riday, May 24, 2013

Lessons Learned from High-risk Speculations: Steve Todoruk

Sprott Global Resource Investments Ltd.’s Steve Todoruk is a geologist and former president of two junior exploration companies himself. He walked me through the full story of a junior exploration investment from start to finish. He helped improve my understanding of how investing in these companies can play out.

The Cash Question

“Before purchasing a portion of a junior exploration company, you need to know how much money it has in the bank. You want them to have enough money that they can continue to work aggressively to advance their project. Shareholders only get paid and make money if the company can reach the finish line. I don’t want to hear that a company is conserving their cash or reducing their drill program,” said Todoruk.

“If a company has discovered a brand new good looking deposit, you want them to have enough money to keep drilling it, growing it steadily bigger and bigger in size. They need to grow their deposit large enough for the major mining companies to come along and acquire it 3-4 years after the initial discovery was made.”

Share dilution – which happens when companies need to raise more money – is a major drag on investment performance. “It’s critical that the company keeps the number of outstanding shares to a minimum,” he says. “You want to see the company doing successive private placements at continually higher share prices. This is not done nearly as often as you’d think and that’s a contributing factor to the challenges in this sector.”

As long as a company can keep raising money at favorable share prices, he said, and maintain a healthy financial position, investors need to be comfortable sitting back and letting the company keep doing their job, which usually means doing lots and lots of drilling. “It can take one week to drill one hole and they need to drill approximately 150-200 holes to establish an ore body. This means you could be in a discovery stock for three or four years.”

“A ‘normal’ market would typically rework the valuation of the deposit continuously. The company’s share price would more or less continue to rise as long as the deposit kept getting bigger. The company’s share price or market capitalization would more or less be steadily rising,” says Todoruk. “As investors, this was a normal pattern and we could sleep well at night watching our investment gradually increase in value over time.”

“But we haven’t been in a normal market environment for over three years,” Todoruk laments. “The market capitalizations of these companies are no longer correlated to the estimated deposit values.”

This makes discipline even more important, he says, as price fluctuations based on external events and institutional selling test investors’ mettle. “Big mining companies still need to replenish their reserves, and are still going to be acquiring junior explorers that have found those elusive high quality deposits.”

Great Geologic Results

“Hathor Exploration taught me and all of my clients a very valuable lesson that I continue to stress to them to never forget as an investor in these stocks,” Todoruk explains.

“I recommended Hathor Exploration, a uranium exploration company in Saskatchewan, Canada, in February 2008 at under $1.00. The company had encountered 30 meters of elevated radioactivity with discrete zones of highly radioactive intervals, measuring ‘off scale’ (greater than 9999 counts per second) – an indication that an important amount of uranium was in the drill core. The property where Hathor was exploring was also located in the Athabasca Basin, a region known for its rich uranium deposits. Very high scintillometer readings, along with the location of the drill hole and the host rock type greatly increased, in my opinion, the chances that the assay results would come back positive for high-grade uranium. The ensuing assays confirmed my suspicions and made it clear from a geologist’s perspective that the company had come across something especially interesting. The uranium grades were around 500% higher than what uranium exploration companies typically report in their assays. Hathor was into something where the ‘uranium juices’ (mineralization solutions) had been flowing and I recommended adding to the position.”

At this time, Todoruk expected he and his clients would follow the company’s drilling program for the next several years with the hope that it would continue to prove out and become large enough to be acquired by a major mining company, resulting in the hoped-for investment success.

“My clients had bought Hathor to the point where we were cumulatively one of the largest shareholders in Hathor (as a reward for hanging in there all the way to the end, I was given one of only 20 individual share certificates showing that I owned 1 share of Hathor that was not tendered to Rio Tinto after their takeover of Hathor in 2011),” Todoruk explains. The road, however, was not a smooth one. “During the three years it took for Hathor to keep drilling their deposit, the market threw everything it could at us trying to get us to sell all of our shares.”

The stock performed well for the first six months after February 2008 (see fig.1) as the company succeeded in increasing the deposit size, reaching a high of $4.36 in August, 2008. “The high reflected Hathor’s success at growing the deposit ever larger and more valuable as an asset,” says Todoruk.

Figure 1: Hathor Exploration January 2008 to December 2012

Trust Deposit Value

“Then,” Todoruk recalls, “the wheels got wobbly. The financial crisis in late 2008 struck, and Hathor fell with the rest of the market, giving up essentially all of the previous six months’ gains.” His clients were shocked and anxious. He counseled them to hold on, or even buy more, at the reduced prices. “The company still had enough money to keep drilling,” he explained. “As a geologist, I didn’t see anything to indicate that the deposit wouldn’t continue to grow. I had to remind my clients that markets don’t stay bad forever – they eventually turn.”

Within a few months, the worst of the market crash was over and Hathor’s price had regained much of what it gave up in late 2008. “While uranium prices were doing well once again, Hathor led the charge in the uranium equities because of its brand new high grade discovery, recovering back up to $3.60,” Todoruk continues. “But then there was another market sell-off and it went down again, falling to $1.30 in September 2009. The stock bounced around the $2.00 level for the next year and a half or so and finally returned above $3.50 in late 2010. We thought the reward was in sight as far as a takeover was concerned by this time – the deposit was nearing the 50,000,000 pounds we felt was the target for a major to come in.”

But then, in March 2011, a tsunami and an earthquake shut down Fukushima and the anti-nuclear sentiments among governments and the public, combined with excess uranium stockpiles due to the shuttered reactors, clobbered uranium prices. Hathor was once again down in the mid -$1.00’s and Todoruk’s clients were not pleased. “Why aren’t we selling this pig Hathor?” one asked.

“Once again, I told them not to panic.” His belief in the fundamentals of the company’s assets remained solid – he advised to hold on or double down.

Those who did fared well: “The vast majority of my clients rode out the crash in Hathor and about 2 months after Hathor made the milestone announcement that they had officially discovered over 57,000,000 pounds of high grade uranium. In response, mining major Cameco announced a hostile takeover attempt to acquire Hathor’s prized deposit. Eight weeks later, Rio Tinto jumped into the fracas and got a bidding war going which ended with Rio Tinto paying $4.70 per share for Hathor.”

His belief and that of his clients was rewarded. Hathor announced they had over 57 million pounds of high grade uranium and Rio Tinto acquired the company for $4.70 per share.

“As long as the story is intact,” says Todoruk, “investors need to be patient. There are several recent discoveries that I am convinced will be very good mines in the future, but you’d never guess it by looking at the share prices today.”

Todoruk reminds investors with the courage and financial profile for investing in junior exploration companies that “Today’s share price is not ultimately the share price that you should care about – it’s the price you get paid at the end of the day when you sell it.”

Past performance does not guarantee returns, however. Success stories remain the exception in this high-risk market. Speculators in natural resources should meet the financial profile before investing in junior exploration companies.

Steve Todoruk worked as a field geologist in many major and junior mining exploration companies after he graduated with a B. Sc. in Geology from the University of British Columbia, in 1985. Steve joined Sprott Global Resource Investments Ltd. in 2003 as a Senior Investment Executive. To contact Steve, e-mail him at stodoruk@sprottglobal.com or call him at 1.800.477.7853. As disclosed above Steve owns one share of Hathor from prior to the acquisition by Rio Tinto.