Crunch time is fast approaching for dozens of junior exploration companies that cannot raise money in near-frozen equity capital markets, and have rapidly dwindling cash balances. The big question is: when will the wave of consolidation begin and how can investors prosper?
A recent Ernst & Young report, Business risks facing mining and metals 2013-2014, found capital allocation and access to capital was now the top risk for minerals companies globally, up from number eight in the 2012 survey.
Companies with a market value of less than US$2 million – about 20 per cent of mining companies across the main sharemarket exchanges for junior explorers – had, on average, less than $1 million in cash at December 31, 2012, the report found. Hundreds of junior miners globally could go under, a significant proportion of which could be in Australia.
The report said: “The pullback of investors from riskier investments in the junior end of the market has created a capital desert for this segment of the market that has not been seen in a decade. The cash and working capital position of the industry’s smallest companies is so severe that many are not in a cash position to wait for market conditions to improve, with a rationalisation of the market expected.”
The obvious outcome is asset-rich, cash-poor companies doing deals with cash-rich companies that can snap up quality projects; more reverse takeovers or so-called “backdoor” listings; and, sadly, a number of marginal junior explorers becoming insolvent as they run out of cash.
A surprise is the lack of consolidation so far. More explorers are sensibly cutting costs, reducing their board size, and cutting or deferring director fees. Some will go into a care-and-maintenance mode to preserve their cash balance until capital-raising conditions thaw and share prices lift. But a wave of takeovers is yet to happen.
Some may not last long; $1 million in cash may buy an average junior explorer a year or so, before ASX listing fees, compliance and administration fees, a few executive salaries, and minimum exploration commitments to maintain tenements chew up cash balances.
Moreover, hopes of a near-term lift in the resource sector are fading. Chinese economic data, notably recent factory data that hit a nine-month low, continues to disappoint. And the US Federal Reserve’s talk about an eventual move away from quantitative easing has crunched the gold price and gold equities.
Back home, the S&P /ASX 300 Metals and Mining index has slumped 25 per cent so far this year. Its five-year average annual return is negative 13 per cent – astonishing given a once-in-a-generation commodity price rally thanks to China, and the resource investment boom.
Eagle-eyed technical analysts will have noted the index, at 2682 points, is approaching its November 2008 low of 2278 points. I’m betting the ASX 300 Metals and Mining Index tests its GFC low by year’s end, and will watch closely if that level has support. It could be a critical turning point.
The main takeout is that several dozen junior explorers will run out cash as the resource sector downtrend continues this year, becoming easy prey for a bear market. Shareholders in speculative exploration companies need to keep an extremely close watch on quarterly cash reports.
I ran a simple database filter over 787 ASX-listed material companies to compare their market capitalisation with total current assets on the balance sheet (assets that can be converted to cash within a year). The aim was to find explorers and producers with current assets well below their market capitalisation, and identify explorers that have been badly oversold.
By my count, 234 material companies, mostly explorers, have total current assets in excess of their market capitalisation. Take gold producer Ramelius Resources as an example. It has a $37 million capitalisation and reported cash and gold on hand of $48 million at the end of the March quarter.
Dacian Gold, a 2012 float, is capitalised at $12 million. It had cash and receivables of $16.5 million at the end of the March quarter, and continues to achieve good exploration results at its Mount Morgan Gold project.
After a share-price beating this year, Mirabela Nickel has a market capitalisation of $92 million, and had a US$141 million cash balance in the March 2013 quarter.
This analysis is not meant to recommend the three stocks above or other junior explorers, but simply to note that dozens of resource companies, some in production, now have a market capitalisation well below their cash at hand – and are worth more dead than alive right now.
Care is needed with such analysis. The market capitalisation, based only on quoted securities, does not tell the full valuation story if there are lots of unlisted shares and options yet to vest, which often happens with new floats. Producers with high cash at hand may also have high debt. And their cash balance may have fallen over the June quarter, to be closer to their current market capitalisation.
Also, by valuing some exploration stocks below their cash balance, the market is signalling surplus cash could be chewed up quickly in ongoing costs, or to prop up a troubled asset as commodity prices fall. Or the market may believe the junior explorer will eventually fail.
Clearly, there are plenty of limitations. But for speculators looking for value, identifying exploration and production stocks trading well below their cash backing is a good place to start. Excess cash, always critical, is a rare commodity when capital markets for speculative companies freeze up.
Those that have enough cash to last several years and snap up assets at distressed prices this year – or take over fallen companies without paying much if any premium – will be the ones to watch. The challenge is finding a catalyst to re-rate such stocks in the next 12-18 months, and understand the extreme risks as ‘tech-wreck’ like conditions wreak havoc on junior exploration stocks.
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Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at Feb 14, 2013. The author implies no stock recommendations from the above commentary. Readers should do further research or talk to their financial adviser before acting on themes in this article.