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Posts tagged ‘gran colombia’

Catching the knife with Gran Colombia

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

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

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

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

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

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

Gran Colombia Second Quarter

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

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

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

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

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

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

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

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

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

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

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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.

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.

 

Gran Colombia’s Debenture Redemption looks favorable

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

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

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

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

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

Debenture Holders can participate

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

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

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

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

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

Its still cheap on Comps

Gran Colombia continues to compare favorably to other gold producers.

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

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

Its still cheap on Cash flow

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

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

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

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

Conclusion

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

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

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

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.