Hecla Mining: Caught in a Bad Market

Well, it looks as though our strategy is paying off very nicely. After just one week, the portfolio is sporting a large gain, and outperforming the SP500 by more than 3%. We have been filled on a total of nine covered call positions, and some of these are already in the money, so if the stocks hold up, we will lose these holdings temporarily at March expiry, but can be glad we made some quick money. I can’t tell you how many times I have had a 20% gain in a stock, held on for a bit more for a month or two, then seen it all disappear in a market slump. Whereas, if I had just written a covered call, the stock would have been taken away from me at a substantial profit, and become someone else’s problem.

The explosive rally in mining stocks has thrust a number of our positions into the win column, with the sad exception of Hecla Mining (HL). Hecla disappointed shareholders last week by entering into an unfavorable agreement to restructure some debt obligations that resulted from its April 2008 purchase of the rest of the Greens Creek mine in Alaska that it didn’t already own.

Hecla management delayed in getting the bridge loan taken out by permanent financing when the debt markets were friendly; then got backed into a corner by the bankers, and as the deadline of Feb 16^th approached, took a huge haircut in the process. Basically, to win approval for a loan amendment which rescheduled all term debt payments to 2010 and 2011, HL agreed to do a stock sale at $2.05 a share so that it could repay the $40 million it still owed on the bridge loan.

The terms were onerous – Hecla sold 32 million shares to Canaccord (CCDPF.PK), plus threw in 16 million warrants with a $2.50 strike, exercisable until August 2014! That means potential dilution is as much as 48 million shares, and at bargain prices, effectively killing a lot of the upside in HL. Before this one-sided “deal” Hecla had just 136MM shares outstanding (end of Q3) and a book value of $5.00.

Silver is on the rebound, and the U.S. dollar is threatened with a serious collapse, which could send silver soaring in price. Hecla has two very productive major mines, but got caught in the grip of lower silver prices in Q4, as well as a real collapse in lead and zinc, two important byproducts at the mines that help to offset rising costs. It also paid a lot for diesel, but that has dropped sharply in price over the past three months, so going forward HL will save some money. But there is no excuse for giving away that much equity at less than half the Q3-08 book price – this is a huge blunder, and seems to have been done at the worst terms money could buy.

To ice the cake, HL announced a very poor fourth quarter update, saying it would lose over $40 million, and it is squandering some deferred tax assets to boot. Part of the reason for owning HL was the quality of the mines, and the fact that if it MADE money it would have a nice tax shield – totaling $47 million in taxes as of Q3 - for years for most of the income. This resulted from losses many years ago that created tax loss carryforwards (CFs). However, these are beginning to expire, and with the outlook now not clear for profits that would utilize the CFs, the accounting rules force a writedown of those assets. Nice, eh?

The only saving grace to me is the very strong outlook for silver, plus the hope of a rebound in lead and zinc, and possibly a benign diesel price for a year or two – this would return HL to the profit column, and begin to suck up those tax CFs. I still like the outlook for the company, despite the bungling of this finance deal, and I will buy more next week, especially if it dips lower. I see very little BK risk, and some considerable upside with rising silver. I’m glad this was put on as only a 2.4% position – I knew a deal was coming, but didn’t expect a debacle. Oh well, you can’t always trust managements to get the best end of a deal – especially in difficult markets like this.

There was a sharp rise in the base metals commodity markets Friday, with copper up 5%, aluminum up 2% more, and other resources such as iron ore, zinc and met coal rising strongly the past few days. This is linked to a resurgence in Chinese demand, as they rebuild seriously depleted stockpiles at bargain prices, at least compared with pricing nine months ago. At the same time, oil has weakened, dropping below the $40 mark intraday on Friday, and with natural gas also very weak, that is viewed as positive for economies worldwide. In addition, a healthy bid under the entire market (except for energy) has resulted in the portfolio now having the following covered call positions written against stocks we bought a week ago. Most of these are resource stocks, but note that Microsoft (MSFT), Broadcom (BRCM), and State Street Trust (STT) all ramped strongly in the market advance:

Stock Covered Call Strike Expiry Price

STT STTCX 30.00 Mar 09 3.00

ANR ANRCX 22.50 Mar 09 1.85

CLF CLFCF 30.00 Mar 09 2.00

[[FCX]] FCXCF 30.00 Mar 09 3.40

RIO RIOCH 18.00 Mar 09 1.15

[[BTU]] BTUCF 30.00 Mar 09 2.40

CJC CJCCW 17.50 Mar 09 0.70

BRCM RCQCD 20.00 Mar 09 0.55

MSFT MQFCU 21.00 Mar 09 0.50

The STT call was entered midday on 2-5-09 when STT rose, and the others were entered on 2-6-09. In every case, we sold one call for each 100 shares of the underlying. Some were filled in the first hour of trading Friday, and the rest later in the day as the market finished strongly - we’ll see where these positions take us. A complete portfolio update will appear weekly, and I have been submitting some updates during the week, so hopefully more of those will appear as they are sent in to Seeking Alpha.

One more thing – the three Canadian stocks are L/T buy and holds, with the expectation of at least a triple in each name. SVM is a severely undervalued Chinese silver stock, Quadra (QADMF.PK) is a Vancouver-based copper and gold miner, and WTN produces met coal, and had been pummeled with the price drop in coal. It has huge leverage to a better coal price, so if steel consumption revives, it will fly.

Enjoy the positive market for a change!

Comments

[ibejack:]

What's more amazing after reading that article is that your "buying more". The entire premise of the article was basically limited upside, years of dilution, struggling profit lines. And yet at the end of the article...your buying more! lol

Feb 09 02:17 PM

[Marc Courtenay:]

You are certainly right about HL Bill. Their management has proven their fiscal incompetence in spite of the fact that they now own such great properties. I hope they have an ace up their sleeve and can restore confidence soon. Thanks for your article.

Feb 09 08:49 PM

[Jim Hawthorne:]

HL caught in a bad market? Yes, that and a whole lot more! Fundamentally, this company is now a train-wreck due to failed management and excessive debt. Even their recent offering @$2.05 is now in the red.

When an outfit with the potential that HL once had drops 86.6% in 9 months, there's more risk here than most would want to sleep with! When there are so many better gold/silver miners around to hitch your wagon to, why not wait and see if HL can ever recover from the mess management has created before buying more???

Feb 11 09:12 AM

[Bill Herbert:]

Jim, Ibejack, Marc -

Thanks for taking an interest and replying.

I am definitely interested in avoiding risk in this market, which is one of the cornerstones of the portfolio's strategy. It was unfortunate that HL management erred in handling their balance sheet - but that doesn't override the quality of the reserves or the very low share price. I am surprised that a savvy PE player didn't step in ahead of the bankers and make a nice deal for themselves, but that didn't happen, to Canaccord's benefit, I guess.

I would love to find a name that has great properties, under their control in mining-friendly areas of the USA, with experienced crews that as far as I know are dependable to deliver solid productivity in a rising price environment. You can find a number of companies that have lower labor costs, but do they have all the other attributes that HL has?

I would love to know of one - by all means share if you have come upon one. I'm taking the position that the extreme sell-off was part intense market panic and part fear of a bankruptcy if things turned really ugly. There have been many companies whose shares have been dumped viciously over the past six months - but as far as I can tell, HL should have good rebound potential. I liked the stock at $4, so even with the new configuration of the balance sheet, I can't resist it at $1.77!

Let's see how silver plays out, and how HL reacts to that, over the next few months.

Feb 16 11:07 PM

[PeteK:]

Bill,
You are right, experience is very important in this business.
HL is an old company with all the expertise of mining.
Agree with your decision to add more shares.

Mar 24 03:45 AM

[IndidnaJohn:]

I did believe that my Hecla shares were safe in my bankbox. The end result is; by err or by theft, I been had by the front office at Hecla. Other Investors, won't you help me vote the garbage out of the office.

May 11 09:48 AM