Guest Post by Bill Powers
January 11, 2019
Adrian Day of Adrian Day Asset Management is a seasoned investor, speaker, author, and adviser. In this interview, Adrian shares key takeaways from 2018 that affect the resource sector and offers his commentary on the Barrick-Randgold merger and its significance. Adrian also provides general insights on mergers and acquisitions within the mining sector, what he looks for in a junior royalty company, and his outlook on copper and copper mining stocks. Dispersed throughout the interview, Adrian discusses five mining stocks that he likes and which he thinks present an exceptional investment opportunity right now.
Bill: Welcome back and thanks for tuning in. You’re listening to the Mining Stock Education podcast and I’m Bill Powers, your host. For this episode, I’m joined by Adrian Day of Adrian Day Asset Management. Adrian is a well-known investor, speaker, author, and adviser when it comes to resource investing, and as I’ve said previous times on this podcast, Adrian wrote the first book that I ever read on resource investing and helped to pique my interest in this niche sector. Well, my last interview with Adrian was about two years ago at PDAC 2017, but Adrian joins me again today, so Adrian, thanks for taking the time to come on the podcast and share your insights.
Adrian: Well, thank you very much, and thank you for the nice comments, as well.
Bill: Let’s talk about the resource sector, first last year, as you peer back over 2018, can you recap for us some of the highlights, and important events that you see, and their significance?
Adrian: As I’m sure most of the listeners know, most resources were down during the year. Resources are a tricky thing because all of the indices are different, and most of the indices are actually commodity indices, which will therefore include a lot of soft commodities like grains and cattle and so on, which most of the people who follow resources are not really interested in, but nonetheless, most of them were down last year, the entire group was down 13%, and that’s even though some of the soft commodities were up, but clearly the most important things were the continued strength in the dollar for most of the year, other things being equal as we know, and things are never equal, but other things being equal, any time you price something in dollars, if the dollar is strong, the dollar price of that commodity is weaker, obviously.
The second major factor was the growing, ongoing tariff war between the U.S. and China in particular, and concerns that that might lead to a swelling global economy, so it’s the tariff war itself, but it’s also concerns of what it might lead to. And then of course, the third thing was the ongoing, the step up in I hate to call it tightening, but interest rate increases by the federal reserve. As you know, they announced that they had stopped QE and we’re going to start tightening back in 2015, and we saw one small rate hike at the end of this 2015 in December, and then a whole year later, we saw another one, so those are very slow in coming, but last year, we had four raises, and so it appeared perhaps that the fed was going to continue pushing rates up, so all those three, and that of course, also not only is that raising the cost of capital for a capital-intensive industry, so that’s a negative in and of itself, but secondly, the concern of raising rates too much might lead to a slowing economy again.
So those three factors, I think, were the main things that just pushed commodities down, and they’re all macro. I’m not talking anything micro, because I think last year the macro, other than perhaps for oil, I think the macro was far more important than the micro last year.
Bill: Within the major miners last year, we saw Barrick and Randgold merge. What’s your commentary on their merger and its significance?
Adrian: Well, it’s interesting because there was, as you know, no premium offered. Barrick obviously approached Randgold. I think it means more to Barrick than it did to Randgold, but there was no premium offered, which was very unusual, and Barrick has suggested, and Bristow from Randgold has echoed that, that we’re likely to see more mergers, more no-premium mergers as the industry consolidates. This is a very, very, for the size of the industry, it is an extremely fragmented industry, both among seniors and even more so among juniors. Very, very fragmented. That is inefficient because if you have 20 companies of a $2 billion size, you’ve got 20 managements to support. It’ll be interesting to see what happens with the Randgold-Barrick, I know that’s not what you were asking me about, but the most important thing to watch there, I think, is the difference in styles between Mark Bristow and Randgold and John Thornton and the masters of the universe at Barrick.
It’ll be interesting to see if they can consolidate or if there’s going to be a culture clash, but that’s a different question. I think we’re going to see consolidation. We have to. We’re going to see it among juniors as well. The difficulty always is if you don’t have strong asset synergies, then your synergies have to come, your benefits have to come from cost savings, which means reducing overlapping managements, essentially, and most people who run companies don’t want to voluntarily give up their jobs, and that is, I think, the biggest problem we have in not rationalizing the industry, particularly at the junior side.
Bill: Unless there’s a large premium and there’s some incentive for management, a windfall, would you say, at the junior level? It’s just that windfall that management would get that would cause them to acquiesce and give into such a merger?
Adrian: No, absolutely, and I think you’re more likely to see that kind of premium when a company, let’s say an exploration company, makes a discovery, and another company wants that discovery because it’s synergistic with something they have, and they’ll offer a premium. I was thinking more, and I don’t particularly want to mention names, because I don’t want anyone to get the wrong impression, but you look at a lot of, let’s say exploration companies, that might be doing good work, but just haven’t made a discovery, and you might have a company, an $8 million market cap, a $12 million market cap, a $10 million market cap, each of those companies has their own managements plus their own regulatory requirements and everything else, and typically if the company is a $10 million market cap, I would say typically 75% of the money they raise goes into overhead, not into the ground.
So if you combine three or four or five companies of $10 million, $15 million each, first of all, you get something that’s a little bit more liquid and therefore more open to more investors or more investors are open to it, $200 million market cap, let’s say. Still small but not micro, and maybe you can reduce, if you have a $200 million market cap, you can reduce $150 million overhead. You can reduce that to $100 million or $75 million, which means more of the money you raise can actually go into the ground, and so it’s not that any of these companies, in many cases, it’s not that any of these companies are doing bad work or are crooks, that’s a totally different issue. I’m talking about good companies with good managements doing good work, but if you’re only $10 or $20 million market cap, inevitably you have to keep raising money, and inevitably a lot of that money, a majority of that money has to go to just staying alive, regulatory fees, compliance fees, filing fees, et cetera, et cetera.
That’s if they’re not overpaying themselves or anything. Again, we’re not even getting to the companies where they overpay. We’re just talking about good companies doing good work, but if they don’t make a discovery, nobody is going to offer them a premium. Why would you offer a premium to someone that doesn’t have a discovery and doesn’t offer you particular synergies? There’s a lack of incentive for these companies to merge because nobody who went out, some of them were 15 years with Placer Dome and again, I’m not talking about anyone in particular, this is a hybrid individual, and he got tired of a big company and he went out and started his own company and raised some money. He doesn’t want to give up his company, and that’s a problem.
Bill: Still talking about mergers and acquisitions except from the investor’s perspective and where they can find the best value in 2019, I’ve spoken to Rick Rule a couple times over the past year and he points out that he thinks one of the most consistent and best opportunities for resource investors is trying to locate those takeover targets before they’re taken out. Would you agree with that and is that one of the places where you’re looking for your investment dollars in 2019?
Adrian: Well, far be it from me to disagree with Rick Rule. I think how I see it is I look at potential takeovers as icing on the cake, so I rarely, not never, I rarely buy a company simply because I think it’s going to get taken over because all too often, one can be disappointed, or it can frankly just take too long before that comes to pass, but if I like a company, I like the management, I like the property, I like what they’ve got anyway, then a takeover can be icing on the cake, and we do have several companies we own, but I expect that I’m fully expecting to get taken over at some point, and frankly, over the last couple of years, we’ve had four, five that have been taken over. Yeah. We’ve got several, and I don’t know if you want names?
Bill: Yeah. Please provide names. What’s of interest to you? You make some of your positions public through your writings or through interviews like this. Can you comment on any of your positions that you’ve made public and some of them that you think are the best value right now?
Adrian: Yeah. I’ll mention on the junior side, I’ll mention a couple, and this one gets back to takeover. Almaden has a great project called Ixtaca in Mexico. It’s a gold-copper project. They’ve just completed a final feasibility. They’ve applied for permits. Almaden is a junior company, very small company. Good people. One would not typically expect them to put this project into production. It’s a very low capex project, a very simple project to run metallurgically, so Almaden is suggesting that in fact they might put it into production themselves if they don’t get an attractive enough offer because it is a simple project and so on.
We own it because we like the project, we like the economics. The thing is selling at about a fifth of the value of … Don’t quote me. It’s even less than a fifth of the value of the feasibility study. At the same time, it’s the kind of project that I wouldn’t be surprised if someone was interested in taking over. 50% silver is very attractive to a lot of silver companies, where primary silver mines are increasingly rare, so this is an attractive project from that point of view, and it’s in Mexico, which despite everything about the new administration, Mexico still remains one of the best mining jurisdictions in the world, so I’m just looking this up. It’s got an after-tax value of $310 million. It’s got a market cap of $80 million.
I think there’s a lot of room there for someone to come in and take the company over, so again, we don’t own it just because we think it’s going to get taken over, but we think there’s a strong possibility that it might get taken over.
Bill: So you like royalty companies. That’s well known. You often in many interviews talk about some of the larger billion dollar plus royalty companies, but of recent years there’s been more of the smaller junior royalty companies come up. Can you talk about what you look for in a junior royalty company, and what are your general comments on, let’s say, the sub-$500 million market cap and below royalty space right now?
Adrian: Yeah. Good question. The first thing I look for is the same thing I look for in any junior company, which is management. You’ve got to have a strong management, and strong management means obviously a lot of things. A management that can execute. A management that has a good business plan and has vision, can execute, can talk to the market, and so on. That’s number one, and number two is balance sheets. You want a company that is able to raise money because it has connections, does not overspend. That’s important. And so when you’re looking at the thing with royalties is there’s a huge difference in valuation between a small royalty and a large royalty.
So if you look at my favorite junior, which would be Metalla. Metalla is a $70 million market cap. Let me just see what the … We don’t even have a P/E ratio. I’m just looking at a metric so we can compare. Price to cash flow of 26, and if we looked at Franco-Nevada, we get a price to cash flow of about the same, but on other metrics, the bigger ones are a lot smaller, on enterprise value, and so on. And so you buy a junior rather than a senior because you think they have the ability to grow and the ability for that valuation to expand, so you want to look at a company that has been able to execute. Metalla, for example, has been around about a little over two years now, two and a half years, and they’ve managed to get four producing royalties, a pipeline of about 14 or 15 in various stages from exploration to developmental, and near-term production, and in fact, they’ve actually introduced a dividend now. The dividend yield is about 2.3% right now. It’s an attractive dividend yield in and of its own right. It’s unusual for a growing junior to pay a dividend.
Bill: Is that the smallest market cap company in the junior space that pays a dividend? You may not know it offhand, but that strikes me as well.
Adrian: It’s definitely one of. I know there’s been one or two that I think had to stop the dividend because it just didn’t make sense. In the case of Metalla, they’re paying a percentage of their revenue as a dividend, so there’s absolutely no reason why they shouldn’t be able to sustain paying a dividend, and I think the idea, again, it’s unusual, but the idea was to show that the revenues that they had achieved were actually sustainable. So you want a royalty that’s growing and that can add various projects and get a diversity of royalty income coming in. Again as I mentioned, Metalla has four producing royalties. Franco has something like 43, so it’s a somewhat different scale, but the idea is that they will build up that revenue stream, and the diversity of the revenue stream, and potentially this would be a takeover candidate at some point for a senior royalty company that has difficulty adding to its royalty base, but that’s maybe two or three years away from now. That’s not an immediate prospect. We own Metalla right now because it’s a solid company, good balance sheet, great management, and it’s growing.
Bill: Would you say that the competition amongst those sub-$500 million dollar market cap junior royalty companies is stiffening, that it’s more competitive for these deals?
Adrian: It’s getting more competitive. For the larger royalties, it’s extremely competitive, as you know. They all look at the same things, Franco, Royal, Wheaton, and Osisko to a large degree, to some degree, but if a royalty is available, they’re all looking at it, and no company is going to do a private deal on a half billion dollar royalty. It always go out to auction or they’ll talk to others, and frankly who gets it depends really on who happens to have the cash at the time and for whom it most logically fits. If someone has just done two big copper deals, a gold byproduct from big Chilean copper mines, they may not be willing to pay up for another billion dollar Chilean copper mine byproduct credit royalty, if you understand what I mean, but sometimes the returns on these deals at current prices are extremely low.
There was one deal recently, a large deal, over half a billion, with a stated return of 1.1%, and it wasn’t necessarily a bad deal. It was a 60 or 70 year mine life, and it was a mine with a lot of upside potential, but nonetheless, that just gives you an indication of how competitive that sector is. When Metalla started, they were really able to … I think it’s true to say that for smaller deals, it’s sometimes able to do a transaction between a royalty company and a company without that project going out to auction to other companies. It has been possible, and so you see a particular company that you think you can do a transaction with, it’s been possible to do it, but I think increasingly, companies are wanting to shove their deals to everybody, and there are more juniors out there, so that sector is going to get a little bit more competitive.
But you know, there aren’t that many companies at the sub-$100 million. People often think of Sandstorm as a small one, but Sandstorm is $850 million market cap, so it’s small compared with Franco, but that’s 10 times larger than Metalla, so at the moment, and I don’t mean to keep harping on Metalla, but at the moment, a company of that size can be a lot more nimble than most of the market, and frankly, they can look at deals that other companies aren’t interested it.
Bill: I was talking to a mining engineer recently, and he said that even though investors looking at these deals may see a 15% IRR, internal rate or return, there’s not a lot of 15% internal rate of return projects out there. Would you agree with that?
Adrian: For royalties or for projects generally?
Bill: For royalties in particular.
Adrian: Definitely for royalties. No question. If you have a 15% IRR on a royalty that is acquired, or created, there’s probably something wrong with it, which it might be in the Sudan or whatever. Any double digit rate of return on a royalty is pretty tough.
Bill: Adrian, before you go, I’d like to get your comments on copper. That’s a metal that you like. Two years ago when I first interviewed you, in fact, you told me that copper was your number one after the precious metals. What’s your perspective on copper right now? We saw copper fall from about $3.30 a pound at the peak, halfway through last year, and now it’s close to 52 week lows, trading around $2.67 per pound. We have the trade talk and the trade truce supposedly between the US and China right now. Can copper in your opinion fall even lower in 2019? We know that there’s the supply deficit ahead of us here, but what about copper in 2019, and in particular, what about the copper equities? Could the copper equities even go lower?
Adrian: Well, things can always go lower. That’s one of the things you certainly learn in the resource business, resource investing, that however cheap they are, however cheap they appear, undervalued they appear, they can always go lower. Copper was interesting last year because as you mentioned, copper actually had a quite strong first half of the year, so it really struck me that copper was really beginning to turn around until the tariff trade dispute really heated up, and that’s what knocked it back. Copper remains after gold, it remains my favorite metal and my favorite base metal, and it does face that near-term production deficit, even without a pickup in demand. Now of course, you don’t want demand to collapse because of a global recession or a Chinese recession, but you don’t need a great pickup in demand for copper to move into a deficit.
You look at big copper mines are very rare. One has to really emphasize this. A big copper mine is very, very rare, and Richard Adkerson, the CEO of Freeport, on the latest conference call, mentioned something really fascinating. Despite the fact that we had that super cycle from 2001 for 10 years, when China was developing and all the base metals including copper were going crazy, not a single new copper mine has joined the list of top 10 producers or top 10 in reserves. Not a single one, despite the fact that we had that super cycle and despite the fact that people were spending money looking. Not only are they rare, but they take time to develop. Freeport has recently announced that apart from a couple of mines already in development, they are not giving the go-ahead to any new mines until the copper price looks more certain.
He said it would take a minimum of five to seven years for another mine to commence production from the time they give the go-ahead, and the way he put it was even a shovel-ready mine, five years minimum from the time the go-ahead is given. He indicated, and I think it’s true, that that stands, so no new mines is true for most of the global, major copper miners in the world. And so you can look ahead with a fair degree of certainty, a high degree of certainty, in fact, on what the potential production next year, the year after, three, four, five years from now, you can look ahead five years with a high degree of certainty what the potential production is going to be, because there’s going to be nothing producing copper in 2023. Nothing that we don’t already know about, right?
On the other hand, there’s a bigger chance of downside surprises. Some of the big copper mines start depleting quicker than we thought, there’s an earthquake in Chile that causes disruptions-
Bill: The union strikes.
Adrian: Union strikes, et cetera. The surprises with copper production are likely to be on the downside, not on the upside, so absent a collapse in demand, we are going to see shortages in three or four years’ time, and that’s got to mean higher prices. We are accumulating copper companies. I think you do need a company with low-cost mines so they can withstand short-term weakness, continue to withstand any continued weakness, and a lot of these mining companies do have their own peculiar problems, but we like Freeport a lot. That’s the largest outside the Chilean government-owned Codelco, it’s the largest private, publicly traded copper company in the world.
Freeport I think is very, very cheap, and they’ve cleaned up the balance sheet tremendously. They’ve done a superb job at cleaning up the balance sheet. Lundin which again has a great balance sheet. I wouldn’t call Freeport’s great, by the way. I’d just say they’ve done a good job cleaning it up. Lundin on the other hand, Lundin Mining does have a great balance sheet. They’ve got a lot of cash. They’re in a position to buy something if something good comes along. As you know, they tried to buy the Timok and they tried to buy Nevsun, but that didn’t work. They got trumped. Frankly, an unusual idea, I like Zijin, which is the Chinese company that purchased Nevsun, the largest gold-mining company in China, but a large, diversified mining company. Gold is their largest asset but copper is about half of what they have in gold and they want to increase their copper, and they also have some zinc mines they’ve bought.
They recently did a secondary offering just last week in order to finance the Nevsun purchase. Stock fell sharply from nearly 3.20 down to 2.76. I think it’s a good buy at today’s price, and it pays a dividend at 3% or something, 4% now. 4%, sorry, at today’s price.
Bill: Adrian, if I could do one follow-up question on copper, you’re a long-term investor, so you’re not in it for short-term trading, but for the short-term trading speculators listening to us, with the trade negotiations between the U.S. and China occurring right now, do you think specifically the copper equities and the junior equities, what’s being priced into those equities now? In other words, is there a lot of downside? If the trade talks fall apart between the U.S. and China, how much downside is still left in some of these depressed equities?
Adrian: Good question. I don’t think there’s a lot of downside left anymore. You look at the major ones and they are selling very close to their lows. You look at the juniors, which were slammed on tax loss selling as well as the macro scenario we’ve discussed. I don’t think there’s a lot of downside left. Obviously, if there was an abrupt end to trade talks with some nasty tweets on either side, the stocks would fall, no question, but I don’t think there’s a major sustained downside at this point.
Bill: Well, Adrian, before you go, is there any contact information or ways people could follow you?
Adrian: Oh, thank you. I appreciate that. Yeah. The best thing is to look at the website first, which is www.adriandayassetmanagement.com, all one word.
Bill: Adrian, thank you for the conversation. I appreciate you joining me on the podcast. Have a great day.
Adrian: Thank you. I appreciate it.
About the Author: Bill Powers is the host of the Mining Stock Education podcast which interviews many of the top names in the natural resource sector and profiles quality mining investment opportunities. Bill is an avid resource investor with an entrepreneurial background in sales, management, and small business development. His latest interviews can be found at MiningStockEducation.com.