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Screening Commodity Stocks

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July 18, 2007 – Comments (2)

I want to come up with a set of rules to essentially screen stock them according to some unwritten criteria that I currently follow. This post is a walk through and see if I can put that screening criteria into “rules” that work for me.  So, what have I been looking at?

Nord Resources on the Pink Sheets

I saw a rumor that Sprott just bought 20% of the company.  Often if you can get into a stock at a price close to Sprott you can do well.  People follow Sprott and screen their selections and many just jump in driving the price up.  This alone can lead to a share price going up just because it has more people looking.  And sure enough, Sprott has bought 15,762,450 shares, giving them 20.5% of the company.  By extrapolation, the company has about 77 million shares.  The site doesn’t say how many shares they have.  Prior to the Sprott purchase another investor calculated 87 million fully diluted in June.  Another 16 million brings it up to 103 million.  At $1/share US the fully diluted market cap is about $103 million.  Not finding this information easily is a problem, and I have no confidence that the 103 million is correct.

 

Looking back at the last 20-day trading activity volume was very low and shares were averaging about 75c.  With the Sprott news the shares jumped to $1 and volume is up, but overall liquidity is low, meaning an exit could be more difficult.

 

The plan is to re-open the Johnson Camp Mine in Tucson, Arizona.  The company looks fully financed and it should produce 25 million pounds per year.  Press releases going back 3.5 years talk about restarting the mine 8 months after financing.  An earlier press release states 20 million pounds of copper from a 9,000 tons of ore per day operation.  Reverse calculating suggests a copper grade recovery of 0.3-0.4% which is low, about $30/ton metal values.  I am not sure how the production-plan when from 20 to 25 million pounds.  Nothing is easy to find with this company through their web site and that has to shy potential investors away.

 

Their Coyote Springs Project is purely an exploration property and if they could establish they have good cash flow to afford to explore this property that would be good, but the grade question of Johnson Camp left me questioning this ability.

 

The Mimbres Project mentions 50 foot intervals of 0.5 to 1% copper.  That’s 11-22lbs/ton.  That is an OK grade for a strip mine but not for an underground mine.  This property also needs cash flow to develop, and it would be a long way off.

 

So, this one steers me away from it.  If they have a good quality reserve/resource for their Johnston property, that information should be easy to find.

 

Grade is a big concern for this one, so what is a reasonable open pit grade criteria?

 

Going back to past posts, in June I found the grade at Bingham to be worth about $90/ton, and prices have gotten stronger making it worth about $105/ton at today’s prices.  Business conditions that make Bingham a lower cost producer include:

 

               

  • Economies of scale because of large size
  •            

  • Economies of scale because of being start to finished product producer as opposed to selling concentrate
  •            

  • Capital cost allocation in deflationary book value dollars as opposed to replacement dollars
  •  

     

    Making an assumption that the 2006 prices they got for their sales was in the $90/ton range I get costs including taxes of about $34/ton and about $28/ton without the taxes.

     

    They say they mine approximately 500,000 tonnes of material per day with about 1/3rd being ore.  Using their 2006 earnings and cost data and an assumption based on 500,000 tonnes of material I get $17/ton costs and $46/ton in metal values.

     

    These two ways of coming up with an estimate are profoundly different.  As an investor I don’t get to see all the data to understand why they are so profoundly different but possible sources are a higher strip ratio, an over estimate of actual material removed and recovery is never 100%.  With that high of a grade 63% of revenue went to earnings.

     

    With another example, looking at Goldcorp’s Alumbrera data, their revenues show they got about $43/ton of ore and their costs without taxes was $19/ton, for pre-tax earnings of $24/ton.  Proportionately, there was about 25% tax so about $18/ton was earnings, or if you look at the grade actually mined at the $3.58/lb copper and $613/oz gold price the metals were sold at, you get $58/ton metal values.  Operating in Argentina, and being a larger operation (400 million pounds/year), they also have some low cost advantages.  For this one 42% of revenue went to earning, but if I calculated the metal values per ton based on what they said the mined grade and correct for what they did not sell I get 34%.  These numbers did not “add” up, but they demonstrate the amount of error one can end up with in their back-of-napkin calculations.

     

    None of these numbers are directly comparable, but what you can assess is that in a low cost environment like Argentina when you can calculate metal prices to be about $60/ton when prices are strong, the actual earning potential is about 30-35%.  The higher grade Bingham in the US was showing 60-65% going to earning.  You can not directly compare production and assume all mines will have equal profitability based on the same production. In general, the better the grade, the more profitable.

     

    Johnson Camp is in the higher cost US and would probably also have higher costs already due to being smaller.  There are lots of companies to consider and I do not see any reason to consider a company that leaves me wondering if the grade is high enough to even break even, especially if say the price of commodities decline by say 1/3rd.  A decline by 1/3rd would still be double the historical average.  It looks like it will be a very high cost producer highly dependent on strong prices for the long term.

     

    Screening Conclusions from Nord

     

    So, what steered me away from this one

     

                 

    1. Grade.
    2.            

    3. Lack of direct links to feasibility study on the web site.
    4.            

    5. Lack of information on fully diluted share count on the web site.
    6.            

    7. Highly dependent on strong prices for success.
    8.  

       

      Read Sprott’s analysis of the markets, especially on China, http://www.sprott.com/pdf/marketsataglance/04-2007.pdf.   They present a case that very strong prices are here to stay.  I believe the overall average prices are increasing and over the long-term will out strip inflation because of how the mining business is changing, but I would never invest in a commodity stock dependent on high prices, or at least as high as they are today.  There are simply too many other choices.  Sprott may like this one, but I did not see anything compelling with how I look at properties.

       

      Screening Rule #1:

       

                   

      • Ore grade should be $60/ton or more at today’s strong metal prices for open pit mining, about 0.75% copper equivalent for a copper property.
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        This gives some protection from downward prices and from optimistic reports on websites.   Personally, I like to see more in the range of $80/ton in metal values, but other reasons would compel me to consider a property with less that $80/ton.

         

        For this one I spent way too much time looking for information that I never found and grade is probably the most important rule for me, simply because it gives the most leeway for problems, price corrections and the most profitability.

         

        Screening Rule #2:

         

                     

        • Basic information such as share structure, reserves/resources, feasibility plan and their goals should be apparent within 10-15 minutes.
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          I hardly stopped to consider their development properties.  The 0.5-1% copper drill result barely meets the grade rule and it will be years before this property can do much, and the other had little information.  There are simply too many other choices where companies that have existing earnings that can be used to explore development properties and the development properties are stronger in that they have more historical work that supports they have value.

           

          Screening Rule #3

           

                       

          • Development properties are a low priority if there is no cash flow and no development on them.
          •  

             

             

            Crowflight Minerals CML

             

            This one passed rule 2 very quickly.  Fully diluted they have 275.5 million shares and that information was updated in June 07.  It is trading at 94c as of Monday, which gives it a fully diluted market cap of $260 million.  Looking at the chart, it peaked in May and has pulled back from $1.35.

             

            They have their Bucko Lake project with a complete feasibility study showing 2.5 million tons of nickel at 2.01% and an additional 1.2 million tons with 2.23% nickel.  Nickel prices have corrected to more reasonable levels, but they are still strong prices and still have some down risk.  But the metal values per ton at that 2% is over $650/ton at these values, something that makes me want to give this company a closer look.  At $12/lb metal values are about $530/ton.

             

            It looks like about a 7 year life of mine can be built with the resource and the inferred reserves could extend it an additional 3 years at a production rate of 12.5 million pounds of nickel per year.  At the current prices the revenue generated would be about $180 million.  It has a year before it would be built so it isn’t ready to cash in on the strong prices now.  More recently it has looked at upgrading to produce 50% more which would increase cash flow but lower the life of the mine.

             

            Funding and permitting for building the mine have not been secured.  This is a negative as it can result in dilution and investors have no control over how much dilution.

             

            They have some future development prospects, the Aer Kidd Project that has 10 million tonnes with 1.5% nickel, 2% copper and 4.8 grams/tonne PGMs, which is very nice.  As a development property, they one has already had investment and gives you an idea of what is there and the grade suggests it will be good.

             

            This one prompted me to look again at FNX, which was the subject of a prior post.  The grade they have looks much better than FNX which means it could have the opportunity to have much more of the relative revenue going to earnings.  FNX has a market cap of around $3 billion.

             

            All this information was easy to find and there are enough good things about this company that it is worth checking out closer.  A comparison of CML to FNX would be a worthwhile activity to get a sense of relative valuation.

             

            They issued 8,450,000 stock options in the last quarter.  That is large.  This company will need to be watched for dilution.

             

            CML is on my watch list for closer evaluation.

             

            Screening Conclusions from Crowflight

             

            CML pass the ease of finding information test.  I spent 1/10th of the time and I certainly wasn’t left to guess work to come up ore grade.

             

            In terms of screening, open pit versus underground mines have very different cost structures.  I want to see about $300/ton or more in metal values for me to consider looking further.  Production costs tend to be in the $100/ton range and then there are all of the other costs and it is easy to see around $200/ton going to costs.

             

            Screening Rule #4

             

                         

            • Ore grade should be about $300/ton or more for an underground mine.  That’s about 1% nickel equivalent.
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              Conclusion

               

              The screening rules are to give some basic guidelines for how to separate out what to spend further time checking out and what to pass, at least with the way I look at commodities.   I would never then just buy a stock because it has a fantastic grade, good information and good cash flow. 

               

              The real work comes next, coming up with some kind of assessment of how realistic their information provided is, how it is valued in the market relative to peers and also assessment that the peers you are using are not valued to what could be considered bubbled levels.  Finding a stock is valued at about 1/2 of the price of another does not mean it is a good deal if the peer stock is trading at 3x its worth.

               

              My now written criteria is not necessarily going to be your criteria, but for me, it looks like ore grade and ease of finding information are the most important starting points.

               

              2 Comments – Post Your Own

              #1) On July 18, 2007 at 9:45 PM, camistocks (< 20) wrote:

              Interesting to read your thought process and your criterias. I would also add management as a main point for screens. Management must be competent and know how to execute. I would think that a good manager can make more money with a low grade mine(s) than a so-so manager with a high grade mine(s).

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              #2) On July 19, 2007 at 1:02 PM, dwot (72.09) wrote:

              Excellent point about management.  I think you have to look at where the mine is in terms of development.  If the mine has to be built, you want someone who has shown they are capable of doing this.  If it is already built, it is far more of a "routine" job once the mine is understood.

              I worked at a pulp and paper mill through a start-up and the work that happens behind the scenes is amazing, as are the problems that need to be sorted out.  They get sorted out and then the business just seems to run itself.  And the staff learns how to deal with specific problem.

              Something that was very interesting in my mill working experience is the workers did good tests and the pulp was not as bright as management would like, and I was working in an area where I was responsible to ensure they were doing the tests correctly and the brightness meter was working properly.

              It amazes me how many times I was sent to check on their work and the pulp was simply yellow at that point due to reasons I never understood.  Management's approach was one that was destructive to working relations between the workers and management because they knew they were doing their job correctly and by sending me down they were constantly discrediting their competence.  The workers weren't being listened to and for months the problem continued.

              My area was simply that the equipment worked properly and was being used correctly.  What needed to be looked at was the correlation of whether the criteria they had defined was a good measure of end result (it was proving to be bad because the end result was good) and to figure out why the pulp was yellowing sometimes and if a test could be developed to correct for that yellowing, such as adjusting the pH before testing.

               

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