Canada Lithium update: the end may be near

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.

Accounting Tidbits

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.

Bottom Line

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.

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2 thoughts on “Canada Lithium update: the end may be near

  1. As a retired former executive in a senior mining company who watched and evaluated other mining companies for his firm, I can tell you that even junior mining companies which have economic properties tend to have a fall in share values around the time they go into production.
    This is in part because the expectations of exploration properties are related to what the stock promotion industry calls the “Blue Sky” factor. During exploration, the excitement of hopes and expectations can soar to the blue sky. There are no limits. Once actual earnings results come in and stabilize, it is Boring, Boring, Boring. Exploration speculators, like poker players, are attracted by the adrenaline rush. Production investors are more like the stereotypical squinty-eyed accountants, basing their valuations on the discounted present value of expected net cash flow.
    By the way, if serious valuation is based on discounted cash flow, it does not matter whether startup costs are expensed or capitalized. This is merely a reasonable accounting convention. It is not fraudulent, since it has been consistent in the industry for at least fifty years. A senior mining company would not develop a property if it did not expect the net cash flow from operations to yield a reasonable rate of return on all pre-production investment and expenses.
    What I would look at here is the huge number of shares outstanding in this company – Say about 375 milllion. How much annual profit do they have to make once they are in production to justify a valuation of even forty cents a share? And how many more shares will they issue to cover development costs before they commission the mine? Look at their projections, make your own estimates, and do your own math. At this stage, the Blue Sky has probably come down a lot closer to earth.

    • Thanks for the comment. I have a feeling that this mine won’t make any profit given their grades relative to Talison Lithium’s (before Talison was taken over).

      There may be a lot of short sellers targeting this because the borrow cost is high. We’re going to find out soon if they’re right.

      2- In my opinion, it’s dangerous to assume that mining companies won’t chase uneconomic projects. They have done so in the past. We do not live in a perfect world where CEOs (some of them part-time) are trying to make money for their shareholders instead of from their shareholders.

      Again, thanks for your comment. It is very well-reasoned and balanced. Perhaps you are used to a level of integrity that is sorely missing from the capital markets right now.

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