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Posts tagged ‘gold’

Week 349: Company updates, a couple new positions but mostly sitting pat

Portfolio Performance

Thoughts and Review

I’ve been slow on the updates.  This is the second time in a row that its been 8 weeks between them.

I’m slow because my portfolio has been slow.  I still have a high cash level.  I took advantage of the stock decline in February, but not enough to have much of an impact on my results.  Since then I sold down a few positions and so I’m back to a high cash level.

Portfolio Additions

I’ve already written about my new positions in DropCar and Precision Therapeutics, as well as reestablishing a position in Radcom and Silicom.

In addition I took a position in Sonoma Pharmaceuticals and Foresight Autonomous.

I’ve got something written up about Sonoma that I will put out in a couple of days, so I’m not going to talk about them right now.

Foresight Autonomous

My position in  Foresight Autonomous is small (less than 1%), so I’ll just mention the thesis briefly.

The company is developing automobile detection systems (called advanced driver automation systems or ADAS).  They have had successful trials with Uniti Sweden, and three successful pilots with Chinese companies.

The stock trades at a $110 million market capitalization.  That’s not really cheap but I think the potential here is significant if they can land a deal with a large car companies.

Foresight also has a 35% interest in Rail Vision.   Rail Vision provides detection systems for rail systems.  Rail Vision was looking to IPO last fall at a $100 million valuation.

Worth noting is that this article said that Foresight’s technology has tested better than Mobileye.  Mobileye was bought out for $15 billion.

Good News from existing positions

While my portfolio has only benefited at the margins, there were a number of positive news events over the last couple of months that do bode well for the stocks I own.

Vicor gave a very positive outlook on their fourth quarter conference call.  They are making progress on the 48V servers, automotive and high end power on package applications.  It seems very likely that they are working with a large FPGA producer (maybe Nvidia?) for high end power converters on the the chips.

Gran Colombia is doing very well at both of their mines.  They provided a February update on Tuesday.  They are on track to do more than 200,000 ounces if they can keep up the mining rate from the first two months of the year.

The next day the company amended terms to the debt exchange deal.  The 2018 debentures will be redeemed, not refinanced.  It means more shares and less debt.

The amendment doesn’t change my opinion on the stock.    With the new terms they will have about $95 million of debt and 54 million shares outstanding.  It doesn’t really impact the enterprise value much, with less debt there is somewhat less leverage to the price of gold but also less interest charges.

DropCar announced they are going to be doing maintenance and cleaning on the Zipcar fleet (transport,prep, cleaning, maintenance) in New York City.

The stock only moved a little on the news but it seems pretty significant to me.  Zip Car has 3,000 cars in NYC according to their website.

While I’m not sure how b2b revenues on a per car basis compare to the consumer business, 3,000 cars is a lot of cars.   Compare this to the 1,500 consumer clients they have right now.

The only question is what sort of revenues do they get on a per car basis for the B2B business?  I need a bit more detail from the company on this.  I suspect there are a lot of investors feeling the same way.

I wasn’t thrilled to see the $6 million private placement.  It conveniently gets Alpha Capital Anstalt their position back without breaching the 10% rule (its a convertible preferred sale).  But I still think the business could have legs. The recent Zipcar deal suggests that is the case.  So I’ll hold on.

Precision Therapeutics (formerly Skyline Medical) has been announcing all sorts of news with respect to its Helomics joint venture.

I honestly don’t know what to make of this.  I bought the stock because it looked like Streamway sales were going to launch, but all the news is about precision medicine, which is maybe (??) a bigger deal, but I don’t really know.

Some have pointed to Helomics revenue being in the $8 million range (which I’m not sure if it is), and that Helomics has spent over $50 million in research over the past 5 years (which appears to be the case based on the past capital raises).  If either of these points are accurate then Helomics is potentially more valuable than the single digit million valuation that Precision paid for the first 25%.

But I’m not going to lie, I don’t really understand the precision medicine area very well.

If anything, the company seems to be prioritizing the precision medicine business and I would think, given that the Streamway business is not profitable, that would put Streamway on the block.   If I’m right about the value in Streamway, then my original reason for buying the stock will work out, and maybe even sooner than I had hoped.

R1 RCM reported fourth quarter results at the beginning of March.  They see revenue at $850-$900 million in 2018 versus $375 million of revenue in 2017.  They are expecting adjusted EBITDA of $50-$55 million this coming year.

EBITDA is going to be depressed by the continuing onboarding of Ascension, new customers Intermountain Health and Presence Health, and the Intermedix acquisition.

In 2020 once the onboarding of Ascension is complete the company expects $200 million to $250 million of EBITDA.   At $7.70, which is after the big move over the last month, that puts them at a little under 7x EBITDA.  That’s still not super expensive and the path to get there seems straightforward so I’m holding on for now.

Gold stocks suck right now but I am adding.  In addition to Gran Colombia, I’ve added positions in Roxgold and Golden Star Resources this week.  Neither is reflected in my portfolio below, which is as of the end of last week.  Taken collectively, gold is my largest position right now.

My thought is simply that this trade war stuff seems to be real and and getting more so, and how is that not bullish gold and gold stocks?  Meanwhile I am picking these stocks up at discounts to where they were 6-12 months ago.  And we just had the takeover of Klondex at a pretty fair valuation.  It seems like a decent set-up.

I sold Essential Energy this week (this was after the portfolio date so its still in the list of stocks below).  I listened to their fourth quarter conference call.  Its hard to get excited about their prospects.  Drilling activity in Canada just isn’t coming back.  I’m going to stick with names like Cathedral and Aveda that have more US exposure.

I also sold Medicure this week after the news that Prexarrtan won’t be launching on the original time line.  I may be jumping the gun, after all Medicure has 3 other drug launches in the next year or so.  But Prexarrtan was the first and without it I don’t see much of a catalyst for the stock in the near term.

Portfolio Composition

Click here for the last eight weeks of trades.  NOTE: I didn’t go back far enough in my trade search.  These are the trades from Jan 15th to Jan 29th that I had previously missed.

Prices below are as of Friday, March 16th.


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.

Comparing Gold Producers

Every quarter I spend an evening or two going through the reports of the 15 or so gold stocks that I follow and updating a spreadsheet that I use to track their progress and compare them against each other.

I do not use the spreadsheet in the way a strict value investor might.  I do not search out and buy the cheapest gold stock of the bunch on a cash flow metric or per ounce metric.  I do look for value, but I also look for growth.  The stock market tends  to treat gold producers in much the same way they treat any other business: stocks with superior growth potential get bid up to higher valuations.  On the other side of the coin, you can sit on what appears to be an undervalued producer for a long time if that producer has a poor pipeline of projects or has no prospects to produce near term incremental ounces.

I did exactly that recently with Aurizon Mines.  I was attracted to the value, it was cheap compared to its peers, it had a lot of cash on its balance sheet and no debt, and they have a well run and profitable operation at Casa Berardi.  Yet Aurizon does not have a strong growth pipelne.  Its closest to completion project is an open pit prospect called Joanna which, while it could one day produce a lot of gold, has been stuck in the feasibility stage for more than a few years and has the worry of requiring a large capital outlay out front.  When you add that to a number of fairly early stage exploration projects the result is a company without the near term potential to grow ounces significantly.  I sat on Aurizon for almost 6 months based on its value story and the stock went nowhere.

At the other end of the spectrum is a company like Argonaut Gold.  I owned Argonaut Gold for a while last fall but sold out way too soon.  I sold because I saw the stock was priced dearly compared to many of its peers.  However I failed to adequately account for the growth opportunities.  It was a silly oversight;  I had originally bought the stock because of the low capital cost heap leach projects that they could bring to market quickly.  Somehow though I forgot about this, got caught up in the valuation and that led me to sell too early.  The stock has since doubled to $10 before pulling back in the recent carnage that has brought all gold stocks to their knees.

When I was looking for gold producing companies a couple of weeks ago I was on the lookout for the next Argonaut Gold.  Unfortunately I have not been able to find them (if you have some ideas, please drop me a note).  In my opinion the closest comparison to Argonaut in terms of near term low capital cost growth potential is Atna Resources.  Atna has a legitimate chance of increasing their gold production from 40,000 to over 150,000 ounces in the next couple of years.  What makes Atna an imperfect comparison is that most of its projects hover around the cash cost level of $900 per oz, which is on the high side of the cash cost scale, whereas Argonaut has been able to achieve the double whammy of low cash cost low capital cost growth.

A second producer that I have bought (back) recently is OceanaGold.  I have had good luck with buying OceanaGold when the market hates them and selling when the market starts to show some love.  This time around I may hold on for a bit longer.  OceanaGold has typically been one of the cheapest gold stocks on cash flow metrics.  This is because, in part, they have struggled with costs and production at their existing mines. However, their soon to be producing mine in the Philippines (Didipio) will bring about some growth to the company, and perhaps more importantly, it will reduce the corporate cash flow numbers substantially.

One thing that got me interested in OceanaGold again was my research of Agnico-Eagle (which by the way is the third producer I own right now).  While Agnico-Eagle has had some difficulties with the closure of their GOldex mine, they remain one of the best growth stories in the industry and I believe the market will come around to forgetting about Goldex and recognizing this once again.  Agnico-Eagle owns 5 operating mines.  Of those five, one mine, Meadowbank, produces about 1/3 of the production.  At the corporate level, Agnico-Eagle has reasonably low cash costs.  They were $594 per oz in the first quarter.  However Meadowbank, the largest mine, has cash costs over $1000 per oz. On its own its a marginal mine that produces a large number of ounces.  Together with the other low cost assets that Agnico has, it receives a much higher valuation than it would on its own.

I liken this situation to the one at OceanaGold.  At OceanaGold, the corporate level cash costs should come down fairly substantially with the introduction of gold production from Didipio.  Didipio will produce a lot of copper in addition to its gold, and this will make the cash costs of the project appear to be quite low.  The cash costs of OceanaGold will not get down to the level of a company like Agnico-Eagle (the high cost mines at Oceana will continue to make up too much of the production) but I do not see it as unreasonable to think they will drop into the high $700 range.  My bet on OceanaGold is that when production begins at Didipio, analysts will begin to revalue the company on the basis of a mid-cost producer rather than a high cost one, and that should provide for some upside in the stock.

I updated the spreadsheet below over the weekend.  I did not update it during this week with stock prices for each stock tabled.  The prices are as of Friday’s close.  There has been so much movement in many of these gold names in the last couple days that the prices are already somewhat outdated.

My hope with gold and gold stocks is that this move is for real.  What I think we need to have for this move to be real is action out of Europe that brings gold back into the system.  I wrote this weekend about how, in general, the turmoil in Europe should cause weakness in paper currencies and lead to strength in gold.  On Sunday Donald Coxe was interviewed on King World News and decribed a scenario whereby gold would be used along with a value added tax as colateral for euro-bonds on ther periphery.  While I am a bit fuzzy on what  the details of such a bond might be, I believe that conceptually this is the sort of event that has the potential to create a great rally.  On the other hand my enthusiasm is tempered that if nothing is done in Europe, and if the Federal Reserve does indeed decide that QE is not working (I don’t think its nearly as clear as others do that the Fed will mindlessly embark on further quantitive easing.  The Fed is, after all, a data centric institution, and if it appears that the benefits of QE are not what was anticipated, and I believe that has been the case, they may decide that a third installment is not beneficial).

Below is my spreadsheet comparison.

Week 30: Cognitive Dissonance, Canaco updates, Canadian house prices and the story of Community Bankers Trust

Portfolio Performance

Portfolio Composition

Trying to not be dogmatic

A few years ago I read a book called Mistakes were Made.  The book described our ability as human beings to remain convinced that we are right to the point where we ignore all evidence to the contrary.

Our predisposition to fabricate reasons why we are right and ignore reasons why we are wrong is based on a concept called cognitive dissonance.  As the book defines it:

Cognitive dissonance is a state of tension that occurs whenever a person holds two cognitions (ideas, attitudes, beliefs, opinions) that are psychologically inconsistent… Dissonance produces mental discomfort ranging from minor pangs to deep anguish; people don’t rest easy until they find ways to reduce it.

All symptoms I am all too well acquainted with.

Along the same lines, I came across an interesting piece on FT this week.  The following quote can be attributed to SocGen’s Dylan Grice:

But all is not lost. The bias towards thinking we’re more correct than we are isn’t driven by an inability to fully assimilate undesirable information but an unwillingness to do so. Therefore, the first step in removing the bias is to adopt procedures that foster a more honest acceptance of logical conclusions. Logic has no emotional content per se. There is no such thing as good or bad information; information is only true or false.

But because of our hardwiring, we only want certain information to be true. In particular, we want the information that confirms our prior beliefs and validates our belief systems to be true — about ourselves, about others, about the world. Thus, debiasing ourselves must involve an honest assessment of what we want: do we want to be right about everything, or do we want to know what’s true?

Let’s bring this back to what this blog is about: investing.  In my piece last week I stepped through the basic premises on which I am currently invested.  The tenants I stated were the conclusion of a somewhat anguished and certainly restless mental reevaluation that I had been running through over the prior few weeks.

As the market moved against me I  started to look at why I might be wrong.  In my spare time I tried to “assimilate the undesirable information” and paint the most contrary picture I could.

I especially went through the exercise with gold and with my rather significant precious metal stock positions (Aurizon Mines, Atna Resources, OceanaGold, Canaco Resources, Geologix, Esperenza Resources, Lydian International and Golden Minerals).  Gold is always easy to question (what does gold really do anyways?).  I attempted to soberly evaluate both the prospects of the metal  and the companys.  I looked for reasons to basically cut them loose.

I hemmed and hawed a lot, and at times began to convince myself that I was indeed wrong.   But in the end I was led back to the basic points of valuation and underlying conditions, which seemed to me to remain firmly in gold’s favor.

This is how I make decisions.  At times it undoubtably appears that I am flip-flopping.  I am sure that my weekly writings must have an aire of contradiction when read one after another.  A reader might wonder how it is that my point of view can go from one extreme to another in the matter of weeks (see Argonaut Gold).  Or at times even flip 180 degrees only to flip back a few weeks later (see Argonaut Gold).

In truth, this is the only process I know of that allows me to really question whether I am right.  If I can push myself to the edge, almost convince myself of the diametrically opposed point of view, and still in the end come back to my original conclusions, then well, that’s really getting somewhere.   At times I push myself so far that I actually begin to believe it myself (ah yes, see Argonaut Gold), but that is just a occasionally necessary casualty.  Far more often I leave the exercise with more clarity, and with that clarity comes the likelihood that I will act properly when the situation arises.

In the end I came away from my “anguished” analysis of gold more confident in my positions than I was when I started.  And this week, on Wednesday, when the Fed news hit the wire that interest rates would be low for time eternity, that gave me the clarity to act.

The moment I read the news I bought a position in Barrick Gold, and I added to my positions in Esperanza Resources and Golden Minerals (though I neglected to make the AUM trade in my practice account).  The next day I added to OceanaGold, and thta was followed by additions to Atna and Canaco the day after that.

In my practice account:

And in my actual account:

You do the work so that you have the confidence to act.  You put in the time learning and working through why so that when an opportunity makes its brief appearance, when Bernanke comes out and says “yeah we aren’t going to raise rates for a long time” you can recognize it for what it is and say “all right, I’m in” and you know what you have to do.

Had I not been stepping through the thesis of why gold and gold stocks remain a solid investment, I likely would not have had the conviction to buy into the rally.  At worst, I would have sold into the rally, because if you really don’t know why you are investing in something you tend to take the first blip after a long period of blah as a “finally I can get out” moment.  As it is, with the Fed putting interest rates on hold for another couple years, and with their actions maybe even foreshadowing a true QE event in Europe, I feel quite confident that I am positioned well for that fall out.

Speaking of Canaco Resources…

I bought Canaco Resources at the end of the year at about $1.10 as part of my “tax loss buying binge”.  A couple of things happened with Canaco this week.

First, the stock went up.

Second, the company updated us on its activities in Tanzania:

  • Expect a resource estimate by the end of March
  • Expect a preliminary economic assessment by the end of the third quarter
  • Expect further metallurgical testing results at some point

Third, Canaccord Capital came up with an updated price target, and more importantly helped give us a glimpse at what to expect from the upcoming resource estimate (hat tip to howestreetbull who posted this on Investors Hub).

  • Canaco has approved a US$35-40 million 2012 exploration budget, and is currently drilling 10,000 metres per month at Handeni with nine diamond drill rigs and one RC rig.
  •  Six of the drill rigs are focused on delineating the Magambazi resource in preparation for the initial resources estimate. Two diamond drill rigs are focused on the Kuta and the Magambazi North Extension targets. The remaining diamond drill rig is operating on the Majiri target, where previous surface sampling and RC drilling indicate a gold anomaly. The RC drill rig iscurrently operating on the Bahati target to test preliminary regional targets.
  • We are expecting an initial resource and metallurgical test results in Q1/12, and a PEA in Q3/12. We are expecting an initial resource of 2.3 million ounces of gold at a grade of 3+ g/t gold. Previous metallurgical testing indicates recoveries of 90+% using a conventional CIL process.

Valuation: with US$110 million in cash, we believe the company is in a strong position to continue to derisk and advance the Handeni project. Our peak gold price estimate of NAVPS (10%, US$1,750/oz) remains unchanged at $7.50. We continue to value Canaco based on a 0.65x multiple to our peakgold price estimate of NAVPS.

At the current price of $1.50 Canaco trades at a market capitalization of $300M.  Subtracting the current cash balance of $115M, the enterprise value of the company is a little less than $200M.  If the deposit does indeed contain 2.3M oz of gold, the valuation being given for those ounces is about $80 per.

This is a 3 g/t open pittable deposit that looks to be 90% recoverable with a straightforward metallurgical process sheet.  In my opinion (and apparently Canaccord’s as well) those ounces should be worth more than $60/oz.

To throw out a comparison point from a recent PEA, Prodigy Gold had a PEA done for its Magino gold property last March.  The PEA assumed a CIL recovery process, a 9 year mine life, producing gold from an open pit at a grade of 1.2g/t for 9 years to give a total mine of life production of 1,585,000 oz of gold.  The after tax NPV5 of the project was estimated at $259M at $1000/oz gold.   That works out to a value of $160/oz.

Albeit there may be better comparisons out there, but this one surely suggests that Canaco is undervalued.  Canaco’s Magambazi project is much higher grade than Prodigy’s (3g/t versus 1g/t).  The location is Africa, versus Canada for Prodigy, which probably suggests a bit of a discount against Canaco but not enough to make me change my opinion.  And while the Magambazi strip is as yest unknown,  the Magambazi deposit appears to be around a hill top, which should lead to a reasonable number (the strip for Prodigy’s Magino is 3.3).

Finally, the last bit of news was that Brent Cook came out with the following plug about Canaco:

“The funds were just jumping in on this thing – and they all bailed out as well – the stock got down to $1.20. During this time period they’ve been drilling and drilling and drilling, and the results continue to show me that they’ve got what I think is going to be a legitimate, decent size, decent grade, open-pittable deposit in Tanzania,” Cook says. “So we’re buying this stock at $1.30 with $115 million in the bank, and a $41-million exploration program. That, to me, seems like a good buy.”


When the gold price broke out on Wednesday, Canaco was the first stock I added to.

and speaking of gold…

I came across this interesting piece of information regarding the appetite of the Chinese for gold.   This may be old news to some but I think it is still worth reporting.

The People’s Bank of China  research director Zhang Jianhua was cited as saying Monday in the central bank publication Financial News that gold purchases should be ramped up when prices drop, although he gave no indication of what proportion of the nation’s $3.2 trillion forex reserve should be allocated to investments in gold.

Apparently, Jianhua called gold the only safe haven left and said that:

“the Chinese government needs to further optimize China’s foreign exchange asset portfolio and seek relatively low entry points to buy gold assets…no asset is safe now.  The only choice to hedge risks is to hold hard currency – gold”.

High House Prices

I’ve been doing some research on house prices in Canada and in particular in my city, Calgary.  I plan to do a separate post on my findings shortly, but for the moment I just want to throw up a couple teaser graphs that gave me pause for thought.

The chart is taken from a speech given by Mark Carney to a Vancouver audience last June.  The methodology used is the ratio of the nationwide median home price to the median household disposable income. A ratio of greater than 3 has traditionally been seen as unaffordable.

It makes you think.

One other chart from the same report.  Below is the average house price in Vancouver:

Its either a heck of a bull market or a bubble.  To say it another way, I don’t know about house prices, but when a stock goes parabolic you typically know how it is going to end.

Anyways, more on this later.

Community Bankers Trust

It was a good week for Community Bankers Trust (BTC).

Earnings will come out for the company on Tuesday.  Hopefully the company will put together another profitable quarter.

The BTC story

I bought BTC as a turnaround story.  Community Bankers Trust is a bank that has been trying to reincarnate itself after the first incarnation came close to an early death. My observation is that they have been successfully navigating this resurrection, and with the recent turn in profitability (and a helpful turn in the economy) the bank is on its way to realizing its earnings potential.

The bank was hit hard by the recession in 2009.  The company saw nonperforming loans skyrocket from 2% of total loans in the first quarter of 2009 to 10% of total loans in the second quarter of 2011.  Yet there have been signs that the efforts the company has been making to turn itself around are working, culminating with a profitable quarter in Q3.

Let’s hope they can keep that momentum.

How did they get to here?

The original strategy of the bank was, as far as I can tell at least, to simply buy other banks and get bigger.  Witness, the name of the original company was called Community Bankers Acquisition Corporation  (CBAC), so they weren’t exactly being subtle.  Along with the acquisition strategy, the bank seemed to have a “worry about the profitability later” strategy, which may have worked ok when the economy was growing but that fell flat when the economy didn’t in 2008.

As best as I can discern the acquisition effort was spearheaded by Gary Simanson. He headed up the original company CBAC, and then moved into a position of Strategic Vice President, a position I don’t think I’ve ever heard of with any other company. According to this article, Simanson was responsible for subsequent acquisitions.

In truth, the timing was what killed the acquisition strategy.  To quickly step through the timeline, in May 2008 the company began its journey by acquiring two local Virginia banks, TransCommunity Financial Corporation, , and BOE Financial Services of Virginia, Inc.  In November the bank moved ahead and acquired The Community Bank, which was a little bank in Georgia.  Finally in January 2009 they acquired Suburban Federal Savings Bank, Crofton, Maryland.

So you had 4 bank acquisitions in less than a year happening at the time of a 100 year financial tsunami.  How do you think things turned out?

Change in Direction

By 2010 Simanson had left the company and the direction of the company was changed to the more pragmatic “we need to get profitable before we go belly up” strategy.

This was described pretty bluntly in the 2010 second quarter report. CEO Gary Longest said at the time:

Our strategy has shifted from that of an aggressive acquisition platform, to one that meets the banking needs of the communities we serve, while providing sustainable returns to our stockholders. To this end, we are taking the necessary steps to return immediately to profitability. We are actively analyzing our market base to assess the contributions of all branches to our franchise value and will take the appropriate actions in the third quarter of this year. Additionally, we will make aggressive expense reductions, and will look to restructure and strengthen the balance sheet. We are confident that the analysis of these potential critical paths and the resulting execution of these initiatives will lead us back to profitability quickly.” “Our goal is an immediate return to consistent quarterly profits. To accomplish this, we have no alternative as a Company but to make clear and intelligent decisions in the next 60 days, no matter how difficult, to accomplish that goal as soon as possible. That is our full focus.”

 In a somewhat odd twist to which I’m sure there is a good story, Longest himself was gone only a couple months later. Nevertheless the interim CEO and soon to be permanent CEO Rex L. Smith took up the reins and has carried out the strategy quite well given the circumstances.

 Where are they now?

I already mentioned that the company had its first profitable quarter in a long time last quarter.  I don’t believe this was a one time fluke.  It looks to me like its the culmination of a number of initiatives put forward by the bank that have been geared towards making the bank more profitable.

The company has made an effort to lower the cost of its deposit base.  Time deposits, which are expensive high interest bearing deposits, have decreased from 73% to 67% of total deposits since the end of 2009.  As well, the cost of the time deposits has come down from 2.9% in 2009 to 1.6% in the third quarter.

The effect has been a steadily rising net interest margin (NIM) since the strategic direction change in 2010.

(note that this graph is a simplified version of NIM calculated as a percentage of all assets rather than the more common formulation of interest bearing assets)

The company also undertook efforts to reduce expenses.  The most common way of illustrating the day to day expenses of a bank is through something called the Efficiency ratio.  The Efficiency ratio is simply the ratio of the total non-interest expenses at the bank (so the salaries, building costs, lawyer fees, pretty much everything except the actual cost of borrowing money) to the  net interest margin (so the amount of interest made minus the amount of interest paid).  The reason that you look at the Efficiency ratio is because it ex’s out growth, since growth should occur for both NIM and expenses in concert with one another.

The Effiency ratio of BTC has been falling consistently.

What’s it worth?

To get an idea of what the bank might be worth if it continues to pull itself together, I put together a proforma earnings estimate.  I stripped out all the provision for loan losses, the FDIC intangibles (from their earlier acquisitions) that the bank is required to amortize, as well as losses on real estate and gains of the sale of securities.  So basically I looked at the banking skeleton that is BTC.  Here is what I found:

What this clearly demonstrates is that if get rid of all the scabs, there is quite a profitable little enterprise here.

Meanwhile, the bank sports a tangible book value that is much greater than the current share price ($1.40 after last weeks run up):

What is left to be done?

The story that still needs to play itself out is the healing process.  The really big negative for the bank is that it still has an extremely elevated portfolio of non-performing loans.  There are signs that this is abating, and in truth part of the bet here is the same one that you make on any regional bank: the US economy is turning the corner, the Fed is not going to allow it to fall into another recession, and so the worst of the loan defaults are behind us.

But just to get an idea of the risk here, typically you wouldn’t want a bank to have non-performing loans in excess of a couple of percent.  Many of the best banks I’ve looked at have nonperforming loans of well less than 1%.  BTC, onthe other hand…

There are tentative signs that the peak has passed, but it will take a few quarters before we know for sure that further write-downs are not coming.

Earnings on Tuesday will give us a lot of insight into the direction of the trends.  I’ll be looking closely at nonperforming assets and the 30-89 day deliquents (which are an early warning of the soon-to-be not performing.  I also will be hoping to see some decent earnings.