It’s ‘show me the money’ time for explorers on the ASX
Cash has become king, as junior explorers and miners find it harder to raise capital in the current climate.
Old school miners reckon ore grade is king in their industry. Smart investors with an interest in mining recognise another king: cash.
Right now, with interest rates and operational costs rising, and even as commodity prices nudge all-time highs, cash beats grade.
At the top end of the resources industry, especially for companies in production, the cash question is largely irrelevant as they ride fabulous prices such as copper at US$4.40 a pound, nickel at US$13.30/lb and iron ore at US$145 a tonne.
The good times for BHP (ASX: BHP), Rio Tinto (ASX: RIO), South32 (ASX: S32) and other well-placed producers roll-on, though there’s also no doubt that management is keeping a close watch on the rising tide of costs, which will eat profits and stick when commodity prices retreat (which they always do at some time).
Available cash drying up
But for explorers relying on cash raised in the capital market to fund their field work, and for potential project developers looking for big licks of funding (and debt) the game has already taken a worrying turn, as it will for companies trying to raise capital through an initial public offering (IPO, or float).
Companies which have successfully topped up their bank accounts in the last few months should ride out the current cycle of cash tightening, but for some small companies, which forget the “cash is king” maxim, the outlook is not so bright.
An example of the sea-change in investor sentiment could be seen last week when Reedy Lagoon (ASX: RLC), a small, lithium-focussed explorer, announced that it had raised the unprincely sum of $362,787 to help fund its exploration program.
The cash will help, but it needs to be put into perspective such as when the new funds are added to the existing bank balance Reedy will have $700,000 in cash which, to not put too fine a point on it, is less than the value of most Australian houses, and lower than the value of some cars in posh suburbs.
What appears to have happened to Reedy is that it left its fund raising too late, going to shareholders on 2 May with a one-for-seven rights issue priced at $0.04 to raise $3 million.
The uptake of the new shares was modest, to say the least, with Reedy pulling in that fresh $362,787 mentioned earlier, about 8.3% of the cash target, which also means that the company has been left with a shortfall of shares which it can only place at the original price of $0.04, which will not be easy as the stock is trading at $0.022.
A discovery would be a big boost for Reedy, but there’s not a lot of cash in the company’s bank account to fund the necessary exploration, especially at a time when field work costs such as drilling are rising rapidly.
Similar story for other juniors
Reedy is not an orphan. The story of small companies with big ideas and a modest cash balance is being repeated across the resources sector as investors turn their attention to the critical question of who’s got the cash to ride out the next phase of the market.
Opportunities for investors to make money in the shift will emerge.
Companies with good assets and no cash will attract merger and acquisition (M&A) attention or seek it out themselves.
Bardoc Gold is a case study of how value can be created when cash is tight and capital markets are getting hard to access. Rather than persevere with the challenge of developing its namesake goldmine in Western Australia, Bardoc last year embraced a share-swap merger with a big rival, St Barbara (ASX: SBM).
Instead of watching their small company struggle with trying to develop a mine at a time of soaring costs, Bardoc shareholders now have a fistful of St Barbara shares and a stake in a mid-tier miner.
Valuable project is key
Investors can expect a lot more of that sort of deal, if their company has an asset that others want.
Looking for small explorers and would-be miners is one way of approaching the next phase of the market, and a potential way of making money in difficult times.
Dodging companies which lack valuable assets in the ground such as an undeveloped orebody is a way of avoiding a loss.
A starting point in sifting potential winners from potential losers is to start with a share-price (and market value) test, because while it’s hard for an individual investor to know exactly how well a company is travelling the market often does.
As a rough guide, companies with a stock-market value of less than $5 million (and there are quite a few) should be avoided, though it can be worth seeing if they have assets to sell which the market might be overlooking.
Sufficient cash balance to fund activities
The next test is the cash balance to see if a small cap explorer/miner has enough spare change to ride out a downturn, while also funding its quarterly cash burn (what it spends every three months on field and office work).
Using Reedy as a guide, the company’s March quarter cash report ($478,000 in the bank) was a signal that money was tight and a capital raising could be expected, which is what happened, albeit too late to avoid a change in investor sentiment.
The next time for testing bank balances will be 30 June quarterly reports and their associated cash reports which will start flowing into the stock exchange in the first week of July.
No-one knows yet which companies will be cash poor (and perhaps asset rich), but a sifting process will start with those June quarter reports.
As for the IPO game, it is already drying up in Australia and overseas as inflation worries muddy the waters and pricing a float becomes increasingly difficult.
Cash, as mentioned earlier, really is king when markets turn, or as Warren Buffett famously said: “Only when the tide goes out, do you discover who’s been swimming naked”.
Or, to use a famous quote from the movie Jerry Maguire “Show me the money!”.