Payback time? Fallback plan? Money in the bank? What would you ask the CEO of a company you were considering investing in? In advance of the Prospectors and Developers Association of Canada convention in March, newsletter writers Keith Schaefer, Eric Coffin and Lawrence Roulston are bringing 15 energy and mining companies together for a "meet the management" Subscriber Investment Summit in Toronto. In this interview with The Mining Report, the experts share their sometimes surprising responses to the state of the industry.
The Mining Report: Keith, in a recent e-mail to your subscribers, you mentioned that one of the secrets to successful investing is meeting the management. Would each of you share some of the questions you ask company heads to determine if they can be successful?
Keith Schaefer: I am very focused on paybacks. When a company drills a well, I want to know how long it takes for that well to pay for itself. In the larger oil sector, anything that has less than a two-year payback is good, but in the junior sector, where I play, payback needs to be no more than 15 months.
You could ask for the net back, or profit per barrel, or the net present value (NPV) or the production rate. But that doesn't matter as much as the payback—how fast you get that money back so you can drill another well. That is, by far, No. 1. The information that goes into that answer encompasses the answers to many other questions.
The other big questions are how much money the company has and how big a deadline it has. How much liquidity does the company have before management has to raise money again? Those would be questions I would ask management out of the gate.
TMR: Do the secondary questions inform the first question? If a company is well funded is the payback time as important?
KS: Regardless, I want to see a 12–15 month payback. If management tells me it has a two-year payback, and it's a really small company, that just doesn't work. If the payback is right, I'll ask how much the wells cost, and how much money is in the bank, because I can do some pretty simple math to figure out the next time the company will need to raise money. But if a company doesn't have a 15-month payback and is really small, I don't care to hear anything else about them.
TMR: Eric, what do you want to know?
Eric Coffin: Life is not so simple at Hard Rock Co., unfortunately. Obviously, how much money a company has is very important. It tells us how fast that company will need to go back to market.
But I need to know the background of management, and what kind of projects the management team has been involved with. I like to see that team members have had hands-on exploring experience. Some guys are very good at running exploration projects successfully, and others not so much.
I also want to hear about the target, the geological model, the upside if this works out and the fallback position if it doesn't. Most of the time, the fallback position is either secondary projects and/or cash in the bank, so the company can go look for something else. You need to get an idea of the scale potential. If a company has a $20 million ($20M) capex and is drilling for 200–300,000 ounces (200–300 Koz) gold equivalent, there's just not a lot of upside there. I want to see that, if management is successful, there's a significant amount of upside. Explaining the target gives me some comfort that management knows what it is doing.
TMR: When it comes to a fallback position, do you like to see companies with multiple projects in the pipeline, or would you rather see them focused on just one project?
EC: I like to see other projects in the pipeline. There is some truth to the idea that you can try to do too many things at once. If I see a company that constantly switches over to whatever is hot that week, I basically just ignore it. I like to see that company management has a concept and a philosophy, like "We look for copper-gold porphyries," or "We're focused on epithermal gold projects." I like to see other properties advancing to drill target stage while the main property actually is being drilled. That gives shareholders a stronger fallback position, because exploration isn't going to work out on most projects. That's just the math.
On the other hand, I like to see that a company has two or three projects it can fall back on, not 15 or 20, with management running around in circles. But if a company is focused on just one property, and if I really like the targets, I'm not going to be afraid of the company. I just know it comes with a bigger downside if the drilling doesn't work out. You have to understand that going in. If that's the case, the target has to be that much bigger.
TMR: Lawrence, what do you ask to determine whether a company will be successful?
Lawrence Roulston: Beyond all the basic questions about the financial situation, the project and management's background, which are all important, I need to know whether management has the drive and determination to overcome the endless obstacles on the road to success. You can only get that sense if you talk to the people behind the company; spend a bit of time and get to know them.
Unfortunately, this industry has evolved away from old-style compensation, where members of management had low salaries and big stock positions, thereby aligning their interests with shareholders. We've moved way too far toward big salaries. There are a lot of people out there who are more interested in protecting their salaries than in adding shareholder value. Those intangible, subjective measures are critical to determining if a company will be successful.
TMR: What do you want to see in a CEO's background? Would you rather see someone from finance/business, or a geologist?
LR: Mining requires some very specialized skills. A person also needs to be an entrepreneur. If someone has had a big success in the past, that can be a plus, but it's also really exciting to find the young guys who are going to be the stars of next year. Both business and geology are important. A good company needs a well-rounded team that can cover all the bases.
TMR: The three of you are putting together a Subscriber Investment Summit the day before the Prospectors and Developers Association of Canada (PDAC) convention in March. You have picked a number of companies to present at the summit, and be available to talk to investors. The three of you will be there talking to investors and companies as well. Can each of you tell me why you picked the companies you did, and about the catalysts that make these companies worthwhile for investors?
KS: A company called rdx Technologies Corp. (RDX:TSX.V) has a novel way of treating wastewater. In addition to purifying the water so it can go back into the ground, the company extracts every little bit of energy from that water. That means any kind of oil, animal or plant residue. The company has the ability to shake that residue out, chemically separate it and create fuel. So rdx gets paid to take in the wastewater, and it gets paid to sell the fuel. So far, the company has two operations up and running.
This process is new and looks to be very cheap. Management has a very aggressive growth program, so the proof is going to be in the pudding on this one very quickly. The company has a very exciting story that they're going to test within the next two quarters.
Madalena Energy Inc. (MVN:TSX.V; MDLNF:OTCPK) is a very simple producer story. It has a big land position in Argentina, a country that might scare a lot of people. But the reality is that big oil is spending big money in Argentina to buy up a lot of land. If you apply the transaction metrics that are going on in the country to Madalena's land block, the stock is a triple from here. That's exciting. I wanted to make sure management can tell investors that story.
TMR: Madalena is operating on the Vaca Muerta shale. How does that shale compare to the Bakken?
KS: So far, it's the only play on earth that could be more oil-charged than the Bakken. Everyone is familiar with fracking. Usually companies will do 20 fracks in a well. In the Bakken, you might get 10 barrels (10 bbl) per frack. In the Vaca Muerta, explorers are seeing as many as 50 bbl per frack. It is very highly oil-charged. If it weren't for the politics in Argentina, the stocks of all the companies in the region would be dramatically higher than they are now.
TMR: What other companies will be at the Subscriber Investment Summit?
KS: Petroforte International Ltd. (PFI:TSX.V) is a very lucky shot for retail investors, simply because one of the top operating teams in Calgary is recapitalizing the company with retail money at a very low valuation. That never happens anymore in Calgary. Usually these companies stay private for a long time and don't come public until they are at about $10 per share. These guys recapitalized at about a nickel per share. Basically, Petroforte is a startup growing very fast at a cheap rate. I made it my largest position because those opportunities rarely come along.
TMR: Another one?
KS: Manitok Energy Inc. (MEI:TSX) is a conventional oil play with a lot of gas. Now that gas prices are starting to move up, the company has been given a huge bonus. Manitok has a lot of leverage because even at very low gas prices, its wells were paying out in 8 to 10 months. It still has very low valuation despite the fast payback, so it is something that investors should know about.
TMR: Does it also have an advantage because it has a conventional well and doesn't have to deal with the depletion rates that some of the fracking wells have had?
KS: That's right. You are looking at very low depletion rates compared to fracked wells. A tight shale well could decline 65% in year one; these guys are closer to 40%. It makes a big difference in how many times you can pay the well back over the course of the life of the well. It is a big advantage.
TMR: What other companies will be at the Summit?
KS: Entrec Corp. (ENT:TSX.V) is a call on oil sands development and liquid natural gas (LNG) development. The company is holding its own doing oil sands work, but if the government in British Columbia gets its fiscal framework set for LNG, Entrec owns the largest crane company in northwest British Columbia, and would be a huge beneficiary. I think the company would be a top stock for a pop once LNG gets going.
Iona Energy Inc. (INA:TSX.V) was the largest junior oil growth story in the world last year. The company went from 1,500 to 7,500 barrels per day—all beautiful, light, high-profitability oil. Sadly, the market didn't end up caring too much. But in 2014, as the production profiles of these wells become consistent, the market is going to reward Iona. Basically, the company is trading at 1x cash flow. When you buy stock at 1x cash flow, you are going to make money.
TMR: This is in the North Sea. Will the company have an advantage because of higher European prices?
KS: Certainly, working in the North Sea gives you exposure to international pricing, which is $10 per barrel ($10/bbl) higher than in North America. The asset that Iona drilled last year pays out in a year. When a well pays out in a year, and you're trading at 1x cash flow, you are going to make money.
TMR: How about a couple more?
KS: High North Resources Ltd. (HN:TSX.V) is a startup that's just finding its legs. It has the Montney asset, which pays back in about a year. All the production around Montney is paying out in a year, and there's a lot of it. There is good well control.
High North is pretty much a no-brainer. It has the next three years of low-risk to no-risk drilling in the Montney oil play, where there are lots of services and high profitability. It is set. It's done. It will just plunk down holes like clockwork for the next few years, then watch the cash register ring.
Lastly, Enterprise Group Inc. (E:TSX.V) has done a fantastic job of buying highly specialized, niche companies that have higher-than-average profit margins. When you do a rollup play like this—an aggressive mergers and acquisitions (M&A) strategy—what makes the stock go up is being able to drive organic growth out of it. This company has been able to do that better than any I've seen. It has surprised to the upside, achieving revenue jumps quarter after quarter. Not just revenue jumps, but real positive cash flow.
I'm quite impressed with what the Enterprise team has been doing. The feedback the company is getting in the market suggests that cash flow is going to triple this year, which indicates the stock should be $2. It's currently trading at about $1. We will see what happens this year, but I like what the team is doing.
TMR: It's a very diversified company. Is there one area that will drive growth going forward?
KS: Yes. Enterprise has a bit of an odd product to those outside the industry—the Hydro-Vac, a water-jet cutter. Super high-pressure water is used to cut the ground to find oil pipes and electrical wires, without cutting the infrastructure itself. It is mucky work, but it's incredibly profitable. The company has plenty of demand from customers if it can get enough product.
TMR: Eric, you have a couple of companies you've invited?
EC: Barisan Gold Corp. (BG:TSX.V) is a fairly straightforward story. This is a straight-up drill play. The company is drilling a porphyry discovery called Upper Tengkereng in Sumatra, Indonesia. I'm not a huge fan of the country. I made that fairly plain when I started following Barisan, but the company put out a couple of good-looking drill holes, the best of which was basically 900 meters (900m) of 0.4 grams per ton (0.4 g/t) gold and 0.25% copper, which is pretty damn good as porphyry holes go. The area has the potential to generate the kind of holes that can give you 100–200% jumps in one shot. The last hole was also a good one, though not as good as the one quoted above. Assays for the bottom third of this hole are still to come—but it's the next couple of holes I'm focused on. These holes will be drilled to the east, back in the area that generated the 900m intercept. I'm hoping to see another long, high-grade intercept. The stock trades at $0.20/share, which leaves plenty of upside. The area being drilled now, on the eastern side of this project, is not governed by the forestry ministry, which is tough to deal with in Indonesia.
TMR: When do you expect the next drill results?
EC: These are 1,000m holes, so they take some time to turn around. The bottom third of the last hole should be out in the next week or two. The next hole should be just about done, so I hope to see those results in early to mid-March. If the stock gets a little bit of a jump, the company may finance so it can add a second rig. That would help results come faster. The target is not going away. It's the real deal. It's just a matter of how big it is, how high of grade it is.
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TMR: Another company or two?
EC: I have followed Nevsun Resources Ltd. (NSU:TSX; NSU:NYSE.MKT) for years. I was pounding the table on this one pretty hard late last year, because it seemed like it was getting sold down with all the other gold stocks, even though Nevsun's Bisha mine in Eritrea was switching to copper production.
Bisha is a high-grade volcanogenic sulfide deposit. And the mine is very unusual in that it has gone from being a gold producer to being a copper producer; the company has gone below the supergene gold mineralization in the same deposit. It is different levels of weathering and oxidation. Nevsun is now into the supergene copper. It will be mining that for the next three or four years. The gold and copper are both very high grade. After that, Bisha will become a zinc mine, also very high grade. This thing generates tons of money.
Nevsun has had a good run in the last three to four months. Its stock has more or less doubled, up to about $4 now. But I expect Nevsun to produce 200 million pounds copper this year, with some gold added in. I would think its cash costs are going to come in below $1. It already has about $1.50/share in cash. It is generating tons of cash flow. It is paying a dividend. I think there's room for that dividend to be increased from $0.14 this year.
The other thing that's always possible is a move on the M&A side, because the company has the cash to buy up assets. I know management has been looking around for a couple of years. Part of the problem is that its own project is so good that management just doesn't run across many assets that look better. Nevsun is a solid base metal stock that I like quite a bit.
Sunridge Gold Corp. (SGC:TSX.V) is an earlier-stage company in Eritrea. It just put out an updated feasibility study, and finished negotiations with the government mining company on a deal to sell its 30% of the Asmara project property. Working with the government is something you have to do in Eritrea, so getting that deal announced was important for the company. The feasibility study looks quite good. I think it's financeable, but Sunridge is also a very distinct takeover target. I know companies are sniffing around because the company would be a nice, long-term, low-cost, base metal producer, and there aren't as many of those around as you might think. They are in demand by larger companies.
TMR: It does look like a lot of investors got interested in the last couple of weeks. Lawrence, is there still upside in Sunridge? Do you feel the same way about the company?
LR: There is huge upside potential in this company. It's trading at about 10% of the NPV of the project, based on the feasibility numbers and even taking into account the partner interest. Typical retail investors are nervous about the country. But Nevsun demonstrates that Eritrea is actually a good place to be: Projects are good, things work and you can make a lot of money. While Nevsun could take on Sunridge as an acquisition, I think it would like to be diversified into another country. But it still proves Sunridge has upside potential.
TMR: Eric, do you want to continue with another company?
EC: Columbus Gold Corp. (CGT:TSX.V) has a 5.5 million ounce (5.5 Moz) deposit in French Guiana called Paul Isnard. It struck a joint venture deal with Nord Gold N.V. (NORD:LSE) late last year. I don't think the market completely understood how strong that deal was. Nord can earn 50.01% of Paul Isnard by spending at least $30M and producing a bankable feasibility study within three years. It's important to understand that is not "or"—it's "and." Nord has to spend the money and do the bankable feasibility. And there are other payments involved, depending on the Indicated resource at the end. The bottom line is, given the size and type of that resource, I think Nord will be very lucky if it gets the bankable feasibility by spending only $30M. I think it's quite possible to spend more than that.
On top of that, Columbus has a large set of properties in Nevada. A couple of the guys on the company's board are old hands from Nevada, with several discoveries to their credit. The deal with Nord frees up some $8M to work on the Nevada projects. Lots of news should be coming soon.
TMR: Lawrence, will you have questions for the Columbus management team when you see them at the conference?
LR: The big question will be: "What exactly are the plans in Nevada?" I know the company is planning to drill three or four projects over the course of the year, with its own money and through joint venture partners. As Eric said, it's got a very strong deal with Nord Gold. The joint venture puts Columbus in a very strong position to see the project through the feasibility study without having to commit any further money.
TMR: Before Eric goes on with a couple more, do you want to talk about a company that you invited?
LR: Graphite One Resources Inc. (GPH:TSX.V) has a big graphite project in Alaska. It's probably the only large, high-grade graphite deposit in the U.S., which gives the company a really strong strategic position. There is a lot of concern about security of supply for graphite. Graphite One is in the best position to satisfy the U.S. domestic graphite supply situation.
The project is seen by some as being low grade, but that's an average grade taken across the entire large deposit. Zones within that deposit have significantly higher grades; the company could easily compete with some of the higher-grade deposits by mining just part of the overall deposit, and it would still have size to be viable. The deposit is in a fairly remote area in Alaska, but it's near tidewater, and that's really important logistically. The company can get the big equipment and supplies it needs, and ship the product out by water.
Graphite One is really strengthening its management team. Jim Currie joined the team a couple of months ago. He's a mining engineer with an impressive background. Beginning in February, Bob Cross joined the board. Bob also has an impressive background. He's presently chairman of B2Gold Corp. (BTG:NYSE; BTO:TSX; B2G:NSX), a $2 billion company. These guys bring a lot of experience, but they also provide an important endorsement for the project and the company. It is still fairly early stage but looking very positive in that the company has a big program planned over the course of this year. With that, I'll turn it back to Eric.
EC: I'll move on to SilverCrest Mines Inc. (SVL:TSX.V; SVLC:NYSE.MKT), a company I've followed since inception. I trust its management team more than any other. The company made a great discovery at Santa Elena in Mexico and put it into production on time, under budget. SilverCrest is now in the midst of expanding that mine. The company produces silver at a cost of about $8.50 per ounce, which is one of the lowest production costs in the industry. It will have about a 50% increase in production this year and next year. It has very good cash flow and good profits coming.
Company management just picked up the project next to Santa Elena. It's a very early-stage project, but it seems to be a Santa Elena lookalike. The company has another project—a large multimetal property called La Joya, with a silver equivalent resource of 200 Moz. I expect to see a preliminary economic assessment to prefeasibility come out this year.
This is a practical, seasoned management group that has put things in production before. It's a company I'm extremely comfortable with.
TMR: How about one more company?
EC: I cover a company called Reservoir Minerals Inc. (RMC:TSX.V), which, along with its joint venture (JV) partner, Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE), made a pretty amazing high-sulphidation copper-gold discovery in Serbia. They put out a resource estimate of 65 million tons (65 Mt) of 2.6% copper and 1.5 g/t gold. It's a really impressive discovery.
Mundoro Capital Inc. (MUN:TSX.V) happens to have concessions surrounding the Reservoir JV project and at the east side of the Bor mine complex, a well-known mining camp. The Tethyan mineral belt stretches through Serbia, into Bulgaria and down through Turkey, through the Caucasus. That belt has generated a lot of very big, impressive deposits. I started following Mundoro because I liked its set of projects and that geology. The company was early stage, and still is. It will get to the drill stage in the next couple of months. Mundoro has lots of room to find new stuff.
The Chinese state mining company recently "won" a project Mundoro had been working on in that country, but gave the company about $13M as a door prize. That means the stock is trading at $0.05/share less than its per-share cash value. So you're paying nothing for the exploration potential. It is a very tight deal, with only 40M shares out. The chairman and one of the directors own about 10% of the company. Mundoro has a lot of room to move if it makes a real discovery.
TMR: This goes back to what we talked about in the beginning, which is a diversified pipeline. Mundoro is also in southeastern Europe and Mexico. Is one area more exciting to you than the others?
EC: I think the Serbian projects are the most interesting. The company is ready to drill on two targets in Q2/14. The area has infrastructure, and is very mining-friendly. The project in Bulgaria looks quite interesting, too, although it hasn't put a lot of data out about it.
TMR: The Summit—where all of these companies are going to be in one place for investors to talk to—is being held in conjunction with PDAC. What are you hoping to hear at the conference? What trends will you be sharing with attendees?
LR: The mood is definitely picking up in the resource industry. We had a terrible couple of years, but interest is coming back. Most retail investors are shell-shocked. But the "smart" money—the veteran investors—are coming into the market now. The better-quality companies are already starting to move up on a fairly consistent basis.
Beyond that, there is a huge amount of money waiting in the wings. Part of that is U.S. private equity. These investors recognize the tremendous value to be found in the industry. We haven't seen a lot of deals announced yet, but they're looking at things. I think we're going to see a lot of money from that sector coming into the resource space over the next few months, which will contribute to what's already beginning to be an upturn for the industry. PDAC is a tremendous event. There are people from all over the world coming together in one place. Conferences are a very important venue, where investors can get face-to-face with the management teams.
TMR: Eric, are you looking forward to the same upbeat spirit?
EC: Yes. I am calling for 30%+ gains on the Venture this year. That sounds like a lot, but it is a speculative index. I pointed out to readers that for those gains to happen, all we really need is 10% of the companies on the Venture to do very well and carry the can for everybody. Another 20% will do reasonably well, and get financed along with the top 10%. Half of the companies will probably do nothing and, hopefully, a bunch of them will disappear. I'm quite happy to see some of the also-rans not around anymore.
Gold has reacted quite well to good news and bad news. The Chinese are strong in the market still. It looks like gold has put in a fairly important double bottom, and I think the Venture index has as well. I expect things to be a lot more optimistic. PDAC will be a chance to find out if management groups are building their own momentum. It's tough to stay on track when you've gone through three terrible years. But the management groups that have been able to hold things together and raise money are the ones that will come out of the starting gate fast.
TMR: Keith, is it the same story in energy?
KS: No, it's almost the opposite. I've been warning my subscribers that energy might be going into a trough. There is a lot of fear that ongoing production increases are going to cripple commodity prices, which would not be pleasant. I tried to a pick a group of companies that either have the teams or the assets—or both—that can make it through any bottoming that we might see in the cycle later this year.
TMR: Thank you all for your time. See you at the Subscriber Investment Summit.
Readers of The Mining Report can sign up for a complimentary ticket to the Subscriber Investment Summit 2014 for a limited time only. Register here.
Keith Schaefer is editor and publisher of the Oil & Gas Investments Bulletin, which finds, researches and profiles growing oil and gas companies that Schaefer buys himself, so Bulletin subscribers know he has his own money on the line. He identifies oil and gas companies that have high or potentially high growth rates and that are covered by several research analysts. He has a degree in journalism and has worked for several Canadian dailies but has spent over 15 years assisting public resource companies in raising exploration and expansion capital.
Eric Coffin is the editor of the HRA (Hard Rock Analyst) family of publications. Responsible for the "financial analysis" side of HRA, Coffin has a degree in corporate and investment finance. He has extensive experience in merger and acquisitions and small-company financing and promotion. For many years, he tracked the financial performance and funding of all exchange-listed Canadian mining companies and has helped with the formation of several successful exploration ventures. Coffin was one of the first analysts to point out the disastrous effects of gold hedging and gold loan-capital financing in 1997. He also predicted the start of the current secular bull market in commodities based on the movement of the U.S. dollar in 2001 and the acceleration of growth in Asia and India. Coffin can be reached at firstname.lastname@example.org or the website.
Lawrence Roulston is an expert in the identification and evaluation of exploration and development companies in the mining industry. He is a geologist, with engineering and business training, and more than 20 years of experience in the resource industry. He has generated an impressive track record forResource Opportunities, a subscriber-supported investment newsletter. Roulston has launched an investment fund, the Metallica Development Fund, to take advantage of severely over-sold positions in high quality resource companies. The focus of the fund is on companies with production and/or advanced-stage exploration and development projects—companies with potential for near-term recovery in value that also have potential for longer-term growth.