Energold Drilling Corporation (CVE:EGD) revisited

Previously, I made a post about Energold where I said that there was some pretty fishy accounting going on.  Shame on me for making snap judgements.

Cash flow

The main issue I “saw” was that Energold had negative cash flow from operations pretty much every year.  The operating business causes it bank accounts to have less money every year before the company spends money on capex (capital expenditures, e.g. replacement of old equipment).  If cash flow from operations is negative, usually it is the case that the operating business is unprofitable.  If the underlying business is unprofitable but profits are being reported, there may be accounting abuses going on.

Back to Energold.  What’s going on is that each new drill rig needs around $250-300k of “inventory” in drilling supplies, spares, etc.  These items go under inventory instead of PP&E (property, plant, and equipment).  I would consider these items to be expansion-related capex.  In other fields you typically see expansion-related capex fall under capex/PP&E on their financials.  If Energold were to do this, then cash flow from operations would be positive.  Basically: its operating business does make money.  It just doesn’t look like it from a cash flow standpoint because Energold is plowing all its profits into more drill rigs.  Or to put it differently, its operating business is not adding any money to Energold’s bank accounts because the company is plowing all their profits into more drill rigs.

I don’t believe that they have fake/overstated receivables or inventories.  If that were the case, then the amount of receivables or inventory per drill rig would go up over time as fake receivables/inventories would accumulate.  (This has not been happening.)

Raising capital

Energold raises capital all the time and I generally hate companies like that.  Underwriters and brokers take several percent in fees… this is a cost that shareholders as a whole have to pay.  It is hard for shareholders to make money when they are paying such huge fees.  One could make the argument that the original shareholders benefit when the company sells stock when it is overvalued (Altius Minerals, a company I really like, did this).  But the new shareholders are the losers as they overpaid for their shares.  If you pay $2 for a drill rig that costs $1 to produce… it’s hard to make money.

The other reason I hate companies which raise capital all the time is that management has strong incentives to try to get the share price higher.  These companies tend to be more promotional than average and they are more likely to try to mislead investors.

In my opinion, it does make sense for Energold to raise capital all the time.  Selling shares at inflated prices benefits existing shareholders.

What Energold does

Here are some different ways of looking at it.

1- It’s a bet on increased exploration spending.  (I actually don’t think that this is a bad bet to make.)

2- Their manportable rig is unique and gives them an economic moat against its competitors as it is lower-cost and more environmentally-friendly.  This gives Energold a franchise value and therefore it does make sense to pay well over book value for Energold shares.  They could also have franchise value in knowing how to drill and provide drilling services to other companies.  Or…

3- They are simply a company in a commodity space and there isn’t anything too special about their products. A company called Hydracore claims to have manufactured at least some of Energold’s drill rigs:

Kluane has always advertised that they made these drills themselves, but in fact we made all of them, as well as supplying the parts service and technical advise.  Now Kluane and Energold have split up and they both make copies of the Gopher Manportable drill.

Energold’s 2011 annual report lists a subsidiary named Kluane:

Omniterra International Drilling Inc. (“OID”) (formerly Kluane International Drilling Inc.) and FMI Technologies Inc.
located in Canada;

Nowadays, it seems that Energold has been branching out into more conventional offerings.  Its website lists a number of different types of drill rigs available other than manportable rigs (as in, ones that cause the minor environmental damage that manportable rigs don’t).  They are starting to do the same thing as everybody else.

4- Energold is a rapidly-growing business because they can sell shares at inflated prices.  It is sort of like a pyramid scheme… but with a real business attached to it.  From 2007-2010, the number of rigs per share grew by about 26%/yr.  (I avoid 2011 as the new acquisitions make the picture murkier.)  This is an impressive growth rate.

5- Like many other companies on the TSX Venture exchange, the cost structure of the company is a little flawed.  The 4 directors on the board were paid $124-195k each for a part-time job (see the management information circular filed April 2011).  Frederick Davidson, the part-time CEO (he is also the CEO of Impact), received $729k in total compensation.  During the year ended December 31, 2010, legal fees in the amount of $400,047 (2009 – $126,878) were accrued or paid to a firm related to a director.  $469,162 was spent on investor relations, promotion, and travel.

It’s slightly harder for investors to make money when G&A is higher than it needs to be.  On the other hand, it is only a minor drag on performance and some companies are able to overcome it.  (*The money spent on stock promotion, while it doesn’t generate value, is arguably money well spent.)

What I think will happen to Energold’s stock price

No idea.  It probably won’t go to zero.  I think it will be harder for Energold to generate unusual returns on its operating business when it is diversifying into other drilling services and products.  It may continue to grow very quickly if it is able to continually raise capital at high prices.

Links

Writeup on VIC by AAOI (long)

Writeup on VIC by hkup881 (long) – the search feature on the VIC site also allows you to see his other writeups and their performance.

Harris Kupperman has a blog with various posts on Energold, such as Mining Services Part II.  I actually really like his blog and it has some excellent posts such as Mining- worse than airlines.

*Disclosure:  No position.  I don’t plan on going long or short this stock either.

Advertisements

One thought on “Energold Drilling Corporation (CVE:EGD) revisited

  1. Pingback: Energold Drilling Corporation: this may end badly « Glenn Chan's Random Notes on Investing

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s