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Ima Casanova Uncovers the Under-Covereds
Source: Zig Lambo and Karen Roche of The Gold Report (4/6/11)
McNicoll, Lewis & Vlak Investment Analyst Imaru (Ima) Casanova specializes in "under-covered" and turnaround companies in the resource sector. In this exclusive interview with The Gold Report, Ima describes several situations that fit her investment parameters, including the unique field of royalty companies.
Imaru Casanova: MLV is a relatively new full-service investment bank/broker-dealer in New York. We've been around for about a year, focusing on capital-intensive industries—namely natural resources, mining, oil and gas and healthcare. Currently, we cover about 40 companies. We did 25 At-the-Market (ATM) issuances in the last 12 months. ATMs are becoming a huge segment of shelf registration takedowns. About 22% of all the U.S. shelf takedowns last year across all sectors were ATMs. Our philosophy on research is to provide very in-depth coverage and expose those ideas to fundamental institutional investors.
TGR: Could you explain a little more about how ATM works for people who aren't familiar with it?
IC: In a very simplified way, companies can issue stock at an opportune time for them under a shelf registration. So, a company might file a US$100 million ATM with MLV under a shelf registration. When the issuer and MLV decide that it's a good opportunity to issue stock, the stock is issued in the open market. The goal is to minimize the disruption to the share price compared to a traditional equity raise. And the costs to the issuer are lower, which, obviously, translates into better value for shareholders.
TGR: Are you looking at mining and metals specifically?
IC: We have other analysts covering the other sectors at MLV. I'm the Metals and Mining analyst. Traditionally, I have looked at precious metals names; but now, I'm also looking at some names with copper exposure. Primarily, my approach has been to provide research on relatively under-covered names—names that don't have a lot of analyst coverage out there that I think can really add value to the institutional shareholder base by providing research that they're not getting elsewhere.
TGR: Let's talk about royalty companies. This is probably an area that most investors know little about because there aren't many of them out there. Can you explain what these companies do and why you think this is an attractive area for investors?
IC: You're right, royalty companies aren't a very well-known area. One example is Royal Gold Inc. (NASDAQ:RGLD; TSX:RGL), which I believe is a very misunderstood company. I think most investors don't understand the business model. Royalty companies enjoy many significant benefits. One of the most important benefits is that by owning this stock, investors get exposure to a diversified portfolio of mining projects, including some of the highest-quality projects operated by many of the major producers. They also get reserve and resource growth at no cost to the company, which is a significant benefit.
Generally, the majority of these royalty deals don't have production caps. If Royal Gold acquires a 2% royalty on a project, it doesn't need to contribute any capital. So, basically, it's obtaining the growth without having to pay for that growth, which is a huge benefit. The royalty on Goldcorp Inc.'s (TSX:G; NYSE:GG) Peñasquito project is a great example of how Royal Gold benefited from a very significant reserve increase without having to spend a penny.
Another key differentiation is protection against operating-cost increases, which all but guarantees expanded margins in a rising commodity price environment. This is not always true for the producers. So, the royalty structure is a great way to get the optionality that comes with owning a mining name versus physical gold or an ETF. I've always talked about it as being sort of a middle ground—a hybrid between an ETF and a producer—because investors get the lower risk profile from the cost-increase protection, as well as the organic growth potential they don't get if they own bullion or an ETF.
TGR: So, by owning a royalty company, investors end up with something like a closed-end mutual fund?
IC: You can look at it that way, except the interests are not equity interests. Basically, the company owns portions of the production of numerous projects operated by many different publicly listed miners; so, investors get exposure to all those equities via one single stock.
TGR: You wrote a very detailed research report on Royal Gold last October that shows quite a large portfolio of royalty interests. Most are fairly small percentages, but they do add up. So how does Royal Gold and/or other royalty companies acquire these interests? What do they pay for them if there's any general rule of thumb?
IC: I did a lot of work in trying to figure out how much Royal Gold was paying per ounce, and it's related to the gold price. In higher-priced environments, obviously, it's paying more. But, ultimately, I found the company's cost to be very competitive compared to other acquisitions. My report includes a table that summarizes Royal Gold's acquisition history, which includes almost 20 transactions starting as early as January 1998.
Many of its royalties come from a transaction the company did with Barrick Gold Corporation (TSX:ABX; NYSE:ABX) in October 2008 when it bought Barrick's portfolio of royalties. Many more also came from its acquisition of International Royalty Corporation in February 2010. Most recently, the company did the Mt. Milligan transaction with Thompson Creek Metals Company Inc. (TSX:TCM; NYSE:TC), which was announced in July 2010 and, actually, is one of the most important royalties it owns now. The company's always looking for, and is being offered, many opportunities across the sector. Royal Gold has very good operational experience in the industry and a great track record of identifying and investing in very high-quality assets, and then benefiting from the remarkable organic growth of many of these assets.
TGR: When a property is first optioned, some sort of net smelter-return royalty is part of the transaction most of the time. And a company ends up buying these from another that owns the actual property, correct?
IC: Yes, that's one of the ways. Royalty companies acquire these in many different ways. They also buy them from third parties, individuals or families. For example, say your company owns a property, and another company buys it. Your company retains a 1% royalty. Then, Royal Gold can buy that royalty interest from your company. It's also being done by companies that need financing and can come to Royal Gold and say, "I'll give you 2% of the future production of this project if you give me this much cash up front." The future producer secures capital to develop its project and Royal Gold retains an interest in the future production of a project. Or, it may buy it from another mining company that has a royalty (as was the case when it acquired the Barrick portfolio). There are a lot of royalties floating around and new ones being structured, and Royal Gold has been pretty successful at getting access to and acquiring these royalties.
TGR: So, you're optimistic about the prospects for Royal Gold in the coming years, I presume?
IC: I am. I built a very complex model of Royal Gold with nearly 200 royalties, including about 35 producing and 25 in development. It's not easy to keep track of all that and come up with a valuation; I think a lot of it gets lost by the market in that process, unfortunately. But, I do think there's a lot of value there. This stock is trading just about $53.27 or so, but I have a target price of $81.50. I think there's a lot of upside there that is not being priced in by the market yet.
TGR: What's going to change between now and when you hit this target price of $81.50? What's going to drive it?
IC: The company has all these assets and many of the important ones haven't reached production or have just recently reached production. But the cash flow is coming. And, the great thing about a company like Royal Gold is that most of that cash is going to be free cash. Examples include projects coming on line, like the ramp up in Peñasquito, the recovery at Voisey's Bay, the new Pascua-Lama and Mt. Milligan. Andacollo, a mine in Chile that Teck Resources Ltd. (NYSE:TCK; TSX:TCK.A, TSX:TCK.B) operates, just came online. The company is very good at picking projects and all of these are going to contribute.
In the next few quarters, as the company proves that revenues are increasing and free cash flow is going to be increasing, pushing dividends up, the market's going to realize that these royalties are actually coming through. It's going to take getting the message out there and companies getting more familiar with the concept. But the proof is going to be the cash-flow generation.
TGR: About how many companies are in a royalty business versus mining business?
IC: You know, there aren't many. Now that Royal Gold has acquired IRC, the only other somewhat similar royalty company out there is Franco-Nevada Corp. (TSX:FNV), which I do not cover. Those interested in a similar business model would probably also want to look at Silver Wheaton Corp. (TSX:SLW; NYSE:SLW), a silver streaming company that operates under a similar model.
TGR: The other area you said you're interested in is companies that are under-covered by other analysts. Could you describe or mention some of these that you think some of our readers would be interested in?
IC: I also cover Fresnillo PLC (LSE:FRES) and Compania de Minas Buenaventura (NYSE: BVN; BVL:BUE), two large mining companies, but also fairly under-covered. I cover Taseko Mines Ltd. (TSX:TKO, NYSE.A:TGB), NovaGold Resources Inc. (TSX:NG; NYSE.A:NG), Great Basin Gold Ltd. (TSX:GBG, NYSE.A:GBG) and Extorre Gold Mines Ltd. (TSX:XG; NYSE.A:XG; Fkft:E1R; OTCQX:EXGMF)—all very interesting companies worth looking at.
I have also been paying attention to companies that fit within a potential turnaround theme. At present, I probably only cover one or two companies that fit that theme; however, I think it can present great opportunities. In general, I'm referring to companies that have had their stock price depressed because of permitting roadblocks that I feel will eventually be resolved. It's a riskier bet, clearly, and one for those investors willing to be patient and hold onto the stock, as these issues can take a while to get resolved.
Taseko is one company which, in my opinion, could become a perfect turnaround situation. I think it's perfect because the company is already a producer. The way I see it, if you buy Taseko, you're paying for the producing and expanding Gibraltar Mine and you're basically getting the large Prosperity gold project, which is facing permitting difficulties, for free. That makes the risk minimal.
Another company I have been learning more about recently, but do not cover, is Revett Minerals Inc. (TSX:RVM;OTCBB:RVMIF). Its Rock Creek project is stalled due to permitting problems. But it does have a producing asset, the Troy Mine. Actually, Royal Gold owns a small royalty on that mine. Again, I think it's a lower risk situation when it comes to this turnaround theme. There are other companies that don't have producing assets, such as Gabriel Resources Ltd. (TSX:GBU) and Greystar Resources Ltd. (TSX:GSL), which are a bit more risky plays in that sense, but that I believe also have a very good chance of overcoming their permitting obstacles and present very good opportunities for investors.
I remember when I first started looking at this theme. It started three years ago with Eldorado Gold Corp. (TSX:ELD; NYSE:EGO). Its Kisladag mine in Turkey had been closed because of issues with the government and permitting so its stock had plummeted. I looked at the situation and understood that once the mine reopened, the stock would bounce back to where it had been or higher, which it did. Since then I've been keeping an eye out for others.
TGR: What other factors do you consider?
IC: Obviously you can't just look at isolated events. You look at jurisdictions. You look at the quality of the project. You look at the strategy of the management to try to recover from whatever obstacle they're facing. And you decide if there's a good chance that it might indeed get resolved. I think they present a great opportunity to realize great returns with the obvious understanding that they're riskier plays. If a project should get built, it will get built. It may just take time.
TGR: You mentioned NovaGold. Can you give us a little further explanation of what you're thinking is on that situation?
IC: Yes, NovaGold is a very interesting company. It has a 50% stake in two main projects, the Donlin Creek project in Alaska and the Galore Creek project in British Columbia. These projects are in an early stage of development and we estimate first production will not come until 2017. Despite this, NovaGold is one of those companies you can't afford not to consider.
You have to pay attention to it because of the size of the assets and also because of the strong partnerships. Barrick is the partner at Donlin. Teck is the partner at Galore. Both are multi-million ounce deposits, which are rare. The company also has another project, Ambler, that's less advanced. But, it's looking very promising and could unlock a lot of additional value for the company. So, that's another positive.
My analysis suggests a target price of more than $18. The stock is trading at around $13.25, so we think there's considerable upside there. The management is solid. The company's gone through some difficult times. But it has, indeed, recovered and this has brought in some solid investors.
TGR: Are there any companies you'd like to mention, perhaps in the lower price range that our readers might be interested in taking a look at?
IC: Certainly. I'll speak briefly about two other names I cover that I think are very interesting. I've been covering Great Basin Gold since I started covering the sector. It's at a turning point right now, I think. The company has two assets, the Hollister Mine in Nevada and the Burnstone Mine in South Africa. Burnstone is actually its main project. It just came online this year. I actually visited the asset in February and was pleased to finally see the mill turning.
It's a company that is hugely undervalued due to some delivery issues. The projects have been late in starting up and had a lot of issues with project financing. There was a lot of equity being issued and expensive debt transactions. I think the next few quarters are going to be critical in demonstrating that these mines are producing and that they're going to be generating revenues. I would anticipate a re-rating of this stock following that performance in the next few quarters.
TGR: It's currently trading around the $2.64 range. What are you expecting for that one?
IC: My target for Great Basin Gold now is $5.30. That's more than double where it's now trading. That's only a 1.0 multiple to my valuation, which is much lower than the 1.5 or so multiple to valuation that many of these stocks trade at in the gold space.
TGR: Any others you care to mention?
IC: I also cover Extorre Gold Mines. It's actually the most recent name I initiated coverage on. It's a very interesting company that is a spinoff of Exeter Resource Corp. (TSX:XRC; NYSE.A:XRA; Fkft:EXB). Exeter thought it wasn't getting much value for its Argentinean assets and it spun those into Extorre.
The Cerro Moro project is their flagship project. It's actually a small project at this time, but what we see is that it has a lot of potential to grow. The company is drilling, increasing its resource and, at the same time, pushing the project forward toward a construction decision, which I think is fantastic. The exploration results suggest that there's a lot of potential there. They already have a 43-101 resource and there are updates coming soon. We have a target price of about $6.70, so we feel there is upside there. And, they actually have a little bit of a potential turnaround project there with their Don Sixto Project, which has also been suspended. It's one of those I also believe could turn around.
TGR: Why was the project suspended?
IC: Don Sixto is in the Mendoza Province of Argentina. A few years ago, the government decided that companies couldn't use cyanide and other chemicals that are required for the metallurgical processing of gold and silver. More recently that province has issued permits to other companies in the area. The San Jorge copper project, which is operated by Coro Mining Corp. (TSX:COP), just received environmental approval this year. That, to me, is an indication that things could move forward, although I should note that Extorre management doesn't really highlight this project at present
TGR: Does your target price of $6.70 include the potential of this project in Mendoza turning around or is it outside of that?
IC: It doesn't. I do assign a nominal value to the project of about $60 million. The last resource on this project is actually about the same size as the current Cerro Morro resource in terms of gold ounces, although much lower grade, but my target price doesn't include a discounted cash flow model of this project or any potential future resources or reserves.
TGR: Thank you for giving us a very good explanation of the areas you cover.
IC: Thank you.
Imaru Casanova joined McNicoll, Lewis & Vlak as a managing director in the research department in September 2010. Ms. Casanova covers the precious metals and mining sector for MLV. Most recently, she was an equity research analyst at Barnard Jacobs Mellet USA, the U.S.-based arm of the South African investment bank, where she expanded the coverage universe and product offering of the metals and mining research practice for BJM in the Americas. Ms. Casanova also has worked as an associate analyst for BMO Capital Markets' gold research team, covering small-, intermediate- and large-cap gold mining companies. Prior to working as an analyst, Ms. Casanova was a production technologist, offshore well site supervisor and petroleum engineer for Shell Exploration and Production in Venezuela. Ms. Casanova earned an MS degree in mechanical engineering and a BS in mechanical engineering from Case Western Reserve University.
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1) Zig Lambo and Karen Roche of The Gold Report conducted this interview. Zig personally and/or his family own shares of the following companies mentioned in this interview: None. Karen personally and/or her family own shares of the following companies mentioned in this interview: Royal Gold, NovaGold and Extorre.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Goldcorp, Franco-Nevada, NovaGold, Exeter and Extorre.
3) Imaru "Ima" Casanova: I personally and/or my family own shares of the following companies mentioned in this interview: Greystar, Gabriel and Eldorado. I personally and/or my family am paid by the following companies mentioned in this interview: None.