Apples to Apples in Mining Analysis
Thursday, 9/18/2014 10:05
Tickerscore's stock rating method explained...
JEFF DESJARDINS founded Tickerscores.com as a universal, independent and comprehensive stock scoring system that gives investors access to investment research on mining stocks.
With mining analyst James Fraser, Tickerscores covers over 450 precious metals companies on the Toronto exchanges, and compares them head-to-head to make due diligence easier.
Here Desjardins and Fraser explain their methodology to
The Gold Report's sister title, T
he Mining Report...
The Mining Report: A recent article on Tickerscores.com, "The Great Divide: Inequality in Gold Juniors Means Opportunity", said: "It's clear we've reached a new level of separation between the wheat and the chaff." What does that mean for investors?
Jeff Desjardins: As the bear market has progressed, many companies have struggled to raise the necessary funds to advance their projects. Even for those that have been more fortunate, it has often come in the form of dilutive financings.
On the other hand, quality management teams have found ways to continue to move projects forward. We're starting to see a big separation in metrics such as cash, general and administrative expenses (G&A), news flow and, ultimately, the creation of shareholder value. For example, we cover 22 exploration companies working in Ontario and 82% of those had less than $400,000 in cash in Q1 2014, up from 65% in Q3 '13. Our top three exploration companies in Ontario hold an average cash position of $2.2 million each. The other 19 average only a mere $150,000 per company. Furthermore, the G&A expense ratio for the bottom 19 companies is a hefty 76%, which means that $0.76 of every Dollar is not going into the ground.
We are looking at a great divide between the rich and the poor. The funny thing is that even though the rich companies have great management teams and cash to continue to develop their projects – key things that you want in a junior name – they are still trading at great valuations.
TMR: In which mining subsector – producer, developer, explorer – is an investor likely to get the most bang for the buck?
Jeff Desjardins: All those types of companies have their advantages. It depends on an investor's portfolio, strategy and risk tolerance. Right now, we're focusing on developers. We published a report in early September that lists some promising companies in this stage. We believe developers with high-quality assets will be subject to merger and acquisition (M&A) activity once they are sufficiently derisked because larger companies want to buy proven resources at rock-bottom prices.
Investors should look for developers with a resource of at least 3 million ounces with high grade and in a safe jurisdiction. A takeover offer is rarely made before a company publishes a preliminary economic assessment (PEA) so investors should look for a PEA or feasibility study with a high net present value (NPV), low capital costs (sub-$700m) and a high internal rate of return (IRR).
TMR: What jurisdictions should investors be taking a closer look at right now?
James Fraser: Certainly anything in North America – Mexico, Nevada, British Columbia and Ontario.
TMR: Are companies in those jurisdictions trading at a premium to the companies that aren't?
James Fraser: Yes. Assets in certain countries in Africa and other places like Russia trade at a significant discount to a similarly sized asset in a safe jurisdiction.
TMR: Tickerscores.com maintains a database of 450 companies that is constantly updated based on financials, management, stock performance and mining projects. What are the weightings for each of those elements and do those weightings change over time?
Jeff Desjardins: They definitely change over time because the weightings are based on macro market conditions. In November 2013, the weightings of those factors were: financials, 54%; management, 20%; stock performance, 4%; and the project, 22%. Right now exploration companies are 43% for financials, 17% for management, 4% for stock performance and 36% for the project.
TMR: What accounts for the greater weighting in projects?
Jeff Desjardins: The biggest reason for the jump in the project weighting is based on an improvement we have made over the last year, which is adding in a drill score economic analysis. We're looking at the economics of all drill holes for each exploration company, and comparing them against other companies in the same jurisdiction. We didn't do that before.
TMR: How do you go about analyzing drill results?
James Fraser: In the drill hole analysis, we always compare companies in similar regions to each other. In British Columbia, for example, we would be comparing companies that are typically exploring for gold and copper together. We look at how many holes a company has drilled on the property and then take a company's best drill results to date and calculate a "gram meter" score. If an interval is 200 meters of 1 gram per ton, that's a score of 200. Or if it's 100 g/t over 2m, that's also 200. Once we have the results for a region, we will then rank them.
TMR: So as much as possible you are trying to compare apples to apples?
Jeff Desjardins: By keeping as many variables as possible the same, it makes it easier to understand the key differences between two companies. We also provide "Power Rankings" to help investors sift through companies. If something jumps out to us, we make note of it there.
TMR: What are the top three or four catalysts that move the score for explorers, developers and producers?
James Fraser: It's still a tough climate for exploration companies. The first thing we look at is cash position. A company needs money to do work. A significant financing or a well-funded joint venture partner would dramatically move a Tickerscore right now. As Jeff said, the higher quality names are outperforming while the majority of other companies are running very low on working capital. We don't expect the latter ones to survive the next 6 to 12 months. After cash, solid exploration drill results will certainly move a stock's Tickerscore.
We see the most change in developers as they advance to the next stage, such as moving from an NI 43-101 to a PEA, or when a resource gets significantly bigger. If a company receives an important environmental certificate or mining permit, that will really move a Tickerscore.
For producers it all comes down to making money. Were they profitable at the end of the quarter? Are their all-in cash costs increasing or decreasing? How do these metrics compare to previous quarters?
TMR: Traditional mining equity analysts use discounted cash flow (DCF) models or other proven metrics like NAV or enterprise value to determine how companies ought to be valued. How do you think your methodology stacks up?
James Fraser: The higher-scoring companies in our database – the companies scoring over 60 – are consistently outperforming the Toronto Stock Exchange and the Market Vectors Junior Gold Miners ETF (NYSEArca:GDXJ).
It's also worth mentioning that in the Tickerscores Top 10 list we published in January, our top picks for the year are up 34% year-to-date.
Discounted cash flow models are generally used for producers and have limitations. The DCF model is static and does not account well for changing metal prices, increasing or declining production, or grade variability. We update our producers at least once each quarter based on their latest quarterly reports. We determine if the mine is high-grading (a process by which higher-grade ore is mined first); we also look at all-in cash costs and other variables. We use 20 different metrics to determine a Tickerscore for each company.
TMR: What should mining investors expect in the final quarter of 2014?
Jeff Desjardins: As we move into the fall, we expect to see more separation between the better companies and the weaker ones, or what we call "The Great Divide". It's all about the capacity to create shareholder value. The companies with no cash have severely limited capabilities to do this – and the quality names with world-class assets are going to be sought out by majors that need to replenish gold reserves.
TMR: Thank you for talking with us today, Jeff and James.
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