Strategic Minerals: With Sentiment At An All-Time Low, It’s Time To Look Forward (OTCMKTS:SMCDF)

Having previously written an article on Strategic Minerals (OTC:SMCDF) (LSE:SML) back in June, I heavily scrutinised the company and board of directors over what has caused the large share price decline seen over the last year or so. Whilst there is no sugarcoating this previous poor performance, I believe it is now time to look forward as a shareholder in Strategic Minerals. With shares now nearing rock-bottom prices, having fallen 10% further since my previous article, I see more opportunity in SML for a turnaround play with a strong asymmetric offering. In this article, unlike my previous, I will look forward at future opportunities and focus less on the previous Brenda Smith/alleged fraud developments.

Source: Proactiveinvestors.co.uk – Leigh Creek copper mine in South Australia

The recent Cobre update

The company actually only too recently provided an update for Q2 sales from its Cobre mine. The results were relatively positive but have since now been drowned out by the poor market sentiment towards shares. Sales were strong, standing at $881,000 – a 5% increase on the same quarter of the prior year. More importantly, it was up 15% on the March 2020 quarter, showing a continued ramp up in sales across 2020. When putting this into more context, the March 2020 quarter was actually up 7% from the previous quarter. This also increased sales for the 12 months to June to $3.1 million. SML’s subsidiary SMG which operates the Cobre mine has done well to mitigate the effects of the crisis and has provided continuous strong cash flows into SML. To me, the Q2 results also showed a gradual ramp-up in sales at Cobre as shown over the last three quarters now.

Sales from Cobre:

Quarter

Sales (US$’000)

Q2 2020

881

Q1 2020

764

Q4 2019

713

Q3 2019

1,130

Q2 2019

841

Q1 2019

554

Source: Table compiled by author from company updates

Focus less on Redmoor, more on Leigh Creek

As well as Cobre, the other key assets owned by SML are Redmoor in the UK and Leigh Creek in Australia. It may become quite easy to get distracted away from Leigh Creek due to the high grades and resources that are boasted at SML’s tin-tungsten Redmoor mine in Cornwall. Redmoor offers a huge upside but will require significant capital investment to get up and running. In an extremely competitive environment with many potential funding partners tightening their pockets currently, I believe realising material gains from Redmoor are still a substantial period away.

Therefore, greater focus and importance should be placed on Leigh Creek. Although this mine has primarily seen failure so far, as the board expected it to be in full scale production by the start of this year, the board is now hoping it will be in production in 2021.) SML has continued to make some headway in moving it towards production. In May, SML lodged a draft for a program for environmental protection and rehabilitation (PEPR). SML expected this regulatory process to take 3-4 months to be accepted, although this may now be further delayed due to Covid-19. However, this is still an important step in getting Leigh Creek into full scale production.

What is more important is securing the necessary JV partner to move the project forward for SML. In the update, SML highlighted that the fall in copper prices has been ameliorated by the concurrent drop in USD/AUD exchange rates, however since then, the copper price has actually recovered back to pre-Covid-19 levels making Leigh Creek more attractive. The capital required to get Leigh Creek into production is actually relatively low in comparison to other projects such as Redmoor. John Peters, SML’s CEO, has real confidence that they can get Leigh Creek into production:

“The continued strength of the Cobre operation, which the board expects to produce circa US$3m in sales and US$1.5m in after tax cash in 2020, provides the Company adequate scope to locate and execute its additional projects with a joint venture partner. Again, this emphasises that, subject to financing, a second income stream for the Group is relatively at hand.”

Although I wouldn’t trust John Peter’s word as fact and of course ‘subject to financing’, is a big key to moving Leigh Creek forward. It is however positive to know SML has the cash resources to work with a JV partner. The board still believes that they may be able to get Leigh Creek into production by the end of 2020. I don’t believe they will as I think the JV will take longer than they believe (they have always been overoptimistic with these things), but I do believe this may be achievable by 2021.

There is value opportunity there

When breaking down what assets SML has, there is good value in comparison to NAV on the books. Whilst this frustrates me now as shares were standing at 1.6p just over a year ago, there is a strong case to show that SML has a NAV of 0.56p without considering future opportunity.

In buying Redmoor, the company paid a total consideration of around $2.1 million for a 50% share meaning a value of $4.2 million for the whole asset was paid. Whilst I think this was the wrong decision at the time, the board considered it worth paying that sum of cash (not shares) for the mine.

In Cobre, we have an asset that has delivered just over $3 million of sales in the 12 months to June and around $1.5 million of profit from the subsidiary SMG – this $1.5m annually then covers corporate overheads and expenses, which are the majority of SML’s expenses. It is extremely tough to value Cobre as SML only has a lease to mine the stockpile of the main mine in a rollover contract every year. It is therefore vital that SML keeps strong relations with the mine owner to obtain future extensions.

Nonetheless, this stockpile will expire in around 5 years’ time and if SML maintains the operation for that time, this will provide the cash SML needs to cover corporate overheads and bring other projects forward. To me, based on a mine life of 5 years and profitability of $1.5 million a year over that period, I see a value of circa $4.5 million (60% of total 5-year profits allowing a discount for future cash flows – i.e. on a DCF basis) for Cobre. Although this is heavily reliant on the positive relationship between SMG and the mine owner – Managing Director of Strategic Minerals John Peters did previously say in a trading update back in 2019:

While the Company considers that access to the Cobre magnetite stockpile will continue to be provided until exhausted (6+ years), this early rollover is strategically significant for the Company as it ensures access to positive cash flows while it prepares to commence its second income stream from Leigh Creek Copper Mine

Finally, there is Leigh Creek. This is also quite hard to put a specific value on. While SML originally paid $2.3 million for the Australian copper mine – they have since pumped large money into getting the mine ‘production-ready’ – however, they were unable to achieve this alone and now need further funding/JV to get it into full scale production. In 2019 alone, SML pumped $2.5 million into Leigh Creek. This also involved preparing the PEPR regulatory submission to allow the commencement of full scale operations.

I don’t believe this makes the value of the mine greater than the $4.8 million invested so far, however, I would say that the refurbishments done to the mine are worthy of noting and do add to the value. Also, the fact that SML was able to bring the Mountain of Light processing facility at Leigh Creek to operational capability was an important step in moving it towards production. I see Leigh Creek as worth at least $4 million (SML itself values Leigh Creek at a book value of $6.8 million).

Adding these together gives an overall NAV of $12.7 million or £9.66 million. With SML being debt-free, this is around 0.56p in NAV at – a minimum, based on current assets alone – and that is a 35% premium to the currently available buy price on SML. This is relatively conservative as I have also considered previous SML performance – so I am taking a cautious view of the asset value. John Peters was far more bullish on these valuations at the AGM offering the idea that there is 1p of base case value there.

Some may see that as minor but for a mining company in the AIM sector with no debt to be trading on a discount to NAV is very peculiar. It’s very normal to see companies trading on large premiums – much of which is ‘hope value’ as many of these will never deliver a profit. Whilst I wouldn’t compare SML to bad companies as a way of justifying the thesis, it can be said that this discount also further limits the downside as it demonstrates the asset backing behind SML.

Whilst I believe this quote is coined far too much, with SML a certain Warren Buffett quote comes to mind:

Warren Buffett: Be Fearful When Others are Greedy... Be Greedy ...

Source: Imgur.com

However, instead of ‘fear’, I see extremely poor sentiment towards SML shares moving them even further under the radar. To me, SML is now undervalued and the market simply just doesn’t see/understand it currently but will eventually come to the realisation of this. However, this will require future further growth catalysts to move the share price higher, predominantly involving moving Leigh Creek forward and getting a JV partner. As highlighted previously, this may take time and poor sentiment is something that will take time to change – if it ever does change. Key note here: investors must be patient.

Even if investors disagree with my value assessment as it is quite a subjective matter, it can still be seen that there is value there in the company at current levels with a market capitalisation of just £7.2 million ($9.46 million). This valuation doesn’t include the opportunities going forward and the benefits that will be seen if Leigh Creek was to provide positive cash flows and make SML an even more profitable entity.

It’s AIM – There are risks

Of course, as it is the Alternative Investment Market (AIM), there are large risks. I still take caution to SML as there is never a point where a share price cannot go lower, if SML can’t secure a JV partner at Leigh Creek or provide material catalyst news, then shares may continue to drip lower. As I said before, patience is key and that may also mean shares move lower until any material news actually comes about.

However, in counter to this, the current share price level in its own right mitigates this risk slightly – with a multi-bag upside opportunity if the board can get things going vs. limited downside of 100%, which would be a cancellation of listing. Most investors will have more time to sell and revisit their original holding before seeing that type of loss anyway. This is also a micro-cap with a large split between the sell/buy price and large volatility – not a suitable pick for those investors looking for long-term sustainable growth hold, nor is it suitable to over-size the position and take up too much of your portfolio.

Conclusion

It is extremely important to not become too attached to companies as an investor and not make emotionally-driven moves. But rather look and weigh up the fundamentals and facts of the company to come to a conclusion over whether you believe there is value/opportunity there. When looking upon Strategic Minerals, I see a company with ample large upside opportunity and minimal downside opportunity at current levels at this point.

Whilst it is hard to not go into depth over previous performance, it is clear that SML is a profitable and cash-generative company with the opportunity to add a further and greater revenue stream ahead. Micro-caps can be some of the least understood shares, with low volatility – therefore, sometimes offering great opportunity with that, to me SML is this case. On Asymmetric opportunity, SML is a buy.

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Disclosure: I am/we are long SMCDF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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