The Toronto Venture
Exchange (TSX-V) is the center of the Canadian junior resource sector. Most
of the listed companies are early-stage exploration and development stocks
that in the majority of cases do not generate cash flow and may not even have
any significant assets. Without income, they rise and fall in concert with
market sentiment toward their potential. From time to time, the expectations
are backed by a genuine discovery, but many times they are a product of management's
promotional efforts.
There is a reason they
are called "the most volatile stocks on earth." And today, these
stocks are showing the downside of that volatility. In this update, we
examine some of the details of this junior market and by extension, what to
look for in a junior explorer.
Got Cash?
Cash is a junior's most
important asset – arguably even more so than a 43-101 compliant mineral
resource. Cash is the lifeblood of their business; those companies that can
raise it on good terms have a chance to discover and develop a deposit into a
profitable mine. Those that don't have much in the till must find ways to
raise more without instigating shareholder revolts, or they won't remain in
business for long.
To look at how
cash-healthy the companies comprising TSX Venture Composite Index are, we
traced their cash positions from the first quarter of 2007 to present, as you
can see in the following chart.
(Click on image to
enlarge)
This chart shows how much
cash a TSX-V-listed company has on average. Since we had several outliers in
the data set, we measured the median amount of cash per company instead of
the mean. Please note that the current index may not include all companies
that entered and left the TSX Venture Exchange since Q107. Also, although the
TSX-V is dominated by resource-sector stocks, some companies are in other
industries.
The chart is quite
telling: the trough from late 2008 through the first half of 2009 is
distinct, as is the giant increase in late 2010. Following the mid-2011 peak,
the Venture Exchange entered a cooldown period that
has continued until now. Today, an average TSX-V-listed stock has one-third
less cash than it did in the second quarter of 2011, having US$2.8 million in
the till compared to US$4.3 million at the peak.
Although the 2011 drop
seems concerning, some may be reassured by the level being much higher than
it was in 2007, before the 2008 crash. However, on a per-share basis it's
worse. As the total share count of the constituents in the composite index
soared from 13.2 billion in the first quarter of 2008 to 54 billion the last
quarter, the amount of cash per share dwindled, coinciding with the bearish
shift in investor sentiment, as you can see in the chart below.
(Click on image to
enlarge)
On average (and we used
medians here, too), a TSX-V-listed company seen its cash backing per share
decrease by a factor of at least two: from 6.2 cents in the second quarter of
2011 to 2.8 cents in the most recent quarter. The current situation resembles
the 2008 downturn, although it is not yet quite as dramatic: at the bottom of
the crisis, in the first quarter of 2009, the average TSX-V listed company
had a mere 1.6 cents of cash per share.
On the other hand, we
believe there's a greater difference between the "haves" and
"have-nots" today. The median doesn't look too dire, but instead of
a sudden crash, we've had a long decline, during which many companies put off
raising funds, hoping to do so when market conditions improved. Those happier
days have failed to materialize for so long, there
must be a lot more companies running on fumes today than there were in 2008.
Bills to Pay
Let's now see how much in
liabilities TSX-V-listed companies have against their cash. The next chart
shows that TSX-V-listed companies now have more liabilities per share than
they did in 2008.
(Click on image to
enlarge)
As of the most recent
quarter, the median amount of total liabilities per share equals just 2.6
cents, slightly below the median company's cash backing per share.
This tells us in simple
terms that the average exploration-stage company, after deducting their
liabilities, has very little cash to continue funding their operations. After
they pay off all their liabilities, they have only 0.2 cents per share to
spend on drilling, for example. By these numbers, a company with, say, 50
million shares outstanding would have only US$100,000 left after its total
liabilities are deducted from cash.
The fallout of this
deficit is that we will almost certainly see less drilling and development
until the market turns around or the exploration-stage companies raise more
cash, which at this point would be on bad terms. In the big picture, this is
bullish for gold: fewer drills turning will lead to fewer discoveries,
limiting supply. Further, this will impact major mining companies that need
to replace depleting reserves and find the pickings getting slimmer. Given
that an average TSX-V stock is basically insolvent, where will the new
discoveries come from? A lot of the majors are cutting back on
non-mining-related activities – which include exploration – so we may see them
drilling less, too. Shareholders are increasingly demanding cost-cutting
measures – rightfully so in many cases – but it's possible that the austerity
the industry demands will backfire on these same companies when they fail to
replace depleting reserves.
This is all very bullish
for the well-run, cashed-up juniors that are making significant,
economic discoveries.
Assets – Liabilities = ?
If current market
conditions persist, we may observe a major cleansing of the TSX-V. Resource
companies that haven't been able to discover a potentially economic, low-risk
deposit will go.
This doesn't necessarily
mean that they will delist from the Toronto Venture Exchange or go bankrupt,
though this will be true for many of them. Some may end up on the NEX – a subdivision of the Toronto Venture
Exchange, where stocks that fail to meet TSX-V standards are moved. According
to the next chart, for the first time in the past six years, the number of
companies that had their shares withdrawn from TSX-V to the NEX exceeded the
number of IPOs at the Venture Exchange.
(Click on image to
enlarge)
It may take a while until
the weaker companies start delisting or go bankrupt in large numbers, but
it's clear that more stocks have fallen below TSX-V standards in recent
quarters.
Conclusion
Where does all this leave
us? Looking for "bottom feeding" opportunities, but with extreme
caution. We will continue paying special attention to companies' treasuries,
as well as their liabilities and burn rates. Those that don't have sufficient
cash will face a choice: move to the NEX, go private, go into hibernation as
shells, or cease to exist. The TSX-V isn't going away – but it may well be on
the verge of becoming much smaller for a time.
As always, we will
continue focusing only on the most crisis-proof companies for inclusion in
the International
Speculator
portfolio. We will continue buying the best of the best companies, which
would see their share prices diverge substantially from the underlying value
(and even cash in the bank) during a true market panic and capitulation. It
is this type of irrationally bearish market that can bring life-changing
profits to those who spot and act on unrecognized value.
For example, in the
latest issue of the International Speculator we initiated coverage
on an exploration-stage company whose projects, according to drill data, host
numerous high-grade zones of mineralization along the same geological trend
as one of the Canada's biggest gold-mining operations. The company has an
excellent management team and a healthy treasury. At the current price, the
company is a steal.
Whatever cleansing the
TSX-V undergoes will be a good thing, separating the wheat from the chaff.
Hunting for opportunities in a such a beaten-down
market is rewarding, provided you get the fundamentals right. We look forward to it.
