Altius Minerals (ALS.TO) – Great business trading at a discount

I would consider Altius Minerals to have the best management team in the resource sector.  Currently, this company is trading below what its assets are worth and is buying back shares.

What they do

Altius Minerals is in the following businesses:

  1. Prospect generation.  Altius stakes claims and spends a minimal amount of exploration dollars to hold onto their claims.  Then, management has to convince other companies (and their geologists) to essentially “purchase” these prospects.  Altius typically enters into joint venture agreements where their JV partner has to spend exploration dollars to earn an interest in these properties.  This business is highly leveraged to Altius’ deal-making skills, its exploration skills, the market price of mining claims, and commodity prices.  Altius has generated most of its unusual returns from this line of business.  Altius tries to acquire land only when it is really cheap.  Valuing land is extremely difficult and so is finding mineral deposits.  I believe that these are areas where it is possible to generate significant value as this is an open-ended problem where smart people can get a huge edge.
  2. Value investing in royalties- buy ’em for less than what they’re worth.  When everybody panicked over concerns that the Voisey’s Bay project would not go through due to First Nations conflicts, Altius stepped in and bought part of a royalty on the Voisey’s Bay project.  Altius will likely make at least a few times its initial investment on the Voisey’s Bay royalty.
  3. Investing in stocks.  Altius has a small portion of its funds managed by Paul van Eeden.

Track record

Altius Minerals IPOed in 1997 at $0.20/share.  It currently trades at around $10.85.  The share price has increased by about 28%/year since 1997.

Altius Minerals also has significant retained earnings so it’s not like they made most of their money from constantly selling stock at higher and higher prices (and from buying back stock when it is cheap).  Altius has both sold and bought back shares in the past.  It currently continues to buy back its shares.

Do I like prospect generators?

It’s unclear to me if the prospect generator model generates enough value to overcome the frictional costs.  A prospect generation company has to expend a lot of effort into selling its properties.  Land/mining claims/prospects are very difficult to evaluate so there are significant costs in the buying/selling process.  Prospects are typically sold in complex joint venture deals so there can be significant legal fees involved too.  (Joint ventures make sense because they help to reduce uncertainties in valuation.  In a joint venture, the seller is essentially partially paid with some equity in the project instead of more cash.  If the prospect is no good, then the buyer has given away worthless equity instead of cash.)

*See http://www.theglobeandmail.com/globe-investor/a-better-way-to-prospect-for-mining-profits/article10812975/ for a bullish thesis on prospect generators.  It’s written by a guy who owns them.  The people interviewed in the story, Mr. Van Eeden included, also own prospect generators.  I am guessing that they all own Altius shares personally.

But here’s why I like Altius.  It is very disciplined with its cash and hasn’t chased dumb deals.  It has been patiently sitting on a large amount of cash waiting for opportunities to come up.  The current environment is actually a good time for Altius as the junior mining bloodbath should create opportunities for them.  A few junior mining stocks are cheap as the TSX Venture index has fallen roughly two thirds since 2011.  Because these juniors are selling at low levels, it is very difficult for them to raise capital and they may need to sell their non-core mining claims/prospects.  At the bottom, Altius will likely start scooping up land when everybody else is selling.  Afterwards, Altius would like to see money flood into the junior sector again so that there is high demand for the prospects that Altius is selling.  The prospect generation model works best when there is extreme volatility in juniors.

What Altius won’t tell you

Junior mining stocks are awful.  Senior mining stocks aren’t as bad, but they’re still bad.  Very few people in the mining industry will tell you this because the mining industry is supported by investors/speculators.

One thing that juniors do is to explore even when it is not economic to do so.  A few juniors will pitch underwater mining schemes or placer mining schemes, none of which are ever economic.  The (part-time) CEO running a junior often doesn’t care if shareholders make money.  He/she just wants to make money for him/herself.  They may potentially overpay for prospects.  After acquiring a prospect, they may continue to explore the property even if initial exploration results aren’t that promising.  This allows them to pretend that the company is doing well so that they can continue to pump the stock and raise more capital (i.e. their next paycheque).

The senior miners have problems too.  Some of the management teams at seniors just want their company to grow bigger and bigger so that they can justify a higher paycheque for themselves.  Some of them constantly overpromise so that their company can continually sell stock at inflated prices.  A side effect is that they need to acquire deposits to grow bigger.  So sometimes seniors will overpay for juniors.  And they will build mines that are only marginally (un)economic.  Practically the whole industry does it.  It’s herd behaviour.  This is why gold stocks haven’t gone up as much as gold itself.  And sometimes when a mine is depleted and should be shut down, they manage to flip the old mine to another publicly-traded company (e.g. Yukon-Nevada Gold, now named Veris Gold because they don’t want any association with the old name).  And so some (part-time) CEO will keep the mine running with capital raised from investors, thus creating another way for investors to lose money.

That’s just how it is.

Why Altius loves royalties

I’m ambivalent about royalties by themselves.  They are a piece of financial engineering.  Royalties are another way of dividing the cash flows of a business into different parts, much like debt, bonds, stock, preferred shares, streaming deals, etc.  There is a minor cost to this type of financial engineering.  It is not unusual for the party paying the royalty to underpay it.  Then a costly lawsuit ensues.  This happened to Altius, MFC Industrial (MIL), and Callinan (CAA.TO).  Sometimes commodity prices will fall and the mine becomes barely economic.  The royalty payments can make the mine uneconomic for the equityholders.  In that situation, hopefully the equityholders and the royalty holder can renegotiate the deal so that the mine keeps running (because it is fundamentally an economic mine).

Because of all the perverse mining companies out there, it is a good idea to own royalties over equity.  If a company overexplores or overbuilds, the royalty holder doesn’t have to put up any of that capital.  And because you don’t own the equity, you don’t lose money from overexploring or overbuilding.  This is why Altius is obsessed with royalties.  When Altius sells its prospects through joint venture deals, it tries to retain a royalty in the project instead of taking more equity.  Altius retains equity (or shares in the junior) because it has to, not because it really wants to.  In an ideal world I think that they would prefer to receive cash and a royalty.

At the end of the day, I think that Altius’ management is really smart because they do things like taking royalties instead of more stock.

Altius’ assets

Alderon

Alderon’s management team is affiliated with Forbes and Manhattan and Stan Bharti.  Stan Bharti is an example of what’s wrong with the junior mining industry.  He is greedy and wants to do silly things like explore in the Democratic Republic of Congo (a country that has stolen Canadian mining assets and currently has armed fighting).

Altius pays its directors between $90,750-$164,625.  Alderon pays its 5 directors between $266,827-$974,810 (virtually all of this is in options; one can debate the valuation on these options… the valuation is arguably a little high).  Pay at Alderon (like most Forbes and Manhattan-affiliated companies like Aberdeen International) is excessive.  That being said, Alderon does have a promising iron ore project that has a good chance of turning into a mine.

Alderon has put out a positive feasibility study on its Kami project that probably isn’t anywhere close to reality.  In the past, the same engineering firm (BBA) did a feasibility study for Consolidated Thompson’s Bloom Lake project (bought out by Cliffs Natural Resources) saying that operating costs would be around $32.62 per tonne of concentrate for the first five years of operation (the technical report is on SEDAR if you search for Consolidated Thompson).  Cash costs are currently around $88/ton.  (*There is a difference between cash costs and operating costs with leasing costs.  But that doesn’t make a significant difference.)  Basically, BBA’s technical reports are a joke (like most technical reports).

My guess is that Alderon’s Kami project will have “all-in” costs of around $120/ton… but don’t take this figure too seriously.  I’m just taking Cliff’s $88/ton cash costs, adding in $17/ton for D&A, and $15 for quality deductions (Kami has higher levels of manganese and sulfur than Bloom Lake).  I think that actual production will come in at 6-7M tonnes/year of concentrate because Bloom Lake didn’t hit 8MT/yr of production in its initial phase.  However, I really have no idea what the actual figures will be.

To value Alderon, I would pay more attention to what a private buyer has paid for its flagship Kami project.  Hebei (a Chinese steel producer) paid $182.2M for:

  • An off-take agreement with Alderon.  It has to buy 60% of production at a 5% discount to benchmark prices, with an option to buy the rest at no discount to benchmark prices.  This is similar to (though not quite) a 3% royalty on the first 8M tonnes/year of production.
  • 19.9% of the outstanding shares of Alderon.
  • C$120M for a 25% interest in the Kami project.

Hebei paid C$120M for 25%.  Therefore, Alderon’s share of the Kami project is worth 75% * ($120M / 25%)  or $360M.  Add $120M in cash (plus Alderon’s working capital, if you feel like it) and Alderon should be worth at least $480M or at least $3.69/share.

Alderon has a market cap of C$140.34M at C$1.08/share.  These shares may be massively undervalued.

Why doesn’t Altius buy more Alderon shares?

I don’t know.  Altius can take its cash hoard and use it to buy undervalued Alderon shares.

Technically, Altius is an insider and has restrictions on trading with insider information.  But if Altius really wanted to I am sure they would find a way to buy shares on the open market (e.g. after all material information has been disclosed to investors).  Doing so would be beneficial for Alderon since it would help promote the stock so that Alderon can sell stock to get the mine financed.

An alternative explanation is that Altius thinks that Hebei overpaid for 25% of Kami.  I might be overly optimistic about Kami’s prospects and overestimating its economics.  Kami is more marginal than Bloom Lake.  Its economics aren’t as good and it is riskier.

EDIT (Nov 28 2013):  My current opinion is that Hebei is the dumb money.

Kami royalty

Altius owns a 3% royalty on the Kami project.  Here is my guess as to its value:

7MT / yr * $140/ton * 3% * 51% after tax profit = $15M/year

Mine life may be 30 years.  I have no idea about the taxes but it could be a mineral rights tax of 20%, provincial tax of 14%, and federal tax of 15% (the mining royalty tax might count as an expense for the other taxes???).

There is always a chance that the mine doesn’t get built, though this becomes less likely as Alderon advances the project.  If I arbitrarily multiply that income by 10 (to account for the NPV of future cash flows and a possibility that the mine isn’t built), this royalty is worth $150M.

The main factors behind a mine being built are iron ore prices, market sentiment, and Alderon’s ability to raise capital.  If people get excited about iron ore again, Alderon will be able to sell stock and (possibly) issue some debt to become fully financed.  There may be other avenues for Alderon to raise enough capital to build a mine (e.g. a buyout by a senior mining company or even Hebei).

Other iron ore properties

Altius has some other iron ore properties that may be worth tens of millions of dollars.  Their mining claims are likely worth a lot more than what they paid to acquire it.  Firstly, iron ore prices have skyrocketed over the past decade.  Higher commodity prices obviously makes exploration more economic.  Secondly, new deposits are being found on similar land (e.g. the Kami deposit).  The best place to look for a mine is by existing mines (and mega-deposits) since (A) the geology is similar and (B) having a mine in the area lowers infrastructure costs.

Junior mining shares

Sometimes in joint venture deals, Altius ends up with shares in junior miners.  In general, I dislike junior mining stocks and think that they will lose money in aggregate.  These shares may deserve some type of discount.  However, I make the simplifying assumption that the value of Altius’ non-Kami iron ore properties and the “correct” discount on its junior mining shares cancel out.

Voisey’s Bay royalty

The royalty generated $3-4M/year in revenue over the past 2 years.  The effective corporate tax rate on that royalty is in excess of 55%.  At 55% tax (I will just assume that it works out to 55%), the after-tax return is $1.35 to $1.8M per year (it would be higher if nickel prices were higher).  It is difficult to guess what Voisey’s Bay actual mine life will be.  Currently it is expected to operate until at least 2035 (22 more years).  It may go on longer if more ore is discovered.  I estimate its value at 15 X $1.35M = $20.25M.

This royalty is carried on Altius’ books at $8.4M.

Brian Dalton

Good management has no book value but is worth paying for.

Altius is somewhat promotional

Altius’ board of directors seems to be of the mindset that Altius’ management should be increasing the share price.  Bonuses for insiders are tied to two things:

  1. Reported earnings.
  2. Share price appreciation.  (Paid in cash, not shares.)

Altius itself spends money on “investor relations” (typically an euphemism for stock promotion), has a fancy website, and puts out presentations.  In my opinion, these expenses do not generate value and are a waste of shareholder capital.  Altius has more than enough cash for its amazing prospect generation business and should focus on shrinking its capital base through buybacks.  Promoting the stock is not in the interest of long-term shareholders.

I don’t like this behaviour but am willing to put up with it.  So far, it doesn’t look like these bad incentives have corrupted the way Altius is run.  It has only sold shares when the share price was high and is currently buying back shares at a low price.  Dalton has been extremely conservative with Altius’ cash and has sat on cash waiting for opportunities.  It takes a rare person to sit on cash when the incentives push you towards action.  I like that Dalton owns a lot of Altius shares.

Other than wasting a very small amount of money on stock promotion, Altius’ capital allocation has been amazing.  They’ve been buying low and selling high… what else can you ask for?

Valuing Altius- shortcut method

Altius is currently buying back its shares (see Canadian Insider).  It has slowed its purchases at the $13 level and buys back its shares at a higher rate when shares are at $9-10.  At all these prices Altius is undervalued.

Valuing Altius- the longer method

As of Jan 31, 2013 Altius had a book value of $268M.

Altius owns 32.8M shares of Alderon, which have a market value of $35.42M at $1.08 per Alderon share.  Alderon is carried on Altius’ books at $70.47M. The difference is -$35M.  (I will ignore decreased taxes on capital gains.)

$268M
-$35M for market value of Alderon shares.
+$150M for Kami royalty
+12M for fair value of Voisey’s Bay royalty
+0M?  for value of non-Kami iron ore properties
-0M?  for junior mining shares discount

$395M

I estimate Altius’ fair value to be around $14.04 / share.  Altius currently trades at around $10.85 / share.

*Disclosure:  Altius is my largest position.  I also own a tiny amount of Alderon.

Links

VIC writeup on Altius Minerals.  It has some good information on Altius’ history.

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9 thoughts on “Altius Minerals (ALS.TO) – Great business trading at a discount

    • Sorry for the late reply. It seems that Dalton really, really likes the royalty assets.

      Altius has been sitting on cash for years. It has been pretty conservative. Dalton decided to take on a lot of leverage to make a huge bet on the royalty assets.

      • I find it interesting that Dalton decided to leverage his bet on the royalties. The leverage was unnecessary; I’m guessing that he would have been able to find partners to finance the rest of the purchase price (e.g. Sprott, Callinan, Liberty, etc.).

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  2. Hi. Glen,

    In the past month things have changed significantly for Altius and are quite different from when you originally wrote this piece last May. The Sheritt deal, share price jumping by 50%, (congrats!), Alderon’s power requirements could be met within days, etc. I’m sure many of your readers would be interested in seeing an updated version of your analysis reflecting the current status of Altius (and Alderon).

    Do you feel more positive or negative towards Altius since you wrote this piece?

    • The share price jumped a lot so I’m less positive.

      I think Alderon’s biggest challenge is getting financing.

      The Sheritt deal may be really, really smart. Dalton understands that some deposits will go on for much longer than expected. The other nice thing about royalties is that earnings can grow without investing any capital when the mine is expanded.

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