Geodrill (GDLLF) is my favourite 'picks and shovels' play on commodities. As a drilling company it allows participation in the coming commodity boom without direct exposure to and risk of individual price fluctuations. As I will argue below, GEO (which is the Canadian ticker) is not only one of the highest quality drillers based on margins, fleet utilization and balance sheet strength. It is also exceptionally cheap and founder led. The risks are fairly limited and at this valuation there is a large margin of safety.
Geodrill is a leading exploration drilling company. As the CEO likes to say, they drill for everything, except oil and gas. However, the bulk of their business is and will be in gold with a fraction of 95% currently, which should trend towards 70% in the medium term as they expand more into base metals. Geographically they are concentrated in Africa (Ghana, Burkina Faso, Cote d’Ivoire, Mali in West Arica) while expanding into South America (Peru) and Egypt. The company serves mix of majors, intermediates and juniors. The current CEO and majority owner Dave Harper founded Geodrill in 1998. He started with 1 drill rig and 1 contract and has built his company into a leading exploration drilling company with a fleet of 74 multipurpose rigs generating more than $100M revenues a year. What an achievement.
While the drilling business is cyclical overall – with cycles of about 7 years – long term contracts at cost plus still afford stability. What is more, business is often sticky as customers will demand more drilling services through the life cycle of a project. As a deposit proceeds from discovery to a full mine, more and more drilling is needed and since depleted pounds or ounces need to be replenished, the drilling continues even during production. Harper told me of one customer where they have begun decades ago with a single rig and to this day, they are drilling at the mine site – only with many more rigs. Geodrill rarely loses business because they do everything to serve the customers well and because the company makes these relationships one of their core values.
Among the drillers the company may well be the best run of all with no accidents or other incidents – remarkable considering the jurisdictions they are operating in. In fact, this is exactly their strength and Harper would not even consider going to Australia, the USA or Canada, despite such requests. They know how to operate in their current jurisdictions and have the highest market share. They are also highly engaged in social activities, spending some money and time on the communities there. I love that as a shareholder because I know that even a little bit of money can go a long way in these poor communities.
Geodrill’s utilization rates are consistently above industry average (70% now). As a rule of thumb, 75-78% would be the maximum possible considering the need for mobilization, repair, etc. Since payment is by the meter drilled higher utilization directly effects gross margins and thus return on capital, which is why GEO consistently surpasses the industry:
The company also has a unique workshop in Ghana where they build hundreds of parts themselves and support operations in Africa making GEO 20% self-sufficient – especially important in a world with continued supply chain issues. This helps the company deal better with cost escalation compared to competitors. The CEO is a true owner operator with almost 42% of all shares being in his hands. He is running the business conservatively with a strong balance sheet. Where other drillers had to enter bankruptcy in the trough years, Geodrill hardly ever lost any money and avoided excessive debt.
The only time they issued shares was in the IPO process and those funds were put to good use expanding the fleet. Management does not draw excessive salaries and stock based compensation is not added back to their reported EBITDA and income numbers, as practically all companies tend to do nowadays. EBITDA is actually EBITDA and not “earnings before all the bad stuff”.
Right now we are in the early stages of an upcycle. Commodity prices from tin to copper and lithium to gold have seen strong price appreciation. Considering the enormous amount of metals need towards greening the economy, batteries, electric vehicles, more electrification and so on, it is quite clear that demand will only grow from here and new resources will need to be discovered and developed. The beauty of the drilling business is that it is only indirectly leveraged to prices. Copper at $3.75 per pound or $4.50 does not directly affect sales of a driller. Much more important is continued demand for new pounds and ounces, which is a given at this point. What is more, at current prices gold miners for example enjoy strong margins generating copious amount of cash which they can spend on drilling. It is no coincidence that Geodrill just reported the strongest quarter in the history of the company, both in terms of revenue and earnings for a record return on capital employed of 21%. They even had to – for the first time – rent six drill rigs. In the beginning of the year, they announced contracts of more than $130M over 5 years and as Harper told me they are "inundated with inquiries”.
GEO has 46M issued shares and 50M issued and reserved shares for a fully diluted market cap of $88M at $1.75 a share. They ended the recent quarter with $5.6M net cash and ample access to liquidity from term loans and a revolving line of credit. After $115M of revenue in 2021, Q1 revenue came in at $33.4M, a 9% yoy increase. Importantly, Q1 is one of the weakest quarters and management highlighted that only the second half of March was particularly strong, which bodes extremely well for Q2. In general, seasonality is such that Q2 and Q3 are strong, while Q4 and Q1 tend to be weaker due to rainy seasons, mobilization of drill rigs into the new year and other reasons. While margins vary from quarter to quarter, on average the company requires 25% EBITDA margins as a hurdle for every new contract. My estimate for the current year revenue is accordingly $126-130M with EBITDA of $32-33M bringing the enterprise multiple roughly to 2.5X. The P/E ratio would roughly be 4x. This is excessively cheap for leading driller like GEO in an upcycle. The generated cash is distributed via dividends (for example they paid a cash dividend Q1 of CAD 0.03 per share) and reinvested in the business. About 25% capex is maintenance, the rest goes into growth and a rig typically lasts for 30-40 years. So while the business is capital intensive, they don’t have to invest all the cash “to stand still”.
From conversations with people in the industry revenue growth of 10-15% per year can be reasonably expected based on realistic assumptions of fleet growth, ending up between $150-200M in this cycle. Using 25% EBITDA margins, the following matrices give an idea about the return potential.
4-5 times EBITDA are the historic multiples GEO had in an upcycle and this is still significantly below many competitors currently.
The return potential would be up to 2X, ignoring any dividends, share buybacks or potential operating leverage. What is more, Harper is not willing do “die in his boots” and would take a good buyout offer any time. This is basically his only exit opportunity considering he owns almost half of the company. In fact it seems highly likely that the company will be bought out within the next years according to analysts I have talked to. The workshop in Ghana, excellent relationships to customers and leading margins make the company attractive even at much higher valuations, especially since many competitors command much higher multiples. Since it can be levered up further, multiples of 5-7 would not be out of question thus boosting the potential return considerably.
Softening demand for commodities and new exploration would be detrimental but is hard to imagine considering the depleting resources of copper, gold etc in face continued demand for the green revolution. But even if no revenue growth materialises for GEO, it is with current numbers extremely cheap and could distribute more cash to shareholders, certainly more than 10% of revenue or up to 15% of the market cap. A strong margin of safety.
Political risk should be considered in Africa, South America and Egypt. However, the long and successful operating history of the company makes this a highly unlikely problem.
Continued cost pressure, from inflation and supply chain issues is something to watch, but so far the company can pass on all cost increases and the high level of self-sufficiency will help mitigate further problems.
While it seems trivial to call the weather a risk, in the short term it may affect results. For example the rainy season in some of the countries GEO operates in may be unfavourable, thus causing more downtime and reducing margins. Something like this happened in Q3 last year.
Competition is an obvious risk, considering this is a highly competitive industry where no player has strong pricing power. However, the leading utilization rates, cost discipline and excellent relationships make this rather to a strength of Geodrill, rather than a weakness.
Geodrill is one of the best drilling companies in terms of margins, return on capital and balance sheet strength and at the same time one of the cheapest. We are currently in the beginning of a cyclical upturn and the share price is barely off the lows. Based on my projections returns between 11 and 300% are possible in the coming years, not counting dividends of around 5% per annum. The business will most likely be sold in the medium term and the risks are fairly low. Even in the downside case of no revenue growth at all, much more cash could be distributed and it is hard to imagine the shares trading at up to 15% dividend yields in that case.
I want to end by highlighting the ESG initiatives Geodrill pursues. This is a priority for the CEO and as a shareholder, I love the engagement of the company. A particular project for example was an innovative Bus Shelter made from plastic waste.
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Disclosure: I/we have a beneficial long position in the shares of GDLLF either through stock ownership, options, or other derivatives. 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.