Alterra Power Corp. (AXY:TSX, 7.83) has agreed to be acquired by Innergex, a Canadian renewable energy company. Investors will receive C$2.06 cash and 0.4172 of an Innergex share. As always occurs, the acquirer's stock price fell on the news (from $15 to $14.11); at today's price, the acquisition equates to C$7.95.
We are often saddened to see a long-term holding go, even at a nice premium, and especially so in this case, where after a long difficult period, the company had turned and was generating operational profits, cut its debt, and instituted a dividend with a view to becoming a cash-flowing, high-yielding vehicle. Founder and Chairman Ross Beaty, in fact, noted that the company "was just hitting our stride" when the offer from Innergex was made. We had recommended it as a buy in our last newsletter at C$5.33.
We do not intend to hold Innergex on our list for the long term. What we know about the company appears positive enough: it has a good balance sheet, a diversified portfolio, it pays a dividend equating to a 4.7% yield (and will continue its payout policy), and combining the companies will reduce the cost of capital for Alterra's projects, a significant drawback to a standalone Alterra. Certainly some of you may wish to hold this company, but we will not be following it.
So for us, we will be selling Alterra and booking a gain. Where and when to sell? The current price is below—though only marginally—the purchase price. It is more so below the value on the day of the bid, C$8.21. On the other hand, apart from the discount being modest, there is also some risk—unquantified—in Innergex stock and in the Canadian dollar. (They could both appreciate as well, of course.)
Let's place a sell on Alterra at C$7.90 and sit there for a while. We may reduce that limit at some point if it doesn't fill, but do not see a rush.
Execution on worthy goals yet to be seen
Goldcorp Inc. (GG, NY, 13.10) has underperformed; we bought looking for a recovery that has yet to come. The company's new 20% goals are fine—20% growth in production and reserves, 20% decline in costs—but we have yet to see significant movement on any of these yet, except perhaps on the reserve goal. It has certainly purchased some reserves and resources with the acquisition of an interest in two mines in the high Andes, but buying reserves is a lot easier than increasing production and cutting costs. It is debatable whether these new deposits will come into production any time in the reasonably distant future. The deposits are uneconomic today and their projected costs keep increasing in every study that has been performed.
But overall operations are improving, particularly at two relatively new mines, Cerro Negro and Eleonore. These took longer to ramp up to nameplate rates, and Eleonore in particular still has problems (production up but reserves cut). The company also saw the completion of a new production circuit at its large Penasquito mine in Mexico a year earlier than expected.
The company must stop value-eroding M&A—it had indicated that the period of major new acquisitions was over immediately before buying Caspiche and Cerro Casale, and needs to improve its balance sheet. Given it no longer trades at a meaningful discount, we are holding but not buying.
Strong cash flow, but problems at major mine
Royal Gold Inc. (RGLD, Nasdaq, 85.95) had a mixed quarter. Most of the news ranged from positive to very positive: solid cash flow with earnings meaningfully higher than expectations, and continued debt reduction. New Gold's Rainy River is ramping up and first revenue contributions are expected in the current quarter, becoming Royal's 40th producing asset. The pipeline is strong, with, following Rainy River, Cortez Crossroads commencing production next year. Currently, 87% of revenue comes from precious metals, of which 77% is from gold.
Currently, all cash flow—over $70 million last quarter—is going to debt reduction and dividends. It has $88 million in cash and around $900 million of liquidity. The company is still looking at (and bidding on) new assets, although such would more likely be in the $100 million to $500 million range rather than the half to one billion of 18 months ago.
Difficulties at major asset
The one negative, but a very significant one, is the ongoing operations difficulties at Mt. Milligan, at which operator Centerra Gold just reduced full year guidance. It does not appear that the difficulties are yet resolved, so we can expect lower production (and revenue to Royal) for the time being. This is significant since that single mine represents 27% of Royal's Net Asset Value.
We like Royal Gold for its reasonably diverse asset portfolio, strong geographic risk profile, solid cash-flow, and good management, but there is an ongoing risk with Mt. Milligan and valuations remain somewhat rich. The stock is down from over $94 in late August primarily on Mt. Milligan; we will look to buy but on any addition pullback.
Adrian Day, London-born and a graduate of the London School of Economics, heads the money management firm Adrian Day Asset Management, where he manages discretionary accounts in both global and resource areas. Day is also sub-adviser to the EuroPacific Gold Fund (EPGFX). His latest book is "Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks."
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1) Adrian Day: I, or members of my immediate household or family, own shares of the following companies mentioned in this article: Royal Gold. I personally am, or members of my immediate household or family are, paid by the following companies mentioned in this article: None. My company has a financial relationship with the following companies mentioned in this article: None. Funds controlled by Adrian Day Asset Management hold shares of the following companies mentioned in this article: Alterra Power, Royal Gold and Goldcorp. I determined which companies would be included in this article based on my research and understanding of the sector.
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