Autumn Reflections

Disclaimer: This is not investment advice, nor is it a recommendation to buy or sell shares in the company/companies mentioned.

Read Full Disclaimer

The information contained herein is accurate to the best of the author’s knowledge, but the material and interpretations contained herein should be independently verified by any party using this information as part of any research, editorial, or decision making process. Any views expressed here represent the author’s opinion only, and as such readers should do their own research and come to their own conclusions if they are using the opinions contained herein as part of any larger due diligence process. The author may have long or short positions in the companies mentioned and may be buying or selling in the market depending on which way the wind is blowing at any given moment. Opinions are subject to change without notice. Prospective resources, predictions, comparisons, financial projections, and extrapolated metrics are, by their nature, subjective and interpretation dependent. The topics covered are highly speculative and involve a high degree of uncertainty and risk. Speculative companies can and do go to zero. By using this site, you agree that the author(s) and Hydra Capital is/are not responsible for any damages incurred by the use of the presented materials. Anyone reading these blog posts should know that they are the author’s thoughts and opinions, which are not to be confused with or construed as research reports.

Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long AAV.TO, B.V, CRE.V, EMM.V, NPK.TO, NSE.V, SURG.V, TAO.V, U.UN.TO, VLE.TO, XYZ.V, YGR.TO (Image credit to Gyu Seon Choi on Pixabay)

About a year ago, I wrote about being an “ox” in 2021, with a bias towards energy and materials. Energy stocks have since reclaimed reasonable portions of their former glory after the market realized that they had become way, way too cheap in the face of what could be a looming energy crisis. Much of that re-rate has occurred now, and although the energy names still represent great value, money flow is just down to value-versus-growth market dynamics at the moment. I remain a bull on oil and gas, and seeing the market shake off this morning’s news about a coordinated SPR release is certainly encouraging. There are a number of great energy companies, with great and improving balance sheets, trading at what I think are attractive valuations. That doesn’t mean the market is going to rip them higher tomorrow, but if energy prices even just hang in around this level, the sector is going to generate the kind of free cash flow that can’t be ignored forever. Meanwhile, the mainstreaming of the electrification theme means that copper has been good if you’ve been in the right names, with small-caps generally outperforming relative to the larger-cap names. Uranium and lithium are so hot that they are on fire, while junior nickel, manganese, and rare-earth stocks are largely still waiting for their time in the sun as part of the electrification trade. Gold had my eyebrow up with its recent move up to the mid-$1800 range (despite a coincident strong move up in U.S. dollar), but yesterday gold dropped $40/oz on Powell’s reconfirmation as Fed chair, and today I’m reading about the Turkish lira being in free-fall — so I’d bet the Turkish central bank is out there selling gold today to try to support the lira as they try to figure out which way is up. I feel like gold is on the verge of something here, so my views will be heavily influenced by the direction of the next major move, with an eye on treasury yields and the dollar. Overall, balance sheets in the mining group are improving rapidly, much the same as they are for the energy stocks. It does look like M&A will continue to be a theme for both energy and materials, so I’m trying keep that in the back of my mind when I think about my holdings. The other theme that appears to be alive and well in these sectors is that of discovery/delineation stories. These are stories where a great deal of value and interest can develop quickly, making for some impressive returns if one is lucky enough to find one in the early days. After all, mines and oilfields need to be replaced as they are depleted by the cash-rich producers.

In terms of positioning, lately I’ve found myself pulling “loose” bets off the table while keeping smaller bets in play in smaller-cap names where I see the potential for outsized value creation. Those loose bets would be characterized as “beta” (i.e., market-driven) names while my higher-conviction stories would be my “alpha” (i.e., event-driven) names. I find that interest in any given commodity and its associated stocks can come and go depending on the day, the week, or the month, but as long as the underlying backdrop is broadly favourable for a given sector, the smaller companies that are truly generating value can be rewarded handsomely. Granted, moving down market is a riskier and harder game, but I think I can mitigate that risk with position size… and, by running fairly cash-heavy at the same time, I’ve lowered my overall market exposure because hey, you never know what’s lurking around the corner — and let’s face it, it’s already been a good run. It’s my opinion that at this point, in this market, no one should still need to prove to themselves that they can make money in stocks. The money making has been good; there’s no question about that. It’s the hanging on to it that’s the hard part, and I think that’s something no market participant should forget.

With that in mind, I’m by no means pulling in the horns. I just want to focus more on specific situations where I think step changes in value are possible, as opposed to, “Hey, maybe this could go up 30% because the chart looks good and I like the sector”. I’m sure I’ll make some loose buys along the way, but I’ll keep tight stops on things to make sure I’m not exposed to unnecessary damage. I never know where these notes are going to go when I start writing them, but I guess I’ll lay out some of those special situations here, in no particular order, for folks following along.

Advantage Energy (AAV.TO, last at $7.87)

I singled Advantage out about six months ago for its embedded carbon-capture subsidiary called Entropy Inc. For anyone not aware, Entropy has developed a modular, scalable, carbon-capture technology that it projects will have CO2 capture costs of half of anything that might be considered to be a peer. It gets interesting when you consider that Aker Carbon Capture ASA (ticker: ACC, listed in Oslo) is probably the closest peer to Entropy… and it has roughly doubled in value over the last twelve months to a ~$2.5B market cap (despite having almost no revenue). Now think about the fact that Aker’s goal is to be able to capture CO2 from direct emissions at twice the cost of what Entropy is targeting. In other words, their goal is to be half as good as Entropy. Hmmmm. Advantage owns 90% of Entropy, has a fantastic gas business, and has a market cap of $1.4B; so a person could draw some conclusions about the amount of upside in play if Entropy is as good as billed. The market should get a good look at the performance of Entropy’s technology when the first phase of a commercial-scale system is rolled out at Advantage’s Glacier gas plant in Q2 of 2022. Whenever there’s some kind of transaction that pegs the market value of Entropy, I’ll revisit my value argument and see how it holds up.

Anacortes Mining (XYZ.V, last at $1.75)

CEO Jim Currie says it best when he points out that the Tres Cruces deposit was lost in obscurity for the better part of 20 years, under the radar of almost anyone in the industry. There hasn’t been any drilling on the deposit since 2008, and no one has ever done an independent economic assessment of the project despite its top-tier grade, notable scale, and potential for expansion. Having been hidden in Barrick’s portfolio for nearly two decades, the Tres Cruces deposit has almost no drilling deeper than 350 metres, despite the fact that it remains open at depth and is in true elephant country for mineral deposits. Tres Cruces is a fully preserved epithermal system, capped by a pre-mineral rhyolite that protected it from erosion. Jim Currie’s last job was as COO of Equinox Gold and he is a proven mine-builder, who now has his hands on a high-grade deposit that’s open to low-cost expansion at depth. I’m looking forward to seeing how this plays out in 2022. This is essentially a Prime Mining (PRYM.V, last at $4.70) replay (the assets are very similar). The difference being that PRYM has a market cap greater than $500 million while XYZ has a market cap of less than $100 million and is just going into a series of catalysts similar the one that took PRYM up multi-hundred percent once the market figured out what it was. Drilling at Tres Cruces is expected to start up in Q1 2022 which is not that far away… I can’t wait.

Tag Oil (TAO.V, last at $0.40)

Well, what can I say? It’s been a year and I’m sure that the TAO executive team are feeling the pressure to get something done that makes sense for the company and its shareholders… but sometimes there’s really nothing to do but wait. Having had the benefit of watching Rally Energy 5-bag in the last major energy cycle not long after Abby came in, I’m keen to see if lightning can strike twice. I see no reason why it can’t given the level of experience and expertise represented by this team. I’d argue that the recent pullback in oil helps TAO, not hinders them as they look to ink deals.

Tenaz Energy (TNZ.V, last at $0.27)

When I first came to Bay Street, I had the pleasure of working with an energy analyst who was the happiest guy I’d met in the business. Just a really, really nice guy. Once in a while, he would mention some massive position that he’d have put on years ago and smile about how simple it all was… “Just follow the teams,” he’d suggest. Stick with quality management teams and they’ll always build value in the long run was the mantra. Well, all I can say is that he’s retired now and riding horses around on his own farm, probably still following some of the same teams around. Sometimes there’s no need to reinvent the wheel. When Marino and crew came into Altura for a re-cap, I couldn’t have been happier. I’ve only added stock since the news and continue to do so. Riding the equity wedge in a re-cap/acquisition story alongside management with this level of industry experience seems like a good idea to me if all I need is the patience to let them execute. Tenaz’s corporate goal is to have 50,000 boepd of production within reach by Q4 2022. Time will tell.

Uranium

The case for uranium remains strong from a climate perspective and the market remains undersupplied. The elephant in the room is the Sprott Physical Uranium Trust (aka “SPUT”, U.UN.TO, last at $14.30), which continues to mop up millions upon millions of pounds in the spot market at prices below the marginal cost of production. I’m keeping it really simple with uranium and my main position is the SPUT (uranium in a warehouse), because for most of the equity values to make sense, the uranium price itself simply has to be heading higher. It doesn’t have the leverage that NXE, DML, UEX, or FCU might have, but for now, I’m content to play uranium by “owning physical”.

Yangarra (YGR.TO, last at $1.60)

The stock sold off after Q3 results were reported for two reasons. Production came in at 8,700 boepd vs 9,700 boepd expected and there was “below type curve” performance in some of the wells were drilled in the quarter. Sometimes the details matter. The production miss was due to the fact that YGR had approximately 800 boepd offline while it was drilling/completing on one of its pads, meaning it had to shut-in producing wells on the same pad. Add that back and you’re looking at 9,500 boepd vs 9,700 expected. That’s “in line”… not a miss. Next, with respect to the underperformance of some wells, welcome to the world of statistics. YGR drills wells above the type curve and below the type curve in what is a real-world example of statistics in action. They base their budgets on the “average” well. In the quarterly report discussion, they mention that four additional wells have been brought onstream at West Ferrier which are not experiencing the same lower flush production (IP) rate and that they remain confident in the corporate type curve. If was reading into that, I might be thinking that the West Ferrier wells are outperforming, thus giving confidence that the “average” is intact. I guess we will see. With a 14-well pad planned at West Ferrier starting in January, I suspect we will be hearing more from this area going forward. I have YGR on autopilot and would prefer to be woken up when the stock starts trading above its PDP reserve value, which is about 100% higher than here. YGR continues to screen as one of the cheapest producers in the Canadian energy sector on EV/CF, P/CF, P/NAV, and EV/FCF metrics. Maybe the market figures it out in Q1, but I think it’s a cheapie that’s being overlooked.

Critical Elements (CRE.V, last at $1.72)

With Federal permits in hand, little CRE is waiting for provincial permits before it can officially enter the lithium dance-a-thon. If you haven’t noticed, lithium is red hot right now as a manufacturer-led staking rush for battery materials continues. CRE has a spodumene (hard rock lithium) deposit in Quebec that boasts impressive economics and a preferable ESG footprint in the eyes of European manufacturers. The project would be an integral part of the “Quebec battery complex” and I expect it will hit a lot more radars once provincial permits are in hand. I can see no rational reason why the provincial permits wouldn’t be forthcoming, so I’m content to wait. It could be days, weeks, or months, but CRE can afford to wait, having just raised $25 million a couple of weeks ago.

Valeura Energy (VLE.TO, last at $0.48)

This is very simple for me. VLE has cash of around 60 cents per share. The stock trades for 48 cents. The balance sheet is clean. A discount to cash suggests that the company is going to destroy value going forward. If VLE was trading at cash value I might think I could do better with the cash myself, but with the stock trading at a 20% discount to cash value, I don’t mind taking the other side of this “no market faith” bet.

Giyani Metals (EMM.V, last at $0.40)

Manganese. It’s the “M” in NMC lithium-ion battery chemistry. We’ve heard lots about cobalt and nickel, but no one talks about manganese… except people like the management team at Giyani. This company has a near surface, free-digging, very high grade manganese deposit in Botswana that checks all kinds of feel-good EV supply chain boxes. Updated economics on the project are due any time now, so battery metal enthusiasts will want to bookmark this one. The first pass on economics here looked very impressive. If the pending new study is as strong, I expect EMM will jump on the battery market train to higher levels.

New Stratus Energy (NSE.V, last at $0.56)

New Stratus announced that it has an agreement on Repsol’s assets in Ecuador where it hopes to extract some 115 million barrels of oil over the coming years. The news release was lacking in some of the details about how this circa US$200 million two-year capital program (2022-2023) is going to be paid for, so the market can expect to see an additional update from NSE on that soon-ish. At this point though, fans of Jose Arata are on notice. He’s baaaaaaaa-aaaack. Place your bets. There’s some 30c paper coming free-trading near month-end. I might add to my position if it somehow gets close to that deal price.

Verde Agritech (NPK.TO, last at $1.84)

I don’t really have anything new to say on this one, but the chart seems to be talking so I’ll wave my arms a bit. NPK recently reported that they are sold out of their glauconitic siltstone fertilizer for the year and are planning to triple capacity immediately. The best part is that the expansion is fully funded by internally generated cash and bank debt, which means it comes with zero equity dilution. NPK has spent years trying to breakthrough in the Brazilian fertilizer scene and it looks like it might be time to pay attention as volumes ramp up. Once upon a time, I remember when the scoping economics on this perfect “regen ag” (regenerative agriculture) play pegged a billion-dollar NPV on the full-scale operation. To be sure, NPK isn’t at those production levels yet, but they appear to be on the path. NPK’s naturally-slow-release fertilizer is impressive on so many levels. It replaces potash (KCl), thus ending the cycle of chloride (salt) accumulation which is toxic to beneficial microbes in agricultural soils. It supplements silica content in plants, adding to weather and drought hardiness. It replenishes micronutrients in the soil (e.g., magnesium) that are depleted by crop production and natural weathering processes. Once you start reading about it, you’ll wonder why everyone doesn’t use it, or want to use it. So there you have it. I dare you to read about what NPK wants to bring to a reasonably large portion of Brazil. I feel like the winds of ESG could really take this one places.

Surge Copper (SURG.V, last at $0.31)

It’s not rocket science. The Huckleberry mine, literally adjacent to Surge’s copper-gold deposits, is on care and maintenance and its owners are trying to figure out its future. Surge has a big resource (with a resource estimate pending soon-ish) and needs to process it somewhere. Hmmmmm. Whatever would the logical conclusion be? Can you say 1+1=3? All I will say is that if Surge’s rock doesn’t go through Huckleberry’s infrastructure (owned by Imperial Metals), then someone missed an opportunity to create a boatload of value. I have no idea if or when this happens, but I think it should, so I am long stock… in the hopes that it will.

BCM Resources (B.V, last at $0.17)

BCM Resources is whale hunting in the desert. I’m talking about the White Whale kind of hunting. The kind of hunting where you can go broke trying… especially when you get early indications that you are in fact in a blind (covered) porphyry system, which BCM appears to have done. It’s very early days here and I don’t think that BCM has hit anything that’ll knock the market’s socks off yet, but the allure of this treasure hunt is building as they continue to confirm the geological model. This is a tiny position for me, but if it ever hits a long, good grade hole, it could have quite a move given its relatively low market cap, so I think it’s a good minnow to have on the radar.

I’m short on time this morning, so I’ll cut this off here. As usual, this note touches on a fraction of the things I follow, but that’s what bubbled to the surface today!