Two roads diverged in a yellow metal

Benj Gallander and Ben Stadelmann
Monday, March 4, 2013

With the Prospectors & Developers Association of Canada meeting in Toronto in full swing, this seemed like an appropriate time to highlight a couple of junior miners. On July 19, 2011, Vancouver-based miner San Gold closed at $3.39. Meanwhile, its colleague B2Gold finished at a similar price of $3.30 a share.

Since then, B2Gold has doggedly moved sideways, but its financial condition is solid enough to earn it a 5-star rating on GlobeInvestorGold. Poor San Gold has fallen off a cliff, down more than 90 percent to 28 cents. It gets a lonely single star for that dismal performance.

In the past, such extreme divergences between producers were sometimes due to hedging programs. These hedges are essentially bets on the future price of gold. They look smart when the spot price is lower on the delivery date, foolish when the reverse is true. However, both of these juniors had optimistic assessments for gold prices down the road, so their production is not hedged.

Another reason miners can hit the wall is when so-called “geographic risk” bites. Surprisingly, in this case it is San Gold that is in the comfy confines of the famed Rice Lake district in friendly Manitoba. Historically, the area has produced about two million ounces since opening in the 1930s. The geologic similarity to the bonanza at neighbouring Red Lake has sustained optimism.

B2Gold operates in trickier territory; its flagship Libertad and Limon mines are in the Nicaragua. It also has exploration prospects in Namibia, Colombia, Uruguay and Costa Rica. Last September, the company agreed to merge with Australia-based CGA, in an almost $1 billion all-stock deal that brings the Philippines Masbate mine into the fold.

Though it is tempting to assign the differences in performance to management — and without a doubt, that is a key element — it is perhaps even more basic. Analysts evaluate junior gold stocks using metrics such as enterprise value per resource ounce, cash cost per ounce of production, price to estimated future free cash flow, and price to net present value. These ratios may be of interest to the investor, but the problem is they are frequently used to put money-losing miners in a positive light.

The ability to make a bottom-line profit is the most basic principle of business, but it is exasperating to see how few junior gold producers can manage it on a consistent basis. Coming up to July 2011, B2Gold had made money in each of the previous four quarters, for a cumulative tally of $64.6 million. The corresponding figures for San Gold were losses in every quarter, putting it into the red by $23.2 million.

Over the next five quarters ending Sept. 30, 2012, San Gold squeaked out a small profit twice, but still lost another $5.1 million over the period. B2Gold went five for five, racking up $85.3 million. Net income a predictor of future viability? Who’da thunk it?

Ben picked up BTO in April 2009 at 68 cents, 16 months after the company had gone public at $2.50 a share. The “busted IPO” is a contrarian niche that does not fit the Contra the Heard methodology, as our portfolios require companies to have a track record of at least 10 years. A modest position made it into Ben’s personal collection of speculative gambits primarily on the strength of CEO Clive Johnson’s remarkable history of astute dealmaking with the former Bema Gold, which ultimately concluded with a $3.5 billion buyout by Kinross.

The astounding thing is that Johnson has been able to build B2Gold into a substantial producer with minimal borrowing and no secondary raise of capital. Both the Central Sun and CGA transactions were formulated as straight stock mergers. The efficient Nicaraguan mines are providing healthy cash flow for expansion.

Johnson has effectively leveraged his company’s reputation as a savvy operator to gain partners and increase scope. Production is estimated to ramp up to 350,000 ounces this year. The sell target on the stock is $7.

Meanwhile, San Gold remains on the VP Watch List. A potential play is the recently issued convertible debentures, which pay 8 percent interest and are convertible at 50 cents a share at maturity in March 2018. If the company’s turnaround continues to sputter, but not so badly as to threaten survival, these debentures could prove a better bet than the common.