etc. Most companies further dilute their shares in order to finance their projects and the expenses can tally up immensively depending on the planning. The effect of poor economics can hurt a company like Novagold (NG) as represented by its chart. Novagold had to suspend their Galore Creek operations in Northern BC after cost estimates ballooned from $2.2 to $5 billion despite them having one of the largest deposits in the world. On a side note, several previously foreclosed mines have been coming into favor again because the CAPEX (capital expenditures) are low. Be aware on the same hand that old mines contain lower grades since the higher grades have been previously mined. If the spot price of metals fall, the cut-off will grades rise along with falling operational margins.
After the construction phase of the mine is complete, the process of commercial production can begin. The last step before the first pour is commissioning and that takes several months. Once final approval is granted, a corporation can begin commercial production and start generating income to finance more projects, acquire companies, pay back debt, or issue dividends, etc. A company can further ramp up production at any given time in order to take advantage of favorable metal prices and further increase their reserves by proving and making probable of the measured and indicated resources. The income from production fluctuates a lot depending on the production yield, grade being tapped, market spot price, cash costs from operations, etc.
Now you have a basic understanding of how metal mining corporations operate and a starting point with how to valuate them.
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