This is the first in what I hope will be a series of articles about zombie companies, companies that trade but have no real prospect of producing long-term positive returns for investors. These companies are characterized by poor business prospects and financial positions that do not remotely justify their market capitalizations.
According to Wikipedia, the term zombie comes from Haitian folklore. A zombie is a corpse said to be revived by witchcraft. The companies I will profile are trading corpses. The witchcraft that revived the stock is usually a combination of momentum trading and technical analysis.
An important consideration is how long a zombie can stay alive. Fortunately, I found an FAQ.
What is the life span of a zombie? Beating heart zombies can live for years. If the heart stops, a beating heart zombie becomes an asystole zombie and reanimates shortly after cardiac arrest. Asystole zombies' average life span is about eighteen months. It can be undead for up to three years. In low humidity environments it can potentially double the undead span.
Investors should be aware that zombie stocks too can have a long life span. They can continue to trade for long periods. In an environment where there is no borrow available for shorting, zombie stocks can trade higher and higher. Ultimately, the fundamentals will dominate the technicals and the stock price will reflect the true economic value of the companies' assets.
Tanzanian Royalty Exploration Corporation (NYSEMKT:TRX) is one such zombie company. The company is a gold mining venture with operations in Africa. Five years ago, I wrote a piece titled Fool's Gold. This is what I said about the company back then.
The rising tide of gold prices has lifted the market value of Tanzanian Royalty Exploration (TRX) to ridiculous levels. The stock has gained over 350% from a 2008 low of under $2 to a current price of around $6.90 There are 94 million shares outstanding, giving the company a market cap of $650 million. That is a tremendous market cap for a company that has less than $50 million of assets.
Change the date and the numbers a little and it is true again today. The stock has gained over 400% this year trading up from $0.26 to $1.32 on Friday. The current market capitalization is $143 million, which is huge for a company with a mere $130,000 in cash on the balance sheet as of May 31, 2016.
Part of the meteoric rise can be attributed to the overall rally in the junior gold miners as evidenced by the rise in GDXJ.
I suspect that traders were looking at TRX as an underperforming laggard in the sector due for a move up. The catch up move is apparent when TRX is viewed against gold. This is a two axis chart with gold on the left axis and TRX on the right. It appears that TRX has caught up.
But that would be deceiving. Below is a normalized chart showing percentage moves. From this chart it appears that TRX has overshot the move in gold.
The charts all show very bullish action on the stock. The news and the fundamentals tell a very different story.
Tanzanian Royalty Exploration Corp. is a gold mining company that has not yet achieved commercial production of gold and therefore has no reported revenue. The company is reliant on debt and equity financing to fund operations. In the latest quarter, cash administrative expenses were approximately C$440,000.
The balance sheet is in shambles and the stock is trading at over three times book value. Ninety percent or C$45.6 million of the accounting book value is intangible Mineral properties and deferred exploration. This line item represents costs that were previously incurred and not actual salable assets. It is an accounting mechanism to match expenses exploring and developing the prospects with potential revenues from mineral production in the future. TRX has written off over C$10 million over the last five years.
Shareholders should expect the write offs to continue. Assets at risk include the C$12.3 million carrying value of Kigosi and the C$3.4 million assigned to Luhala. The Kigosi licenses are located in a game reserve and the company has been unsuccessful in having the license areas carved out. Additionally, the Kigosi Access Agreement signed in 2012 has expired so the company cannot even enter the license area to conduct exploration or testing. TRX has spent just over C$225K, a mere 7% of the balance sheet value, on Luhala over the last decade. It strains credulity not to take an impairment charge on both.
Further, the company has a working capital deficiency and the debt hole is getting deeper. Below is a table with selected balance sheet items for the last three quarters. All amounts are in Canadian dollars.
I have highlighted three items of concern Cash (orange), Payables (yellow), Loans (pink).
The cash balance of C$168,635 is insufficient to fund even a quarter's worth of corporate overhead. I project that in the absence of additional financing the company has already exhausted its cash. I said this in an article back in the fall of 2014. I predicted that the company would fold by the end of the year. But I seriously underestimated the financial voodoo that keeps this zombie trading. There are two components. The first is not paying trade creditors and the government of Tanzania and the second is borrowing gold coins and bullion.
Payables have ballooned to C$4.4 million. From the notes to the financial statements on sedar.com,
In order to maintain the existing site of mining and exploration licenses, the Company is required to pay annual license fees. The Company has not paid its annual license fees since October 2014 with exception of Buckreef mining licenses. As at May 31, 2016 an accrual of $970,000 has been recorded relating to unpaid license fees. The potential penalty relating to unpaid license fees is around $485,000
In addition to not paying those fees, the company has not paid the penalties for not bringing the Buckreef gold mine into commercial production. Stamico is the State Mining Company of Tanzania.
The joint venture agreement contains an obligation clause regarding the commissioning date for the plant. The clause becomes effective only in the event the property is not brought into production before a specified future date which was originally estimated to be in December 2015. The Company shall be entitled to extend the date for one additional year: i) for the extension year, on payment to Stamico of US$500,000; ii) for the second extension year, on payment to Stamico of US$625,000; and iii) for each subsequent extension year, on payment to Stamico of US$750,000.
By my estimation, TRX owes Stamico US$1,875,000. The more troubling aspect is that the mining licenses are the only real asset the company has. Not paying the fees puts those assets in jeopardy.
Without any revenue to fund mining operations or corporate overhead, management has executed a number of "gold loans" where the company has borrowed $3.4 million of gold coins and bullion and sold them to finance operations. The company has entered into at least five of these borrowings in amounts ranging from US$100,000 to US$1,000,000. As a long-term financing solution, raising capital in small increments is just not tenable. The capital raises basically pay the corporate overhead but are not sufficient to run the mining operation. If and when this source of funds runs out, this zombie company will die.
Tanzanian Royalty Exploration Corporation has been attempting to redevelop the Buckreef gold mine in Tanzania. The company built four heap leach pads and constructed a Carbon in Column (NYSE:CIC) plant. While senior management would like shareholders to believe that progress is being made, the reality is otherwise. To date the company has not achieved commercial production. It appears that for all intents and purposes, mining operations ceased in the fall of 2015. The operation has devolved since then leading to the company issuing a declaration of Force Majeure on February 4th, 2016 and culminating in a dispute with the Tanzanian government.
From the financial statements, it is apparent that the lack of cash in the treasury has negatively affected mining operations. Note 14 details the value of supplies in inventory. At the end of Q1 on November 30, 2015, the value of fuel in inventory was C$519. The balance declined to C$0 at the end of Q2 and remained at that level at the end of Q3. This is evidence that no mining activity occurred for at least 9 months, as fuel is required to run excavators and hauling trucks. Further, the stock of processing chemicals remained constant at C$5,900, which is evidence that no processing occurred during the same period.
More damning evidence of the complete shutdown of operations comes from Google Maps.
This most recent satellite image shows the South Pit filled with water. Clearly, no mining is being done.
The government of Tanzania has been dissatisfied with the project and in January, Deputy Minister for Energy and Minerals, Dr. Medard Kalemani toured the mine where he "gave directives to the investors following the negligence that has led to the poor development of the mine." Shortly thereafter, TRX at the insistence of the government smelted all the gold recovered from the heap leaching of 45,000 tons of ore. The final product was 188.51 ounces of gold worth approximately $250,000.
TRX management does not provide production statistics like most companies in the industry. The table below details my estimate of the recovery rate. According to the company the leaching process was completed in the summer of 2015 so the 188 ounces of gold represent the fruits of the entirety of the mining effort.
After mining almost 46,000 tonnes of ore, Tanzanian Royalty produced just 188.51 ounces of gold for an anemic recovery rate of just 4.58%. Since management did not release any cost data, it is impossible to estimate the cost per ounce. One can only guess that it significantly exceeds the current price of gold. At the 2014 AGM, CEO Mr. Sinclair, described the Buckreef South Pit as the "low hanging fruit." He told shareholders that cash flow from mining the South Pit would be used to internally finance the Buckreef Mega Pit. It should be obvious now that is not going to come to fruition.
In the wake of the dispute with the Deputy Minister and the declaration of Force Majeure, Mr. Joseph Kahama, TRX's Chief Operating Officer (Tanzania), resigned. He is a Tanzanian native and had been with the company and its predecessor since 1997. Additionally, the other Tanzanian on the board, Professor Mruma, resigned. Their departures leaves the company without experienced mining executives in the country. It is doubtful that TRX can revive the operation without an experienced team at the mine.
The whole Force Majeure declaration seems to have been designed as an excuse to shareholders by Mr. Sinclair for his company's failures. The Ministry of Energy and Mines published this press release,which rebuts all of Mr. Sinclair's assertions. Stamico had this to say according to All Africa.com
"Buckreef faces major technical challenges due to total failure of the newly installed but poorly designed Heap Leach Process Plant," The team also revealed serious financial problems, amid increasing list of aggrieved debtors and suppliers.
The press out of Africa is portraying a much different picture than the CEO. To me it seems that the mining operation is dead in the water and the corporate treasury is empty.
But a zombie doesn't die so easily. This member of the walking dead continues on with the stock trading at YTD highs. Investors should avoid drawing positive conclusions from the recent price action and chart patterns and instead focus on the imploding operations and deteriorating fundamentals. The stock borrow for shorting is costly at over 100%, making it expensive to maintain a short position. Put options are available.
Disclosure: I am/we are short TRX.
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.
Additional disclosure: An investment fund that I advise is short. The fund has no plans to trade in the next 72 hours.