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Copper stars not quite aligned

Sometimes all the stars align for a trade.  And sometimes there is one star that is way off in its own orbit, throwing off the whole picture.

That’s what I’m thinking about copper right now.

There is a lot I really like about this idea:

  1. The demand picture is premised on what seems like the inevitable adoption of electric vehicles and increasing electrical infrastructure
  2. The supply picture paints a scene of depleted reserves and an empty pipeline that will lead to significant deficits for years to come
  3. The prices of copper equities are reasonable, if not downright cheap, and certainly not pricing in the upside of a rising copper price

It all fits.  Except for one thing.  These damn tariffs.

In my opinion there are reasonable odds that what is to come is more brinkmanship, more anti-ups, and maybe even some sort of climatic event ala Nixon in 1971 that changes the way the world operates for good.

Of course maybe not.  The market is certainly saying its all good.  But the market also rose right after Nixon put a 10% surcharge on imports and pulled the rug out from under Bretton Woods.

The 70s didn’t really go all that well.

I don’t know what is going to happen.  But it’s uncharted territory and it wouldn’t surprise me if the market is as clueless as I am.

Consider the following:

  1. We have a President that was elected, in part, by folks who lost their jobs or had their communities disrupted by the relocation of industries that were allowed to leave because of free trade (yes its complicated and there were other causes, but free trade was definitely part of it).
  2. The President has made it clear he will do whatever it takes to make good on his promise to fight for these people and communities and get those jobs back (whether or not what he is doing is actually going to be in their best interests is not clear but also not really relevant to the line of reasoning here)
  3. It’s not really clear if anything can be done to turn back the clock on these cities, counties and communities that have had the industries they were built on stripped from them, so perhaps regardless of what the President does, the outcome will disappoint

Those 3 points suggest that it is at least possible that we spiral into a vicious circle of escalating actions that don’t have the intended effect and therefore lead to even more escalation.

I’m just not sure I want to own a lot of copper in that environment.

With that all said, the picture for copper supply and demand assuming a “steady as she goes” economy is pretty enticing.

BMO put together a long and very interesting research piece describing the supply and demand dynamics of copper over the next number of years.

The demand side is being driven by electric vehicle demand and the grid infrastructure required to move to a higher amount of renewables.

The simplest explanation of why this will increase the demand for copper is this: An internal combustion engine contains 23kg of copper for wiring, whereas a battery electric vehicle and plug-in hybrid contain between 60-83kg of copper.  On top of that another 20kg of copper is needed for grid capacity and 6.5kg for the charging point.

On the supply side, a combination of declining grade, rising capital costs and a number of years of depressed copper prices have left us with a depleted pipeline of projects.

The conclusion, which is hard to find fault with, is that there is a significant shortage of copper projects in the development pipeline and projects will only be added if the price of copper rises enough to incentivize them.

So how do you play this?  Well maybe you don’t because there is just so much risk in the world.  I’m still trying to figure that out.  But if you do, I certianly think the copper stocks are reasonably priced for it.  Below is a comparison of a few that I have dug into where I just took analyst EBITDA estimates and averaged them to get a rough idea of the EV/EBITDA multiple these companies trade at (note that because Amerigo isn’t followed by any brokerages I have reports for I used the companies own estimates that I found in their presentations).

At the moment I have taken positions in a couple: Copper Mountain and Capstone.  But these positions are really, really small (<<1% each).

For now they are going to stay that way.  I’m just too uneasy about where all this trade stuff is going.


Week 359: Buoyed by the CAD

Portfolio Performance

Thoughts and Review

Another quiet month for my portfolio as I only added and subtracted a few stocks around the edges.  But I had quite a good month.

I can’t take credit for all of it however. I have been getting a boost from the Canadian dollar.  Since March the dollar has fallen from 81c to 77c.  Last spring I talked about this when I was going through a period of massive headwind from a rising Canadian dollar. Now it’s the opposite.

If you do the math, the move in the Canadian dollar has added about $25,000 to the tracking portfolio totals since the beginning of March.  So I’m looking somewhat better than I actually deserve (which is quite the opposite of last spring, when I looked like a schmuck as the CAD rose some 15% in a few months!).

Much of the rest of the move (which I can take credit for) is the move in Gran Colombia Gold.

Gran Colombia

In the last 5 weeks Gran Colombia completed the redemptions of their 2020 and 2024 debentures and announced first quarter results.    The results were great.  AISC of under $900/oz and EBITDA of $27 million.

After accounting for debentures redemptions and share conversions (including all the in-the-money warrants and the not yet converted 2018 debentures) I get about 60 million shares.  So that’s a market capitalization of about $200 million (CAD) or USD$153 million at the current conversion.  There is another USD$98 million of the new debt and they should have about USD$41 million of cash once all the warrants are converted.

The company did USD$27 million of EBITDA in the first quarter.  It seems pretty reasonable that they should do at least USD$100 million of EBITDA in the full year.  So even after the big jump in the stock price, Gran Colombia only trades at 2x EBITDA.  I realize the gold stocks are cheap and unwanted, but even the most unloved get at least 3x EBITDA and some are getting 6-7x.

I think the re-valuation still has a ways to go.

Tornado Hydrovac

Here’s a stock I haven’t talked about in a while.  I took a closer look at it after the first quarter results and had someone on Twitter ask about it which got me thinking about the stock a bit more.

Tornado is a $6 million enterprise value company with almost $5 million of cash.  However, most of the cash ($3+ million) is in China and not readily available for the North American business.  They have an established hydrovac business in North America, and one they are trying to get off the ground in China.

These are the same trucks that Badger Daylighting rents out.  But Tornado’s business is not quite like Badger, as they are primarily building the trucks not renting them out.  Tornado has had a few rentals (1-4 trucks per quarter) over the past year, so its not a significant business.

The first quarter wasn’t great.  I had been hoping for a follow-up on the fourth quarter, where revenue hit a 3+ year high at $9.4 million.  But they only had $4.8 million of revenue in Q1.

So it was disappointing and the stock hasn’t really done much.   But to be fair, the stock has never really done much so let’s not read into that too much.  Still I’m inclined to think the business is turning for the better.

The poor results were partially seasonal – in 2014, 2015, and 2016, there was a significant slip in first quarter revenue from Q4 to Q1 (2017 was a bit of an anomaly because the industry was recovering from the downturn).

Also, inventory ticked up from $6.49 million in Q4 to $9.1 million in Q1.  Inventory has been a pretty good indicator of the next quarter revenue, which I imagine is because of the part procurement and build cycle.  The company said the following in the MD&A.

For the three months ended March 31, 2018, inventory was $9,072 compared to inventory of $6,490 as at December 31, 2017.  The increase in raw materials is due to stocking up for production ramp-up in the second quarter.  The increase in finished goods is due to 3 completed trucks held in finished goods as at March 31, 2018 that were not delivered and sold to customers until early Q2 2018.

The other angle with the company is China.  They are getting closer to generating revenue from China.  Tornado expanded into China over a year ago.  Since that time most of the efforts have been establishing a footprint, starting up a manufacturing operation and developing relationships.

In the first quarter they sent out their first three demonstration units in China.  Overall, China has overhead of $300,000 per quarter and no revenue.

The inventory related to the three demo units was $1.14 million.  Assuming 15% gross margins (margins for the company are around this level), they need to sell about 5 trucks per quarter in China to break even.

But that’s only assuming sales of trucks.  The model is China is both sales and services and I’m not sure about what the economics of the services side will look like.

Bottom line is that the stock is reasonable and I think its not a bad bet that they can have a breakout quarter one of these days.   Book value is over $17 million while the enterprise value is $6 million.

On the other hand, margins are super-thin and the operating history isn’t exactly stellar.  This remains a pretty small position for me, but an interesting one and one worth reviewing from time to time.

Oil Stock sales

I sold out of a few oil stocks last week.  I can’t say that I had foresight into the carnage.  A lot of my selling was done on Friday, so after the plunge had occurred.  I sold Black Pearl, Whitecap and Spartan.

I have to admit, having missed a better opportunity to lighten up earlier in the week, I was a bit reluctant to do so after these stocks sold off.  Nevertheless I had a couple of reasons that led me to decide to sell anyways.

First, I was just getting a little too overweight into oil.  In particular, I took on a big position in Altura, which I wrote about, and hadn’t really sold anything.

I was getting particularly uncomfortable with my exposure to heavy oil.  The Western Canadian Spreads are looking good but I was long Gear, Zargon, Black Pearl, and now Altura.  It was a bit too much exposure.

Spartan was really now a bet on Vermillion and I don’t really know enough about Vermillion to want to take a position there.

Whitecap was just because I was nervous about Canada and Transmountain.   I know Whitecap isn’t heavy oil so maybe my logic doesn’t string together that well, but I didn’t want to sell Gear, Zargon or Altura and yet wanted to get my Canadian exposure down a bit more, so there you have it.

The other consideration I weighed was the build in crude last week.  It was a surprise, to say the least.  It could be a one-off and there seem to be indications that this week will look much better.  My thought was that the crappy number last week puts a lot of pressure on this weeks numbers.   What if, for whatever reason, its another surprise build?

With the Trans-mountain decision out of the way I might look at buying some of these names back.  But I think I will wait until after the Thursday numbers (delayed a day because of Memorial day) come out before doing anything.

Solaris Infrastructure

My services companies aren’t doing that well.  Cathedral has been terrible, down to almost $1.20 and if it goes much lower its going to hit the 52-week lows of when oil was $20 less.  I already gave up on Essential Energy.  Energy Services of America is always a next quarter story.

The problem is that none of these service companies can seem to generate any gross margins.

One story that is not a problem for is Solaris Infrastructure, where gross margins are a pretty amazing 60%.  But the stock is suffering nearly as much as these other names anyways.

Solaris provides a last mile solution for storing and delivering frac sand.  They don’t actually sell sand.   They rent out silos and conveyor systems that are installed on the well site and act as a sand buffer during the completion process.

The silo solution seems like it’s a big improvement over the Sand King trucks that are typically used.  Costs are lower, trucks don’t have to sit and wait, and the footprint on the well site is smaller.

Solaris builds the silo units and rents them out on a monthly basis.  The gross margins are as high as they are because of the rental model of the business.

Solaris is growing like crazy.  Revenue grew at over 205% in 2017.

Here’s my back of the napkin math for a theoretical 2018 exit.  At the end of the first quarter they had 98 systems in operation.  On May 9th, the date of the conference call they had 108.  They are adding systems at 8 per month.

So lets say they have 170 systems at year end.   Solaris gets roughly $100k per month of rental revenue per system so that works out to $204 million of annualized revenue.

There is no reason to think they don’t maintain their EBITDA margin of 60%, which would mean they are annualizing $122 million of EBITDA by year end.

In the first quarter they had $3.2 million of depreciation on an average of roughly 90 systems in operation during the first quarter.  That works out to $142,000 D&A per system or on 170 systems $24 million annually.

There is no debt so that means income before tax is $98 million and after tax is $77 million at a 21% tax rate.   On 47mm shares that would be $1.63 EPS.

If I assume they slow down their build to 6 systems per month in 2019, I get EBITDA of close to $180 million and EPS over $2.50.

None of this includes their new sand terminal in Kingfisher.  Or their sand supply chain management tool Propview.

There are a lot of things I like about Solaris but the one thing that I don’t like, that actually gives me a lot of pause, is the stock performance.  It is such a good environment for oil stocks and here is a fast growing service company right in the middle of it. And the stock price is as dumpy as can be.

That makes me think that maybe I’m wrong about it.  I’m hoping the market is just slow to jump on board, but its also possible that I’m too optimistic.  Maybe margins will decline and growth vanish as competition comes on the scene.  I have to think that’s what the market is worrying about.  Because otherwise the current share price doesn’t make a lot of sense.

One last Buy

The last thing I did was buy a small position in 3 copper stocks.  I’m not quite ready to talk about these, meaning I’m not sure I should have bought these stocks or not yet.  So I’ll leave that for now.

Portfolio Composition

Click here for the last five weeks of trades.

A Game Changing Disposition for Altura

I mentioned Altura last week in a comparison table I made to Zargon and Gear Energy.   As I noted in the comments, I had a position in the stock in another portfolio (my RRSP and my wife’s account) but not in the portfolio I track online so I haven’t talked about the stock outside of that reference.

Well that changed today.  I added to the stock in all my portfolios even though I was getting it up 20% on the day.

I want to give a big hat tip to @BrownMarubozu for bringing my attention to Altura a month or so ago.

Altura announced first quarter results after the market closed last night.  The results were fine, maybe a little weaker then expected actually, but the real news was the announcement of the sales of their Eye Hill, Macklin, Wildmere, Killam and Provost Minor assets.

Altura sold the assets to Surge Energy (here’s their press release on the transaction.  The transaction metrics the company provided are below:

The sale of these assets leaves Altura with about $20 million of cash and no debt.  With the rest of their properties sold off, they are a pure play on their remaining asset: Leduc-Woodbend.


They are going after the Upper Mannville formation at Leduc-Woodbend, which is about 1,300 meters deep.  They have amassed 65 sections (41,000 acres) in the area, with 40,000 of those acres considered undeveloped.  The formation produces 17° API heavy oil.

The Leduc oilfield has been around forever and is a well drilled out area using conventional vertical wells.  Given that its not a new area (Altura themselves says there are over 700 vertical wells in the area) I’m not sure if Altura discovered something new here or whether this was a previously uneconomic pool for vertical wells that is now being unlocked by better technology.  At any rate Altura described the pool as “one of the largest conventional oil pools identified in the Western Canadian Sedimentary Basin within the last 20 years” in their initial press release on the prospect.

This is early in the game in Leduc-Woodbend.   They have only drilled 5 wells in the property so far.  But these wells look quite good.

They started drilling into the Mannville formation in early 2016.  The first well, the 13-15 (see the map below), produced 230 boe/d over the first 30 days and was producing 160 boe/d after 5 and a half months.  It was producing 70 boe/d in July, after 8 months of production (from this news release).

The 13-15 was a one-mile horizontal and cost $1.7 million to drill and complete.

Their second well, the 12-15, was another one mile lateral drilled at the beginning of 2017 and place on production in April 2017.  This well was a full 6 sections north of the initial discovery well but production was inline with the 13-15 (this press release).

You can get an idea of how far apart these wells are in the map below (the 13-15 is the well furthest to the south while the 12-15 is the northern most well).

In their November presentation Altura detailed a reasonably steady decline profile from both wells (they are both one mile laterals):

Since the beginning of the third quarter Altura has followed up with 3 more longer wells, 1.5 mile extended reach horizontals (ERH).  The first two (03-02 and 13-14) were placed on production in October (from this press release).

The third ERH well (02-02) was drilled in January and placed on production in February.  This well averaged 334 boe/d in the first 26 days of production (from this press release).

In the May 15th release the company said the well had produced 10,626 bbl of oil in the first 45 days, which equates to a 236 bbl/d average before being shut in for a month to replace a broken rod.

The company went on to say that they expected 150-175 boe/d over the first 12 months for all 3 of the ERH wells.

My takeaway from all this well data is that the results are consistent.   We only have 5 data points but so far the repeatability looks excellent.  Its particularly exciting that the original discovery well is so far away from the others and yet has yielded comparable results.

I was cautiously optimistic about Leduc before the quarterly release but the numbers presented have added to my confidence.


The company obviously has confidence.  In addition to focusing entirely on Leduc they raised guidance significantly even after divesting over half their production.

Right now Altura is producing around 550 boe/d from Leduc, 80% oil.  They expect to exit the year at 1,900 boe/d.

To do this they are increasing their capital budget from $15 million to $33 million and expanding to an 8 well program.  So the cash they are getting on this transaction will be put to use drilling out Leduc.

Based on their presentation it looks like the wells cost $2.65 to drill, complete and tie-in.  They also spent $7.3 million already in the first quarter.  That means the company is spending roughly $7 million on infrastructure at Leduc.

The infrastructure money is going towards a larger oil battery.  They are increasing the size of their oil battery to 3,000 – 3,500 bbl/d.  So that gives you an idea of where they are expecting to take the property to.

They seem undervalued to me

When I forecast ahead at what Altura looks like at year end using the company’s guidance, it looks cheap to me on most metrics.

Here are my estimates of cash flow and EV/CF using their guidance.  I am assuming they use all the cash to complete the drill program which should be conservative.  I looked at two scenarios:  A WCS price consistent with the first quarter (so a low price) and the current WCS price (a high price).

Apart from the valuation, what’s interesting is that at roughly $70/bbl WCS, Altura can cash flow $30 million based on their exit volumes.  So they should be able to fund a similar sized capital program in 2019 (actually a bit higher because they wouldn’t be building an oil battery) without adding at all to debt.  If they get similar production growth from that budget (based on exit guidance growth in 2018 is 1,250 boe/d), they’d grow over 60% and be producing over 3,000 boe/d by the end of 2019.

Considering that sort of growth runway, the company seems extremely cheap to me.  The risk of course is whether the oil price holds up and whether they can meet their target.

It’s still early days so we’ll have to see.  The economics that they present for these wells is impressive.

The wells have IRRs of close to 75%, which is pretty good.  But it looks even better when you notice the price forecast these are based on:

They are essentially using $55 WCS prices for 2018, followed by $61 for 2019 forward.  At last look WCS stood at $74/bbl.


One question that might be asked is why the stock didn’t move even more?  One answer is that I’m totally missing something.  Maybe, but I don’t think so.  Another is that the market isn’t going to de-risk Leduc until they drill more wells.  That definitely accounts for some of it.

A third reason has to do with liquidity.  I know that one of the reasons I didn’t buy more Altura before today was because it was so hard to buy.  The share volumes were anemic and it seemed like my bids would sit for days some times before getting bought up.  The Level 2 liquidity was usually equally sparse and it seemed like I would quickly move the price up to 44c or higher if I bought too much.

With that in mind I wonder how many sellers today are just liquidity sellers.   This is a liquidity event, lots of volume, so it’s a chance to unload shares.  If you have a very big position, you probably want to take some off.

Whatever the reason I took advantage of the volume and bought a decent position.  I’m looking forward to the next operations update.



Sticking with Zargon

I have owned Zargon Oil and Gas for almost two years now and it has been one of my worst performers.  I bought a small position after the company announced the sale of its South Saskatchewan asset in July 2016.  I added to the stock early in 2017 after the company announced a redemption auction for its convertible debentures whereby they would either redeem the debentures in full or exchange them for longer dated (December, 2019) lower strike ($1.25 per share) debentures.

Neither of those purchases have worked out so far.  I thought the asset sale would reduce debt and bring back interest in the stock.  I thought the debenture exchange would be a catalyst.  Maybe most importantly I thought the environment for oil stocks was improving, so it seemed a reasonable bet that Zargon would benefit.

As it turned out I was about a year too early. The stock languished through much of 2017, falling from 80c to under 40c at one point.

Why Zargon?

Zargon is not my biggest oil position. It’s one of a basket of stocks I have been holding and adding to.  In the last few days I added Black Pearl Resources and ProPetro Holdings to that list.

So why am I choosing to write about Zargon and not my other larger holdings?  Well for one, apart from a few Seeking Alpha articles Zargon doesn’t get much attention.  I could write about Whitecap or Gear Energy but you can get all the information you need from brokerages reports already.

Second. with the prospects for oil improving I decided to really dig into Zargon again a couple weeks ago.  The stock has under-performed for so long and I wanted to come to a conclusion as to whether to keep holding the stock or move those dollars into another E&P.

I decided to stick with Zargon.  Here’s why.

Zargon operates 3 assets.  They produce about 500 bbl/d from their Little Bow enhanced recovery project, another 300 bbl/d of conventional heavy oil at Little Bow, about 400 bbl/d of medium/heavy oil from North Dakota, and another 1,200 boepd from various assets around Alberta.

Little Bow ASP

The Little Bow asset would be considered Zargon’s flag ship.    The company produces 20-21° API oil from the Mannville formation at Little Bow, Some of this production is conventional, and some of it is an advanced waterflood technique called Alkali-Surfactant-Polymer (ASP) recovery.

An ASP is a waterflood recovery where the additional “A-S-P” chemicals are added to the water.  The chemicals thicken the water and turn the oil into a more mobile foam.  Together the thickened water and thinned oil mean that the oil moves more effectively than a traditional waterflood alone.

The problem with an ASP flood is that it’s expensive. The chemical costs alone are $6-$8/bbl.  Zargon has corporate operating costs of $20/bbl and while they don’t break out the cost of the ASP, I am certain its around the same level.  When oil was extremely low in 2016 Zargon suspended Alkali and Surfactant injections at Little Bow and shut in higher water cut producers.

The good news is that ASP at Little Bow is long life and has a low decline.  Zargon has examples in its presentation of a Husky Taber ASP waterflood and Gull Lake ASP waterflood where production has been fairly close to flat for 10 years and counting.  Proved reserves for the Little Bow ASP were a little under 2mmbbl and proved plus probable (which includes the yet to be developed Phase 2) is 3.9mmbbl.  At 500bblpd this is 11 year reserve life index for proved and 21 years for proved plus probable. In their 2017 reserve report McDaniel is forecasting an increase in production in 2018 as Zargon reinstates the full ASP flood and brings back on previously shut-in wells.

Little Bow Conventional

Zargon also has conventional oil production at Little Bow.   This is from the “G” and “U” units in the map below.

Both the G and UW units are targeted as Phase 3 and Phase 4 stages of the ASP development.  But for now the land is produced conventionally.

Together these pools produced 285boepd in 2017, 65% liquids.  The company doesn’t list additional locations anywhere that I can see, so I have to assume this asset is going to continue to decline until the ASP flood is implemented.

Bellshill Lake

Zargon owns 21.5 sections (13,760 acres) of land at Bellshill Lake.  Bellshill Lake is in East-Central Alberta, very close to Hardisty.  They produce out of the Dina sands formation there.

Bellshill Lake produced 409 boepd, 94% oil in the fourth quarter.  Bellshill oil has an API gravity of 27°API, so its firmly in the medium oil category.

This is another low decline property.  Based on the McDaniel decline (below) it looks like the decline on the field is 10-11%.   According to the company the area has aquifer support, which helps support the low decline.

Zargon hasn’t drilled the property since 2014.  The McDaniel reserve report booked 5 undeveloped locations and Zargon says they have 4 more.  I believe these are all vertical locations.  In the fourth quarter Zargon expanded the water handling at Bellshill Lake which will allow multiple “low risk, low cost well pumping optimization projects” in 2018.

Its worth pointing out that before the collapse of the price of oil in late-2014 Zargon was able to keep production at Bellshill relatively flat at 550-600 bbl/d.

Proved reserves on the property are 850,000 bbl of oil.


It looks like Zargon has about 90 sections of land (57,600 acres) about 30km south of the town of Taber.  I say “it looks” because I’m counting sections of the map so I might be off give or take.

Zargon produces from a part of the lower Mannville Group called the Sunburst Sand.  There are two pools that they are producing from, North and South.  Both these pools are receiving pressure maintenance from waterflood.

The North Pool has a little ligher oil, 20 API, then the South at 16 API so again this is heavy oil.  Both these pools are fairly mature, having produced over 50% of the expected ultimate recovery.

Zargon has drilled 30 wells into these pools since 2007, of which 5 are injectors.   McDaniel has 3 more horizontal locations booked and Zargon has an additional 5 they have identified.  I don’t believe they have drilled any wells here since 2014.  They have also identified a Glauconite oil pool north of Sunburst.

Taber South is another low decline property.  Based on the McDaniel estimate it looks like the decline is around 13%.

Proved reserves at Taber South stand at 1,144mbbl.

North Dakota

Zargon owns a scatter of land across Haas County, Truro County and Mackobee Coulee County in North Dakota.  This was originally part of a larger land package that extended into Saskatchewan, but the Saskatchewan portion was sold in July 2016.

This isn’t Bakken land.  I believe the focus on these lands is the Mississippian but I’m not sure which others are contributing.  They have 97% working interest in 18.78 sections (12,000 acres) of land.

They produce about 400 boe/d from North Dakota.  These are low initial rate, low decline wells.

The decline on existing production is very low, varying between 11% at Mackobee Coulee to only 4% at Haas.

Strategic Initiatives

Zargon initiated a strategic alternatives process in August 2015.  Since that time they have sold the Saskatchewan assets for a pretty good price (at the time) but not done much else.

To be fair, that was perhaps the best choice.  I’m sure that the value of their assets has risen significantly in the marketplace over the past few months.  Even if the stock market doesn’t agree.

With the value of the assets rising, part of my expectation is that we start to see asset sales.

I don’t have many good analogies for the North Dakota assets.  I searched but I didn’t see any sales in Bottineau county.  In September 2017 Halcon Resources sold non-operated Williston Basin assets for $104 million of cash for $45,000 per flowing boe.  But this acreage is in Montrail, Mckenzie and Williams county, and prospective for the Bakken, so I doubt its analogous.

With such low decline base production and a land package that can support more drilling I would think that the North Dakota assets should fetch at least $40,000 per flowing boe in the current environment.  There are plenty of cases of oil assets in general selling for more than this (like the Cardinal purchase from Crescent Point of South Saskatchewan assets for $64,000 per flowing boe which I realize is not a great comparison).

If they can get $40,000 per flowing boe, that would be $20.5 million Canadian.

It might be worth noting (it also might not) that the company took down their February corporate presentation a number of weeks ago and has yet to replace it.

Paying off the Debentures

After the conclusion of the debenture redemption auction Zargon has $42 million left outstanding.  These debentures pay 8% interest (works out to $3.68/boe) and mature at the end of 2019.

The need to work a deal for these debentures in the next year and a half make me think that asset sales are probable.  The North Dakota assets seem like the most likely target.

I think these debentures are a real overhang on the stock.  Zargon has over $40 million of debt but only a $15 million market capitalization.

Paying off a significant portion of the debentures would go a long way towards improving market confidence.

Heavy Oil

A big knock against Zargon is that they are a heavy oil producer in Alberta.  And they are small.  This makes them vulnerable to the swings in Western Canadian Select (WCS) pricing.

It’s also going to hurt their first quarter results.  I am braced for a bad first quarter.  WCS spreads were huge, which means the price that Zargon got for its heavy oil was not very much.  To make it worse, Zargon seems to have hedged WTI on 1,000 bbl/d in the first half but not the spreads.

So it’s something to consider when trying to time a purchase.  On the other hand it should be well known at this point, and spreads have come in dramatically in April.

In fact I’ve been doing some work on heavy oil and drawn some interesting conclusions.  While pipelines are by far the best way to transport oil, rail cars are not a death knell to the industry.  According to an RBC report that came out a few weeks ago, rail transportation costs are $11-$15/bbl whereas pipelines are $8-$9/bbl.   That’s high, but its not crazy, “I have to shut-in my production and go home” high.  Especially at crude prices like what we are seeing now.

In fact with the Canadian dollar at 77c USD or whatever it is at today, these Canadian heavy oil producers are probably doing better now then they were the last time oil was this high, when the CAD was closer to 90c.

The pipeline story gets so much attention that these details get lost.  It made me rethink things, and made me add another heavy oil producer in Black Pearl in addition to Zargon and Gear.

Cheap compared to its peers

The other consideration that made me decide to stick with Zargon is that its quite cheap.  Especially if oil prices can stay at these levels.

I am comparing the stock to two relatively close peers, Gear Energy and Altura Energy.  Neither of these stocks could be considered expensive in its own right.  In fact Gear is owned and touted by a number of funds as a cheap way of playing oil.  GMP recently listed Gear and Altura as two of their cheapest names.  I chose Altura because it does get brokerage coverage and because its roughly the same size as Zargon.

Now for the first half of 2018 Zargon is partially hedged at lower WTI and with no corresponding hedge on WCS spread.  So first half results are not going to look nearly as good as this comparison.

But come the second half of the year, if oil prices and spreads hold, things should work out to about this level.

Yet Zargon appears pretty favorably, even cheaper than these two.  The comparison below is at $65 WCS, so roughly $10/bbl higher than the fourth quarter.  Costs are based on the fourth quarter costs of each company.  I also estimated spreads off of heavy and light oil off of their fourth quarter pricing and for NGL pricing for Gear and Altura I just added $10/bbl to their fourth quarter pricing.  I might be wrong with the royalties, I added $3 to the fourth quarter royalty because I didn’t want to dig into the complicated calculation of figuring out how it escalated with price.

Based on proved reserves and net asset value again Zargon looks pretty good.

Looking at cash flow, on an EV basis Zargon is comparable to Gear and Altura.  On a per share basis, Zargon has a lot more torque.  In fact they trade at about 1x P/CF on these price assumptions.  On a reserve basis Zargon is very favorable, trading well under the value of its proved reserves.

The discount was justified when oil prices were low.  Just look at the operating costs to see that Zargon is by far the higher cost producer.  But if we really believe in these oil prices, I think you can make the argument that it’s time to peel it off.


Look I realize Zargon’s assets are not best in class.  They are high cost operating assets mostly in land locked Alberta.

They are also extremely profitable at current oil prices.  At $65 WCS the stock is trading at 1x cash flow.

Zargon spent $8.9 million on capital expenditures in 2017.  On those expenditures they kept production pretty much flat (in the fourth quarter of 2016, after the sale of the South Saskatchewan assets, production averaged 2,449 boe/d).  In the AIF McDaniel estimated $6.4 million in capex in 2018 in their proved reserves NPV calculation.

With cash flow of nearly $15 million (once the hedges in the first half run off) at $65 WCS, that works out to somewhere between $6-$8 million of free cash flow on a market capitalization of $13 million.

I decided that was worth sticking with.  I actually even added a little more.

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.

Golden Star Resources: Betting against a history of disappointment

I have been slow getting to this write-up.  My plan was to write about how Golden Star had drilled a number of holes that extended the depth of their Wassa underground by 180 meters, that this would add a lot of resource to the mine, and that it was not priced into the stock.

But Golden Star beat me to the punch with this news release Friday.  The company announced that they had doubled the inferred resource at Wassa, adding 3.1 million ounces for a total of 5.2 million ounces.

The next step will be further infill drilling to upgrade the resource to measured and indicated, and a preliminary economic assessment of the extensions.

So that took some of the wind out of my sails.   The near-term story I was going to tell was kind-of squashed.  Nevertheless the big picture story is by no means finished.  In fact I think Golden Star is just getting started along a path to credibility.  I’m hopeful that the destination is growth, and a valuation in-line with other gold stocks.

History of Disappointment

Golden Star Resources has always been a very cheap gold stock.  The problem has been that this was well-deserved.

I’ve watched the company on and off for years.   They have always been one of the highest cost producers.  Cash costs typically exceeded $1,000/oz. This is what cash costs and all-in-sustaining costs (AISC) looked like from 2013 to 2015:

These kind of numbers made them bottom quartile in costs.

But that’s changing.  In the last two years Golden Star has gotten their costs down. With the transition to underground operations at both of their mines (Wassa and Prestea), costs are expected to come down even more.  ASIC in 2018 are expected to be between $850-$950/oz:

These new numbers don’t put Golden Star in the high cost bracket any more.  They are in line with the majority of producers.  Here is a brief list of other companies where estimates range from $850-$950/oz AISC or higher for 2018: Acacia Mining, Argonaut Gold , Detour Gold, Eldorado, IAMGold, Kirkland Lake, Klondex, Lea Gold, New Gold, OceanaGold, SEMAFO, Teranaga Gold, …  you get the picture.

While costs are trending towards the average, the valuation has not.  Golden Star trades at less than half the price to cash flow multiple as these other names.  If you start to factor in the potential growth it looks even cheaper.

So why the disconnect?

I think its just years of disappointment.  The market needs a lot of proof before they will re-rate the company.

Wassa and Prestea Underground

The bet here is that things are changing.   Golden Star has two underground mines that are ramping up, a tonne of exploration prospects both within these mines and in the surrounding land base, and the capacity to grow production within their existing asset base using little additional capital.

Golden Star operates two mine complexes, Wassa and Prestea.

Both of these mines started off mainly mining open pit ore but are transitioning to underground.  Wassa is ahead of Prestea, having begun underground production in early 2017.  Wassa has been ramping up since and is performing well.

I think that one of the problems Golden Star has had is that reserves for both Wassa and Prestea underground are limited.  Mineral reserves for Wassa are 742,000 ounces which they say is about a 5 year mine life.  Similarly Prestea has reserves 463,000 ounces, which works out to a 5.5 year mine life.

I’m not sure why the reserves at these mines is so limited.  Some of it is that underground mines often have smaller resources because drilling out too far ahead of the mining activities is expensive.  Golden Star has been hanging on by a thread for years, so these were likely costs they chose to to incur.  I also get the impression that there have been stability issues at Prestea that have only recently been corrected and allowed more drilling to take place.

While reserves are small, there is a much larger inferred resource for both mines.  With Friday’s press release, the Wassa inferred resource is up to 5.5 million ounces.  Prestea has 800,000 of measured and indicated and 868,000 ounces of inferred.

The small reserves and large inferred resource present an opportunity.

When you look at analyst estimates they, quite rightly, are basing their net asset value calculations primarily on known feasibility studies and preliminary economic assessments.

Take BMO for instance.  They have an NAV5 for Golden Star of $1.04.

I can reverse engineer that number (like I’ve done below).  To do so, I back-out total production from Wassa of a little over 1,000,000 ounces and 471,000 from Prestea (both the NAV0 and NAV5 match reasonably well, so I think I’m on the right track with these numbers).

Wassa has 5,000,000 inferred ounces.  Prestea has 1,600,000 measured, indicated and inferred ounces.  Very few (in the case of Wassa) to none (in the case of Prestea) of these ounces are included in the net asset value.  The inclusion of these ounces, if the company can successfully prove them up, represents a lot of upside for the stock.

What’s more is that Golden Star can add significant production within its existing mining infrastructure.  They have built their mine and milling capacity with expansion in mind.  The mine at Wassa has capacity for 4,000 tpd while the mill can handle up to 7,000 tpd.  At Prestea its even higher, with the mine at 1,500 tpd and the mill at 4,000 tpd.

Wassa could easily expand its mine rate by 30% before having to expand the shaft and decline.  Prestea could more than double production before having to do so.

What this means is that if Golden Star is successful in turning inferred ounces into reserves, the cost of bringing those into production will be minimal.  They should be able to ramp to double their current production without having to put out a lot of capital.

First Quarter Results

Golden Star provided first quarter production numbers on Wednesday night.  Wassa exceeded the expectations of most analysts, producing 35,506 ounces at 4.54g/t grade.  Grade had been an issue during the ramp of the underground at Wassa.  In the third quarter grade averaged 2.6g/t, well below the 4g/t feasibility grade.  The fourth quarter improvement to 4.04g/t, followed by this latest news is evidence that Wassa is on track.

The Prestea underground is earlier in the ramp.  The mine just reached commercial production (defined as 60% of capacity) in February.  They are having problems typical to a new start.  In the first quarter they were only producing from a single stope, and the models of that stope were a little off the mark, which led to more dilution (lower grade).  They say they’ve reviewed the stope model, figured out what was wrong with it, and expect better grades when they start mining a second stope in mid-April.

The second and third quarter numbers will have to be watched carefully for progress from Prestea.


Apart from getting Prestea up to plan, the big news will be exploration results.  The company  is spending $6.6 million in 2018, split between Wassa, Prestea and new targets around the Prestea and Wassa complexes.

The drilling at Wassa will be focused on filling in the areas between existing drill holes. In the section below the pink area represents the original 2,000,000 ounce inferred resource.  The step out to 18900N is where they drilled the extension that added another 3,000,000 ounces.  You can see the large gaps that need to be filled to clean up the resource.  Doing so will upgrade the inferred resource to measured and indicated and to reserves.

To facilitate drilling they have created an exploration drift extending from the mine to facilitate the drilling.  I believe this is the line extending from the mine to the north just above the pink inferred resource box in the map above.  Therefore the drilling meters planned at Wassa are a little deceiving, because they can drill a lot more holes from closer to the ore from this drift, so I expect them to accomplish a lot in those 11,000m they have planned.

The opportunity at Prestea is a little less clear.  Prestea is about a year behind and so the company is just now starting to evaluate how they might expand production in the coming years.  Drilling this year will infill the existing inferred resource and more importantly focus down plunge on the West Reef (the green lines are the drill holes).  Good results there will add new resource that could expand operations at the mine.  Prestea is very high grade (14g/t or so) and the mill only operates at 600 tpd, so it doesn’t take a lot of new ore to add significantly to the mine.

There are a few other exploration prospects that Golden Star will spend about $1.4 million on in 2018:

All of these are quite early stage and I don’t know much about them yet.  The most advanced appear to be Father Brown and Subriso West, which have a combined inferred resource of 476,000 ounces.  Father Brown has an underground grade of 6g/t which sounds promising.


Friday’s price action not withstanding, I’m not expecting an overnight success with Golden Star.  It is more likely to be months of positive results that slowly build back the company’s reputation.

But I think that the outcome will be worth it.  Especially if gold prices can stick to the current $1,300 level or move higher.

The BMO estimate I pointed to has an NPV5 of $1.04 USD on the stock.  Even after Friday’s move, that’s a significant discount to the current price of 66c.  That estimate is done at 2018 gold averaging $1,280, dropping to $1,200 in the long term.  It includes minimal tonnage from Wassa and Prestea exploration.  It includes no ramp of production to 4,000 tpd at Wassa or 1,500 tpd at Prestea.  So there are lots of ways that number can move higher.

It’s a simple play.  Cheap on comps, cheap on net asset value, a good chance to ramp significant growth over the next couple of years, and in a commodity environment that, in my opinion, is more likely to go up than down.

Sonoma Pharmaceuticals: A Simple Bet on Rising Revenues

Note: I wrote this post up a few days ago but kept postponing the final edit.  In the mean time this news came out (this morning).  I haven’t really dug into it yet, I’m not entirely sure if this is a brand new product or a gel reformulation of their existing scar treatment product.  But anyways, its constructive to the story as they added another product for their sales team to sell.

On to the post.

I’ve had Sonoma Pharmaceuticals on my watchlist for a couple of years now.   I hadn’t paid it much attention, but I saw a couple of articles about the stock on Seeking Alpha over the last 6 months (here and here) and they kept me watching the stock.  They were interesting, but not compelling enough to buy.

More recently when I saw that Daniel Ward had been accumulating a large position I got more interested.

Still I waited.  I saw the company was short of cash and there would probably be a raise coming sooner or later.  When that day came, I took a position.


After the capital raise Sonoma has about 6 million shares outstanding.  At $4 that gives the company a market capitalization of $24 million.

There are a bunch of warrants and options outstanding but they are well out of the money.  There are 1.3 million warrants priced at between $5 and $6.50.  There are another 1.4 million stock options priced on average at $12.

The company has no debt and after the recent share offering closes they should have about $13 million of cash.

Burning Cash

Sonoma is not a profitable company yet.  They burn cash.   They are using about $2.3 million of cash each quarter.  With the recent raise they would have enough to get them through 5-6 quarters at the current burn rate.

I think they are going to start using less cash as time goes on.  The company has been growing its dermatology revenues like a weed.  If this continues then they should close the gap to break even over the next 18-24 months.

Hidden Growth

Sonoma operates 3 segments.  Only one of these segments is growing quickly.  The growth is hidden by the other two slower growing segments, and by poor comps created by the prior sale of other businesses.

In October 2016 Sonoma sold its Latin American business for $19.5 million.  The business made up 30% of revenue at the time.

As part of the agreement, Sonoma agreed to continue manufacturing the products sold until Invekra S.A.P.I. de C.V. of Mexico establishes their own facility.  Gross margins on this manufacturing business are only about 6%.

The consequence has been a double whammy. The revenue comps have looked bad because of the revenue loss.  And margins looks bad because of the manufacturing agreement.

They also have a lower margin, low growth international business.  They sell both dermatology and animal health products through this segment.

To be honest, there isn’t a lot of information on the international business.  I know that in general they sell their derm products abroad and the list of countries is long, but I haven’t been able to pin down where sales come from and which products are the drivers.

The international business is expected to grow modestly going forward, in the 5-10% range.

The High Growth US Dermatology Business

Sonoma sells 6 products in its US dermatology segment.  The four established products (Ceramax, Mondoxyne, Celacyn and Alevicyn) have shown significant sales growth over the last couple of years.

Overall U.S dermatology has been growing like crazy.  Year over year gross revenue (before returns and rebates) was close to 100% in the fourth quarter.

The growth has been due to both price increases and script increases.  Below is script growth for each of the 6 products over the last few years.

I’m going to dig in a bit further to each of these products next.


This is a prescription hypochlorous acid-based scar management gel.  It softens, flattens and reduces the redness of scars.

Sonoma launched Celacyn in the fall of 2014.  There are only two prescription scar treatments on the market.  The other product is RECEDO.  Sonoma estimates that the market share is about 60/40 in favor of RECEDO right now.

The company has talked about how the scar market is a big market.  While I couldn’t find a number for the total addressable market (TAM) applicable to Celacyn, the global scar market is extremely large, at $16 billion and growing at a 10% annual rate.

I also found a quote from the company saying that the addressable market for Celacyn is “62 million scars formed annually”.  So the TAM is big.

According to this paper, the scar management market is seeing acquisitions.  In March 2017, Hologic Inc., announced the acquisition of Cynosure Inc., to expands its business in medical aesthetic market.  The acquisition was at 3.3x sales.

Prescriptions of Celacyn were pretty flat last year.  But the company has been putting through price increases which has brought sales up.  Based on company data (which I believe comes from teh Symphony database) the average price per script was $200 in Q4 2017 vs $133 in Q4 2016 and $102 in Q1 2016.

According to this blog post, which admittedly is a couple of years old, Celacyn at the time was “the low cost provider compared to competing products sold for wholesale acquisition cost (WAC), or the price paid by the wholesalers, in excess of $200 and ranging up to $800.”  Just from a few Google searches, it looks like RECEDO retails right now at $314 per bottle.

So I’m going to say the move to $200 per script is just catching up and the company has saw better leverage to price then volume over the past couple of years.


Ceramax manages skin irrations, rashes, and inflammation.  It is FDA approved as a “skin barrier repair product” for eczema and atopic dermatitis.

Sonoma launched Ceramax in May 2016.  It was an acquired drug (US License) from the Lipogrid Company of Sweden.

Sales have had a bit of an uneven trajectory.   Scripts jumped from 1,908 to 2,382 yoy in the fourth quarter. But in the third quarter sales were down year over year, from 1,410, to 2,12.  Still its a new product, and the trend is clearly up.

There has also been price increases.  When they launched in the second quarter of 2016 Ceramax, the average price was $225 per script.  That has increased to $314 per script in the fourth quarter.

Sonoma seems pretty optimistic about the outlook for Ceramax.  In the last call they said:

Ceramax was our fastest seller in December due to several factors. First, Ceramax has the highest concentration of ceramides, fatty acids and cholesterol that our skin craves, on the market today. Second, everyday dermatologists see patients with inflammatory skin diseases and every inflammatory skin disease patient has disrupted skin barrier in some way, shape or form. We think the sky is the limit with this product. Third, we have a great rebate program for Ceramax, meaning, we go out of our way to make it affordable to every patient. And then finally, the winter months in North America bring on winter itch and Ceramax has great clinicals in addressing itch.

To some degree its a seasonal product, so we should expect sales to trend down in the first quarter.

Its tough to get an exact figure on the market size because all the reports are expensive and I’m not paying $4,000, but its easy to glean that ballpark, its a big market.  According to one older study I found, globally the market is around $800 million with the US accounting for $600 million of that market.  I’ve seen estimates suggesting it could grow to over $2 billion by 2021.


Mondoxyne is a prescription oral tetracycline antibiotic used for the treatment of certain bacterial infections, including acne.  It works by slowing the growth of bacteria which helps the immune system catch up.  The sell it in 50mg, 75mg and 100mg bottles.

Mondoxyne is a cheap alternative to other brands.  This post says that Mondoxyne is similarly priced to generics and far below branded products.

Sonoma acquired Mondoxyne in 2015.  Since that time they have had a lot of success growing the brand.

Quarterly scripts have increased from 222 in the first quarter of 2016 to 1,733 in the fourth quarter last year.  Price growth has been very modest, and prices actually appear to have declined from $595 to $459 sequentially in the fourth quarter.  I’m guessing this would be due to mix, selling more 50mg bottles?


Alevicyn is a prescription hypochlorous acid based atopic dermatitis product line.   It reduces itch and pain associated with various skin conditions.

Alevicyn is the their largest revenue product.   Revenue was up from $1.1 million to $1.6 million year over year in the fourth quarter, or about 50% growth.

The growth is coming from unit growth, up 17% year over year in Q4, from 4,204 to 4,930, and from price increases.  Using Sonoma’s data I estimate that the price per script was $100 in Q2 2016, rising to $150 in Q4 2016 and to $200 in Q4 2017.

Much like Celacyn it appears that the price increases are just catching up to the competition.  On the August 2017 call the company said:

“Our price per gram of product is currently well below that of our competitors. For example, Topicort, a solid branded mid-potency topical steroid for the treatment of atopic dermatitis, sells for $4.50 per gram; a comparable generic sells for $2.67 per gram; and our Alevicyn gel sells for $1.11 per gram”

In many cases Alevicyn competes against corticosteroids that go for $100 to $800 per script.

In November and December, the FDA approved expanded antimicrobial language for Alevicyn.

According to this report from Stonegate capital, the addressable market for Alevicyn is between $500-$600 million.


Sebuderm is a prescription topical gel used as an alternative to corticosteroids for the management of the burning, itching and scaling experienced with seborrhea and seborrheic dermatitis.

Sebuderm was launched just over a year ago and scripts have been growing significantly.  In the fourth quarter scripts were 1,206 up from 948 the prior quarter.

There is not a lot on the size of the market, but Sonoma did say that “25% of the general population has seborrheic dermatitis” earlier this year.

Worth noting is that in the same press release Sonoma commented on the products efficacy.  They announced the results of a study that showed an improvement in appearance and symptoms “from baseline was 33% at day 14 and 52% at day 28…[and] 62% through day 28.”


Loyon is a prescription liquid for managing erythema, itching for seborrhea and for seborrheic dermatitis.  They have some pictures in their last presentation showing Loyon being used on peeling skin around the hairline, where it clears it up after about 7 days.

Loyon is the most recent launch.  It was launched in September after receiving FDA approval in March.

Loyon can also be used for psoriasis but it isn’t approved yet.  They are in the queue requesting approval from the FDA.  On the last call they said:

In Europe, it’s currently being sold in Germany and the U.K. for broader indications than we got in the U.S. to start. They have a psoriasis indication in Germany and the U.K. We took their clinical data, got back into the FDA queue and it is very, very compelling clinical data. So we have our fingers crossed that we’ll get that. Bob, are we saying within the next 12 months?

Loyon is already widely used in Europe.  They bought the US license for the product from a German company.  On the fiscal second quarter call they said that European sales (in Germany in the U.K) are about $10 million.  In Europe Loyon is approved for psoriasis.  In the US its competing against two older legacy products.


Sonoma does better than average job of explaining what it will take for the company to reach break even.  On slide 25 of their February slide deck, they show where they are now on a per salesperson basis and where they need to get to in order to break even.



Increasing the number of prescriptions per sales rep is not as daunting as it appears.  Last May CFO Robert Miller said that the more experienced 17 sales reps that had been with company 1-2.5 years did around 815 scripts per quarter.

With new products and extensions added since that time, getting all 30 reps up to 900 scripts per quarter should be an achievable task.  At least that’s what I’m betting.

To help growth they have been trying to add a new product or line extensions every six months.  In the fourth quarter of 2017 they launched Loyon.  In early 2018 they have new line extensions for Ceramax.

The rest of the increase is going to come from price increases and mix improvements.  From the above table it looks like Sonoma is betting they can raise the average net per script about 30% from the last quarter’s average.

I’m less certain about how easily they can do this.  There is evidence anecdotally that many of their products are cheap compared to the competition.  But I have a difficult time knowing when they hit the ceiling on price increases.

Sonoma also provides a detailed rundown of what it will take for company wide break even on the following slide of their presentation.

The key number is the $4.158 million of net revenue.  Sonoma grew the US dermatology segment at 78% year over year last quarter.  The quarter before that was 53%, and before that was 74%.

Presumably they are going to see growth slow as the initial ramp from the new reps begins to level off.  Nevertheless, I am willing to bet they can reach breakeven in about 8 quarters.   That would require year over year growth of net revenue from dermatology (assuming no growth outside of derm) of 40% on average.


With a market capitalization of $24 million, cash of $13 million and their derm segment growing at 50-70% I am betting Sonoma has bottomed.

I think that we are inflecting to where derm is big enough to overwhelm the lower growth segments.  And where the market starts focusing on this growth more than the cash drain.

I’m also betting that as the company gets closer to break-even, they can get revalued more conventionally on a revenue multiple.

I mentioned above this research paper, which noted that scar management  “has been experiencing a number of acquisitions and collaborations”.  They point to the acquisition of Cynosure by Hologic, which was acquired at an enterprise value of $1.4 billion, net of cash.  This works out to 3.3x sales.

Sonoma trades at 0.6x revenue including cash.  Looking at some similarly sized competitors, Novabay Pharmaceuticals trades at 3.3x revenue and grew revenue of their only product, Avenova, at 50% year over year.

Novabay used $3.3 million in the first 9 months of the year.

Novabay seems like a particularly good comparison because the stock moved from $2 to $4 as the company demonstrated growth and began to close the gap to break even.  I think Sonoma is in a similar spot to that now.

I have owned Novabay in the past and followed the company for a couple of years now.  Using that experience as a roadmap, the trajectory for Sonoma is going to entirely depend on quarterly revenues going forward.  If the company can maintain its growth momentum the stock price should do well.

Even tiny competitor Wound Management, which grew revenues 14% year over year in 2017, trades at 1.2x sales.

It will help that analyst estimates for the company are not that aggressive.  Revenue for next year is expected to come in at $19 million which is less than 10% overall growth.

For the next quarter (fiscal Q4) the average estimate is $4.49 million.  The fiscal fourth quarter is always seasonally down from the previous quarter.   Backing out the derm numbers from the first quarter forevast implies expectations of about $1.7 million from dermatology sales.  This would be a 41% year over year increase and a 40% sequential decrease.

This doesn’t seem like a high hurdle.

Bottomline Sonoma is a pretty simple bet.  Beaten down and bottomed out.  Continue the sales momentum and bridge the gap to breakeven.  Hopefully if that happens the stock gets revalued closer to 3x revenue.