Using Stockopedia to find Junior/Nano miners - Where angels fear to tread

You know the scenario. A little known mining stock suddenly appears on your broker's website on the best performers list with a very large green number next to its name. And you think to yourself, “WOW” how do I identify them?

However, the reality is that just like a modern day Indiana Jones, if you want to find the holy grail you first have to roll around in the mud, dodge poisonous arrows and brush off the occasional tarantula.

Before I continue, I just want to make something abundantly clear... Most of these ‘businesses’ are NOT investment grade. They are high risk, run on hope alone and seem to be more keenly discussed in chat rooms, rather than in board rooms.

But c’mon… we’re Aussies and Kiwis… we love the punt! And it gets no more exciting than jumping on a junior looking to become the next BHP. Right?

The key obviously is to identify these businesses before they run. Often it’s too late by the time the price spikes, and playing with it then can often lead to an investors’ fingers being burnt

Just like in horse racing, once a filly shows promise, the odds on it will shorten.

The reality is that no one knows:

1. what's under the ground until you find it.

2. even when they do find ‘something’ how much of the price move is legitimate and how much is hyperbole.

Focusing on point 1 above, the only way to find out if there is something underground is if you dig (drill) a hole. And while you may burn time and company resources to find nothing, there is always hope right? Except for one thing - you need cash to pay for getting a hole drilled.

Drilling holes costs money

You don’t need to be told, but just in case you weren’t aware, junior miners consume cash like they are tickets to a Billy Joel concert…. In both instances they go quick!

The process of drilling holes is far more technical and complex than simply finding a few burly blokes and buying them shovels from Bunnings.

There are different types of drilling that complete different tasks in the discovery cycle and each stage costs a fair chunk. Though it obviously costs more the more accurate and deeper you wish to go.

The well worn strategy of a junior miner is to dig a hole, find something, dress up the result in a nice announcement to the ASX, and then convince the market you need more money to drill deeper holes.

Even if a company doesn’t find anything, all they have to do is find somewhere else to dig, preferably looking for the “metal de-jour” and then convince the market they need more cash to find it.

And here within this cynical view on junior explorers is lesson #1. “Very rarely, if ever, is your first investment in a junior explorer your last.” This lesson rings true even if you are in the next Fortescue who has raised countless millions on its way to production.

That is why if you are going to invest in these types of businesses don’t go too heavy on your first swing, because pitch number two is often just around the corner and you will need to front up with an additional investment should you want to avoid being diluted.

But I digress…

Finding the next home run

Other than obtaining a Masters degree in Geological Science, it is difficult for us regular punters to know the chances of a miner's success. This is on top of the nuances and vagaries of specific drilling results.

But you’ll be glad to know there is somewhere we can look to help get the odds working in our favour.

More specifically, we can look at a miner’s cash balance and approximate when a company will need another dilutive capital raising.

Junior explorers have the fortunate task (from their perspective) of playing with other people’s money, but even that can eventually run out.

Therefore what seasoned digger dogs (investors) often look for is how much cash does the company have and how many swings at bat does it afford it to eventually have a chance of hitting that home run?

One measure used to help determine this is Enterprise Value. It’s calculation is:

Enterprise Value (EV) = Market Cap – Cash on Hand + debt on the books

The text books will tell you that Enterprise Value is a quasi-takeover value for a stock, where once you take out cash and add back debt to the market cap, what is left is a value that is a theoretical takeover value of the business. Often this number is displayed on a per share basis and is used within a number of ratios such as the EV/EBITDA value ratio.

In mining stocks it can be used in a slightly different way. We can measure the EV of a mining stock and compare it against its market cap to get a sense of the cash on hand relative to the value the market is attributing to the company.

You can then use that result in absolute terms or compare it against a peer in a similar stage of exploration.

Basically if the EV is significantly below the market cap, it implies that there is not much value being attributed to the entity itself with much of the value caught in the cash balance. So a low EV mining company may be sitting on a lot of cash for future drilling. With more cash on hand, it increases the chances of hitting a home run as they can drill more holes before the next capital raising.

Here lies a strategy that mining speculators may wish to consider. Look for companies trading on an EV of at least 30% below their market cap as it implies that there is sufficient cash for a coming drilling campaign and that the market hasn’t already paid too much for the ‘potential’ of the business.

For example, say there are two businesses with a market capitalisation of $20M. However company A has an enterprise value of $19M and Company B has an enterprise value of $11M. As cash is subtracted from the market cap, in this scenario it suggests that company B has more cash to drill future holes than Company A and the extra $8 million attributed to Company A’s EV .

For keen observers you would have noted that within the calculation of Enterprise Value we have to add back the debt, and therefore it could be a scenario where Company A is carrying more debt, and that is why it is more highly priced.

That would normally be true, but remember we are talking about junior explorers here who are all pre-revenue. No financial intuition in their right mind would lend money to a non-cash generating entity with ongoing expenses in the millions (except us generous shareholders of course - does that make you feel better?)

Using Stockopedia scanning tool to help with prospecting

First, I just want to stress that Stockopedia is not a tool built to support a gambling habit. Nor does it possess any unique insight that delivers an edge with the process of identifying a multibagger in the junior mining space.

BUT the scanning tool can help us.

So this is what we want to create…. We want to create a scan on mining stocks that shows us small companies trading at a discount of at least 30% to its market capitalisation.

So how do we create this scan in Stockopedia?

• Market cap less than $100M

• Industry group includes “Metals and Mining”

• Enterprise value less than 70% of the market capitalisation

The only tricky criteria is the last one. To build this criteria you need to perform the following steps…

Step #1 - Select Enterprise value

Step #2 - Select “Add Advanced Rule”and then select “Compare”

Step #3

Change ‘greater than’ to ‘less than’

In the value box enter 0.7 (this means 70%)

In the select ratio choose “market capitalisation”

At the time of publishing this article, this scan returns 154 results. Obviously if I play around with the market cap and/or EV discount to market capitalisation I will return different results. For example, if I increase the EV discount to 50%, then my list is reduced to 65 stocks.

I can even use this scan on other ‘higher risk’ sectors like Biotechs or Oil explorers.

If you were to run this scan at the time of writing, you will notice that one stock in particular jumps out . It is Prospect Resources (ASX:PSC) which is trading on an EV of -$423.6M relative to a market cap of $51.6M suggesting that the company has over half a billion in cash assets.

I don't know about you, but when I see a numuber like this it reminds me of another of the basic tenements of investing, "if something sounds too good to be true, it probably is (too good to be true)."

In the case of PSC, it has such a low (negative) EV because the company sold is 87% interest in the Arcadia Lithium project to Chinese based Huayou Cobalt for US$378M. This transaction realised a significant return for shareholders who received A$0.96 per share in August 2022 while the company retained approximately A$33 million for future activities.

But here is the thing, the A$433m that was distributed in the form of the $0.96 dividend was still on the books on 30 June 2022, therefore the cash balance is overstated due to a timing issue, so the cash balance was elevated. Today the company now only has the Step Aside lithium project in Zimbabwe and the Omaruru lithium project in Namibia and their cash balance will be reduced when the half years are reported.

The reason why I have highlighted this example is because it highlights the need to dig deeper to understand why the numbers are showing the results they are. For the record, removing A$433m in cash results in the EV being A$10m which is still well below the current market cap of $51m.

That is why your research doesn’t stop at the scan I have shared above. There are a lot more elements to assess when identifying what potential speckie to put your hard earned into.

You still need to do the work to identify these key elements:

• The Management Team (and their past history and remuneration)

• Location of the drilling (Close to infrastructure? Proven region?)

• The commodity being drilled for. (The hotter the commodity, higher the price and the more likely any future funding will be successful)

• Are there any previous drilling results? What were they like?

• Does the company still have an active and current drilling campaign underway? You don’t want to hold a junior sitting on its hands. Otherwise capital raisings are just to pay management wages.

• Are there any high profile backers or investors?

• Is it a Greenfields (New) or Brownfields (Previously worked) project

• The number of shares on issue and past history of capital raisings

• Current costs and cash burn

• Political risk in which the company operates

• Plus other considerations….

And ultimately you will need the biggest factor of all by your side, “Luck” - a factor we are yet to model within Stockopedia. But in all seriousness, a stock that goes from 6 cents to 12 cents might double your money, but if it goes from 6 to 3 you've lost half of it. So be careful where you tread when considering this space.

But back to the topic of this contribution,  this scan shared does two things:

1. Finds low value miners

2. Identifies those where cash makes up a large part of the business valuation

The rest is up to you.

I hope this article has helped with the shortening of odds in trying to identify the next multi-bagger.

I hope the mining gods will be generous and sprinkle a little mining dust on your portfolio soon.

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