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Energold is an obscure, under-appreciated, illiquid, Canadian, and run by a non-promotional management team. The combination oI conservative accounting and depressed operating results over the last two years make the company look expensive based on TTM math.
Energold is an obscure, under-appreciated, illiquid, Canadian, and run by a non-promotional management team. The combination oI conservative accounting and depressed operating results over the last two years make the company look expensive based on TTM math.
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Energold is an obscure, under-appreciated, illiquid, Canadian, and run by a non-promotional management team. The combination oI conservative accounting and depressed operating results over the last two years make the company look expensive based on TTM math.
Авторское право:
Attribution Non-Commercial (BY-NC)
Доступные форматы
Скачайте в формате PDF, TXT или читайте онлайн в Scribd
Energold Drilling (EGD) is an obscure, under-appreciated micro-cap Iranchise that possesses
both a large margin oI saIety and what we believe is an incredibly Iavorable, highly skewed risk/ reward equation.
Investment Highlights:
An investment in Energold at or around the current price possesses nearly all the qualities we look Ior in a great long-term investment. In particular (1) an unsustainably low valuation (both absolute and relative to peers) (2) a good, Iully incentivized management team (3) near to medium-term operating momentum (4) a highly attractive long-term business model (5) multiple internal and external high probability catalysts (which we expect will drive substantial near to medium-term upside) and (6) a situation where a variety oI temporary issues converge to mask a signiIicant inIlection point both in regards to the company`s corporate development and Iuture prospects as well as in relation to its industry as a whole.
Other attractive attributes oI Energold include. A dominant competitive position in a rapidly growing niche market An unlevered balance sheet Improving economics on an attractive and Iast growing asset base A high likelihood oI experiencing meaningIul improvements in near-term proIitability and cash Ilow Opportunity to invest capital at (1) a very high rate and (2) Ior a very long time Valuable hidden assets their stake in Impact Silver could potentially be worth more than Energold`s entire current EV A natural inIlation hedge/low risk way to participate in minerals/commodity bull market
Why is it Mis-Priced?
It`s small, unknown/under-Iollowed, illiquid, Canadian, and run by a non-promotional management team
The combination oI conservative accounting and depressed operating results over the last two years - due to a once in a generation recession and the lingering eIIects oI the credit crisis - make the company look expensive based on TTM math
Brief Business Description/Operational Overview:
Energold is an operator oI environmentally Iriendly man-portable drilling rigs that service the mining industry. With its operations in over 20 under-served countries throughout the developing world, Energold emphasizes an environmentally and socially sensitive approach to contract drilling. The company`s primary competitive advantages are its permanently lower operating costs and its use oI proprietary, highly portable rigs in serving Irontier-drilling regions. Long- term, the company seeks to become the worlds leading specialty driller.
Unlike most oI its competitors, Energold`s operations are managed in a way meant to consistently protect and grow shareholder value regardless oI the environment or where the company is in the cycle. The companies operating principles reIlect this, and are intended to both maximize Ilexibility and the ability to capitalize on opportunity over time.
Energold`s core business is oIIering drilling services in 'Irontier markets by utilizing a proprietary Ileet oI 'man-portable rigs. 'Man portable rigs are high quality, low cost drills that Energold designs and manuIactures in house which possess a variety oI unique (and game changing) attributes attributes that have been at the heart oI why Energold has been able to rapidly penetrate over 20 under-served markets in an impressively short period oI time. What we mean by 'under-served in Energold`s sense is developing nations with high mineral drilling potential and minimal competition.
The company`s use oI an innovative modular component technology allows them to create small, highly portable rigs that aren`t mounted on trucks and hence don't require roads and/or trees to be cut down Ior access to drilling properties (notably, the vast majority oI the ~7000 rigs in the world today are truck mounted). This not only saves a signiIicant amount oI time and money, it allows drilling to take place without leaving a large environmental impact in its wake. In other words, Energold`s mineral drills possess dramatically lower all in costs to build, transport, and/ or operate, and equally as importantly, leave an essentially non-existent environmental Iootprint in an industry plagued by the secondary eIIects oI its inability to operate in an environmentally Iriendly manner. OI course, Energold`s revolutionary rigs also provided the company with a high return business model and a tactical advantage in a rapidly growing market.
Framing The Opportunity:
There is couple oI helpIul ways to think about the unique attributes oI Energold`s business model and long-term opportunity. The Iirst relates to how when we think about this company`s prospects Ior sustainable value creation over time, we just can`t help but draw comparisons to both Geico and Walmart in certain respects. Like Walmart, you have a business that has grown over time by expanding into under-served markets with minimal competition, which in turn allows them to quickly entrench as the low cost producer based on economies oI scale. Like GEICO, you have a business with very low market share, a tremendously long runway Ior growth, hard to replicate cost advantages, and compelling incremental economics. Hkup881 also compared Energold`s investment proposition to be akin to 'betting on CSCO in 1995 knowing that the Internet thing would work, but reIusing to buy pets.com or anything like that which we believe to be an apt comparison as well. Feel Iree to take the above comparisons with a grain oI salt, but we wanted to mention it here in brieI because - like the excerpt below - we think it`s helpIul as Iar as Iraming the opportunity and helping others 'see what we see, iI you will.
The second is about how history has taught time and again that the low-risk way to make money in any gold rush is to sell the "picks and shovels, and our how our expectation is that this time around should be more oI the same. With that in mind, the gentleman over at Praetorian Capital who (1) notably did most oI the heavy liIting here (2) also happen to be the purveyors oI one oI our absolute Iavorite blogs Adventures in Capitalism and (3) recently put how this historical reality relates to Energold in a recent Sum-Zero write-up better than we ever could.
That said, rather than try and regurgitate our own inIerior articulation on the matter, we will just quote an excerpt Irom Mathew Goodman's Iantastically insightIul take below....
"Im an equities guv, but I want gold exposure
If vou are still reading, vou are aware that gold is in a multivear bull market that is unlikelv to let up anvtime soon. Even if vou are no gold bug, but are traditional value and subscribe to Jeremv Granthams ideas, particularlv his recent piece "Time To Wake Up. Davs of Abundant Resources and Falling Prices Are Over Forever", this mav work for vou. If vou are scared of the commoditv sector because vou dont want to participate in putting a future price on something without financial statements, vou might want to look elsewhere. While understanding golds bull market, I set out to find a wav to get leverage to the price of gold. This would cause one to turn to the mining sector, the companies that actuallv set out to find and then produce the shinv metal. Mv conclusion upon studving the mining industrv is that it fell in the too difficult pile. I did not have a geologv degree. I did not want to pav a massive amount of monev to bet on a consultants word on the prospective geologv. In mv opinion, everv single factor determining profits was based on commoditv prices. Betting on mining meant that I wasnt onlv betting on gold but on the relative outperformance of gold versus other commodities. Then we get to the mining.
Mining is 'a series of problems`, quite literallv. We can start with the amount of guesswork that incorporates the geologv side, lets fust sav it would make Nostradamus blush. Then we get into communitv relations, convincing a tribe of indigenous Ama:onians that an international companv extracting billions from their communitv reallv is best for evervone in the long term. Oh, and we also need to build a road thru vour rain forest. This is fust the beginning. The capital outlav is incredulous. A bank wont even talk to vou until vouve pissed awav millions on a non income-producing endeavor. Yes, that means dilution is an issue. Mines can take 3-5 vears to build, and lots can happen between then and now. So what kind of management does such an industrv attract? You have the Ibankers who are there simplv to raid the treasurv. And vou have the geologist, he knows the gold is there, but doesnt have the slightest clue in how to obtain financing or exploit the value chain. Part of the business plan is to spend all vour monev in the name of exploration, which is, based at least 50 on luck, I kid vou not.
When plaving bull markets I constantlv look for the trickledown effect. I turned to historv to find out where the monev was made in previous mining booms. Samuel Brannan was the first millionaire of the California gold rush. Must have been a big deposit? Brannan actuallv opened town stores next to the mines and after having bought as manv shovels in the state of California as he could, proceeded to sell them to the miners. Another gentleman who in mv own opinion left the largest legacv of the gold mining boom, died with an estimated fortune of $6M (in 1902). This gentleman was Levi Strauss. Bv using copper fastenings, his feans stood up to the hard labor of mining. Those who came in search for gold, left with little more than thev came with, if thev were luckv. A sawmill operator, Marshall, was the first to discover the gold that set off the gold rush. He shared this information with his boss, who owned the land and mill. Neither of them ever profited from the discoverv of gold. In fact Marshall died penniless, after he became the partner in a gold mine that ultimatelv failed. His boss shared a similar fate. As stated at the California gold rush Wiki page, 'recent scholarship confirms that merchants made far more monev than miners during the gold rush`. If vou were not convinced reading annual reports that mining is a trickv business, mavbe vour mind has now changed.
A friend who is more familiar with the mining industrv than I calls fr mining 'drill hole roulette`. Once vou own land the remaining fob is to get as much of other peoples monev as possible, and spend it all drilling holes. The more monev that is attracted to the gold industrv, the more holes will be drilled. Following mining industrv financings are a telling tale of the trickledown effect of monev spent on drilling. Mafors are finding it almost impossible to replace reserves which will lead them to plaving the game themselves or supporting others who are in. The world produced approximatelv the same amount of gold at $1200 gold as we did at $300 gold 10 vears ago. On the other side of this sits the casino, or the service companies. Im a fan of investing in the house. There is also a second driver here for the service industrv. The general population is unfamiliar with the gold mining industrv, as it had been dormant for so long. It is thought that the cost of gold is about $500 or so per o:. This is the cash cost of mining the gold. This comes after the shit show of spending and dilution I mentioned earlier. Most knowledgeable analvsts believe the price to locate new gold is upwards of $1200 todav, and growing rapidlv as we mine what is easiest to find, and are forced deeper into the earth, and to more remote locations (read. more expensive). At a recent mining conference, an HSBC precious metals analvst put the marginal cost at $1200, 'the long term floor`. Mining companies have done an awful fob replacing gold over the last 10 vears because thev were paid less than the cost of finding new reserves. Monev does not flow into unprofitable ventures. Jerv little exploration occurred and the service industrv made few advancements. There are manv statistics out there talking about how little the allocation to gold is in worldwide assets, as this is readfusted upwards, monev will flow into mining. Now that mining offers an appropriate return on invested capital, more capital will again find its wav into mining. This monev will be used to explore for gold."
Opportunity Overview - Key Points:
Sustainable Cost Advantage:
One oI the most important aspects to understand when analyzing Energold`s business is the Iact that it possesses a sustainable cost advantage, which is a Iunction oI their decision early on to build their own drills. Realizing that vertical integration and owning their own assets was integral to establishing a sustainable cost advantage, the company made an early transition. This has allowed them to squeeze out the manuIacturing middleman, more eIIectively control their production proIile, and continuously wring out increasing amounts oI cost eIIiciencies as they have scaled. The company also possesses a lower operating cost structure due to a local, less skilled work Iorce and due to superior scale achieved in developing markets, which enables leveraging oI Iixed costs. The end result is a business with the lowest operating cost and hence the highest margins in an extremely Iragmented industry.
Again, the Iact that their drills can be made internally at lower cost allows Energold to 1) oIIer the same services to clients at lower prices 2) operate with a permanently lower cost structure and 3) rapidly innovate and deploy new technologies at a much Iaster clip. The end result allows them to quickly become the dominant business within the markets it serves, where by 'dominant we mean a business that can be highly proIitable at a price level that leaves smaller competitors (in terms oI local mkt share) with permanently higher than average costs, which in turn makes the company nearly impossible to compete against long-term. Again, consider Ior a moment how powerIul the ability to run its business at a permanent 10 diIIerential to its closest competitors really is, as it not only provides the company with an ability to bid contracts at a level that allows them to operate at a proIit where others cannot, but also to more eIIectively preserve and/or steal share in diIIicult market environments.
The key take away here is that competitors operating within their markets can try to take share, but eventually they will either go bankrupt or just end up walking away aIter the eventual realization that attempting to compete is truly absurd given what is a permanent and insurmountable cost disadvantage.
Overly Conservative Accounting
Unlike most companies, Energold is incredibly conservative Irom an accounting standpoint and chooses to immediately expense all oI what would normally be considered maintenance cap ex (such as the purchase oI rig modules Ior existing rigs that have useIul lives which exceed one year). This results in huge hits to the income statement and artiIicially depressed earnings. ThereIore, during periods oI high growth, investors can (obviously) expect periods oI particularly depressed earnings. We mention it, only because it is policies like this that oIten provide a IruitIul source oI opportunity Ior the bargain hunting investor, who oIten looks Ior situations where high growth is penalizing today's earnings and in particular, situations where that high growth is being employed at high and improving ROIC.
Anyhow, Energold has a high return business that`s been in rapid growth mode. Currently the market is (as expected) Iailing to notice the Iact that operating cash actually includes signiIicant growth cap ex since growth in inventories (changes in non-cash capital) is directly related to rig unit growth, in Iavor oI a myopic Iocus on depressed operating income. OI course, such a Iocus is mis-placed, as once the high margin/high growth stops, the hugely artiIicially depressed operating income numbers will normalize. As it does, the multiple will naturally begin to expand rapidly.
Point being, Ior those who are Iocused on what matters, i.e., the normalized earnings power oI the existing business as is (assuming no growth), and can see past the accounting related distortions, a very diIIerent picture emerges. By our calculations, the company is trading at only ~5x owner earnings, or earnings aIter they have been adjusted Ior growth capex in order to approximate the company`s steady state earnings power. In other words, stupid cheap Ior a non-distressed business with highly attractive underlying economics and a huge runway still ahead oI it.
1remendous Incremental Economics
Perhaps even more interesting is that we think we are at a crucial inIlection point in the company's evolution, where its huge growth investments over the last Iew years have resulted in a level oI scale within the company's key markets that should begin to unlock a signiIicant amount oI operating leverage going Iorward as the company's top and bottom lines accelerate and the beneIits oI Iixed cost utilization really begin to kick in.
In other words, the company has just started to hit critical mass and we expect that the combination oI 1) a much larger drill Ileet 2) improving asset utilization 3) rapidly improving day rates (price/meter) and 4) a positive mix shiIt (as lower margin brownIield services start to transition towards the company's higher margin "Irontier" drilling), should result in signiIicant gross margin expansion within the near to medium term - the primary eIIect being that as gross margins expand, the company`s high incremental margins will Iinally begin to Iall to the bottom line. OI course the price doesn't reIlect any oI these temporarily hidden dynamics, yet given how these high margin revenues have an increasingly outsized impact on earnings as they increase, it's a good bet it won`t take long beIore the company`s rapidly growing earnings and cash Ilows start becoming incorporated within the Iinancials and in turn quickly priced into the stock.
Favorable Long-1erm Market Dynamics
To appreciate the growth opportunity here we think it's crucial to understand a couple oI things, namely (1) how a structural problem Iacing the world`s major gold producers has resulted in a permanent change in their spending habits going Iorward and as a result, a likely permanent improvement in Energold's underlying economics and long-term growth prospects and (2) the Iact that Energold is Iirmly in the pole position to capitalize on this transition. A solid understanding oI the likely eIIects oI the transition on Energold`s top and bottom lines (and the growth potential oI "Irontier" drilling as a whole) is in our opinion, Iundamental to developing a proper appreciation Ior Energold`s long-term investment potential.
The structural issues reIerred to above relate to the Majors` diIIiculties associated with successIully replacing (let alone growing) their reserves going Iorward. Importantly, with major producers at this point unable to even replace annual depletion, the only way they will be able to maintain, let alone grow production long-term is by devoting an increasing amount oI their growing capex budgets towards greenIield work in "Irontier" markets. The reason Ior this mix shiIt in capex spend is because it is really only within these markets that the major gold producers are likely to Iind deposits big enough to alleviate what is a large and growing problem. Keep in mind that the vast majority oI the world`s existing production comes Irom a relatively small amount oI massive, low cost deposits, all oI which are currently in decline. This Iact alone essentially ensures that 'proving up the world`s well known existing mineral assets won`t come anywhere close to bridging the widening deIicit between what's been Iound and what's actually needed (in order to simply keep overall production steady). The implication being that there is a very high likelihood that all oI the proverbial low hanging Iruit within the world`s existing asset base has already been picked, and as a consequence, the only way to stabilize and/or reverse this dynamic long-term is through ratcheting up exploration spending in hopes oI discovering new deposits oI suIIicient quality, size and scope to close the gap.
In sum, most oI the world`s incremental production currently being brought on line has much higher Iinding and development costs than miners current cash costs would indicate. It`s not so much that the world is running out oI gold per se, as much as it is that we are running out oI 'cheap gold (or the massive deposits that produce at prodigious rates at low costs). As these older 'super deposits produce less and less each year, the worlds major producers have been having an increasingly diIIicult time making up Ior this lost production. This dynamic should support the price oI gold in our opinion and will result in higher exploration spending in remote locations in an eIIort to counteract this reality (cue, Energold :)). Again, there is no other way that we are aware oI Ior producers to alleviate the current bottleneck other than by spending tens oI billions oI dollars collectively over the coming Iew years and beyond on exploring/drilling Ior new high impact deposits. To Iurther this point, we would make the case that this isn`t really discretionary spending going Iorward, as without it, they will Iully deplete their resource base and in the process, cease to be a viable going concern.
Let`s review some high level Iigures exploration spending wise in order to paint a better picture oI how we Ieel the above dynamic will eIIect the Iuture prospects oI the Irontier drilling market and EGD in particular. First, total exploration spending amongst all base and precious metals producers looks to be coming in around ~$14B in 2011, and with Jr. miner`s raising U.S. $12B last year Ior gold related projects, spending should remain stable, iI not improve in 2012 (potentially surpassing the all time spending record set in 2008). Again, overall activity and hence spending is, in our minds, highly probable to remain strong/Iirmly in an uptrend over the next Iew years with (1) commodities and mineral prices high across the board (2) the structural reserve issue getting worse and (3) both majors and juniors having the cash and resources necessary to ramp up spending. OI that ~$14B, roughly ~50 oI that spending - or ~$8B - is currently being allocated towards gold exploration (which may be higher going Iorward, but is essentially in line with gold`s historical share oI the overall exploration pie). Also, the share oI total spend allocated towards Irontier drilling has been decreasing over the last Iew years but importantly looks to have stabilized around 33 oI the total. We think this is interesting as it appears that right about the same time Irontier drilling`s share is set to normalize (i.e., begin to revert towards its natural LT equilibrium closer to say ~45), the structural issues discussed above are set to kick in, which should naturally turbo charge the share gains that accrue to the Irontier market. In other words, the ~$4.62B ($14B in total metal exploration * 33 to Irontier) dollars oI total Irontier drilling spend should grow materially in the coming Iew years, and Energold is almost certain to garner a growing oI this growing pie.
Another point worth mentioning is that at the margin the absolute dollar amount that this incremental demand increase will likely bring about is massive, and our expectation is that the resulting incremental demand Ior Irontier drilling rigs will overwhelm incremental supply. This is a really crucial point, as the dynamic described above should lead to both (1) incredibly high/sustained demand Ior new 'Irontier rigs and (2) signiIicant pricing power Ior rigs already deployed, which is pretty much as good as it gets Ior pretty much the only company capable oI supplying both pieces oI the above puzzle. The result should be huge increases in both volumes and pricing on existing and new rigs, which will lead to an explosion in Energold`s underlying operating perIormance as this dynamic plays out.
All in all, given that EGD is the dominant player in a variety oI relatively unexplored, mineral rich "Irontier" markets, and because their 'man portable rigs are both environmentally Iriendly (unlike competing rigs) as well as possess the ability to drill in remote, hard to reach places (i.e., where their competition can`t), we don`t think it necessarily takes a genius to realize that (1) the company is perIectly positioned to exploit the above dynamic and (2) holding such a key position within what is an abnormally proIitable, rapidly growing niche market - on the cusp oI accelerating growth due to structural change - is almost certain to be an immensely lucrative venture.
Additional thoughts on Energolds Market Position...
Remember that Energold is pretty much the only game in town at this point, and its position as essentially the sole source provider in regards to 'man-portable rigs is likely to stay that way Ior at least the next Iew years, iI not indeIinitely. AIter all, the company`s more mature (read bureaucratic/slow moving), structurally less eIIicient peers have been built in a way that makes successIully competing in remote, diIIicult to reach locations (that lack traditional inIrastructure) practically impossible. Also, local competition within Energold's core markets doesn't stand a chance long-term, as Energolds unmatched Iinancial Ilexibility, superior size and scale, the breadth and depth oI its service oIIerings, etc. practically ensures that threats Irom local mom and pops will always be a non-issue. As things stand then, we don`t see any serious potential competitors anywhere on the horizon that have a prayer in our opinion oI taking a non-negligible amount oI market share.
To understand why this is, consider that in order to seriously compete in attractive new "Irontier" markets in the Iuture, Energold`s larger comps would have to radically transIorm the way they have always done business, literally Irom the bottom up. Granted, success is theoretically possible with enough time, money, and determination but such an outcome is highly unlikely in our opinion, and even under the chance that such a low probability event comes to be, it should take a couple oI years at least beIore these eIIorts would gain any real traction.
A Iew oI the Iactors as to why we think the odds oI Energold's comps successIully engineering such a transition are so low include the majors` (1) entrenched culture (2) radically diIIerent Ileet composition and core "target" market (3) lack oI Iully interchangeable skill sets between the two companies crews and mid-level management (Ior example, the material diIIerences related to diIIering training requirements Ior personnel, the typical target crew member, etc.) and (4) lack oI the requisite in house manuIacturing and logistical expertise, back oIIice systems, political contacts, and other unique "on the ground" experience that is Iundamental to eIIectively produce, mobilize, transport, and train "man-portable" rigs & crews around the globe (at least in an eIIicient, cost competitive manner). OI course as things stand, the Iact that many oI these comps have chosen not to enter the market at all, and perhaps even more telling, oI those that have, none have been able to make any real progress over what has been a suIIicient period oI time to make a good run at it is quite telling as well.
Jalue Proposition (Continued Market Share Cains are a High Probability Event)
Given that Energold`s saIe, low cost, and high quality rigs are 1) cheaper 2) more productive (i.e., quicker per meter) and 3) better Ior the environment than the average drill (read 99 oI the market), the value proposition here is obviously signiIicant. In other words, it seems a near certainty that the company`s suite oI drills/services is intrinsically beneIicial to producers operations on nearly every level.
It`s a similar story Ior the local communities they serve. Unlike the company`s comps whose drill crews are primarily Ioreigners and whose equipment is certain to leave the local landscape scarred long aIter they have packed up and gone home (aIter extracting a Iew billion dollars Ior the trouble oI course), Energold appears to truly care about and actually improve the communities which they operate in. For example, not only do they leave the surrounding environment essentially as it was, they are able to act as a source oI job creation and in the process meaningIully improve the local economies they serve. AIter all, roughly 80 oI Energold`s drill crews are comprised oI locals who are both trained and provided with a competitive and steady paycheck in a world where such things are sadly nearly nonexistent. Additionally, the company usually sets aside 1-2 oI revenues in order to reinvest in local community projects.
Best in Class Management
No discussion on Energold would be complete without mentioning CEO Fred Thompson, who is arguably the best CEO in the industry and is in our opinion responsible Ior almost the entirety oI Energold`s historical (and Iuture) success. OI course we also want to discuss his paper trail because we are, aIter all, talking about a micro cap operating within the mining/commodity industry, so mentioning why we Ieel he has what it takes to deliver over time is absolutely crucial in our minds Ior other investors to properly calibrate the overall risk/reward equation here. So with that said, let`s get to it.
First, we wanted to quickly discuss Thompson`s paper trail and how his leadership has not only Iacilitated high return rig growth oI ~30 annualized since the company`s inception, it also resulted in Energold - unlike nearly all oI its drilling peers - consistently generating cash throughout the worst Iinancial crisis in a generation. Clearly he has proven himselI capable oI (1) running the company to make money regardless oI the market environment or where the company is within the cycle and (2) grinding out market share gains year in and year out, both oI which are an incredibly impressive testament to his skill as an operator as well as in regards to his dedication to preserving/growing shareholder value.
Second, we want to discuss his incentives and uniquely capable background in order to add some insight into why we think he is Iully capable oI executing the company long-term plan. For example, his historical dedication to maintaining...
(1) A strong balance sheet (net cash) - provides suIIicient liquidity/Iinancial Ilexibility to weather the vicissitudes oI a cyclical, commodity industry, as well as to opportunistically capitalize on the mistakes/misIortune oI competitors when and where the opportunity presents itselI.
(2) Capital discipline - Ior example, by Iocusing on ROIC and conservatively growing the company at an appropriate rate (given the appropriate top down and bottom up considerations), an investor doesn't have to worry about the immolation oI shareholder value typical oI the avg management team within the space/industry. OI course the Iact that he owns a ton oI stock might have a lot to do with his prudence as well.
(3) The establishment oI - and improvement upon - the company's permanent cost advantage. A management team that not only excels at operations but that actually gets competitive strategy, and that is continuously Iocused on widening the moat is almost "unicorn" rare in our experience when dealing with micro cap managements operating in the commodity/mineral industry.
(4) A capital light operation with a variable cost structure - this augments the companies ability to quickly react to any signiIicant detonation within the company`s Iundamental outlook and in turn to preserve proIitability much more easily than most over a Iull cycle (2009 was a perIect testament to the power oI this model).
...Have all played key roles in his tremendously impressive operational success since Energold`s creation in 2006 and should continue to as Energold evolves over time.
Another crucial element to Energold`s success is Thompson`s uniquely capable background. His experience as an economics undergrad, International Iinance MBA, CPA and public company auditor, Iinance proIessor and consultant to mining companies, beIore being asked to run Impact Silver, and eventually - once he had the big idea - a specialty driller (Energold), has all been integral to his success and we think oIIers important clues to understanding why he is so capable/ uniquely qualiIied to lead and execute Energold's long-term vision. First, his business background helps in all the obvious ways (capital allocation, strategy, etc.) and second (perhaps more importantly), his experience running both a highly successIul commodity/mineral producer and service company (at the same time) over the last halI decade or so allows an understanding oI the needs and wants oI both businesses (i.e., his customers and competition) that is unmatched in the industry.
Attractive Inflation/Macro Hedge
In light oI structural credit risks and the large amount oI quantitative easing/money printing that has been occurring and, all things considered, will likely continue, it is reasonable in our minds to be concerned about the Iuture buying power oI the U.S. dollar and the paper currencies oI these economies in general. The truth is that continued money printing in the developed world is very likely the only politically Ieasible solution to dealing with the large and growing liabilities that the world`s major economies have racked up over the previous Iour decades or so.
Luckily though, the eIIects oI such policies on Energold`s business and Iuture prospects are not only not harmIul, they are actually beneIicial on a variety oI diIIerent levels. AIter all, this business (1) earns the vast majority oI its proIits globally (2) has pricing power given its market position and the 'man-portable rig supply/demand bottleneck currently underway and (3) its huge leverage to the price oI commodities/minerals generally, but in particular, to gold and silver. All oI which make it a natural hedge against inIlation and in some sense, a play on the current Iiscal and monetary irresponsibility oI our various leaders continuing uninterrupted.
Consider the secondary eIIects that our present Iiscal and monetary policy has on Energold and the virtuous cycle oI operating tailwinds that result. For example, continued money printing all things the same equals higher precious metal prices. Higher prices mean above average and improving ROIC Ior mineral/commodity producers, which equals increasing capital inIlows/ investment in mining companies, which equals increasing exploratory budgets/capex and hence more drilling demand. More drilling equals more demand Ior Energolds service`s, which is interesting but especially in light oI the limited supply oI experienced and capable drilling crews, the majors structural issues related to reserve replacement, and the weak to non-existent competition in the companies large/growing core market, all oI which should result in not only high growth, but in a signiIicant amount oI untapped pricing power Ior the company going Iorward.
Taken together then, Energold oIIers investors 1) tremendous leverage to the price oI precious metals without all oI the operational, commodity and Iinancing risk typical oI mining industry and 2) short to intermediate-term optionality on the continued depreciation oI the dollar and developed world currencies and the signiIicant currency tailwinds that would result (remember that almost all oI Energold`s markets are by deIinition mineral/commodity rich, so rising prices should result in rising currencies relative to our own).
In sum, A Low-Risk, High-Return Investment Opportunity
Given Energold Drilling (EGD CN) (1) is currently trading hands at ~5x our estimate oI normalized owner earnings and (2) will likely continue to organically compound book value at a rapid rate - say 20 - Ior the Ioreseeable Iuture, the company's current valuation is stunningly cheap on an absolute basis and relative to (1) comps (2) other business service companies with similar growth prospects and returns on capital (3) to the 10 yr. treasury or (4) relative to the S&P as a whole.
Preposterously, the current valuation assigns absolutely no value to the company`s premier contract drilling Iranchise or its signiIicant high margin secular growth prospects. In our experience, rarely does one get the chance to purchase a competitively entrenched, high return growth business at a no growth price. Even rarer still, when the company in question operates in a secular growth industry, has a recent history oI high growth, Iavorable near to medium-term operating momentum, and various top and bottom line tailwinds Iirmly at their back.
AIter all, businesses that typically trade at 20 maintenance FCF yields are almost always businesses that are undergoing Iinancial distress and/or are in terminal decline with very little, iI any hope oI value accretive growth in the Iuture. For a competitively entrenched, high return business with an above average secular growth proIile to trade at a similar valuation makes no rational sense. Clearly then, our view is radically diIIerent than the markets regarding the value oI Energold`s growth prospects and/or in relation to the presence oI a durable competitive advantage. It`s this mismatch (expectations wise) that we think is primarily responsible Ior the magnitude oI the current mis-pricing and hence Ior what is in our opinion a truly one oI kind opportunity to purchase a wonderIul business at an almost impossibly cheap price.
Jaluation:
Note all figures are in Canadian Dollars
Adfusted EJ Jalue Calculation.
Current price - $3.79 F/D shares outstanding - ~46.5m MKT Cap - ~$176.25m Debt $10m Value oI Impact Stake today - 6.9m shares ~ $2.02 ~$13.9m Value oI Dominican Republic mineral deposit ~$1m (wild ass guess) Value oI Bertram acquisition ~$18m (accounted Ior at cost) Cash - ~$22.4m
Adjusted EV ~$130.9m
Notes: In order to get a Ieel Ior what we are paying Ior Energold's core mineral drilling business (and b/c its not consolidated within the company's Iinancials yet, which could lead to a decent amount oI noise post deal Ior a Iew quarters) we have deducted the acquisition cost oI Bertram Irom our Adj. EV calculation. Our take is that management likely got a steal here and that long term the 2.5x normalized EBITDA multiple that the company paid will look like a ridiculous bargain in retrospect, especially as the strategic and Iinancial beneIits become increasingly clear. Regardless, the assumption here is that Bertram is worth at least the ~$18m they paid.
Also, Energold's true adj. EV could be signiIicantly lower (potentially negative even) depending on a couple oI issues.
First, one could potentially justiIy canceling out some, iI not all oI the $10m in debt related to the recent Bertram acquisition with the 10m backlog acquired Irom the recent Dando purchase (bringing the adj. EV to ~$120.9m).
Second, the Dominican Republic land/deposit could be worth materially more than the $1m listed above, as other producers continue to prove up their own high quality parcels surrounding EGD's claim. The thought is that (at least as we understand it) as these producers continue to de-risk EGD's play the accretion oI value here could be both quick and material. Fwiw, Thompson has stated he intends to be opportunistic and that they will monetize this asset in the near to medium- term as the above dynamic unIolds.
Third, and this is where things get intriguing, EGD's stake in Impact Silver could potentially be worth somewhere between ~ $25m to $130m (maybe more) over the next 3-5 years depending upon the amount oI oz. the company produces and the price oI silver (obviously). We can run the the numbers on a variety oI scenarios, but at minimum we think that it's really hard to rationally argue the IV oI this stake is worth less than $25m (vs. Our current mark oI 13.9m). Anyhow, our back oI the envelope calculations leads us to believe that the optionality associated with EGD's ~10 Impact stake is signiIicant. Notably, iI things go reasonably well over the next Iew years - which Iwiw we think is likely given management`s history oI operational excellence, low cost producer status, ability to internally selI Iund organic growth, and numerous levers available to them to help Iinance a massive production ramp through 2015 Energold`s stake is worth at least ~$50m (again, based on what I think are plausible estimates, i.e. 1.5m in 2012 production, $50 silver, etc.). II we assume $30 silver, a static $13 cash costs, and a production ramp that amounts to only halI oI its 2015 production potential oI 6k ounces - i.e. 3k ounces (and a 10x multiple), investors would be getting Energold`s operations essentially Ior Iree.
Clearly then the Impact stake is a material hidden asset that in many ways amounts to an embedded call option leveraged to higher silver prices and managements ability to execute the company's huge production ramp over the medium-term. It appears entirely reasonable to us that we may look back two years Irom now and realize we actually got paid to own a best in class, rapidly growing niche business Ior less than nothing. Not saying it's probable, but it's certainly possible and better yet, we aren't paying a dime Ior it.
For a more granular look at Impacts valuation, the recent and well-done write-up by Iriend oI the blog Mario Skonieczny oI the superb Classic Value Investors is posted below. His discussion oI the valuation under diIIering scenarios provides a great, quick and dirty overview oI what IPT is/could be worth under a variety oI potential Iuture outcomes, and is particularly helpIul in our opinion as Iar as thinking about the value oI the optionality/embedded call option here. The Iull write-up can be Iound here.
"Jaluation
IMPACT Silver increased silver production from 348,949 ounces in 2007 to 823,571 ounces in 2009 which represents a 136 percent growth. All this growth was financed bv internal cash flow, which is absolutelv ama:ing. Also, lets not forget that the price of silver was nowhere near where it is todav. In 2010, production dipped to 750,259 because the companv revised cut-off grades and mined more medium grade ore as it took advantage of high silver prices. In 2011, silver production is on track to reach 1 million ounces. During the first quarter of 2011, the companv alreadv produced 260,970 ounces. Bv 2012, the companv profects a production level of 1.5 million ounces of silver. Considering that so far, the management is executing flawlesslv, I have no doubt that thev will be able to execute again.
Lets first look at how much monev IMPACT Silver can make with the production of 1 million ounces of silver. I will use a silver price of $30 per ounce even though it is $36 per ounce as of the date of this report.
Revenues 1 million production x $30 per ounce $30 million
Expenses 1 million production x $13 per ounce $13 million
Profit before Taxes $17 million or $0.24 per share
Using a multiple of 10 on this number gives us a value of $2.40 per share.
Now lets take a look at how much IMPACT Silver can make with the production of 1.5 million ounces of silver which is scheduled to occur in 2012.
Revenues 1.5 million production x $30 per ounce $45 million
Expenses 1.5 million production x $13 per ounce $19.5 million
Profit before Taxes $25.5 million or $0.35 per share
Using a multiple of 10 on this number gives us a value of $3.50 per share.
What if Eric Sprott is right and silver reaches $50 per ounce?
Revenues 1.5 million production x $50 per ounce $75 million
Expenses 1.5 million production x $13 per ounce $19.5 million
Profit before Taxes $55.5 million or $0.77 per share
Using a multiple of 10 on this number gives us a value of $7.70 per share.
What if Eric Sprott is even more right and silver reaches $100 per ounce?
Revenues 1.5 million production x $100 per ounce $150 million
Expenses 1.5 million production x $13 per ounce $19.5 million
Profit before Taxes $130.5 million or $1.81 per share
Using a multiple of 10 on this number gives us a value of $18.10 per share.
As vou can see the value of IMPACT Silver will depend on the price of silver and its underlving production. Consequentlv, if we assume silver production levels of 1.5 million ounces of silver, then we arrive at values between $3.50 and $18.10 per share. While I have no idea where it will fall, buving it for $1.70 per share does not seem like a bad idea.
But the storv does not end here. The above production calculations are onlv from the Zacualpan Silver District. Thev do not include Mamatla Mining District, which as I mentioned before could add over 4.5 million ounces to the companvs silver production levels. Running the same number using 6 million ounces of production can get vou a stock price that is significantlv higher than anv of mv conservative estimates. Because the companv is cheap based on the current production, I wont bother calculating it and I will treat it as a free option that might have some value in the future."
Net Asset Jalue.
Given the myriad oI risks/headwinds that still Iace the global economy we think it makes eminent sense Ior investors to look Ior low-risk investments with rock solid downside protection along with certain other deIensive characteristics that in combination, will likely ensure the business in question should continue to do well under any reasonable Iuture outcome we can imagine. With that in mind, we believe purchasing EGD at or around NAV (at current prices) and/or a mid single digit to its steady state earnings power oIIers investors exactly such an opportunity.
AIter all, its pretty hard to lose money purchasing a Iast growing Iranchise business with 20 EBIT margins and the ability to grow organically at high double digit rates at roughly its readily saleable tangible asset value.
Quick and Dirtv Pro Forma NAJ.
A) Current Mineral Drilling Rig count oI 118, assuming a private market value oI ~750k/per rig $88.5m B) EGD's adj. net working capital ~$34m C) Bertram NAV at cost $18m D) Dominican Minerals $1m Total Assets $141.5m Less: $10m Debt NAV $131.5m NAV per share $2.83 Price to NAV 1.35x
Energold`s NAV is calculated by adding the private market value oI the mineral drilling Ileet, the value oI Energold's net working capital (less inventory), and the book value oI the rigs recently acquired through the Bertram acquisition. Note that our private market value calculation is based on the value oI the rigs being sold along with their contracts (which is why it is higher than the 500k/rig replacement cost) - as the remaining cash Ilows Irom the existing contract in place will always be included in a private sale.
NAV should approximate roughly $131.5m, implying a net asset value per share oI 1.35x. We note that given the build out oI twelve more rigs and cash generation, Energold is likely trading at or slightly below our estimate oI NAV Ior year end `11. Although an earnings power valuation is the more appropriate metric, the Iact that investors are paying NAV Ior a Iranchise business should provide an additional layer oI comIort/downside protection. Generally speaking, buying businesses that can generate 30 ROIC near the saleable value oI their assets is a very good strategy.
Normali:ed Earnings Power (Base Case)
We believe the Iollowing assumptions are conservative as Iar as normalized pricing, utilization and rig count is concerned (Ior some historical context, Energold has grown revenues over 900 over the last Iive years). Notably, we have purposeIully attributed no value to the ~100 rigs acquired in the Bertram acquisition Ior conservatism's sake. In other words, the normalized earnings capacity listed below is entirely a Iunction oI what we expect the core mineral drilling business alone to earn in a normal year going Iorward on Energold`s existing asset base (everything else is gravy).
So with that said, Q1 11 pricing was $170/meter. $190/meter assumes 5 price increase and 5 Irom improvement in mix shiIt.
Energold is adding roughly 25 to its rig count. II we assume that only Iour out oI Iive are Irontier drilling rigs (it will likely be all oI them) and Irontier pricing is $250 versus $140 Ior brownIield, then average revenue per meter could be raised by another $30MM. This would add $10MM in net income.
valuaLlon - normallzaLlon of LxlsLlng AsseL 8ase
8lg CounL 118 MeLers er 8lg 6,300 Average 8evenue er MeLer $190.0 1oLal 8evenues (MM) $143.7 CosL of urllllng $87.4 Cross roflL $38.3 S,C&A $20.0 CperaLlng lncome $38.3 1axes $12.6 !"#$%&'()" *+,-.
We think such a yield is mouthwatering, rub your eyes and check again attractive, especially given the tremendous qualitative attributes oI this business and the Iact that this ~20 maintenance FCF yield will likely grow at a low twenties double digit clip over time. Personally we Iind it incredible that EGD's tremendous high margin/high growth potential is currently being assigned zero value by the market, especially given that above avg, highly proIitable growth going Iorward is a high probability event given Energold`s dominant market share, sustainable cost advantage, superior value proposition, etc.
From a Iinancials perspective, we think this is one oI the most important elements. Comparison oI Historical ROIC with Normalized Operations on Existing Asset Base
Note: Inputs Ior normalized conditions include: 118 current rig count, 6,500 meters per rig annually, $190 revenue per meter, 26 operating margins, $10MM add to asset Ior Bertram Acquisition convertible issue and $2MM contribution to NOPAT Irom Bertram division)
Historically, Energold`s ROIC has ranged Irom mediocre to downright bad. This is attributable to two major Iactors (1) a signiIicant lag in the time between capital investment and revenue generation and (2) a catastrophic hit to the industry in `09 and `10. Over the last two years Energold has added 40 rigs to its Ileet count. This investment, along with acquisitions, has total $40MM, yet until the end oI 2010 and into the beginning oI 2011 revenues had actually declined Irom 2008 levels. With rigs now built and being delivered to their work site as we write this and utilization in Iull recovery mode thanks to $1700 gold, this trend is set to reverse. Fast.
Energold possesses highly attractive opportunities to reinvest its cash, resulting in high contribution margins and Iurther improving returns on invested capital. Assuming that each new rig consists oI $350,000 investment in capital assets and $250,000 in working capital, we estimate that Energold`s investment in new rigs has a strong chance at generating 50 aIter-tax returns.
Cost oI a New Rig $600,000 Meters Drilled 6,500 Revenue Per Meter (Frontier Pricing) $215 Annual Revenue $1,397,500 Gross Margin 40 Gross ProIit $559,000 Incremental SG&A 5 SG&A Load $69,875 Operating Income $489,125 Taxes $161,411 After-Tax Incremental Cash Flow $327,714 After-Tax ROIC 54.6
Normali:ed Earnings Power (5 vears)
The Iollowing long-term scenario assumes that Energold is capable oI tripling its current man- portable rig count looking out long-term. This is supported by what we believe is the entirely reasonable assumption that this superior high return, capital light business, with its innovative, proven, Iully incentivized jockey, durable competitive advantage, and a long, high-return growth runway should be able to grow it's overall industry wide market share Irom the current ~2 (118/ 7000) to ~5 (354/7000) within the next 5 years.
So given the above and assuming similarly conservative assumptions similar to our base case, we get a total rig count oI 354 rigs. Assuming they do 6.5k meters per drill at rates averaging ~$190/ meter, normalized revenues should equal $437,190,000.
II we also assume a conservative normalized 40 GM, SGA at 10 (to reIlect the considerably larger scale and inherent operating leverage within the business), and a 30 tax rate, Energold`s core mineral business alone should generate NI oI ~ $91.8m.
Compared to its current Adj. EV oI ~$130m, Energold appears to be presently trading hands at little more than 1x core 2017 owner earnings. Not a bad outcome Ior long-term investors who possess the willingness to wait patiently Ior management to deliver/execute the plan, no?
YE 2017 total rig count 354 6.5k Meters per drill Revenues per meter $190
Normalized Revenues $437.2m Normalized GM 40 $174.9m in gross proIit Normalized SG&A 10 $43.7m in corporate expense Normalized Tax Rates 30 $39.4m in taxes owed Normalized NI $91.8m Normalized Maintenance FCF Yield $91.8m/~$130m or a ~70 maintenance FCF yield
Applying reasonable 10x multiple on 2017 NI, the business is worth $918m which divided by the ~46.5m F/D SO, equals ~19.75/share. At a more rational market multiple oI 15x 2017 Owner Earnings, the business is worth $1.37B or ~29.61/share. Not bad given a current share price oI ~3.86/share.
Note: Because the company has hit an inIlection point within its corporate development that should allow it to internally Iund the entirety oI its growth capex on a go Iorward basis we have decided to keep the share count the same. We realize that management has historically\recently opportunistically issued shares to Iund a Iair amount oI its Ileet growth/acquisitions but the past is not likely prologue in our opinion and why issues shares when there's no need to (again, internal cash generation should be plenty suIIicient to add the rigs necessary to capture 5 oI the market. Historically it made sense (all things considered) and given rig count grew at 3x the growth in share count, that growth was still massively value accretive on a per/share basis.
Normali:ed Earnings Power (Scorched Earth Scenario).
Now that we`ve looked at the some oI the more probable outcomes, lets assume that the Iuture turns out to be considerably worse than we imagine and not only does growth cease, but that the mix shiIt and thereIore revenue and gross margin expansion we expect never materialize. As the low cost operator then, we assume that the company starts bidding contracts out at say a 30 gross margin or a level at which its comps will lose money. Lets also assume meters drilled per day are only ~5.5k and purposeIully inIlate SG&A and depress the price/meter piece oI the equation to account Ior a potentially equally as diIIicult market environment as the company experienced in 09 - all oI which we think are incredibly unlikely to happen again but we are attempting to see what this business is worth under a scorched earth scenario so we`ll run with it.
So with YE 2011 rig count at ~130, 5.5k meters/rig, and price/meter at $165 we get normalized revenues oI ~$117,975,000. At a 30 gross margin, SG&A at $20m, and a 30 tax rate Energold will earn ~$35.4m in gross proIit. Taking that ~$35.4m and subtracting the ~$20m in corporate expense equals ~$15.4m. AIter adjusting Ior the 30 tax rate we get ~$10.78m in aIter tax income or ~12x the current adjusted EV.
Ironically enough then, we think that iI one assumes an almost impossibly draconian outcome that implies (1) no growth (2) no market share gains (3) depressed Ileet wide utilization and (4) a price per meter drilled less than what was earned Ileet wide at the trough oI the worst environment in modern memory, then investors are paying something much closer to Iair value on an earnings basis or a ~12x multiple on depressed 2011 earnings. Yet our margin oI saIety under this scenario comes Irom the Iact that we didn't purchase the company at a signiIicant premium to NAV. Wherever we are in the cycle, a wonderIul business run by a phenomenal jockey is worth more than its tangible asset value.
We think the odds oI such an outcome coming to Iruition are less than 5 and even iI it does, the company would in reality still oIIer downside protection, consistently generate cash and grind out additional share gains (and hence grow) by undercutting less eIIicient comps, which as it happens would Iuel even stronger core earnings once the cycle eventually turns at some point in the Iuture (and preserving/growing Energold`s per/share intrinsic value in the process).
1op and Bottom Line Drivers - Recap
Companv Specific Factors
Rig Count is Increasing - As more low cost, quick payback, high ROIC rigs are built and deployed towards the company`s highest return opportunities, Energold should increasingly beneIit Irom Iixed cost utilization as early stage markets gain scale and the higher margins and better utilization rates on incremental revenue start Ialling towards the bottom line. As rigs are rapidly added, we expect the combination will be explosive, as increased activity should result in more rigs doing higher volumes at better prices, which in turn should drive rapid improvements in revenues and gross margin.
Also, investors should take comIort in the Iact that demand Ior additional rigs should stay extremely strong given industry trends as it provides a relatively visible and signiIicant growth trajectory Ior Energold to exploit. It`s also nice that Energold is in a great position to meet this large and growing demand given it has the internal cash Ilow and balance sheet strength to continue to Iinance above average (high return) Ileet growth as long as necessary.
Price/Meter is Increasing - With the shortage oI rigs within the industry already evident and the step change in exploratory spending in Irontier markets just beginning, pricing power should rapidly accrue to the industry as what is an increasingly tight supply/demand bottleneck only gets worse Irom here (as incremental rig demand should continue to overwhelm incremental 'Irontier capable supply).
With that in mind, we expect both overall rig demand and day rates to continue to move up - and given the company remains pretty much the only game in town - we expect that most oI the mineral industry`s increasing exploration spend on Irontier drilling should, in one way or the other, accrue primarily to Energold. AIter all, there isn`t a competitor in sight that has anywhere close to the unique capabilities required to step into this growing gap in order to help 'de- bottleneck the situation.
Rig Utili:ation Increasing - With large and growing spreads between the ROIC and the cost oI capital, gold producers oI all sizes should continue to Iire up their drill bits as Iast as possible. Again, this increase in Irontier related exploration spend looks set to continue Ior quite awhile and will obviously augment the demand Ior man-portable rigs, in turn driving a growing proportion oI Energold`s total Ileet towards higher margin markets.
Positive mix shift - a large oI the company's assets will be redeployed at more attractive rates within the next year as more rigs are added and legacy, lower margin drilling contracts run oII. The result is that higher margin Irontier contracts should begin to make up an increasingly large portion oI the companies total revenues and operating proIit over the next couple years. This will slowly transIorm the cash generating capabilities oI the existing Ileet in a hugely positive way, and ultimately leading to Energold generating rapidly increasing amounts oI owner earnings/ share.
Industrv Specific Factors
Increasing Commodities Prices (primarilv gold) - Given how proIitable gold production is around current levels, increasing amounts oI capital should continue to Ilow into the industry. This could cause both volumes and pricing to simultaneously increase dramatically, which in turn would likely result in exponential as opposed to linear EBITDA growth as operating leverage and pricing power magniIy FCF growth in relation to revenue growth.
Mafor/Junior Capex Budgets are Increasing - With both major and junior E&P`s sitting on record cash balances and structural issues being what they are, producers have (unsurprisingly) continued to expand their exploration budgets Ior the 2011/2012 Iiscal year(s). Notably, exploration spending Ior 2011 is on track to clock in at ~14B and due to issues already covered, will almost certainly go higher Irom here.
Conclusion:
So, what we have here is an innovative, environmentally Iriendly business with 1) a sustainable, nearly impossible to replicate cost advantage 2) attractive incremental economics 3) very low market share and 4) a tremendously long runway Ior high return growth in Iront oI them coupled with a growth strategy Iocused on rapidly expanding in under-served markets with minimal competition, which in turn allows them to quickly entrench as the low cost provider.
This is a business that also happens to be 6) a leader in innovation with an ability to grow rapidly over time Irom its present small base oI revenue and proIits and perhaps even more importantly, has a very high probability oI earning multiples oI what it earns today looking out a Iew years and 7) is run by a uniquely capable, visionary owner/operator with a long and impressive paper trail oI success and huge insider ownership. It also happens to be unsustainably cheap.
We think the combination oI the above Iactors should provide investors with the opportunity to earn 2-10x their money with very little risk oI permanent capital loss under any reasonable Iuture scenario we can imagine looking out 3-5 years. In the incredibly improbable event that a scorched earth scenario happens, its important to keep in mind that even then, the company would likely still prosper in a downturn (at the expense oI its weaker comps) and its still cheap to Iairly valued (and growing).
The bottom line here then is that Energold appears to be a classic low-risk, high-return Iat pitch and in our opinion it`s only a matter oI time beIore the market wake`s up and comes around to our point oI view (our guess is sooner rather than later). When it does, we expect the market will quickly award this high quality business with an appropriate (i.e., higher) multiple much more reIlective oI the quality oI this business and its high return, above average growth prospects.
Catalyst(s):
Investor recognition oI a great business
Improving operating perIormance - increasing rig utilization and pricing power begin to demonstrate the company`s latent/true earnings power
Miscellaneous Must Read's:
CEO Fred Thompson's Recent Interview
Adventures in Capitalism Blog Posts
Mining Services Part 1
Mining Services Part 2
ENERGOLDen
Eric Sprott Interview/`Markets at a Glance`
Recent Chris Martenson Interview
Follow the Monev
Energold Companv Materials
Energold Financials/Letters to Shareholders
Energold Drilling July Presentation
Appendix:
3 Crucial Questions:
The million dollar question(s) with Energold in our minds revolves around three issues. The Iirst two relate to thinking about what really drives Energold`s top and bottom lines, in particular, (1) how many meters will the company drill, and (2) what price will they get per meter? II you can satisIactorily answer both oI those questions than you can approximately estimate what the company should earn. The other relates to the durability oI its moat (or lack thereoI). In particular, is their advantage permanent or merely temporary? AIter all, iI Energold truly is one oI those exceedingly rare businesses that possess above average prospects Ior sustainable value creation then it is very likely worth many multiples oI its current price. II not, then the risk/reward calculation changes considerably and its a pass. So again, the question really boils down to whether or not Energold`s present level oI owner earnings is - at an absolute minimum - sustainable, and iI so, why?
With the above in mind, lets get down to answering the questions at hand, namely how does one evaluate a company`s prospects Ior sustainable value creation and gain conviction in their possession oI a sustainable competitive advantage? Well, we know that a company must have two characteristics to claim that it has a durable competitive advantage. The Iirst is that it must generate, or have an ability to generate, returns in excess oI the cost oI capital. Second, the company must earn a higher rate oI economic proIit than the average oI its competitors. So given that, its helpIul to review a quick primer on the unique attributes oI a durable moat beIore discerning the issue.
The excerpts below are taken Irom the Iantastic series on competitive advantage (which can be Iound in Iull here, here, and here) via another one oI our Iavorite blogs, the outstanding The Fallible Investor.
So, Iirst things Iirst, what is a sustainable competitive advantage?
'As most of us are aware, a sustainable competitive advantage is the abilitv for a business to do something that its (potential) rivals cannot. It means being able to. 1. Keep the businesss current customers and, 2. (Possiblv) grow bv attracting new customers, 3. On terms which are more profitable than the businesss competitors, 4. For a reasonablv long-time (it is sustainable not temporarv)`
Second, what is, and how does one evaluate, an economies oI scale competitive advantage?
'A business has an economies of scale competitive advantage when.
1. It has a much larger market share with a product or service than its competitors in a.
Geographic area, or, Product or service space (for example Intel with computer CPUs), and,
1. Fixed costs make up a large share of total costs.[2]
If this occurs the dominant businesss average cost per unit will be lower than its competitors. Its smaller competitors will have higher average costs because thev cannot reach the same scale of operation. The dominant businesss lower average cost per unit means it can keep competitors at bav bv using one or more of the following tactics. It can have.
1. A lower price for its product or service than its competitors, [3] 2. A more technologicallv advanced product or service than its competitors (it can spend more on research and development), or, 3. Better marketing for its product or service than its competitors (it can spend more on advertising and sales promotion).[4]
However, as Professor Greenwald points out, pure si:e is not the same as economies of scale.[5] It is the share of the relevant local market rather than si:e bv itself that creates economies of scale.`
Third, an economies oI scale advantage alone isn`t enough - only in combination with customer captivity, will economies oI scale result in a durable advantage...
'Economies of scale bv itself are not enough for a business to keep a competitive advantage. If a business has onlv an economies of scale advantage, its competitors will be able to take some of its customers and will eventuallv be able to capture enough market share to remove its scale advantage. 1he business with the economies of scale advantage needs to be able to keep its larger market share. It does this by keeping its customers. 1he way to do that is to have at least a mild form of customer captivity.`
'The overwhelming prioritv of a business with an economies of scale advantage is to protect its market share and, thus, keep its large si:e relative to its competitors. It can do this bv matching the moves of an aggressive competitor price cut for price cut, new product for new product, niche bv niche. If it does, then its customer captivitv will secure its greater market share. Its competitors average costs will be higher than its average costs at everv stage of the struggle. While this will reduce the profit of the business with the economies of scale advantage, its competitors will usuallv make verv low returns on capital, or a loss, and will eventuallv stop competing.