Underappreciated companies and companies with management teams that have disappointed in the past can be opportunities to buy, not sell, says Derek Macpherson of M Partners. Don't be dazzled by flashy drill results, he advises. In this interview with The Gold Report, Macpherson says that investors are better to look for junior explorers with long-term vision, high grades and simple operations in good jurisdictions, and names eight companies that make the grade.
The Gold Report: Derek, when it comes to junior mining equities you're something like a shark cruising for prey, seeking an opportunity to strike. What common buying opportunities do you look for that other investors might overlook?
Derek Macpherson: We seek out assets that have been underappreciated or unjustly tossed aside, companies whose stories are starting to change. That change might be an operations turnaround, a turnover in the management team or a revision to the capital structure.
TGR: One of your recent research flashes reported on the Mexican government's consideration of imposing a royalty on Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) on companies that mine commodities in Mexico. Tell us about that.
DM: Whenever that topic comes up, it puts pressure on Mexican producers and developers. We are seeing the potential of a royalty getting priced in to those companies, and priced in as a worst case scenario.
Initial discussions centered on a 5% EBITDA royalty, which could affect company valuations significantly. However, Mexican mining companies are working with the government to find a more reasonable solution. If the proposal gets ratcheted down to a 2.5% EBITDA royalty or perhaps a 2% net smelter return, then company valuations could recover.
In Mexico, you want to look for companies that have low all-in cash costs. They will be somewhat insulated from the royalty because their margins won't be as compressed as higher cost operations.
For example, we like Timmins Gold Corp. (TMM:TSX; TGD:NYSE.MKT), which sold off on the royalty news. We think the selloff was unjustified, because the company has generally low all-in cash costs and higher margins than many of its peers.
TGR: Timmins is expected to announce that the mine life at San Francisco could be extended 10 years. Would that attract a buyer?
DM: It could, but I don't think Timmins is in the sweet spot for acquisition. The company is too small for a big company to acquire and too big for some of the midtier companies.
Once Timmins' resource report comes out, the stock should move up as investor confidence improves. There has always been concern about Timmins' long-term grade profile and the mine life at San Francisco. The pending resource update will answer those questions.
TGR: Your share target on Timmins is $3.20, correct?
DM: Yes, and we have a buy rating on Timmins. Considering its cash cost profile, Timmins is trading below three times 2014 EBITDA. If you look at the company's low cash cost peers in Mexico, similar open-pit, heap-leach operations trade at six to eight times EBITDA. I think the resource update will improve investor confidence and we could see an upward rerating.
TGR: What other common events lead you to undervalued equities?
DM: One of the most obvious is when management teams disappoint; the mining space is littered with those.
In those instances, we look at the underlying value and whether the management team can turn the operation around. We ask ourselves if the selloff was excessive, potentially creating a buying opportunity if the damage is recoverable.
TGR: Do you think management teams are being punished too harshly for performance shortcomings?
DM: I think it's partly a function of the commodity price environment. In a rising gold price environment, there was more room for error and setback didn't have as large an impact on project economics.
In a volatile price environment, investors have shown very little patience. If production results or a resource update aren't in line with projections or better, the market pushes the stock down.