Geodrill Limited: West Africa's Leading Metals Driller Is Trading At 50% Of Tangible Book Value

| About: Geodrill Ltd. (GDLLF)
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The metals drilling sector is in shambles

Globally, drilling companies focused on metals have been nearly beaten to death. The cause of this thrashing can be traced directly to the serious downturn in precious metals' prices as well as a number of other drilling-dependent commodities such as iron ore, uranium etc. Further aggravation has been added by rapidly rising finding and development costs in the mining industry. This double whammy has caused a very serious malaise to settle into the world's mining companies, which has rapidly cascaded to the drillers as one of the mining industry's largest cost outlays. Drilling budgets have been slashed thus greatly reducing driller revenues.

No precious metals-focused driller has been spared the wrath of the market as can be seen by the dismal share price performance of the following industry participant examples over the last two years:

MDI Chart

The above chart shows the share price performance of a sample of international precious metals weighted drillers. It is obvious that whether the company is a large cap or a junior cap, the share price performance has been very poor over the last two years. But, as usual when the market dumps a sector, it "throws out the babies with the bath water."

However, there are some leading drillers that get way oversold (versus their peers) as the market loses focus on their core fundamentals and ignores additional positive attributes:

  • Being in the right exploration and mining regions
  • Having very solid balance sheets
  • Having a high quality late model drill fleet
  • Having industry-leading management (and that is "on the ground" living and working right in the heart of the company's business footprint)

When the eventual turnaround in the metals drilling sector occurs (and it will) or when the market wakes up to the dislocation of the drilling leaders' share price to their core fundamental valuation metrics versus peers, these kinds of drilling companies will be in a great position to generate significant Alpha to the market and sector indexes.

One such company is Geodrill Limited (OTCPK:GDLLF). The company is not very well known as it just went public three years ago. It also trades with more liquidity on the TSX under the ticker GEO.TO. I also wrote an article on Major Drilling (a very high quality large cap global driller) not long ago, if you are interested in reading about another driller investment opportunity.

Some detail on the company

Geodrill Limited is "the" leading West African based exploration drilling company. Currently (see map below), Geodrill operates in six (6) West African countries namely: Ghana, Burkina Faso, Niger, Cote d'Ivoire, Guinea and Senegal (see Operating Countries in Orange in the map below). Other potential countries of interest (for expansion) are highlighted in green on the map as well. The company has an investor presentation on its website which also gives a good overview of the company. The company is the "go to name" for metals drilling in the West Africa region.

The company was founded by the current CEO Dave Harper in 1998 with one rig and one contract. Today, Geodrill operates a fleet of 37 drill rigs and provides reverse circulation, diamond core, and air-core drilling services to a number of well-known exploration, intermediate, and mining companies.

The company has experienced workforce and management team coupled with a modern well-maintained fleet of late model rigs and support equipment. This combination has contributed to Geodrill's strong reputation in West Africa as being a result-driven and customer-focused drilling company with tight relationships with its customers. Geodrill operates a modern, state-of-the-art workshop and 10-acre supply base near Kumasi, Ghana, which provides rig repair and equipment, supply, storage, administration services and also serves as the company's training center.

The proceeds from a highly successful IPO in December 2010 (at a share price of $2.00) have provided financial strength and flexibility for Geodrill to execute its long-term strategy, including adding more drill rigs and growing its current client base while continuing to assess expansion opportunities throughout West Africa as well as other mining regions within the African continent.

GEO Chart

The above chart tracks the company's share price since its IPO in December 2010. This is an ugly duckling! But as a value investor, this is what I look for: quality companies in really beat-up sectors whose share price should be higher relative to their peers given their core fundamentals and leadership position, but have been excessively oversold relative to peers. Geodrill's shares will have a strong upward movement once the sector turns the corner or when the market comes to recognize the dislocation of its share price relative to peers based on average valuation metrics. The company's shares hit almost $4 back in early 2011 and then began a downtrend coincidental with the commencement of the precious metals mining downtrend that began shortly after the company's share price peaked. The stock price rebounded sharply in mid-2012 as things seemed to being looking up with another round of QE coming up. However, the market paid no attention to the commencement of the latest QE3 effort in September 2012 and the PM prices continued their downtrend to where they are now.

The balance sheet is strong

The company's balance sheet is in solid condition with shareholders' equity being nearly five times larger than the total liabilities:

Geodrill Qrtly Balance Sheet (USD $Mil)
Assets Sep-13
Total Current Assets $ 29.47
Total Assets $ 77.77
Total Current Liabilities $ 14.29
Total Liabilities $ 16.44
Shareholders' Equity
Common Stock $ 21.15
Preferred Stock $ -
Total Shareholders' Equity $ 61.32
Book Value Per Share (basic shares) $ 1.44

Some balance sheet ratios:

  • Net debt to TTM EBITDA ($3M/$12.35M) - 0.24
  • Liabilities to assets - 0.21
  • Current ratio - 2.1
  • Book value to share price - 0.46
  • Debt to equity - 0.05
  • Net debt ($7.5-$4.5) - $3 million

It is obvious that the company is in very good condition from a balance sheet perspective. However...

Operations have been negatively impacted from low utilization and day rates

Though the balance sheet remains robust, Geodrill's operations have been significantly impacted by the dramatic reduction in mine drilling budgets resulting from the steep drop in operating profits brought on by the steep decline in commodity prices over the last two years or so. The following is a table of the last five quarters of operating performance:

Qrtly Income Stmt (USD $Mil)
Income Statement Sep-13 Jun-13 Mar-13 Dec-12 Sep-12
Total Revenue $ 4.03 $14.90 $15.03 $12.92 $10.15
Depreciation, Amort. & Depletion $ 2.41 $ 2.41 $ 2.39 $ 2.32 $ 2.03
Operating Expenses $ 5.49 $ 8.47 $ 10.75 $ 9.74 $13.55
Income before Interest and Taxes -$ 3.94 $ 4.02 $ 1.88 $ 0.86 -$ 6.05
Interest Expense $ 0.26 $ 0.28 $ 0.33 $ 0.40 $ 0.17
Income before Tax -$ 4.20 $ 3.74 $ 1.55 $ 0.46 -$ 6.22
Income Tax -$ 0.69 $ 0.91 $ 0.13 -$ 0.52 -$ 1.23
Profit/Loss -$ 3.51 $ 2.83 $ 1.42 $ 0.99 -$ 4.99
Diluted Earnings per Share($) -$ 0.08 $ 0.07 $ 0.03 $ 0.03 -$0.12

The company has remained profitable with a trailing 12 months (TTM) EPS of $0.05. The loss in Q3 was also a result of the rainy season in addition to the impact of the downturn. The same quarter in 2012 was even worse so one can see that the company has reacted to the downturn and has battened down the hatches quite tightly.

The company's highly respected CEO (and 39% owner) Dave Harper stated in the conference call that "we are not going to put rigs to work just for the sake of it." "It makes no sense to have them work at a loss, so we are selecting our work very carefully"...."would rather have a rig idle than reacting to competitors that will put their rigs to work at day rates that are unprofitable just to show higher levels of utilization." To me this is a very prudent action as nobody wins a price war in a downturn. Mr. Harper also indicated that the company is using this downturn as an opportunity to get the entire rig fleet in tip-top condition and ready for the eventual upturn. The following chart of the first nine months' operating income statement versus 2012 shows some interesting facts in relation to Mr. Harper's statements:

It is very evident in the first nine months' income statement above that the CEO's strategy of not putting rigs to work if they cannot make money has been the prudent thing to do. Even though the revenue days and the meters drilled are down by nearly 50%, EBITDA margin is up significantly (from 20% to 27%) and EBIDTA is only very slightly lower. What is not shown here on the operating statement is the savings in capex as a result of not needing to refurbish rigs to deploy them into money-losing assignments that competitors have been doing. I believe this is an example of the strong alignment of management to shareholders' interests (with Mr. Harper and other insiders owning ~43% of the company).

As demand improves for drill rigs, Geodrill, because of its high quality rigs and operations, will be the driller of choice in West Africa, and earnings will go up dramatically. Prior to the downturn, analysts at some major research firms had targets of between $5 and $6.50, which is a far cry from the current share price of $0.67.

Also, the TTM EBITDA is $12.35M and the current Enterprise Value is a mere $31M (Market cap (42.5 M shares x 0.67) + ($3M net debt)). So the trailing EV/EBITDA is a mere 2.54 which is very low valuation by any standard.

Some other important facts about Geodrill Limited

The CEO and founder David Harper is a highly respected on the ground mining executive with 23 years' experience in the drilling industry, 20 of those years in management and 16 of those in Ghana and West Africa. Prior to founding Geodrill, Mr. Harper worked in various capacities for Stanley Mining Services from 1986 to 1996. Mr. Harper's roles with Stanley Mining Services included Operations Manager, Exploration Manager and General Manager of the Ghana division, where he expanded the fleet of drill rigs and developed new markets in Ghana.

Very high percentage of insider ownership

Insiders own over ~43% of the share base with founder and CEO Harper owning 38.5%. So it is highly likely that the interests of the insiders and the public owners are strongly aligned. Over the last couple of years insiders have been buying stock at significantly higher prices than today. Also to my knowledge, there have been no insider sells at all. It is important to note that Dave Harper has seen his interest in the company shrink in value from $66 million at the highs two years ago to just $11.6 million as of the writing of this article. So suffice to say that Dave Harper will act prudently and wisely during this downturn and equally so when the environment in the sector improves to protect his own large interest in the enterprise.

West Africa's largest, most modern drill fleet

Geodrill operates the largest fleet of multi-purpose exploration drill rigs in West Africa, which have the ability to perform both RC and Core drilling. This gives the company the flexibility to transition mid-way through a hole based on client requirements with one rig, rather than having two rigs on site. This versatility reduces costs associated with mobilization and demobilization, and effectively reduces the realized cost per meter associated with a drill program.

The fleet stands at 37 rigs and is made up of 5 types. It is also a very late model as well as modern fleet:

  • 3 - EDM 2000 multi-purpose
  • 13 - Sandvik DE 820 multi-purpose
  • 8 - Sandvik DE 810 multi-purpose
  • 8 - Sandvik DE 710 core
  • 5 - Austex X300 air-core

The investment thesis: A steep growth company that has now become a deep value investment

I believe that this is easily a multi-bagger equity investment in the making. Geodrill is a growth story (postponed for the time being) that has now become a deep value story. If you take another look at the share price performance chart earlier in the article, you can see that the stock reached almost $4 on two occasions. The reason for this is that the company was in a rapid growth phase...building and deploying new rigs (paid for with cash flow) at very good day rates. West Africa is a very prolific resource exploration and development region that as a whole is quite geo-politically friendly.

This company is biting at the bit to resume their expansion plans but will wait for a turnaround in earnest to resume this. You can note the countries of interest highlighted in green on the above map. I will attempt to summarize nine good reasons why this is a great investment opportunity:

  1. Trading at a huge discount to its Tangible Book Value (46% of TBV)
  2. EV/EBITDA is a very low 2.54
  3. A very strong balance sheet (as articulated above)
  4. The go-to name for metals drilling in Western Africa
  5. Ability to remain profitable even in a severe downturn
  6. Very late model, quality drill fleet
  7. Strong alignment of insider and public shareholder interests
  8. Strong leverage to an upturn in drilling activity
  9. Strong, highly respected, on the ground CEO

Analysts utilize two main core financial valuation metrics when analyzing the relative value of drillers:

  1. Tangible Book Value to share price (P/TBV)
  2. Enterprise Value to EBITDA (EV/EBITDA)

These metrics are preferred because drilling companies' assets are hard assets with a long depreciation schedule but require ongoing capex to refurbish and keep the fleet in acceptable operating condition to remain competitive. Regardless of whether a rig is being utilized or not, it has an easily determined book value based on the original capital cost minus ongoing depreciation of the hard asset. Notwithstanding, the liquidation of any asset may be more or less (typically less) than its book value based on the condition of the market and the current demand to acquire these asset types.

At the time of writing Geodrill shares are trading significantly below the peer average with respect to the value of the enterprise relative to the company's trailing twelve month EBITDA generation.

Here are some EV/EBITDA peer comparisons in the following table:

Geodrill 2.54
Ausdrill 2.75
Major Drilling 7.21
Orbit Garant 7.64
Energold Drilling 11.92
Foraco 16.81
Peer Average 8.15

Source: Bloomberg Financial

When one considers the quality of the company's balance sheet as well as the other positives listed above, there is no good reason why the market would assign a value to the company's shares such that the Enterprise Value to EBITDA (2.54) would be at the bottom of its peers and significantly below the peer average of 8.15.

Upside scenarios

1) Current environment

Even in this current downturn, the shares are significantly undervalued trading at just 46% of TBV and an EV/EBITDA of 2.5. If the company was trading at its TBV, the share price would be $1.44 which is over 100% higher than it is today. If the EV/EBITDA was even a more reasonable 5.0 times (which is still nearly 40% below the peer average of 8.15), the share price would be ~$1.40 or 85% higher than they are at the time of writing.

2) Improved environment

If the market turns at all and drilling activity picks up in 2014 (which many pundits expect it to), the increased drilling activity is highly likely to translate into significant EBITDA and EPS improvements and the share price will rerate significantly higher toward the levels in early 2011 (prior to the downturn in the sector). These kinds of share price levels would result in a multi-bagger rise in the share price.

Downside scenario

With the stock trading at less than 50% of its book value and the assets being very late model, I do not see the share price getting more than 10-15% lower than it is currently as the value of the company's assets are more than twice the value of the share price. The company's workforce is contracted and can be very effectively scaled to the level of "profitable" work available. Also, the company has shown that it can continue to generate outsized EBITDA relative to its enterprise value.

Some potential catalysts

Buyout - With the stock trading at an over 50% discount to TBV, it truly surprises me that a global driller has not swooped in and bought the company (particularly with the fleet being so late model and in a geopolitically friendly frontier mining exploration region).

Quarterly Updates - The CEO indicated on the Q3 conference call that they are signing new drilling contracts and the environment is looking like it is beginning to improve some. A solid improvement in an upcoming quarterly financial and operations update would provide strong support for a significant improvement in the share price. Remember that (despite a strong balance sheet and low financial valuation metrics) the stock is 85% off from its high two years ago and has a larger asset base and the same share count as it did when it made those highs.

Metals pricing improvement - The company's shares would greatly benefit when the upturn commences in the precious and base metals' prices. Just the knowledge of this renewed uptrend would quickly cascade through the mining industry to their major vendors...the drillers.

Accretive acquisitions - With the drilling sector in such a downturn, there may be opportunities for the company to use its healthy balance sheet to expand into the neighboring countries it operates in through buying assets at very distressed price levels. The market would likely see this as a positive for the company and its share price.

Risks to the thesis

Geopolitical - Though West Africa as a whole is a relatively stable jurisdiction compared to the rest of the continent, there is a substantial risk of regime changes or regulatory changes that could impact the finances or operations of the company negatively.

Prolonged sector downturn - Though we are over two years into the metals drilling sector downturn, it could continue into the future for some time to come and put further pressure on the balance sheets of drillers.

Credit default - As a significant percentage of Geodrill's customers are junior miners that have been severely comprised financially, the company has increased risk of customers defaulting on their payments owed to the company.

Liquidity - The company may experience a liquidity crisis if it cannot collect receivables or if revenues continue to fall due to a prolonged market downturn.

Concluding remarks

Finding value in the equity markets is becoming more and more difficult as most sectors have experienced significant multiple expansion and their member companies are trading at multiples of their book value. Considering that many resource sectors are in nearly three year downturns, it would seem logical to assume that as global growth continues, demand for commodities should increase. Also at current commodity prices for metals (particularly precious metals), mine production has come under pressure and is resulting in shutting in marginal production and putting a halt to marginal mining developments and expansions.

I believe that the risk-reward has become quite good in the global metals drilling sector and a rotation of investment funds from the higher performing overbought sectors to the unloved underperforming sectors may be a wise investment decision.

Geodrill Limited is an extremely well run Ghana-based metals drilling company, with a leadership position in a prolific, geopolitically acceptable region of Africa. The company has 37 late model drill rigs and is trading at a ridiculously low 46% of its Tangible Book Value and an equally ridiculously low EV/EBITDA of 2.5 times, which is at the bottom of the peer average and nearly 70% below the peer average of 8.15. There is a very large percentage of insider ownership (~43%) which should keep shareholder interests aligned. The company is trading 85% off of its early 2011 high (66% off of its $2 IPO price) and also has a strong balance sheet to weather the current downturn and to leverage to grow into the upturn.

So it seems very obvious that this severely undervalued and little known African junior metals driller is offering a very good entry point to owning a portion of the company at a price that is over 50% less than the value of its net tangible assets (shareholder equity).

Disclosure: I am long GDLLF. 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.