I’ve previously thought that Canada Lithium’s mine would be extremely uneconomic. It looks like the thesis is playing out. The company is desperately raising capital to shore up its working capital. It hasn’t been able to generate cash flow from the mine yet, which raises doubt about the company as a going concern. I’ve quoted the company’s financial statements below and added my own emphasis:
The Company has secured off – take partners in major Asian markets, but has not generated revenue or cash flows from its operations. The Company has limited financial resources and no current source of recurring revenue and continues to rely on the issuance of shares, debt or other sources of financing to generate the funds required to develop the Québec Lithium Project, for corporate expenditures, and to satisfy debt obligations as they fall due.
Odd warrants accounting (may be extremely aggressive)
Page 11 of the latest financial statements filed on SEDAR state that the Black-Scholes model was used to price share purchase warrants. Oddly enough, the volatility assumption drops from 122.5% to 30.0%. Perhaps this is a typo and the financials really meant to say 130%. (I’m lazy and my position in this stock is not big enough to justify the work to figure out if this is a typo or not.)
If this isn’t a typo, this is an extremely aggressive and inappropriately low assumption. There’s no way that volatility should be assumed to be that low.
Capitalization of expenses (aggressive)
Various expenses have been capitalized into the mine. While one can make an argument that this accounting practice is legitimate, it does decrease losses in the short-term and inflate the books.
The operating costs are capitalized during the commissioning period until such time when the Project reaches commercial production. Operating costs of $23,049,448 (2012 – $nil) incurred at the Québec Lithium Project during the six month period ended June 30, 2013 are capitalized in the mineral property and construction in progress balances. In addition, borrowing costs of $4,721,592 (2012 – $997,965) incurred during the six months ended June 30, 2013 are capitalized in the cost of the construction in progress at June 30, 2013.
Depreciation expenses of $159,344 (2012 – $59,730) on vehicles and computer equipment are expensed in the interim consolidated statement of loss, and depreciation expenses of $942,251 (2012 – $106,606) on mobile equipment are capitalized and included in the cost of construction in progress for the six month period ended June 30, 2013.
During the three and six month periods ended June 30, 2013 interest expenses of $1,881,374 (2012 – $nil) and $3,761,769 (2012 – $nil) respectively were recorded and capitalized to construction in progress. In addition, guarantee fees of $682,260 (2012 – $nil) and $1,342,684 (2012 – $nil) were also capitalized to construction in progress.
In addition, share based payment expenses of $13,000 (2012 – $nil) and $26,000 (2012 – $662,850) were capitalized to construction in progress for the three and six month periods ended on June 30, 2013.
It’s still a little early to tell what the mine’s economics will be. You could make an argument that you need to wait until the mine fully ramps up. Currently management is saying Q1 2014. We will likely find out the mine’s true economics in the next several months, though I expect management to announce more delays in the ramp-up. My guess is that the mine will be so uneconomic that it will be shut down early. Debt will push the company into bankruptcy.
Unfortunately for me, my position in Canada Lithium is net long. I own shares in Northfield Capital, which owns shares in Canada Lithium. I shorted a very, very small amount of Canada Lithium shares but my position is still net long as I didn’t fully hedge my position. This is mostly because the shares are hard to borrow with IB Canada and I’ve had somewhat bad experiences with shorting non-Canadian stocks that are difficult to borrow. If the shares were easy to borrow and there was absolutely no chance of buy-ins, I likely would have gone net short.
I’m starting to think that I should go out and start shorting junior miners that are about to ramp up an uneconomic mine. These types of companies may make attractive shorts because it has a catalyst: the failure of the mine. It is likely that management will prolong any declines in the stock by making excuses and announcing delays. Still, my theory is that the stock price will decline within a year or two of the mine’s original start date as investor’s hopes and expectations are violated.
*Disclosure: Sigh… still net long CLQ.