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It’s been an incredibly tough last
couple years for the miners. Not only have they had to endure sharply
falling metals prices, they’ve had to battle continually rising
operating costs. For the producer companies this combination has been a
margin killer. And for the non-producers it’s been flat-out
devastating.
Mining companies that are non-producers
obviously don’t generate any revenue. They are junior-level
companies in various stages of exploration and/or development. And they
primarily rely on investor capital to fund their operations. In some
cases they are able to procure bank loans, but this is the exception.
If it costs more to operate, and the
prospects of juniors’ metals of focus fade via falling prices,
investors lose incentive to subscribe to their shares. And if investors
aren’t subscribing to their shares, then capital quickly runs
dry. This is a major problem in a capital-intensive business!
Perhaps no group has suffered more than
the silver juniors, for the simple reason that silver has seen more carnage
than the other metals. In 2013 alone silver was down a brutal 36%.
And since its April 2011 high, it was down a staggering 60% to the end
of last year. If the metal took this much of a beating, you can only
imagine how the miners have fared.
Last month I looked at the SIL Silver Miners ETF, which is comprised of the stocks of the world’s
best-of-the-best silver miners. And indeed this ETF took it on the
chin. As bad as it’s been for these elites though, it’s
been far worse for the small juniors. A powerful sentiment maelstrom
has sent investors running for the hills, leaving hardly anybody left to buy
their shares.
To no surprise the juniors lack
representation in SIL’s underlying index. In fact, as of this
week only two of this ETF’s constituents were of junior ilk.
Without an index and/or ETF, it’s of course difficult to measure group
performance for the juniors. But as any investor who has owned silver
juniors the last couple years will tell you, the going has been incredibly rough.
They’ve leveraged silver to the downside, and have left us in a sea of
despair.
Perhaps more prudent than measuring
performance at this stage is measuring health. With their stocks
pulverized, there’s little arguing that the juniors are on life
support. And since it is so difficult to find a pulse, we need to be
creative in getting their vitals.
At Zeal we have a research arm that
delves into various sub-sectors of the commodities markets. We dig deep
into companies’ fundamental underpinnings via the examination of such
things as financial statements, technical reports, and management histories
in hopes of identifying stocks with the highest probability for
success. And our latest undertaking took us into the silver realm,
specifically companies that explore for and/or produce this shiny-white
metal.
The particular universe of companies we
focus on are those that list their stocks in the US and Canada. And
since the US/Canadian exchanges are the world’s premier destinations
for resource companies seeking to raise capital in the public markets, this
universe offers an excellent representation of industry trends.
When analyzing these companies
it’s important to categorize them into different peer groups, as it
wouldn’t do any good scrubbing up a 5m-ounce-per-year producer with a
single-drill-rig explorer. Thus the most logical dividing line is
between those that produce the metal, and those that don’t.
Producers versus non-producers, or in our case juniors.
Interestingly when it comes to
producers, the population is pretty thin. In fact, there are only a
couple dozen in our universe. But though these companies number few,
they’re responsible for a big chunk of the world’s mined supply that
comes from primary silver mines. And it is these bigger, safer,
revenue-generating companies that dominate SIL.
On the periphery of the producers are
the juniors, exploration companies seeking to discover and develop
silver-centric mineral deposits. At a high level juniors end up
traveling one of three roads. First, and most common, is the road to
failure. It is incredibly difficult to prove up an
economically-feasible silver deposit. Second, they sell their companies
and/or successful projects to producers for development. And third,
they go down the road of development themselves, becoming producers.
All three of these roads traveled have
one thing in common, the need for capital. And yes, in this business
even failure requires money. You really don’t know if a project
is a dud until after you’ve paid staff, spent money on acquiring
claims, and funded expensive exploration programs.
Cash is king, all juniors need it.
And since they don’t generate revenue, the nearly 100 juniors in our universe
are scraping and clawing for every dollar from a limited pool of investor
capital. Silver juniors must sell their stories to investors. And
these stories must be compelling if they want to attract enough capital to be
productive in their exploration endeavors.
So with cash as king, one surefire way
to measure the health of these juniors is to have a look at their balance
sheets. As part of our research we pulled the balance sheets from these
juniors’ latest filings in order to catalogue their working-capital
positions. And with cash typically the key component of the asset
portion of the working-capital formula, especially for junior resource
companies, it was also catalogued.
When we ran this data in September, the
latest available financial statements were from Q2 2013. And with the
two years leading up to these filings pretty rough for this sector, I
anticipated some ugliness. But what I found was beyond ugly, it was appalling!
To get a feel for the juniors as a
whole, I performed a simple average of these nearly 100 companies’
working-capital and cash positions. And coming in at only $3.4m
and $4.7m respectively, we can begin to get an idea of how bad things
really are. But sadly, they’re
much worse than this initial read.
As would be expected, there are some
outliers that skew this data. On the high side there are a handful of
companies that have exceptionally large working-capital/cash positions.
These juniors have advanced-stage projects that are either being developed,
or are on the cusp of development. And they’ve successfully
tapped the debt and/or equity markets to raise the capital necessary for
their mine builds.
On the bottom side there are a number of
companies with negative working-capital positions. Now negative
working capital is not always a negative thing depending on the business
model, but in the mining business it is usually bad. And since cash is
typically the largest current asset for junior explorers, a negative working-capital
position means that current cash is not sufficient enough to fund current
liabilities.
To smooth out the data I removed the
five outliers on both the top side and bottom side. And this put the
average working-capital and cash positions at only $1.4m and $1.6m
respectively. This would be paltry for a small chain of yogurt
shops! How is it supposed to be sufficient for a company that needs to
pay for hard-rock exploration?
The reality is,
it is not sufficient. It costs a lot of money to pay for the services
of professional geologists and engineers, to pay laboratories to assay
samples and perform metallurgical work, to buy or rent equipment for
surveying, mapping, and drilling, and for other incidentals including
transportation (most mineral deposits are off the beaten path). $1.6m
doesn’t go very far when it comes to performing meaningful exploration
work!
Amazingly this low average is still not
the worst of it. Fully 35 silver juniors have negative working-capital
positions, with this group sporting an average cash position of only $233k.
Talk about being on life support!
The vast majority of silver juniors desperately
need capital injections. And if they don’t get them soon,
they are at risk of no longer being “going concern” companies.
These injections are of course easier said than done though.
As mentioned the sole source of funding
for these cash-strapped juniors is proceeds from the sales of their
shares. And the buyers of these shares are typically retail investors
(some of the larger juniors can attract institutional investment, but they
still heavily rely on retail). There’s one problem though,
silver-junior investors are currently nowhere to be found.
It’s no secret that equity
financings for junior resource companies are way down over the last few
years. And this is readily apparent when comparing this balance sheet
data with our previous analysis of junior silver stocks in late 2012.
With that round of research pulling from Q2 2012 financials, we essentially
have a year-over-year comparison of working-capital and cash positions.
In only a single year, working capital
and cash were down a whopping 56% and 48% respectively.
And this is even with capex burn rates way down as
most companies freeze spending. Sadly I suspect these vitals will
register even worse in 2013’s year-end financials given the ongoing
lack of activity on the equity-financing front.
Overall meaningful equity financings in
the silver-junior realm have been few and far between. Sentiment is so
poor that these explorers just aren’t able to attract many
investors. And the sad reality is meaningful investor interest
isn’t likely to return until there’s a meaningful silver upleg.
Silver-junior struggles are not only
painful to watch for the remaining contrarian investors, they are painful for
the industry. These juniors serve a vital role in the silver production
cycle. And with the current capex freeze
delaying project advancement while grassroots exploration is all but dead,
there will no doubt be pipeline issues down the road. This will
adversely affect reserve renewal, and ultimately production.
Now if silver’s secular bull
market is over, this junior cleansing won’t be a big deal. But if
it’s not, it will serve to build fundamental silver strength down the
road. And the surviving juniors will see their stocks soar as silver
makes its comeback and investors return.
At
Zeal we believe silver is on the verge of making a roaring comeback after an
anomalous 2013 sold it off way too hard. And silver’s launch higher will rekindle interest in silver
stocks. This interest will eventually filter down to the juniors, and
it’ll result in them procuring the capital necessary to resume
operations.
Now
is the time to buy silver stocks, while the blood is still in the
streets. And though the blood is thick in the junior realm, there are
still some quality ones available that ought to thrive in a new silver upleg. As a product of our aforementioned research
we identified a dozen high-potential silver stocks to fundamentally profile
in our latest fascinating 27-page report, and 4 of them fall into the junior category. Buy your report today!
At
Zeal we’ve been layering in silver-stock trades for months now in our
newsletters. In both our weekly and monthly publications we now have a foundation
of open positions that ought to see legendary gains if the precious metals do
what we believe they will in 2014. To find out which stocks we are
trading, and to get unequaled contrarian market analysis, subscribe today!
The
bottom line is junior mining stocks are currently the pariahs of the
markets. And perhaps no group has had it worse than the silver
juniors. Silver’s collapse has scared away investors, which has
greatly tightened the capital pool. These juniors are thus having a
heck of a time selling their shares, which has ultimately resulted in appalling
health conditions as measured by their balance sheets.
With mineral exploration and development a highly
capital-intensive business, most silver juniors have been forced to put a
halt to their work programs given their inability to fund them. They
are dead in the water until silver’s fortunes turn around. If
silver’s bull market is over, it will be the end of the road for these
juniors. But if it’s not, they’ll roar higher as investors
return. With the latter the most likely scenario, now is the time to
buy. Jump on in while junior silver stocks are at bargain-basement
prices.
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