[Editors' Note: This article covers micro-cap stock(s). Please be aware of the risks associated with these stocks.]
"Mimicking the herd invites regression to the mean"
- Charlie Munger
Over the last few years, the herd has been aggressively buying gold, and only recently has the herd been stampeding away from anything related to the precious metal. In particular, the junior gold miners have had a particularly hard time of late- with the Junior Gold Miners ETF (GDXJ) falling roughly 62% since its October 2012 highs. With the top two direct holdings in Torex Gold Resources and Argonaut Gold, with market caps just under $1 billion, it is easy to see how susceptible and volatile the smaller players in the industry are to any decrease in the price of gold. Going forward, it appears quarter over quarter comparisons will be the toughest they have been in years, given the large drop in spot gold prices.
GDXJ data by YCharts
With that theme in mind, we would like to focus on a company called Sandstorm Gold (SAND). Sandstorm Gold is described as:
"...a gold streaming company, focuses on acquiring gold and other precious metal purchase agreements from companies that have advanced stage development projects or operating mines. The company also offers upfront financing for gold mining companies that are looking for capital and in return it receives a gold streaming agreement, which gives the right to purchase a percentage of the life of mine gold produced, at a fixed price."
To summarize, Sandstorm Gold is basically a bank for gold producers, providing the initial capital (loans) while getting a percentage of the production (interest, principal, & potential upside) from the life of a mine minus a fixed contracted cost per ounce. The Sandstorm Gold management team operates under the assumption that these contracts enable "all the upside, while mitigating some of the downside risks", as stated by CEO Nolan Watson. Unfortunately, we feel that the management team is operating under a faulty assumption of low risk, when in actuality, we think the financing provided is extremely high risk and speculative in nature. To give a general overview of the current and pending streaming contracts, every single company contracted with Sandstorm Gold is under $200 million in market capitalization. Furthermore, approximately 80% of the gold streams and pending contracted streams are with companies that have market valuations below $100 million.
|Colossus Minerals Inc.||$85|
|Brigus Gold Corp.||$122|
|Metanor Resources Inc.||$18|
|Rambler Metals & Mining||$58|
|Donner Metals Ltd.||$10|
|Sante Fe Gold Corp||$16|
|Solitario Exploration & Royalty||$29|
|Magellan Minerals Ltd.||$16|
|Canadian Zinc Corp.||$78|
*Data from Capital IQ reported in USD (million) based on 07/15/2013 closing data
Macro issues with junior gold miners
Earlier this year at the PDAC conference in Toronto, there were multiple forecasts for a high percentage of juniors to file for bankruptcy within the next 18 months as capital dries up. One forecast was as high as 40% of all juniors; others were more modest, stating a couple hundred would fail in the next 18 months.
David Strang CEO of Lumina Copper, says it is analogous to the internet bubble in the late 90's.
"It's no different than the Internet boom of the late 1990s where there was cheap venture capital money available - everybody built all of those companies and very few survived."
A Grant Thorton survey found that, "389 miners in the United Kingdom, South Africa, Australia and Canada showed that 43 percent of them had cash balances of less than $2 million. Nearly 40 percent needed to tap markets within the next six months."
Sister Co. Sandstorm Metals & Energy a proxy for Sandstorm Gold?
On July 15th, 2013, Sandstorm Metals & Energy was down approximately 25% on heavy volume reaching an all time low (considering the reverse stock split). This was likely a carry over effect from the news that day with Colossus stating major issues with the Serra Pelada gold-platinum-palladium Mine and the news from the prior week on the amended contract with Donner Metals.
Where is the money coming from?
Well, the quick answer is shareholder dilution. As shown below, shareholders have experienced significant dilution while Sandstorm attempts to garner additional streaming cash flows. Unfortunately, many of the recent streams secured have experienced major issues with development time tables and/or financial viability of the streaming companies themselves. We feel this is a case of dilutive cash chasing high risk gold streams from pink sheet/micro cap companies that are not financially viable entities, especially in a declining price environment.
During 2012, Sandstorm Gold management raised roughly $167 million in capital through stock/warrant issuance, resulting in significant dilution to existing shareholders. This appears to be the main financing vehicle for Sandstorm- raising capital through shareholder dilution. Unfortunately, we are not seeing the organic growth strategy promised years ago of accumulating cash flow from gold streams, and prudently reinvesting those into new profitable growth opportunities.
"Tell me what company you keep and I'll tell you what you are."
-Miguel de Cervantes
Cracks on the surface: Sandstorm Gold streaming Projects
It is becoming more obvious that Sandstorm Gold has surrounded itself with many streaming partners that are in precarious financial situations. We feel this is the real crux of the matter with regards to Sandstorm's long-term viability. We think this eventually affects Sandstorm to a significant extent, as the reality sets in that a significant portion of its overall business model (streaming cash flows) may not be viable in the next 12-18 months.
- Mutiny Gold Limited, The streaming contract has been cancelled indefinitely per Denver Harris, VP of capital markets at Sandstorm Gold due to funding issues. Although there has not been a public press release from Sandstorm Gold, Denver Harris notified us via email further developments pertaining to some of the issues surrounding Mutiny.
"The gold stream that Sandstorm completed with Mutiny back in December 2012 was contingent on Mutiny raising additional debt financing by June 2013. Mutiny was unable to put the debt package together and therefore Sandstorm is not obligated to move forward with the stream and at present, Mutiny does not have the capital necessary to advance the Deflector project."
- Luna Gold- stock has lost about 75% of its value from the recent high. It is currently sitting at roughly its 52-week low.
- Colossus Minerals- has lost about 85% of its market value since its high in late 2010. The stock just lost 50% of its market value yesterday (July 15th 2013), after Colossus announced significant issues at its Serra Pelada mine. Unfortunately for Sandstorm Gold, this is a mine which they had just contributed $60 million for streaming rights. In our mind, this was the mine that had the most potential for Sandstorm Gold with possible cash flows in the near term. With the stock down 50% in one day, the project seems to be up in the air until further financing is found. In our view, additional financing (equity or debt) for the Colossus Serra Pelada mine is very unlikely, given the collapse in the stock and the already high debt load on the balance sheet from prior development activities. Sandstorm Gold could potentially provide the funding needed; however, we feel this would be good money chasing after bad money. The management team at Colossus mentioned,
"Management is currently evaluating the amount and timing of additional funds required to address the impact of the delay in the ramp-up and otherwise continue development and construction of the Serra Pelada Mine. "
- Brigus Gold- just recently hit an all time low and has over 3 times debt to cash.
- Silvercrest Mines Inc.- just recently hit an all time low in share price, a small cap junior with a market cap below $200 million. This is likely the lowest risk gold stream for Sandstorm. Silvercrest has very little debt and over $40 million in cash, and is currently profitable on a trailing 12 month basis.
- Metanor Resources Inc.- trading at an all time low, currently around $.07, with a total market value of less than $19 million and very illiquid.
- Rambler Metals & Mining PLC- trades at a market capitalization of roughly $59 million, over 10 times debt to cash. Roughly $32 million in debt and only about $3 million in cash along with a very illiquid stock.
- Entree Gold, which has primary operations in Mongolia, has lost roughly 90% of its market cap in the last 2 years from its peak. It trades at roughly 29 euro cents per share. Currently has very low liquidity and trades on average on around 800 shares per day. Cash flows from this project are not likely for approximately 10 years, and we've heard of additional delays with regards to joint venture mining licenses from the Mongolian government.
- Donner Metals Ltd.- trades at roughly $.05 cents, just recently hit an all time low. Currently it has a market cap of approximately $11 million. Donner recently amended its agreement with Sandstorm Metals & Energy halting all copper payments during all of 2013 due to issues surrounding its working capital and financing.
- Santa Fe Gold Corp- just recently hit an all time low trades at over 25 times debt to cash. Has only approximately $430K in cash and is not currently profitable.
- Premier Royalty- Sandstorm acquired roughly 59.9% of the outstanding shares of Premier, which was announced on Jan 31st, 2013. Since peaking after the share acquisition at around $2.40, it has lost roughly 71% of its value. Just a little over 3 months after acquiring 59.9% of Premier royalty, Premier's management announced issues on May 14th, 2013. One of its gold streams from the Buffelsfontein Mine in South Africa would no longer continue production. This represented roughly 13% of the company's total revenue during 2012.
"Goodwill impairment pg 30: The Company completed its annual impairment test for the goodwill which arose on the purchase of a controlling interest in Premier Royalty and concluded the carrying value of the net assets acquired exceeded the recoverable amount. The recoverable amount has been determined by the fair value less cost to sell method, using quoted market prices for the common shares of Premier Royalty. An impairment charge $14.0 million was recognized in the condensed consolidated interim statement of income at March 31, 2013. A reconciliation of the goodwill for the period ended March 31, 2013 is set out below:"
- Solitario Exploration & Royalty Corp. just recently hit an all time low with a $29 million market cap. It currently has a debt of approximately $7 million and does not have any recorded revenues.
- Magellan Minerals Limited- currently trading at roughly an all time low, has roughly a $16 million market capitalization and no reported revenues.
- Canadian Zinc Corp- trades at a market capitalization of approximately $78 million and has roughly $5 million in cash, with cash burn last year of approximately $10 million.
*Note all the above information utilized Capital IQ data, market cap information can change rapidly any may not be accurate at the time of publication
Insider sales from CEO, Nolan Watson
-Above data is from the 2012 annual report.
It appears from the above data, that, from mid-May through June, Nolan Watson exercised (and sold) approximately 36,500 options at a strike of C$3.40 (expiration 11/26/15), and sold 125,000 warrants in the public market. Within the annual report and the most recent quarterly report, there are no mentions of any planned sales arrangement.
Sandstorm Gold fair value price?
We feel Sandstorm Gold is essentially a penny stock masquerading as a half billion dollar NYSE listed company. Since almost every streaming partner is listed on the pink sheets (all below $200m mkt. cap), we feel its partner alignment will prove to be an unsustainable business model later in the year. While on the surface it appears Sandstorm is making a small amount of money, we believe this is a temporary illusion due to the massive dilution used to finance risky streaming deals. Considering the risk adjusted dilutive capital used on the streaming projects, Sandstorm Gold is hemorrhaging cash on a year over year basis.
While we would like to perform a DCF analysis on Sandstorm, we feel that it would require too much guess work relating to the pending & current streams that are encumbered in some fashion on almost a monthly basis. Just recently, management began aggressively selling stock, and we feel there are significant operational risks having never been in an environment with declining gold prices. Going into the second quarter, comps will likely be quite negative, given the overall downward move in spot gold during the quarter. This will likely lead to the potential for a miss on the quarter.
We also feel, given the information flow from the streaming partners during the most recent quarter, this could provide an additional negative catalyst on the quarter. Management for the most part, has not issued any press releases (exception being Colossus) on the problems of the streaming portfolio companies; we think this needs to be addressed on the Q2 call.
We justifiably think Sandstorm's stock deserves, at most, a slight premium to cash of 10-20%. Management needs to prove to shareholders that it, first and foremost, has a viable business model, and that going forward, it will not squander the dilutive cash just raised in late 2012.
Risks to the short thesis
- If gold prices rise substantially above marginal costs, our stance on Sandstorm would likely change, as higher gold prices would benefit smaller struggling junior miners, potentially enabling them to solidify long-term capital.
- If the deal making team at Sandstorm is able to find attractively priced deals with near term cash flows that can replace recently failed projects.
- There is a small possibility for a buyout of Sandstorm by another gold producer or a competitor given the depressed valuations.