Finding Value In Sprott Resource Corp.

| About: Sprott Resource (SCPZF)

On August 14th, Sprott Resource (OTCPK:SCPZF) reported disappointing second quarter results and the cancellation of its dividend. Shares dropped from a high of $3.39 to close the day at $2.93. As its CEO Kevin Bambrough explained:

"The second quarter was a challenging period for the Company as the sharp sell off in precious metals had a significant negative impact on the value of our physical gold bullion holdings," (Source: Sprott Resource Corp)

Sprott Resource reported a net loss of $43.4 million due to impairment of assets. Sprott's gold holdings decreased $27.3 million, which accounted for most of the loss during the quarter. Below is a brief recap of the quarter and outlook for the company.

As of June 30th equity attributable to shareholders


(in thousands)


Cash and Cash Equivalents




Gold Bullion



Other Current Assets



Consolidated investment in:


OEOG (defined below)



One Earth Farms (defined below)



Fair value investment in:


Long Run




Union Agriculture Group




Virginia Energy (defined below)




Potash Ridge (defined below)



Other investments



Equity investment in:


Stonegate Agricom









Less: Current Liabilities



Less: Non-Current Liabilities



Total equity attributable to shareholders {NAV}




(Source: Sprott Resource Corp)


Sprott Resource had revenue of C$10.1 million in the second quarter, up from C$8.7 million from the same quarter a year prior. Most of the revenue came from the controlled agricultural operations which generated C$9.5 million. For the first six months of 2013, Sprott Resource had revenues of C$26.2 million compared to C$23 million the same period a year prior.

Notable 2nd quarter updates:

On July 17, 2013, One Earth Farms acquired the assets of Toronto based baby food retailer Sweet Pea, which markets a range of meal options and hand-held, age appropriate snack solutions for babies and toddlers across Canada. The two founders of Sweet Pea will continue in the business with a focus on new product development and expanding the customer base of retailers.

On July 24, 2013, Stonegate Agricom completed their previously announced short form prospectus offering (the "Stonegate Offering") of units (the "Units") of Stonegate Agricom. SRC acquired beneficial ownership of 12.5 million Units for a purchase price of $0.30 per unit...Prior to this acquisition, SRC beneficially owned 58.5 million Stonegate Shares. Following completion of the Stonegate Offering, SRC beneficially owns 71.0 million Stonegate Shares

The Company opened a Margin Account (defined below) which it initially used to fund its investment in ICD. As at June 30, 2013,the Company had hypothecated 62,665 ounces of gold bullion.... the Company has hypothecated 69,965 ounces of physical gold bullion with a fair market value of $96.2million, a maximum borrowing capacity of $70.3 million and has drawn $67.6 million on the Margin Account

For the six-months ended June 30, 2013, the Company has purchased and canceled 2.3 million common shares under the 2012 NCIB at an average cost of $4.26 per share for an aggregate cost of $9.8 million. (source: Sprott Resource Corp.)

SCPZF.PK was trading at $2.70 on August 27th, equating to a market capitalization of $269.5 million. If the company had sold off all of its holdings on June 30th, each share of Sprott Resource would be worth roughly $3.47. SRC's gold holdings (73,971 ounces) on August 27th have increased from $92.71 million to $104.89 million ($1418/ounce). The underlying assets have increased in value while the share price continues to drop. This creates a buying opportunity for value seeking investors. The most important news on the quarter, as it relates to the stock price, was the cancellation of the dividend:

"Our Board of Directors has elected to cancel our dividend policy and dividend reinvestment plan and to cease paying monthly dividends in order to preserve capital and protect our ability to continue effectively executing our business plan."

The dividend cancellation is a positive. The news of the cancellation was unexpected by shareholders, myself included. Long-term this lifts the burden on management to continue pumping out much needed cash and puts its focus on producing long-term returns for shareholders. The large dividend was unnecessary and short sighted by CEO Bambrough. Clearly management wanted to return proceeds to shareholders from the sale of Waseca Energy and PBS Coal. A more sustainable 5 percent dividend or a one time special cash distribution would have been more conservative. This more conservative approach would have prevented the expectation of recurring cash payments and the inflation of Sprott's margin account.

Below is SCPZF.PK's 5-year stock performance

As shown in the chart above, SRC traded around $5 back in 2011 when commodity prices were higher. It now appears that investor sentiment towards Sprott Resources underlying assets or to management is so negative that many shareholders elected to sell shares below its NAV. Despite the continued drop in commodity prices, SRC has maintained its positions. As CEO Bambrough remarked:

" 'We continue to be pleased with the progress of our investee companies and believe the portfolio is well-positioned in sectors that are poised for significant recoveries over the long term,' continued Mr. Bambrough. 'The outlook for natural gas, in particular, is positive and we have positioned ourselves well to benefit from its recovery through investments in businesses like Independence Contract Drilling,Inc. ("ICD") and Long Run Exploration Ltd. ("Long Run"), which has significant oil and natural gas assets in Alberta.' " (Source: Sprott Resource Corp)

Back in June, a Seeking Alpha article written by Emmet Kodesh titled Sprott Resource - A Solid, Mixed-Commoditty and Income Play outlined a strong argument for purchasing the stock. The core of that argument relating to the company's holdings still holds true to this day despite the cancelled dividend. Since I am mostly recapping the Q2 results, I recommend for further analysis of SRC to read Mr. Kodesh's article.

I will admit, Sprott Resource has many challenges ahead. The major liability is the $57.3 million the company currently has on margin. Management will need to respond to the margin account and its ongoing liquidity sooner than later. The management also made a blunder with the dividend but the history of the managements successes outweighs that issue. Many shareholders "jumped ship" after the Q2 announcement. I am sticking with SRC. It is still well undervalued relative to its book value and the future in its holdings is immense. With rising commodity prices and a possible sale of assets, as alluded to by its CEO, the company's outlook is still positive. I am long SCPZF.PK.

Disclosure: I am long OTCPK:SCPZF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.