Payback time? Fallback plan? Money in the bank? What would you ask the CEO of a company you were considering investing in? In advance of the Prospectors and Developers Association of Canada convention in March, newsletter writers Keith Schaefer, Eric Coffin and Lawrence Roulston are bringing 15 energy and mining companies together for a "meet the management" Subscriber Investment Summit in Toronto. In this interview with The Mining Report, the experts share their sometimes surprising responses to the state of the industry.
The Mining Report: Keith, in a recent e-mail to your subscribers, you mentioned that one of the secrets to successful investing is meeting the management. Would each of you share some of the questions you ask company heads to determine if they can be successful?
Keith Schaefer: I am very focused on paybacks. When a company drills a well, I want to know how long it takes for that well to pay for itself. In the larger oil sector, anything that has less than a two-year payback is good, but in the junior sector, where I play, payback needs to be no more than 15 months.
You could ask for the net back, or profit per barrel, or the net present value (NPV) or the production rate. But that doesn't matter as much as the payback—how fast you get that money back so you can drill another well. That is, by far, No. 1. The information that goes into that answer encompasses the answers to many other questions.
The other big questions are how much money the company has and how big a deadline it has. How much liquidity does the company have before management has to raise money again? Those would be questions I would ask management out of the gate.
TMR: Do the secondary questions inform the first question? If a company is well funded is the payback time as important?
KS: Regardless, I want to see a 12–15 month payback. If management tells me it has a two-year payback, and it's a really small company, that just doesn't work. If the payback is right, I'll ask how much the wells cost, and how much money is in the bank, because I can do some pretty simple math to figure out the next time the company will need to raise money. But if a company doesn't have a 15-month payback and is really small, I don't care to hear anything else about them.
TMR: Eric, what do you want to know?
Eric Coffin: Life is not so simple at Hard Rock Co., unfortunately. Obviously, how much money a company has is very important. It tells us how fast that company will need to go back to market.
But I need to know the background of management, and what kind of projects the management team has been involved with. I like to see that team members have had hands-on exploring experience. Some guys are very good at running exploration projects successfully, and others not so much.
I also want to hear about the target, the geological model, the upside if this works out and the fallback position if it doesn't. Most of the time, the fallback position is either secondary projects and/or cash in the bank, so the company can go look for something else. You need to get an idea of the scale potential. If a company has a $20 million ($20M) capex and is drilling for 200–300,000 ounces (200–300 Koz) gold equivalent, there's just not a lot of upside there. I want to see that, if management is successful, there's a significant amount of upside. Explaining the target gives me some comfort that management knows what it is doing.
TMR: When it comes to a fallback position, do you like to see companies with multiple projects in the pipeline, or would you rather see them focused on just one project?
EC: I like to see other projects in the pipeline. There is some truth to the idea that you can try to do too many things at once. If I see a company that constantly switches over to whatever is hot that week, I basically just ignore it. I like to see that company management has a concept and a philosophy, like "We look for copper-gold porphyries," or "We're focused on epithermal gold projects." I like to see other properties advancing to drill target stage while the main property actually is being drilled. That gives shareholders a stronger fallback position, because exploration isn't going to work out on most projects. That's just the math.
On the other hand, I like to see that a company has two or three projects it can fall back on, not 15 or 20, with management running around in circles. But if a company is focused on just one property, and if I really like the targets, I'm not going to be afraid of the company. I just know it comes with a bigger downside if the drilling doesn't work out. You have to understand that going in. If that's the case, the target has to be that much bigger.
TMR: Lawrence, what do you ask to determine whether a company will be successful?
Lawrence Roulston: Beyond all the basic questions about the financial situation, the project and management's background, which are all important, I need to know whether management has the drive and determination to overcome the endless obstacles on the road to success. You can only get that sense if you talk to the people behind the company; spend a bit of time and get to know them.
Unfortunately, this industry has evolved away from old-style compensation, where members of management had low salaries and big stock positions, thereby aligning their interests with shareholders. We've moved way too far toward big salaries. There are a lot of people out there who are more interested in protecting their salaries than in adding shareholder value. Those intangible, subjective measures are critical to determining if a company will be successful.
TMR: What do you want to see in a CEO's background? Would you rather see someone from finance/business, or a geologist?
LR: Mining requires some very specialized skills. A person also needs to be an entrepreneur. If someone has had a big success in the past, that can be a plus, but it's also really exciting to find the young guys who are going to be the stars of next year. Both business and geology are important. A good company needs a well-rounded team that can cover all the bases.
TMR: The three of you are putting together a Subscriber Investment Summit the day before the Prospectors and Developers Association of Canada (PDAC) convention in March. You have picked a number of companies to present at the summit, and be available to talk to investors. The three of you will be there talking to investors and companies as well. Can each of you tell me why you picked the companies you did, and about the catalysts that make these companies worthwhile for investors?
KS: A company called rdx Technologies Corp. (RDX:TSX.V) has a novel way of treating wastewater. In addition to purifying the water so it can go back into the ground, the company extracts every little bit of energy from that water. That means any kind of oil, animal or plant residue. The company has the ability to shake that residue out, chemically separate it and create fuel. So rdx gets paid to take in the wastewater, and it gets paid to sell the fuel. So far, the company has two operations up and running.
This process is new and looks to be very cheap. Management has a very aggressive growth program, so the proof is going to be in the pudding on this one very quickly. The company has a very exciting story that they're going to test within the next two quarters.
Madalena Energy Inc. (MVN:TSX.V; MDLNF:OTCPK) is a very simple producer story. It has a big land position in Argentina, a country that might scare a lot of people. But the reality is that big oil is spending big money in Argentina to buy up a lot of land. If you apply the transaction metrics that are going on in the country to Madalena's land block, the stock is a triple from here. That's exciting. I wanted to make sure management can tell investors that story.
TMR: Madalena is operating on the Vaca Muerta shale. How does that shale compare to the Bakken?
KS: So far, it's the only play on earth that could be more oil-charged than the Bakken. Everyone is familiar with fracking. Usually companies will do 20 fracks in a well. In the Bakken, you might get 10 barrels (10 bbl) per frack. In the Vaca Muerta, explorers are seeing as many as 50 bbl per frack. It is very highly oil-charged. If it weren't for the politics in Argentina, the stocks of all the companies in the region would be dramatically higher than they are now.
TMR: What other companies will be at the Subscriber Investment Summit?
KS: Petroforte International Ltd. (PFI:TSX.V) is a very lucky shot for retail investors, simply because one of the top operating teams in Calgary is recapitalizing the company with retail money at a very low valuation. That never happens anymore in Calgary. Usually these companies stay private for a long time and don't come public until they are at about $10 per share. These guys recapitalized at about a nickel per share. Basically, Petroforte is a startup growing very fast at a cheap rate. I made it my largest position because those opportunities rarely come along.
TMR: Another one?
KS: Manitok Energy Inc. (MEI:TSX) is a conventional oil play with a lot of gas. Now that gas prices are starting to move up, the company has been given a huge bonus. Manitok has a lot of leverage because even at very low gas prices, its wells were paying out in 8 to 10 months. It still has very low valuation despite the fast payback, so it is something that investors should know about.
TMR: Does it also have an advantage because it has a conventional well and doesn't have to deal with the depletion rates that some of the fracking wells have had?
KS: That's right. You are looking at very low depletion rates compared to fracked wells. A tight shale well could decline 65% in year one; these guys are closer to 40%. It makes a big difference in how many times you can pay the well back over the course of the life of the well. It is a big advantage.
TMR: What other companies will be at the Summit?
KS: Entrec Corp. (ENT:TSX.V) is a call on oil sands development and liquid natural gas (LNG) development. The company is holding its own doing oil sands work, but if the government in British Columbia gets its fiscal framework set for LNG, Entrec owns the largest crane company in northwest British Columbia, and would be a huge beneficiary. I think the company would be a top stock for a pop once LNG gets going.
Iona Energy Inc. (INA:TSX.V) was the largest junior oil growth story in the world last year. The company went from 1,500 to 7,500 barrels per day—all beautiful, light, high-profitability oil. Sadly, the market didn't end up caring too much. But in 2014, as the production profiles of these wells become consistent, the market is going to reward Iona. Basically, the company is trading at 1x cash flow. When you buy stock at 1x cash flow, you are going to make money.
TMR: This is in the North Sea. Will the company have an advantage because of higher European prices?
KS: Certainly, working in the North Sea gives you exposure to international pricing, which is $10 per barrel ($10/bbl) higher than in North America. The asset that Iona drilled last year pays out in a year. When a well pays out in a year, and you're trading at 1x cash flow, you are going to make money.
TMR: How about a couple more?
KS: High North Resources Ltd. (HN:TSX.V) is a startup that's just finding its legs. It has the Montney asset, which pays back in about a year. All the production around Montney is paying out in a year, and there's a lot of it. There is good well control.
High North is pretty much a no-brainer. It has the next three years of low-risk to no-risk drilling in the Montney oil play, where there are lots of services and high profitability. It is set. It's done. It will just plunk down holes like clockwork for the next few years, then watch the cash register ring.
Lastly, Enterprise Group Inc. (E:TSX.V) has done a fantastic job of buying highly specialized, niche companies that have higher-than-average profit margins. When you do a rollup play like this—an aggressive mergers and acquisitions (M&A) strategy—what makes the stock go up is being able to drive organic growth out of it. This company has been able to do that better than any I've seen. It has surprised to the upside, achieving revenue jumps quarter after quarter. Not just revenue jumps, but real positive cash flow.
I'm quite impressed with what the Enterprise team has been doing. The feedback the company is getting in the market suggests that cash flow is going to triple this year, which indicates the stock should be $2. It's currently trading at about $1. We will see what happens this year, but I like what the team is doing.
TMR: It's a very diversified company. Is there one area that will drive growth going forward?
KS: Yes. Enterprise has a bit of an odd product to those outside the industry—the Hydro-Vac, a water-jet cutter. Super high-pressure water is used to cut the ground to find oil pipes and electrical wires, without cutting the infrastructure itself. It is mucky work, but it's incredibly profitable. The company has plenty of demand from customers if it can get enough product.
TMR: Eric, you have a couple of companies you've invited?
EC: Barisan Gold Corp. (BG:TSX.V) is a fairly straightforward story. This is a straight-up drill play. The company is drilling a porphyry discovery called Upper Tengkereng in Sumatra, Indonesia. I'm not a huge fan of the country. I made that fairly plain when I started following Barisan, but the company put out a couple of good-looking drill holes, the best of which was basically 900 meters (900m) of 0.4 grams per ton (0.4 g/t) gold and 0.25% copper, which is pretty damn good as porphyry holes go. The area has the potential to generate the kind of holes that can give you 100–200% jumps in one shot. The last hole was also a good one, though not as good as the one quoted above. Assays for the bottom third of this hole are still to come—but it's the next couple of holes I'm focused on. These holes will be drilled to the east, back in the area that generated the 900m intercept. I'm hoping to see another long, high-grade intercept. The stock trades at $0.20/share, which leaves plenty of upside. The area being drilled now, on the eastern side of this project, is not governed by the forestry ministry, which is tough to deal with in Indonesia.
TMR: When do you expect the next drill results?
EC: These are 1,000m holes, so they take some time to turn around. The bottom third of the last hole should be out in the next week or two. The next hole should be just about done, so I hope to see those results in early to mid-March. If the stock gets a little bit of a jump, the company may finance so it can add a second rig. That would help results come faster. The target is not going away. It's the real deal. It's just a matter of how big it is, how high of grade it is.
Next page: More company analysis...