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April 12, 2012
Will The Gold Miners Ever Bottom…??
April 24, 2012

Energold Q4–Just Fine

Energold reported earnings about two weeks ago. Since then, I have received about a dozen emails asking “my thoughts.” Look, if I have something to say, I’ll say it. I didn’t even bother to delve into the earnings report until yesterday. If you live and die by one quarter, you will get chopped to pieces. I own things because of long term macro themes—not because of how expenses and revenues get allocated during one quarter. The Energold thesis is very much alive and well. According to the Metals Economics Group, mineral exploration spending is expected to increase from USD $17.3b in 2011 to USD $20.3b in 2012 (up from USD $11.2b in 2010). Where else in this no-growth world can you find a sector growing at such rates? In Energold, you have a company that is constantly taking market share in a growing market.

Here are some quick numbers.

Hard Rock Drilling Numbers
Fy 2010 FY 2011 % Change
Meters Drilled 346,300 585,900 69.2%
Revenue Per Meter 157.7 180.6 14.5%
Revenue 54,600 105,800 93.8%
Gross Margin 21.1% 31.4% 48.8%

So you have a big increase in meters drilled, a big increase in revenue per meter and it leads to an even bigger increase in total revenue. Margins increased by 48.8%. By any metrics, this was a stunningly huge year for the company. They tracked ahead of the industry in an impressive way—true category killer in a growth industry.

In the past year, Energold has made two sizable acquisitions which made a mess of the accounting—Dando and Bertram. They paid $78,605 for Dando in January of 2011. Energold then invested a bunch of capital and expertise in Dando to turn it around. In Q4 of 2011, Dando earned $300,000. Not bad for a 9 month turn-around. What if run-rate earnings for Dando are $2-$4 million in a few years (up from $1.2m currently)? Will they make 30-50 times their investment annually? Those are numbers that the best investors in the world can only dream about. They’ve also guaranteed themselves a steady supply of drill equipment from an in-house provider—which is much more important than just the earnings.

Bertram is an even smarter acquisition. Previously, Energold had been almost entirely reliant on hard rock drilling. While I’m a huge bull on this sector, it is highly cyclical as we learned in 2008 and 2009. However, there is a region known as the tar sands, which is basically the northern half of Alberta. This whole region will end up getting 100 meter spacing drilling. Do you know how long it takes to drill out half of a province? 50 years? 100? No one knows, but it’s a forever job.

In March, I spent a day with Bertram on site in Fort McMurray. It’s a fantastic business. The economics are much better than I had expected. They’re actually better than the hard rock business, and they’re longer term contracts—so there’s much less downtime. The real kicker is that in the next few years, the business might go from being just 4 months a year, to year-round as new technologies are implemented. It’s still a long shot, but it completely changes the economics. In any case, Energold bought Bertram for a bit more than 60% of book—hence the funny accounting treatment in the fourth quarter. When you pay less than sale value for the rigs, you are getting a great bargain—and the Bertram brothers (true gentlemen and outstanding operators) came along with the deal for free (though with earn outs).

These two acquisitions muddy the accounting and somewhat confuse the numbers that previously were very simple. However, you build a business by creating value—not by making your accrual accounting increase sequentially in a linear format. I’m willing to deal with some accounting muddle as long as the key metrics are booming.

What did Energold earn in the fourth quarter? Depends on who you ask. Even the Praetorian Capital office is unsure. After cleaning up all the charges and 1-timers, we think that any number between 7 and 9 cents is about right. That compares to a penny or 2 in last year’s 4th quarter. Was it a good quarter? Not bad is how I’d put it.

I should point out that Q4 is always the weakest quarter in the year. This is because the company only drills for about 10 weeks of the quarter, yet pays salaries for the full quarter. There is also substantial downtime for rigs that are located in cold northern regions. I should also point out that Energold is still in a rapid ramp-up phase. This will likely begin to trail off by next year as it gets increasingly difficult to grow at over 30% organically as the rig fleet increases from lower levels in prior years. I would expect this to create substantial additional earnings as ramp-up expenses come down.

In summary, Q4 was another fine quarter for Energold. I will say that my 2012 estimate of $1.00 may be a bit aggressive, but I think that $0.70-$0.90 should still be possible if you strip out ramp-up expenses. What do you pay for a business with such strong secular tail-winds that is growing so rapidly and with such high returns on capital? At a current $4.80 price, it seems that you’re paying somewhere between 5 and 7 times earnings and that excludes the earnings from impact silver. Sounds like one of the cheapest companies in the market to me.

On a final note, Q4 revenues per meter were $201, or the highest in the company’s history. I think this is a very good omen for margin expansion in 2012.

Categories: Current Investments
Positions Mentioned: none

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