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Siddharth Rajeev: Discover Fair Value Gold Stocks
Source: George Mack of The Gold Report (5/25/11)
Siddharth "Sid" Rajeev isn't a miner. But in his search for value, Sid, head of research for Fundamental Research Corp. in Vancouver, digs deep into the world of small- and micro-cap stocks to find undiscovered gems. In this exclusive Gold Report interview, Sid drills down on some relatively unknown resource stocks he has uncovered.
Sid Rajeev: I initially worked for an engineering firm for a few years. I developed a strong interest in finance and investment analysis in those years, so I decided to pursue an MBA degree. Soon after I got my degree, I joined Fundamental Research and it's my sixth year here. At Fundamental, we have a team of analysts, including financial analysts and geologists. We cover about 150 companies; three-quarters of them are in the natural resource sector. The rest are from agriculture, technology, aerospace and other industries.
TGR: Instead of putting target prices on stocks, your firm uses a fair-value metric. Does that imply perfect pricing, a theoretical point at which there's no upside or downside?
SR: Fair value is basically the intrinsic value of a stock on a particular day, which is calculated based on the stock's fundamentals. And you're right—it's basically the point at which there's no upside or downside.
TGR: When shares reach fair value do you recommend them as momentum plays?
SR: No, Our valuation methodology is always based on fundamentals; we will not give a buy recommendation on a stock if its share price is higher than its intrinsic value. We tend to evaluate or review our valuations on a particular company every three to four months—sooner if some significant news develops.
TGR: With a fundamental theory, you recommend taking money off the table when a company achieves fair value and seeking fair value in another company's shares.
TGR: You cover a lot of metals, from gold and silver to rare earths and others. Sid, I assume you think of gold as a currency and believe it has different drivers than the commodity industries you follow. Could you tell me about the different drivers of these industries?
SR: You're right, we think of gold as a currency simply because most investors buy gold to preserve their capital. All the other commodities—except silver—are driven by supply and demand. If a supply deficit is forecasted, that means prices should go up and vice versa.
Silver is unique because it's priced as a commodity and as a capital preservation asset.
TGR: Do gold and commodity stocks correlate or do they provide diversification?
SR: As the drivers of gold and the drivers of the rest of the commodities are different, I would definitely view a good diversification strategy as one that includes gold and commodity stocks. Commodities' main driver is supply and demand. When an economy does well, so do commodities. But gold, on the other hand, tends to do well when there's uncertainty in the economy. When the value of paper money is expected to depreciate, gold tends to do well. It's definitely good to have gold and other commodities in a portfolio.
TGR: What are you trying to achieve for your clientele through your general investment theory?
SR: Our main goal at Fundamental is to bring out those underexposed small- to mid-cap companies that no one really follows. Those are the ones that are most likely to be undervalued. Our geologists look at the technical aspects. They work in conjunction with our financial analysts to come up with the intrinsic value and a recommendation.
TGR: Are you generally bullish on commodities right now and which ones?
SR: I've never been a big fan of gold or silver since gold crossed $1,100 and silver crossed $20. Although I don't see any major upside from current levels, gold should stay at its current price for the near term. Slow recovery in the U.S. and the continued weakness in the U.S. dollar should keep gold high. In the long term, three or four years down the line, we expect gold and silver to soften from current levels.
In terms of the other commodities, we had predicted a correction when we last spoke to the Gold Report early this year. Although we have experienced some kind of correction since then, we think there is a little bit more room for downside. If you look at copper, for example, at $4.11 per lb., most of the projects out there are making a lot of money. Producing companies and upcoming projects can still make good margins at lower copper prices.
Even though we don't think there's much upside in the base metal sector in terms of commodity prices, there are a lot of companies in those sectors that are very undervalued—companies with quality assets, quality management teams and solid cash positions.
TGR: Where should investors be deploying capital?
SR: Compliance Energy Corporation (TSX.V:CEC), a coal company, recently announced a positive feasibility study and it should go into production in the next 24–36 months. It has a quality management team, strong cash and investments and a significant position in Copper Mountain Mining Corp. (TSX:CUM).
We also like Pacific North West Capital Corp. (TSX:PFN; OTCQX:PAWEF; Fkft:P7J.F) and Commerce Resources Corp. (TSX.V:CCE; Fkft:D7H; OTCQX:CMRZF).
TGR: Pacific North West has a gold and polymetallic project. The company is going to need about $5M to explore its River Valley project this year, but it only has about $8.4M in cash on the balance sheet. When will Pacific North West have to go back to the market?
SR: We always look for a strong management team and strong cash position in juniors, and Pacific has that. Holding $8M-plus in cash is strong for any junior, especially when that company's market cap is less than $30M. I think the current cash should easily be enough for the rest of the year. The company has several projects, but four main assets really contribute to our fair value of this stock.
First is their 100%-owned River Valley project near Sudbury, Ontario, which has a measured and indicated resource of 953,000 ounces (953 Koz.) palladium, 330 Koz. platinum and close to 60 Koz. gold. The second project is the Destiny Gold project in Québec, which also has over 600 Koz. gold in indicated and inferred resources. The third project is the Rock and Roll silver-gold rich VMS project. The company recently announced a resource estimate on that project as well. And, the fourth asset is an 8% ownership in Fire River Gold Corp. (TSX.V:FAU; OTCQX:FVGCF), which is focusing on the Nixon project that is expected to be in production shortly. We think it's a strong buy at this time.
TGR: It sounds like it should not have any problem raising capital.
SR: Yes. The management also has solid experience in raising capital. We don't see cash as a problem for this company at this time.
TGR: Commerce Resources shares are up 166% over the past 52 weeks, but you're still very hot on this company?
SR: Right. We've been following Commerce for the last six years, so we know very well how they have been advancing their main project, the Blue River project in British Columbia, which is an advanced stage tantalum-niobium project. The company has recently received a lot of attention for its rare earth project in Québec, the Eldor project. It came up with an initial resource estimate that stated 117 Mt grading 1.74% TREO in the inferred category. We think that resource is one of the world's largest NI 43-101 or JORC rare earth deposits outside of China. This is a huge development for the company. Our fair value on this stock is $2.13.
TGR: I'm wondering about industries where the resources are not traded by open outcry or electronic markets. You follow some markets like that?
SR: Yes. One good example is the vanadium market. We have a long-term positive outlook on the vanadium segment. One of the best bets for investors who are looking for pure exposure to vanadium plays is Apella Resources Inc. (TSX.V:APA; Fkft:NWN) in Vancouver. The company completed a 16-diamond drill hole program on its Iron-T project in Québec. It also has the Lac Dore vanadium project, which has a huge historic resource.
TGR: Is that the next market-moving event for Apella?
SR: I would say the results of the current program, if positive, will be the next catalyst.
TGR: The company won what could be a milestone victory against SOQUEM Inc. for 18 of 21 claims in the Lac Dore deposit, the world's second-largest vanadium deposit. I'm wondering how far along this project is from being a major play for the company?
SR: A lot of work has to be done on it. The numbers that we have seen so far from this project have been excellent, but a significant amount of work has to be done before a production decision can be made.
TGR: How do you value a company based on underlying assets that don't have a published commodity price?
SR: That's a very good question. Investors typically find it easy to value revenue or cash-flowing companies. Over the last eight years in business, we have developed a strong expertise in evaluating juniors who have no revenues. At Fundamental, we use three valuation models, the discounted cash flow model, real options model and a comparables valuation model. For comparables, we use a metric called "EV-to-resource," which is basically enterprise value to resource of a company. When we are valuing a company like Apella Resources, we look for similar companies focusing on vanadium. We examine their EV-to-resource ratios and find the average. In the case of Apella, we found that the average valuation metric was $0.06/lb. and Apella was trading at $0.01/lb., which shows that Apella was undervalued. Our fair value for Apella at the time of our last report was $0.65.
TGR: You follow some micro-cap companies where investors can get major returns if projects pan out. Can you talk about some micro caps that stand out?
SR: We recently issued coverage on two companies: Musgrove Minerals Corp. (TSX:MGS; OTCQX:MGSGF) and Hunt Mining Corp. (TSX.V:HMX).
Musgrove Minerals' main focus is gold and polymetallic projects in Idaho. One of its main assets is the Empire Mine project, a polymetallic project in Idaho with a historic resource estimate. The company is expecting a prefeasibility study on that to be completed this year. Its second key asset is the Musgrove Creek project, which has an NI 43-101 resource. The company currently has close to 1.5 Moz. gold equivalent in historic and inferred. We initiated coverage on the company with a fair value of $1.66/share. The company is trading at just $0.15.
TGR: With a market cap of $5.5M, any kind of resource could vault these shares up to unbelievable heights. Your implied return is probably about 1,000%, I'm guessing.
SR: The intrinsic value reflects a return of 1,000+%. These projects are in Idaho, which is a well-known, mining-friendly community. We know the management team well. The company also recently announced a financing. We expect the company's progress at its two main projects should move the stock price closer to our fair value estimate.
TGR: Hunt Mining is also very small with a $36M market cap. It is up 22% over the last three months, 47% during the past six months, but it's about flat for the year.
SR: We initiated coverage on the company a few weeks ago with a $0.50 price valuation. At that time, the stock was trading at $0.33. After we initiated coverage, the company came out with some extremely positive results and the stock moved up significantly. I think it's close to our fair value now. We are revising our valuation on the stock and we will be releasing an updated report on the company with new recommendations soon.
It has a strong management team and a strong cash position. It's located in Santa Cruz, Argentina, which is a really mining-friendly area with great infrastructure. There are a lot of other huge players there that are trading at significantly higher multiples compared to Hunt.
TGR: You've talked about some very interesting plays here.
SR: We also recently initiated coverage on Thunder Mountain Gold Inc. (TSX.V:THM, OTCBB:THMG), which has made some good progress over the last 12 months. Its main project is the South Mountain project in Idaho. That has close to 20 Moz. silver-equivalent resource. It's a polymetallic deposit. They are currently completing an updated resource estimate and PEA for this project. Recently the company signed an agreement with Newmont Mining Corp. (NYSE:NEM) to advance its Trout Creek project in Nevada. The company just announced a $4.5M financing. The company should be in a strong cash position after this financing. Our fair value on this stock is $0.70.
TGR: It's currently trading at about $0.29. That's a more than a 100% implied return. It's a micro-cap company with about an $8M market cap. Almost any resource would have a dramatic impact on the share price.
TGR: Thanks. I've enjoyed meeting you very much, Sid.
SR: I've enjoyed our discussion as well. Thanks.
At Fundamental Research Corp., Sid Rajeev heads the research department, which covers over 150 small- and micro-cap companies and 15 exempt market/private issues from a broad array of industries including energy, mining, real estate and technology. He also manages the FRC list of Top Picks, which are the stocks under coverage that he has the highest conviction level about. These picks have historically helped the firm finish strong in various third party analyst performance rankings.
Sid holds a bachelor of technology degree in electronics engineering from Cochin University of Science & Technology, and an MBA (Finance) from The University of British Columbia. He is a CFA Charterholder, and has completed studies in exploration and prospecting at the British Columbia Institute of Technology.
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1) George Mack of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Copper Mountain Mining Corp., and Commerce Resources Corp., Fire River Gold, Apella Resources Inc., Musgrove Minerals Corp.
3) Siddharth Rajeev: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None.