Skip to content

Posts from the ‘Gran Colombia Gold (GCM)’ Category

Catching the knife with Gran Colombia

This has been just a brutal week for my portfolio.   I have been sliced and diced by the commodity bear market.

I was prudent enough to exit all of my base metal positions and that saved me through the early part of July.  But this week oil stocks and gold stocks joined in the carnage and I was not well positioned for that.

I admitted defeat on a few of my oil stocks.  I sold Zargon, reduced Gear Energy and reduced GeoPark.  I don’t have the conviction.  The second quarter has not shown the inventory draws that I had anticipated.  I’m worried about what happens as inventory builds begin.  What if Saudi Arabia decides to direct more oil towards the US?  Even if overall supply remains constant, the market seems to react with blinders to the weekly US storage numbers.

On the other hand I have held onto my gold stocks.  Until this week they had been holding up pretty well even as gold fell.  I even had a big winner in Wesdome and a little winner in Golden Star Resources. But this week the bottom fell out of all of them, in particular Roxgold, Gran Colombia, Jaguar and Golden Star got creamed.  I sold a bunch of Jaguar because it just isn’t operating well but have kept the rest.

The irony of Roxgold, Golden Star and Gran Colombia is that each released second quarter results and they were really quite good.  But the market doesn’t care much about results when it is busy panicking.

I’m going to focus on Gran Colombia right now because that stock has gotten into the “this is pretty insane” territory in my opinion.

Gran Colombia Second Quarter

Gran Colombia released second quarter results on Tuesday.  Since that time the stock has fallen almost 20%.

When a stock falls 20% in the days immediately following earnings you would expect to see an earnings miss, a reduction in guidance or an increase in costs.  Here is what Gran Colombia gave us:

  • Raised production guidance to above 200,000 ounces for the year from previous guidance of between 182,000 and 193,000 ounces.
  • Produced 52,906 ounces of gold in the second quarter up 15% year over year
  • Total cash costs and all-in sustaining averaged $696 per ounce and $913 per ounce, well below the company’s guidance of $735 per ounce and $950 per ounce

If there is a negative side to the results, its that costs were up a little over the first quarter and earnings were down a little, mainly because the price of gold was a bit lower.  But the company’s measure of free cash flow was up to $11.4 million USD for the second quarter, up from a little over $2 million the previous quarter.

Anyways those are the results.  Next let’s consider the valuation of Gran Colombia.

We can look at the stock two ways.  Either using the current share count and debt levels, or assuming that the warrants get converted, increasing the share count but also increasing cash on hand.  Because the current share price is below the warrant strike, I am not including the warrants in the calculations below.

After full conversion of Gran Colombia’s 2018 debentures (which happened on August 13th), the company had 48.2 million shares outstanding.  So at the current price the market capitalization is $100 million CDN or $78 million USD.

Gran Colombia has $98 million USD of senior Gold notes and $25 million USD of cash.  Net debt is $73 million USD.  EBITDA last quarter was $26.5 million.  EBITDA in the first quarter was $27.3 million.  Below is what the company is trading at currently if you annualize first half EBITDA as well as what it’s at based on my estimated EBITDA at $1,200 gold.

Below I have tried to work out a simple pro-forma model of what EBITDA and free cash look like at $1,200 gold.  I’m using the company’s own production and cost guidance.  They have been consistently beating the cost guidance and are trending above the new production guidance in the first half.  I’m also assuming the tax rate for 2019.

So the stock is trading at a little over 3x free cash flow using the company’s own guidance.  That seems a little crazy to me.  I’ve added to my position here and am hoping the carnage ends soon.

Advertisements

Week 366: The Wishy Washy Portfolio

Portfolio Performance

Thoughts and Review

I’ve done a lot of flip-flopping over the last 6 weeks.  I couldn’t get comfortable with certain oil producers, I couldn’t get comfortable with oil servicers and I couldn’t get comfortable with the copper stocks.  I also owned and then sold Cameco and Energy Fuels before settling on buying the debentures for Energy Fuels.

These transactions weren’t trades.  I don’t really trade in my portfolio.  But I often buy into ideas that I am not completely committed to.  Having a position clarifies my conviction.  If I don’t have it, I’ll sell a few days later.

As it turns out it probably wasn’t a bad idea to step away from these ideas.  The oil servicers, which I will talk about below, have done little.  Copper stocks, which I talked about here, have done even worse.    Cameco has floundered.

What I have added and stuck with over the last 6 weeks is RumbleOn and Smith Micro, both of which I have already talked about, GeoPark, which I’ll talk about another time, and Overstock, which I’ll talk about right now.

Overstock

When I first wrote about blockchain I said I found it interesting because: “it’s a way of dis-embodying trust into technology. The middle man disappears. The skim shrinks. Everyone (other then the middle man) benefits.”

Since that time crypto has gone to the moon and crashed again.  While its easiest to base an opinion on the latest bitcoin price, I don’t think that is necessarily correct.  I still think the premise of what blockchain promises has value.  It just has to find ways of being integrated into applications that have broad usage. If I were to bet, I would say that the current lull in sentiment will pass and that blockchain will come back into vogue in some new form relatively soon.

So let’s talk about Overstock.

I bought the stock two weeks ago after tZero announced that they had received a $100 million letter of intent (LOI) from GSR Capital.

Like most things with Overstock, its a fuzzy data point.  First, its an LOI, which doesn’t really mean anything is certain.  Juniors on the Canadian venture exchange love to use LOI’s to put out big numbers and generate big hype (coincidentally I will talk about a situation like that shortly!).  The deals often don’t amount to anything.

Second, GSR Capital looks a bit sketchy.  This post from CoBH kind of makes that point.  Of course you can dig in the other direction and find less bearish takes on what GSR is doing.

I’ve always thought of Overstock as a stock that has an asset value with a huge standard deviation.   You can create a legitimate case that the stock is worth $30 or $80. There is that much uncertainty about outcomes.

It’s all about buying it at the right place within that band.

Being able to buy the stock in the low $30’s (I got a little at $31, more at $32 and the rest at $33), especially after there was incrementally positive news, seemed like a reasonable proposition to me.

The GSR investment, if it is followed through, represents the first time in a while that something Byrnes has hinted at actually happened.  So I’m getting it at the bottom of the band and with a positive data point to boot.

When I sold Overstock in January and February it was because the projections Byrne had made a quarter before were not coming to fruition.

  • He had said the stock lending platform had billions of inventory and would start making money shortly.   But in the tZero disclosures in December there was no mention of the stock platform at all!
  • He had talked about partners knocking at the door.  But all that materialized was Siebert and a couple of other tiny acquisitions.
  • He talked about the mysterious man in the room and one other big opportunity he had.  This turned out to be De Soto, a very interesting idea but something that he himself has said that he only “thinks” can make money.

Byrne also talked at length about the Asian money that was interested in tZero.  That was another strike out.  Until the GSR investment.  Now its not. So something actually panned out.

Its clear that the advanced state of tZero that was described at the end of last year was exaggerated.  It also seems likely to me that Byrne was not entirely aware of the state of the software.  Witness that the CEO of tZERO was replaced by Saum Noursalehi, who was moved over there to add a “Silicon Valley” mindset to tZero:

But I think this is going to become an innovation game. I think that by putting Saum there, I mean he’s extraordinarily able as an executive anyway, but in terms of managing innovation, Saum and I have a decade’s history of working together on [O lab] And other things that have changed our company and I don’t think anyone I’ve met in New York was going to be able to compete with what I know Saum has in mind.

tZero was supposed to offer a stock lending platform and would be on-loading inventory they had accumulated. That didn’t happen and they are now in the business of licensing it out.  The software also probably wasn’t all that functional; on the first quarter call Noursalehi said they were (only now) building out the functionality to allow you to carry the digital locate receipts for intra-day periods.  That this wasn’t available in the original software is odd.

They are also only in the process of building out the token lending platform, which is to say there is nothing operational yet (one of the first major red flag I mentioned from the tZERO memorandum last December was that the security token trading system was described as something that still needed to be built!).

Of course the sale of the e-commerce platform, which was supposed to be done by February-March, is ongoing and now more of a “souffle”.

So there are lots of negative spins you can make here.  On the other hand they are forging ahead with the tZero platforms, they have over $250 million of cash on the balance sheet and another $320 million from the tZero token offering (if you count GSR and all the executed SAFEs), and the sale of e-comm is still ongoing, so there is the potential for a positive resolution there.

There is also the initiatives to transform e-comm into something that is growing.  While these are still in the early stages it seems to be working.  So that’s just another probability to add to the list.

Most importantly, at a little over $30 buck a lot less of the positive potential is priced into the stock then at $80.

Look, Overstock is what it is: a stock with a lot of optionality, a lot of uncertainty, operating in an brand new industry that I don’t think any of us know how it will play out in the next 5 years.

So speculators pretend that the price of bitcoin is somehow a proxy for the state of blockchain. It’s probably not.  I didn’t buy Overstock as a quick trade to capture a short pop on speculation of GSR.  I actually think at $33 it represented a fair value for all the risks and rewards.  So I’ll see wait for the next data point how and evaluate from there.

Wanting to Buy Oil Services but can’t

I’m not a trader.   When I get into a stock its with the intent of sticking with it for 6, 12 or 18 months or however long I need to in order for the idea to play out.

So when you see me in and out of a stock in a short time frame it usually has nothing to do with trading.  Its just indecision.

Such has been the case with the oil services stocks where I’ve been in, out, back in and back out again.

What’s going on?  I’m being torn between two sides.

The bull side is simply this: oil is up, growth in production needs to come from the US, and oil servicers should benefit.  The stocks are extremely cheap if their businesses are on a growth path.

The bear side is that all of the on-shore servicers are exposed to the Permian, Permian capacity constraints are going to kick in this summer, and volume and pricing of drilling and completion services are going to get squeezed.

I should probably just walk away from the idea.  The stocks don’t act well.  Considering that this should be a bull market, the action is even worse.

What keeps me interested is just the absolute valuations.  Below are 5 companies with average EBITDA multiples for 2018 and 2019 (these prices are from a week or so ago but I don’t think anything has moved much since then so I haven’t updated them).

Seems cheap?  That’s what I thought.

But when I buy any of these stocks, all I do is fret about them.

The problem is the Permian.  RBN put out a really good piece describing how the infrastructure bottleneck in the Permian is likely to play out, and what the alternatives now.  Unfortunately it’s behind a pay wall.

The issue is that there isn’t enough pipeline capacity to get the oil out and new pipeline capacity won’t be finished until the second half of next year.  So you have about a year of constrained takeaway.

Source: PLG Consulting

As RBN pointed out the alternatives to pipelines have their own constraints.  Rail can only carry as much as the available tankers and loading capacity.  This is less than 100 thousand barrels a day.

Trucking is theoretically unlimited but the logistics of bringing in trucks and truckers caps it in reality.  A single truck can carry about 180 barrels a day.  So for every 10,000 barrels a day of production you need to add 100 to 150 trucks and drivers.

The Permian accounts for about 50% of activity in the United States onshore.  As an oil servicing business its hard to avoid the Permian.  Exposure of the companies I’ve looked at varies from 30-60%.  Solaris has about 60% of their fleet in the Permian.

But just how much of a hit will these companies take?  That is the other big question.

According to the company’s themselves, they are insulated.  They talk up their long-term contracts, how they are dealing with the stronger operators in the region, and how these operators have secured takeaway capacity and hedged their exposure and thus will be able to keep drilling.

But are they really?  I don’t trust them.  We won’t really know until the second quarter calls start hitting and they have to fess up about the state of their operation.

So what do you do?

For now I’m back out.  I think.

The only exceptions are a couple of non-Permian related servicers that I own.  Cathedral Energy, which I don’t believe has as much exposure to the Permian (though they do have some), and Energy Services of America, which is a pipeline builder in the Marcellus/Utica that has a host of their own problems but the Permian is not one of them.

RumbleOn

I was worried that my lead touch was failing me.  I am resigned to the fact that I take positions in stocks where I will have to endure months of it  doing nothing or going down before it actually begins to move as I suspect it should.

RumbleOn moved as soon as I bought it and before I was even able to get a write-up out.

<sarcasm>Fortunately</sarcasm>, that situation was rectified as the company offered a little over 2 million shares at $6.05.

In retrospect, the entire move to the mid-$7’s and back to $6 was probably bogus.  I don’t understand all the in’s and out’s of these share offerings enough to be able to tell you why, but I’ve been held hostage to enough of them to know that this sort of activity seems to be part of the process.

So what do I think of the move to raise cash?  I don’t see it as a big deal either way.  I had thought they might use their recently created credit facility to bridge the gap to profitability.  I figured given the management holdings they’d be reluctant to dilute.  But whatever.  If the business works the 2 million shares is not going to matter much to where the price goes.

I used the opportunity to add more.

Mission Ready

I have been patiently waiting for 9 months for something to happen with Mission Ready. I haven’t said much (anything?) about the company since I wrote about them last September.  That is because essentially nothing has happened.

Nine months with no news (after announcing a massive LOI) is pretty ridiculous.  There is a valid argument that I should have walked away.  But something about the company made me think its more than just a hyped up press release with nothing behind it.  For sure, the stock price has held up incredibly well since September considering that nothing has happened.   So I have stuck it out.

Now maybe we get some news?  The stock is halted.

Is this the big one?  And is the big one a rocket or a bomb?  No idea.  But I am excited to find out.

Gold Stocks

Back in May when I last talked about the gold stocks I own I wrote:

…these stocks are more of a play on sentiment. I think all I really need on the commodity side is for gold not to crash.

I should have knocked on wood.

That said, the gold stocks I own have held up pretty well.  Wesdome is up a lot.  Gran Colombia is up a little (albeit it was up a lot and has given back most of those gains).  Roxgold is roughly flat, as is Golden Star.  Jaguar Mining is down a bit.  Overall I’m up even as the price of gold is down over $100.

I still like all of these names.  But whereas my original thesis on each name was based on the micro – I simply thought each stock was cheap given its cash flow and exploration prospects, I am actually getting more bullish on the macro.  Even as gold has fallen.

This tariff thing is becoming the shit show I thought it would be.  I expect further escalation before any agreement.

There are a lot of US based commentators that think other countries will be rational and give in to their demands.  I really don’t buy that.  I think its got to get worse before that happens.

I’m Canadian.  So I am on the other side of the tariffs being introduced.  My visceral reaction when I hear of a new tariff being introduced against Canada or I hear Trump make some inaccurate or at least unbalanced comment about Canadian subsidies, is “screw them – I would rather go into a recession than give in to that BS”.

Now you might say that is an irrational response, that it is not reasonable, and point out all the reasons it is wrong.  Sure is.  Doesn’t matter.

If that’s my response, I bet that is also the response of a lot of other Canadians, and of a lot of other citizens of other countries.  We would rather see our government’s stand up for us then be pushed around.

You don’t think that all the other foreign leaders don’t realize that?  Look at what Harper just said: that Trudeau is manipulating the NAFTA negotiations because he can gain political points.  Maybe, maybe not.  It wouldn’t be that surprising.  Does Trudeau get more votes next year if he can say he stood up for Canadians or if he says he buckled under because it was the right thing to do?  You think the European leaders look stronger if they give into US demands?  Same thing for China.

My point is we are all going to stand up for ourselves.  It won’t be until we all see (including the US) what it feels like to be sinking in the boat that we reconsider.  Right now this is a matter of principle and what is rational is irrelevant.

I expect the trade war to escalate.  And gold to eventually start going up.

DropCar, Sonoma

I sold out of both DropCar and Sonoma Pharmaceuticals.

DropCar has been a disaster. When I wrote the stock up I said it was highly speculative, even for me.  But I have to admit I didn’t expect it to crash and burn so quickly.

I don’t like selling a stock just because its just dropping.  If there is a negative data point that comes out, then sure I’ll dump it in a heart beat.  But random drops are frustrating and I often will hold through them.

But the DropCar collapse was too much and I reduced my position in April.  That turned out to be a good idea.  I sold the rest of the stock after the first quarter conference call.  It was just such a bad call.

During the Q&A they were asked about gross margins.  They could have provided a long-term speculative answer, talking about how margins are being pressured because of their growth and the drivers they are hiring, and how long term they expect margins to settle in the mid-teens or low twenties.

They didn’t have to be specific, they just had to spin it positively.  Instead they basically deferred the question.  We aren’t going to talk about that.  You can maybe get away with that answer when things are going well, but when you just announced a negative gross margin quarter you just can’t.

Anyways, I sold.

The other stock I sold was Sonoma Pharmaceuticals.  Sonoma had what was just a really bad quarter.   Sonoma had been growing consistently for a number of quarters and much of my thesis here was simply a continuation of that trend.  That didn’t happen.

The problem is if they don’t grow they are going to have to raise cash again.  They have a limited run way.  The company kind of implied on the call that this was a blip, but it wasn’t enough to convince me with certainty.  So I figured I better sell and wait to see what the next quarter brings.  If they are back on track, I will add it back.  There is still a lot I like about the story.

Portfolio Composition

Click here for the last six weeks of trades.  Note that I added Energy Fuel stock to the practice portfolio because I couldn’t add the debentures (a limitation of using the RBC practice portfolio).  Also note that Atlantic Coast Financial was taken over and my shares converted but this didn’t happen in the practice portfolio (they just stay halted in the RBC practice portfolio).  That’s another change I will have to manually make before the next update.

Week 354: Winners and Losers

Portfolio Performance

Thoughts and Review

My method of investing generates a lot of losers.  I think it’s a pretty good bet that over 50% of the stocks I pick for my portfolio lose money.

My performance is generated primarily by a few winners that end up being big winners.  When I went through a slump in late 2015 – early 2016 I pointed out how few multi-baggers I had.  I was generating lots of losers of course, but I didn’t see that as a problem.  The problem was that the winners weren’t winning enough.  For my method to work, I need at least 2-3 stocks a year that go up 2-5 times.

The math on that works in my favor.  If I have 2 stocks a year that make up 4% of my portfolio each (I usually start out at 2-3% positions but add as they go up) and they go up 3x then my portfolio gains 24% from those positions.  If they double then I gain 16%.  If I can manage the rest of the portfolio to limit the damage; sell the losers before they get too destructive and have a few other smaller wins to help offset the losses, then overall I’ll do okay.

Anyways, that’s my plan.  Its why I invest in a lot of businesses with high upside but questionable paths to achieve that upside.  I’m fine with those that don’t pan out, as long as a few of them do.

Since last summer my big(gish) winners (this is off the top of my head) were: Combimatrix, R1 RCM, Gran Colombia,  Aveda Transportation, Vicor, Helios and Matheson and Overstock.

Combimatrix was taken over and ended up being between a 2-3 bagger.  R1 RCM was a triple.  Gran Colombia is almost a double so far from my original purchase at $1.40.  Aveda Transportation got taken over a couple weeks ago and was nearly a double.  Helios and Matheson was a little less than a triple (I sold out well before the top, in the $9-$10 range) and Overstock was about a 70% gain.

Both Helios and Matheson and Overstock turned out to be flops in the end, but that’s okay too.  A big part of my strategy is to know what I’m getting into, and not fall in love with it because there is a good chance it ends up going south.  In both those cases I was pretty cognizant of the company’s faults, and I freely admitted there was a lot of uncertainty with both.  As the faults materialized, or as too much optimism was priced in, I reduced my position in each and eventually sold out.

Vicor Results

I had been going through a drought in the new year before I finally got the move I had been waiting years (literally years!) for with Vicor.  Finally the rest of the tech-world is catching up with Vicor’s 48V converter technology.  Applications are popping up all over.  There are the 48V servers, which were the original reason I got into the stock, but also low voltage GPUs (from Nvidia and AMD) requiring power on package, new areas like electric vehicles and AI, and most recently the evolution of a reverse 12V to 48V datacenter application.  All these customers seem willing to pay for Vicor’s superior and patented technology.

I looked at Vicor way back in March of last year and worked out the numbers on an optimistic trajectory for the company.  At the time I pointed out that while the stock didn’t appear cheap on most metrics (it had no earnings and was at a fairly high P/S ratio given the lack of growth), if they could follow through on their growth plan, the earnings they could generate were pretty impressive.

I updated that model recently based on new projections and the fact that after the first $100 million of earnings Vicor is going to have to start paying taxes (they have about $34 million of valuation allowances right now).

It looks to me like a $450 million of revenue run rate gives Vicor about $2.10 EPS when fully taxed.

The first quarter numbers were strong.  Bookings and backlog have been outgrowing revenue.  Backlog grew 23% sequentially.  Bookings grew 15% sequentially.  Revenue grew 11% sequentially.

After the first quarter numbers its looking more like that first $450 million of revenue could happen sooner than you think.  $450 million is roughly what Vicor can do in their current facility.

Vicor is expecting to double capacity with a second facility later this year.    If you assume that Patrizio (Vicor’s CEO) hasn’t gone off the deep end and that they can fill that second facility, the earnings numbers get much higher.  Given that right now they are growing at 10% sequentially and that is before the larger orders that are expected in the third quarter start hitting.

I am inclined to hold the stock with the view that we are just getting started.

What I did in the Last 5 weeks

As I said I will always have a lot of losers.  An important part of the strategy is to sell that which I perceive as not working out.

In the last month I did more selling than buying.  This is partly due to broken theses but also because I remain cautious about the market.  But to be honest, this caution has hurt me more than it’s helped.

Much of my selling has been poorly timed.  For example, I sold Largo Resources at 1.30, only a couple of days before the stock made a run up to $1.90.  I’ve written about the Largo story before: Largo is a great theme play on vanadium but it has always been hard to make the stock look cheap by the numbers.  That has nagged at me and it finally won out.  I took a nice gain on Largo, having bought it at 80-90c, but it still hurt to watch the stock subsequently take off.

I also sold Aehr Test Systems shortly before it ran from $2.20 to $2.60.  With Aehr I took a loss.  I’m still not sure whether I did the right thing selling it.  On the one hand it feels late in a semi-equipment cycle, and the company has had very few announcements of new contracts lately.  On the other hand it appears their relationships with Intel and Apple are intact and so the next big deal could happen at any time.  It’s a tough stock to judge.

I also had poor timing with Essential Energy, which I sold at 55c range after listening to their fourth quarter conference call.  The call painted a depressing picture of drilling in Western Canada.  I didn’t get the sense they had any pricing power and the year over year utilization rate appeared to be flat.  Now maybe that has changed as oil has risen another $10 since I sold.  As well, the lawsuit with Packers Plus is in appeal (so its still not settled), which means a takeover is unlikely.   I decided to focus instead on US leaning servicing companies like Aveda Transportation (which subsequently got taken over for a double, though it was a modest position for me) and Cathedral Energy Services, which I continue to hold.

I had somewhat better timing with my exit of Sherritt International, as the stock sank after I sold.  But even the jury is still out as the share price has come back with nickel skyrocketing.

I likewise sold my position in both Orocobre and Albemarle.  This fits into the “loser thesis” even though I made small profit on Orocobre.  My thesis was that the consensus for lithium had under-estimated demand and over-estimated supply.   However, the more I’ve learned about the supply/demand dynamic the less sure I am.  It’s not so much that I’m a believer in the coming lithium supply tsunami.  It’s just that I’m unsure enough to not want to make the bet either way.   I’ll revisit these names again, especially Orocobre, but I need to study lithium some more and make sure I’m not wrong about it.

I also exited my position in Foresight Autonomous.  I mentioned the stock last month and its just not working.  They are going to need capital at some point and the recent death that was at the hands of an autonomous car isn’t helping.  But probably my biggest reason for the turnaround is that this just doesn’t seem like a good market to be holding many nano-caps in.

Finally I reduced my DropCar position (which is heavily in the red) by about 20%.  I probably should have reduced this stock earlier, but it was a tiny position to begin with (~1%) and so I’ve been more willing than maybe I should have been to give it some leeway.  I still think they could pull off some big growth but the revisions of their option strikes, the share offerings and the lack of news has worn me down.  Being down 40% on the position means at this point it so small that its a bit of a lottery ticket.  Which is really what it always was.

Gold and Oil

What’s been working for me are my gold and energy stocks.  Those that follow the blog know that I’ve been holding a number of gold and energy stocks for months now and that number has been increasing.  Up until recently they have done nothing.

I wrote up my reasons for owning Golden Star Resources a few weeks ago.

I also continue to hold Gran Colombia Gold.  I admit that I am a little nervous about selling pressure in the near term.  I don’t totally understand what the short term outcome of the 2018 debenture conversions will be and whether sellers of those debentures will pressure the stock over the next while.  Nevertheless, I think the company is on track for a re-rating at some point and I’m happy to wait out the weakness.

I also have positions in Jaguar Mining, RoxGold and Wesdome.

The idea with these stocks isn’t really about gold prices.  I don’t feel like I am making a bet on whether gold will imminently go through the roof.  I feel like I’m just buying stocks that are really cheap.

All the miners I mentioned above have EV/EBITDA ratio of between 2x and 5x.  Those multiples are trailing ratios that are based on lower gold prices then what we have now.  Each of the miners  has good growth prospects and an exploration upside if drilling comes up positive.  Apart from Gran Colombia, they are all well off their 52 weeks highs.

I also recently took a small position in Asanko Gold.  The stock has been written up a number of times on the IKN blog.  Gold Fields recently did a deal with Asanko, taking 50% of their property in return for enough cash to pay out their debt.  Otto Rock, who writes on IKN, thinks Asanko should trade back to at least 1x book value now that Gold Fields is available to provide their expertise and hopefully right the ship at the Asanko Gold mine.

So if the gold price breaks out, that’s an added bonus.  But these stocks are more of a play on sentiment.  I think all I really need on the commodity side is for gold not to crash.

I don’t really have a crystal ball with what gold will do.  I will note that the chorus of the gold bears on twitter seems very loud right now.  “It didn’t go up with North Korea”, “It can’t break $1,360”, “It’s setting up a technically bearish formation (a compound fulcrum top?)”, “The Australian dollar, the Canadian dollar are canaries in the coal mine that the rally isn’t real”, and so on.

Who knows?  Maybe they will be right this time.

I have been reading about the 70s, and in particular what Nixon did that led up to the Smithsonian agreement.  The circumstances today are different of course, but not so different, and I was surprised how much of what Nixon did rang true to what Trump is doing now.

Nevertheless,  I own tiny companies that are not in the GDX or GDXJ, typically don’t follow gold prices all that closely (Golden Star went down nearly 40% during the last gold rally!), and have unique attributes that I believe will lead to price appreciation. Gran Colombia, which is up 90% since I bought it last summer, is the poster child for this.

On the oil side I have all my old names: Gear Energy, Spartan Oil and Gas (which got taken over so now I effectively hold Vermillion shares), Zargon Oil and Gas, and InPlay Oil and Gas.  I also bought WhiteCap as another way to play the run.

On the US side I continue to hold SilverBow and Blue Ridge Mountain.  I also added Extraction Oil and Gas, which looks to be generating a lot of free cash in the coming years at these prices.  I’ll write something up on them shortly.

The summary of what I have read on oil is that things are potentially tighter than we realize, that they are getting tighter, and that relying on a small patch of west Texas to supply the world’s growth is likely not the best strategy.

I’ve been surprised by the strength in the oil stocks.  They seem to go up every day, and a lot of days they start down big and recover throughout the day.  It’s hard to see that as bearish.  I’ve read about the big net long positions, and I suppose that means we get a correction here at some point soon.  But I’ve held these stocks for this long, I might as well see it through.

New Purchase: Ideal Power

The one stock I bought that I will mention in some detail is Ideal Power.   This is the perfect example of a high risk, tiny little micro-cap that has a chance (maybe not a big chance but a chance) of being a 5-10 bagger.

Ideal Power sells inverters into the solar industry.  One of their inverter products, called the Sundial, has been built into a Flex solar plus storage offering called NX Flow.  NX Flow, interestingly enough, uses a vanadium battery.

Flex initially had huge expectations for NX Flow.  Leading up to the product launch in December, Flex was saying they could sell 15MW per week of their product.

Now if you do the math on 15 MW per week, considering that Ideal Power sells their Sundial for about $10,000 per unit, that there is one Sundial per  30 KW capacity, you get a very, very big revenue number.

The reason the stock is at a buck and change is that those sales forecasts haven’t materialized.  Maybe they never will. Flex is trying to “educate” their customers on the vanadium battery.   The real benefit of a vanadium battery compared to its lithium-ion competitor is that the vanadium battery doesn’t degrade over time.   The life span can be significantly longer and performance doesn’t suffer.  The problem is that customers are used to buying a battery strictly on a per MW basis.   On that metric alone the vanadium alternative appears more expensive.

Nevertheless Flex is a big company and I don’t believe they just pulled these numbers out of their ass.  I feel like it’s worth a bet that the NX Flow begins to get some traction.

The stock has one other lottery ticket in its back pocket.  Ideal Power has developed an alternative switch for converting between DC and AC power called a B-Tran device.  Pretty much every inverter out there has some combination of IGBTs, MOSFETs and diodes that let you switch power back and forth from AC to DC and vice versa.   The B-Tran can do this too, and it can do it while reducing losses to 1/10th of what an existing IGBT solution will have.  The double-sided nature of the device means that you can replace two IGBT’s or MOSFETs, and two diodes with a single B-Tran.  So there is a cost savings.

The company just finished prototyping the device using their anticipated manufacturing process and it appears to work as advertised.  The power semi-conductor market is $10 billion and the company has said that if all goes well B-Tran could address 50% of that.

Look I have no idea if this concept flies.  It seems to have some merit based on what I’ve read from various electrical sites and papers but its very technical, there is incumbency at play, lots of factors will determine the success.  My main point is if you are going to throw a hail Mary you might as well go for the end zone and that is exactly what this is.

The stock has a $20 million market cap and $12 million of cash, which they are burning as we speak.  I could easily see myself selling this stock at 80c in 6 months time.  In fact, that’s probably the base case.  But the bull case is so big that I believe its worth the risk.

Portfolio Composition

Click here for the last five weeks of trades.

Gran Colombia’s Debenture Redemption looks favorable

On Thursday Gran Colombia announced the warrant terms of a $152 million USD senior secured note offering.  Attached to the notes the company is offering 124 warrants priced at $2.20 per share per $1,000 of note principle.

Dilution amounts to 18.8 million shares.  This compares to 72.2 million shares that would have been issued under the existing 2018, 2020 and 2024 debentures if they were fully converted (the table below is from the third quarter MD&A filing).

I think the deal, if it is approved, is pretty positive.  Consider:

Under the prior share structure, a $2.50 share price translated into a market capitalization and enterprise value of about $230 million (~92 million x 2.50 = $230 million).

Under the new notes, and considering redemption of all of the existing debentures at par, the share count is roughly 39 million and the market capitalization is $97.5 million (39 million x 2.50).  The enterprise value is $202 million (97.5 million + $150 million (x 1.25 CAD/USD exchange) – $45 million (assuming in the money warrant conversion of the 18.8 million warrants) – $9 million).

Debenture Holders can participate

As a debenture holder (I own both the stock and some of the X and V debentures) I’m interested in what my options are with the debentures.

The terms gives existing debenture holders the right to participate in the offering:

Existing holders of the Company’s Outstanding Debentures that are eligible to participate in the Offering may (subject to complying with certain procedures and requirements) be able to do so by directing some or all of the redemption proceeds from their current debentures into Units on a dollar-for-dollar basis.

I’m not entirely sure how to read this.  Does it mean that existing debenture holder gets preference to convert their debentures into new notes or is this just on a best efforts basis where an over-subscription to the notes would mean partial allocation?

I’m hopeful that I can direct my debentures into the new notes, but I’m not counting on it.

Its still cheap on Comps

Gran Colombia continues to compare favorably to other gold producers.

One of the quick scans I like to do compares companies on a simple EV/oz produced basis.  I’ll do the comparison and then weed out why some companies trade at lower multiples than others.  Usually there are good reasons.

At $1,400/produced-oz Gran Colombia trades at one of the lowest multiples of the group.  Only the really poor operators that are cash flow negative at current prices (an Orvana Gold for example) are cheaper.   Most of the companies I compare to are in the $4,000 – $6,000 per produced-oz range.  Even the lower tier companies like Argonaut Gold or the struggling one’s like Klondex trade at over $2,000 per produced-oz.

Its still cheap on Cash flow

Even forgetting that it is a gold stock, Gran Colombia remains reasonably priced as a business.

On the third quarter conference call Gran Colombia reiterated guidance for $16 million USD of free cash flow in 2017.   In the fourth quarter they produced 51,700 ounces versus an average of 40,700 ounces per quarter in the first three quarters.

The indication after the strike at Segovia was that new agreements with artisanal miners should lead to more processed ore at the plant.  Based on this and progress at the Segovia mine, my expectation is that 2018 free cash guidance will exceed 2017.

I suggested in my original post on Gran Colombia that I thought $20 million USD of free cash flow was not an impossible goal.  I still think that’s possible.  Assuming the note and debenture deals go through, the market capitalization of the company will be a little under $100 million CAD at current prices.  Even though the stock has climbed since my original post, this still means the stock is at less than 4x free cash flow.

Conclusion

Eventually the note offering and debenture redemption should be positive for the stock.  But it might take a few months.

What’s tricky is that at $2.40 the stock price is right about where the debentures convert.  It isn’t really in anyone’s interest (other than the current debenture holders, though even that is debatable) to see the stock price rise too much above the convert price until the deal is done.

I’ve been adding to Gran Colombia all the way from $1.40 to $2.20.  I see no reason to take any off the table yet.  The company is doing everything right so far.  Hopefully with the new capitalization and simpler structure the market will continue to recognize this.

Week 324: Underlying Conditions

Portfolio Performance

Top 10 Holdings

See the end of the post for my full portfolio breakdown and the last four weeks of trades

Thoughts and Review

The late spring and early summer months were a trying time for my investments.

I haven’t written up my portfolio in a while.  Part of that was due to the summer, being away and not having the time to do my usual work.  But I also went through a 3 month period, from mid-May to mid-August, where I lost money and struggled with why. That dampened my spirits for putting pen to paper.

Losing money is hard enough, but it is harder when you have been generally right in your decisions.   I try, like the namesake of this blog, to analyze underlying conditions and let that determine my general bent on sectors and the market.  Where there is a bull market I like to be very long those stocks, and when there is a bear market I like to pull back significantly, retreat into cash, and go short where I can.

Throughout the spring and summer I found myself in a general bull market in US stocks, one that had made me a lot of money throughout the winter.  I was, quite rightly, very long US stocks.  The market kept going up, albeit in fits and starts.  But I began to lose money.  Now I didn’t lose money quickly.  In retrospect that may have been a better route as at least I would have been forced to discover my error.  But instead my losses slowly accumulated over the months of May and June.

What’s more, I did not see noticeably poor performance from any of the stocks I owned.  Sure my names weren’t breaking out to new highs, but my core positions at the time, the likes of Radcom, Silicom, Sientra, Combimatrix, Identiv and Vicor were not by any means breaking down (I leave out Radisys as it is a separate discussion).

It wasn’t until my portfolio was down about 6%, in the middle of June, that I woke up to the fact that something was wrong.  I scoured my list of stocks but found nothing worrisome with the names I held.  I knew that the Canadian dollar had been rising so that must have been having some effect but I had never really quantified my currency exposure.  I had always thought of currency as an afterthought, something that balances itself out in the end.

As I crunched through the numbers on my currency losses, I realized that while in the very long run my theory that currency balances itself out might be correct, in the short run a currency can make or break you.  The Canadian dollar was in the midst of unwinding 2 years of gains in two months.  Measuring my losses from the portfolio top in mid-May, I was 6% down, of which 5% came from currency.

It is here that I made my first big mistake. I was armed with the information I needed to act decisively.  I knew my problem: stocks were in a bull market, but clearly the US dollar was not, and I was, rather unwittingly, very long the US dollar.

So what did I do?  Something that, in retrospect, was absurd.  I made only a token effort towards the problem, taking only the excess US dollar cash in my portfolio and putting it into a Canadian currency ETF.  This effort, while directionally correct,  impacted about 15% of my US dollar holdings and thus did nothing to alleviate the problem.  I followed this up with an even more inexplicable move, even to me looking back on it now.  I put on index shorts to hedge my long positions.

Here I was with losses proving that I was wrong.  I had determined the source of those losses.  And what did I do?  I did something that was likely only to exacerbate them.

It really goes to show how wrong one’s logic can be when you are trying to cling to what you had. The reality, I think, is I didn’t want to do what was right.  What was right was to sell my US stocks.  Not because my US stocks were going down. They were not.  Not because the theses behind these positions was not sound.  They were.  But because I was losing money on those US stocks.

Unfortunately I could not wrap my head around this.  All I saw were good stocks with strong catalysts.  How could I sell my positions?  It’s a bull market!

I spent most of June compounding my problem with band-aid solutions that only dug me in deeper. I fell back on oil stocks as a Canadian dollar hedge.  This had saved me the last few times; in the past the Canadian dollar had risen because oil had risen, so I had gone long oil stocks and my losses on currency were more than compensated with my gains on E&Ps.  I was saved a lesson and left none the wiser to how impactful currency could be.

But this time around the currency was not rising because of oil.  My appraisal that I should be long oil stocks was based on the flawed logic that what works in the past must work again regardless of conditions.  That is rarely the case.  In June and July I bought and lost money on companies like Resolute Energy, US Silica and Select Sands, all the time continuing to hold onto US dollars and lose on them.

I also went long gold stocks on the similar thesis that if the US dollar is weak then one should be long gold.  In this case I was at least partially correct.  That is the right thing to do given conditions. But my conviction was misplaced. Rather than being long gold stocks because I thought gold stocks would go up, I was long gold stocks to hedge my US dollar positions.  You cannot think clearly about a position when you are in it for the wrong reasons even if a right reason to be in it exists.  Thus it was that in late July I actually sold a number of my gold stock positions. It was only a couple weeks later, finally being of a clear head (for reasons I will get to) that I bought them all back, for the right reasons this time, but unfortunately at somewhat higher prices.

As I say it was at the beginning of August that I finally was struck by what I must do.  I’m not sure what led me to the conclusion but I think an element of deep disgust played a part.  I had just seen my biggest position, Combimatrix, get taken over for a significant premium. My portfolio took a big jump, which took down my losses from my mid-May peak from -10% (over 8% due to currency!) to -7.5%.  But then in the ensuing days I saw those gains begin to disappear.  Part of this happened because Radisys laid an egg in their quarterly results, but part of it was just a continuation of more of the same.  Currency losses, losses on index short hedges, some losses on my remaining oil stocks, and the ups and downs of the rest of my portfolio.

I simply could not handle the thought of my portfolio going back to where it was before Combimatrix had been acquired. I was sick of losing money on currency.  And I was reminded by the notion that you never see conditions clearly when you are staked too far to one side.  So I sold.

When I say I sold, I really mean I sold.  I took my retirement account to 90% cash.  I took my investment account to 75% cash.  There were only a couple of positions I left untouched.  And I took the dollars I received back to Canadian dollars.

I continued to struggle through much of August, but those struggles took on a new bent.  I was no longer dealing with portfolio fluctuations of 1%.  The amounts were measured at a mere fraction of that.   This breathing room afforded me by not losing money began to allow me to look elsewhere for ideas.

I don’t know if there is an old saying that ‘you can’t start making money until you stop losing it’, but if there isn’t there should be. When you are losing money, the first thing you need to do is to stop losing it.  Only then can you take a step back and appraise the situation with some objectivity.  Only then can you recover the mental energy, which until that time you had been expending justifying losses and coping with frustration, and put it towards the productive endeavor of finding a new idea.

In August, as my portfolio fluctuated only to a small degree but still with a slight downward slant, I mentally recuperated. And slowly new ideas started to come to me.  It became clear that I was right about gold, and in particular about very cheap gold stocks like Grand Colombia and Jaguar Mining, so I went long these names and others.  I realized that being short the US market was a fools errand, and closed out each and every one of those positions.  I saw that maybe this is the start of another commodities bull run, and began to look for metals and mining stocks that I could take advantage of.  I found stocks like Aehr Test Systems and Lakeland Industries, and took the time to renew my conviction in existing names like Air Canada, Vicor, Empire Industries and CUI Global.

Since September it has started to come together.  I saw the China news on electric vehicles and piled into related names.  Not all have been winners; while I have won so far with Albemarle, Volvo, Bearing Lithium and Almonty Industries, I have been flat on Leading Edge Materials and lost on my (recently sold) Lithium X and Largo Resources positions.  Overall the basket has led to gains.  I’ve also been investigating some other ways of benefiting from the EV shift.  It looks like rare earth elements and graphite might be two of the best ways to play the idea, and I have added to my position in Leading Edge Materials (which has a hidden asset by way of a REE deposit at the level of feasibility study) to this end.  Likewise nickel, which is not often talked about with electric vehicles and has been pummeled by high stock piles, has much to gain from electric vehicles and could see a resurgence over the next couple of years.  I’m looking closely at Sherritt for nickel exposure and took a small position there so far.

I saw that oil fundamentals were improving and got back into a few oil names, albeit only tentatively at first.  Such is the case that once you are burned on a trade, as I was when I incorrectly got into oil stocks in June and July for the wrong reasons, you are hesitant to return even when the right reasons present themselves.  Thus it has taken me a while, but over the last couple of weeks I have added positions in Canadian service companies Cathedral Energy and Essential Energy, and E&Ps Gear Energy, InPlay Oil and even a small position in my old favorite Bellatrix.  A company called Yangarra Resources has had success in a new lower zone of the Cardium, and I see InPlay and Bellatrix as potential beneficiaries.  These newer names go along with Blue Ridge Mountain Resources, Silverbow, and Zargon, all of which I held through the first half slump in oil.

I even saw the Canadian dollar putting in the top, and converted back some currency to US dollars a couple of weeks ago.

Most importantly, got back to my bread and butter.  Finding under the radar fliers with big risk but even bigger reward.  I have always said it is the 5-bagger that makes my returns.  If I don’t get them, then I am an average investor at best.

I found Mission Ready Services, which hasn’t worked yet but I think is worth waiting for.  I found some other Canadian names that I think have real upside if things play out right (in addition to the above mentioned metals an oil names, I added a position in Imaflex). Most profitably, I was introduced to Helios and Matheson after reading an article from Mark Gomes.

I don’t completely understand the reason why, but good things do not come to you when you are mired in a mess of doing things that are wrong.  It is only when you stop doing what is wrong that other options, some of which may be right, will begin to present themselves.

I also don’t know which of what I am doing now will turn out to be right, and what will turn out to be wrong.  I will monitor all my positions closely and try to keep a tighter leash than I have been.  What I do know is that I will not continue to be wrong in the same way I was through the months of May to August.  And that is a big step in the right direction right there.

Portfolio Composition

Click here for the last eight (!!) weeks of trades.  Note that in the process of writing this update I realized I do not have a position in Gear Energy or Essential Energy in the practice portfolio.  I have owned Gear for over a month and Essential for a few weeks.  This happens from time to time.  I miss adding a stock I talk about and own in my real portfolio.  I added them Monday but they are not reflected below.

Note as well that I can’t convert currency in the practice account.  I know I could use FXC but in the past I haven’t, I have just let the currency effects have their way with the practice portfolio. Thus you won’t see the currency conversions that I talked about making in my actual portfolio.  I may change this strategy the next time the Canadian dollar looks bottomy but as I am inclined to be long US dollars at this point, I’m leaving my allocations where they are for now.

Adding Gold Names

I decided to add more gold names yesterday as it looks to me like gold is breaking out.  I finally got a move out of some of my existing positions.  Americas Silver has jumped from $3.80 to $5.80, Gran Colombia Gold has moved from $1.40 to $1.60 and Klondex Gold has broken out of its $4 choke hold and is trading at $4.35.

First, I decided to add to both my existing positions in Gran Colombia and Klondex.  Gran Colombia had very good news on Monday, announcing that their mine strike had ended.  The stock, at $1.60, has hardly participated in the gold move, and is one of the cheapest gold stocks out there and less than 4x free cash flow.  The hair remains but the settled mining dispute removes some of it,  and I have to think it goes higher.

Klondex is my largest gold position and I added to it yesterday.  My add here was simply that it appears to have broken out from the $4 level (Canadian).  I’ve written about Klondex in the past.  Its been under pressure for months from an unusual GDXJ rebalancing that caused a lot of forced selling from the fund and follow-ons.  I note that there was a 25,000 share purchase by one of their directors on Thursday.

I added two new positions.  First, I added Wesdome.  Wesdome operates two mines at its Wawa complex in Canada and also has two advanced stage projects in Canada.   They have a $320 million market capitalization and $22 million of cash and no debt.  Guidance for the year is 55,000 oz.  I ran a quick comparison of gold companies looking at their enterprise value per ounce produced.  This is super simplistic of course, it doesn’t account for costs, reserves or development projects that are generally big determiners of value. Nevertheless, when I look at Wesdome it compares favorably (at $5,500/oz) to other miners.  There are cheaper one’s out there (for example Gran Colombia and Jaguar Mining, which I will talk about in a minute), but these generally have a lot of hair.  I don’t see much hair on Wesdome.

Jaguar, which I also added, comes out even cheaper, with an enterprise value of less than $1,000 per ounce.  But it has lots of hair.  I actually owned Jaguar years ago.  It has a new management team, a lot more shares, but essentially the same mining complexes.

Jaguar has a market capitalization of $90 million, $20 million of debt and $20 million of cash.

Apart from being really beat down, and very cheap (at least on a superficial basis), Jaguar actually seems like they had gotten their shit together up until the last quarter.  They had consistent production from both their Turmalina, Pilar, and Roca Grande mines.  But production slumped at Turmalina in the first quarter, causing the shares to slide.

The share drop was potentially accelerated by Resolute Funds, which sold 30 million shares over the quarter.  I found this article, which speculates on the impact of the Resolute Funds liquidation.

My bet with Jaguar is that in a rising gold price environment, many past transgressions will be forgotten.  It is also that maybe the second quarter does not portend the future. Jaguar kept guidance in the second quarter, and they had been producing consistently at Turmalina for the past 6 quarters.

Buying Gran Colombia Gold, A Levered, Free Cash Flow generating Gold Producer

I like the looks of gold right now.  Short positions in the metal have been climbing for a number of weeks.  Fred Hickey (of the High Tech Strategist) tweeted on Friday that “gold large spec future shorts at 157.4K contracts are second highest on record”.  Anecdotally, the charts of many of the gold mining stocks have been depressed for some time.  Often July is a seasonal turning point for the miners, as they perform well into the second half.

I took positions in Argonaut Gold and Klondex Gold a few weeks ago.   Argonaut worked out, and I actually sold some of my position last week, but Klondex has not.   To be honest, the more I look at both of these names, the less excited I am about them.  They haven’t generated free cash in the past, so their projections about the future leave me skeptical.  I have been searching for other ways to play gold (in addition to Gran Colombia I have bought Rox Gold and Americas Silver).

I found out about Gran Colombia from this tweet from Brown Marubozu.  They are a tiny gold producer with two mines in Colombia. They operate the Segovia mine and the Marmato mine.  They also have an exploration project called Zancudo.

The Segovia mine is by far the bigger of the two mines.  It produced 126,000 ounces in 2016. Marmato produced 23,500 ounces.

Costs at Segovia are much lower than Marmato.  In 2016 cash costs at Segovia were $655 per ounce while Marmato cash costs were $981 per ounce.  The company doesn’t break down all-in sustaining costs (AISC) on a per mine basis but over in 2016 they had AISC of $850 per ounce

For 2017 Gran Colombia is expecting production of 150,000-160,000 ounces of gold and AISC are expected to be under $900 per ounce.  The rise in costs is because of more exploration at Segovia and a higher Colombian peso.  AISC of $900 per ounce and under makes them a relatively low cost producer.

Debt and Cash flow

Gran Colombia is heavily indebted compared to most gold miners.  The company has $145 million of debt outstanding, denominated in US dollars.  They have 20 million shares outstanding.

However, looking at nominal debt and shares outstanding is a bit misleading.  The outstanding debt is comprised of 3 convertible debentures.  There is a $46 million 2018 debenture, a $52.4 million 2020 debenture and a $47 million 2024 debenture.  All of the debentures are convertible at $1.95 per share.

The 2018 debentures have a unique feature that I have not seen before.  If the share price of Gran Colombia at the debenture maturity is less than $1.95, the company has the option to repay up to 81% of the debentures with shares at $1.95.  It’s a very odd clause, and it factors into debt and outstanding share calculations. .  Nevertheless it is clearly stated in note 8 from the debentures FAQ:

The 2018 debenture pays only 1% interest.

The reason that the 2018 debentures have such a strange structure is because they are the result of a restructuring of debt in early 2016.  The company exchanged two sets of existing notes (called the silver and gold notes) for debentures and shares.  The silver notes, which presumably were subordinate (I admit I haven’t looked into all the details of the old securities) were given poorer terms than the gold notes, including this odd repayment clause.  The 2020 and 2024 debentures, which are the successors of the gold notes, are payable in cash at maturity and carry an interest rate of 6.5% and 8.5% respectively.

Assuming the conversion of 80% of the 2018 debentures into stock at $1.95 per share, the true amount of shares outstanding is 39 million, so a market capitalization of $58 million.  Likewise, true debt is $108 million USD, which is still a lot of debt, but not quite as much as it appears at first glance.

How about Cash Flow

Gran Colombia has a lot of debt but they also generate a lot of cash flow.  Looking at cash flow from operations before working capital changes and capital expenditures, I calculate that the company generated $17 million in free cash flow (I am calculating this before working capital changes, just to be clear) over the last four quarters. In 2017 the company has given rough guidance (slide 19 of this presentation) that “excess cash flow” will be “at least” $15 million.

I actually think that may understate free cash flow.  The company includes debt repayments as part of their calculation of excess cash flow.  Below is a reconciliation of excess cash flow to EBITDA for the first quarter of 2017.  Note that excess cash flow is calculated after subtracting $390,000 of debt repayments.  This repayment is likely to a small term loan they have with a Colombian bank that is paid down on a quarterly basis. There is $700,000 remaining on this loan that will be repaid this year.  True free cash flow would be $1 million higher after accounting for this.

Guidance suggests that excess cash flow may exceed the $15 million minimum that the company has guided to.  The midpoint of the company’s production guidance is 155,000 ounces for 2017.  AISC is expected to be $900 per ounce.  At an average price of $1,200 per ounce gold, the company generates an AISC margin of $300 per ounce, or $46.5 million.  If I assume the same level of cash interest and cash taxes as 2016 I deduct another $26.5 million.  This would leave $20 million of excess cash flow.

The company is likely to have a very strong second quarter.  On the 12th of July the company announced second quarter production of 46,000 ounces.  This is significantly above the 39,000 ounces that they produced in the first quarter and is more than 10% higher than any quarter in 2016.

Summing it up

I find it very hard to resist a gold miner trading at less than 4x free cash flow (I’m using a market capitalization of $60 million Canadian which includes conversion of the 2018 debentures and free cash flow of $15 million USD for 2017, which I believe to be conservative).  To say it is unusual to find a miner with this sort of free cash yield is an understatement.  Unheard of is more like it.

Gran Colombia compares well to the peers I have looked at.  Below is a table of 4 other gold stocks that I liked because I didn’t think they were exorbitantly expensive.  Gran Colombia is the cheapest of the bunch.

However I know there have been issues with management.  They clearly got themselves into way too much debt and had to restructure once already.   The shares had to be consolidated due to the fall in the stock price.  Management may be the Achilles heel of the idea.  But the last few quarters they have produced solid, if not stellar results.  So maybe the past is the past.

I also understand that the debt level remains quite high.  It makes them a leveraged bet, no question. And that leverage can go both ways if they fail to perform.  However because it is convertible debt, it can easily play into the company’s favor if the stock price moves up.

Let’s say the stock goes to $2 USD.   I have a nice return from my recent buys (60%).  The convertible is now in the money and is exchanged into stock at $1.95 USD.  The result is dilution of 55 million shares.  Total shares outstanding are 94.4 million, so the market capitalization is $190 million.  Free cash flow increases by $10.5 million because cash interest goes to zero.  So free cash flow is somewhere between $25 million and $30 million.

At this point, do you think a gold miner with $25 million plus in free cash flow and no debt is going to trade at a multiple of 7.6x FCF?  I highly doubt that.  The reality, whether you agree with it or not, is that historically gold miners trade at above market multiples.  Most miners (at least those not currently at depressed levels caused by in discriminant GDXJ selling), trade at 10x operating cash flow, not free cash flow.

My point is that the share price could be its own best friend.  Confidence that the company can generate the free cash needed to deleverage could quickly cause that deleveraging to occur and in turn cause a revaluation to a level consistent with other miners.  I think the path is there.  If the company executes, and the gold price stays at this level (or even better, moves higher), I think we will see this process occur over the next 12-18 months.